While it would be premature to predict the end of the wave of European gas pricing arbitrations with the issue in January of the latest arbitration award in the ten year saga between Greece’s public gas corporation (DEPA) and Turkey’s BOTAŞ Petroleum Pipeline Corporation (BOTAŞ), the award does seem to straddle the end of one era and the opening of a new (and more contentious) one in the Mediterranean. The contract between the disputing parties, reported to be coming to an end in 2021 by mutual agreement, is one of many troublesome long term gas supply contracts which have been the subject of scrutiny and disputes following the global financial crisis.
In 2015, gas provided for 23% of Europe’s energy needs; 69% of that gas was imported from and through the EU’s neighbours at a cost of EUR 261 billion. The EU’s lack of self-sufficiency in natural gas is a factor that continues to shape its foreign policy (and that of its member states). For example, it is impossible, when analysing EU-Russian relations, to ignore the fact that around 40% of the EU’s gas needs are met through Russian supplies. Where gas is delivered by pipeline, the countries whose territories are traversed (such as Turkey and Ukraine), also have some political leverage over the end client member state by virtue of their ability to “turn the taps off” on their territories. In particular, the most recent award in DEPA v BOTAŞ comes at a moment when the energy map in the Mediterranean is potentially being redrawn.
A (very) brief history of natural gas prices and arbitration
Three key changes have occurred in the European natural gas market in the last 20 years, which provide a useful backdrop to the current landscape.
- First, the liberalisation of the European gas markets (from 1998 onwards) has decoupled the strong economic link between oil prices and gas prices. Gas producers now compete with other gas producers, with the result that oil prices and gas prices have decoupled. However, while linking a price formula to oil price references in a gas contract no longer makes much economic sense, some parties are nonetheless still tied into 20-30 year agreements, under which they are buying and selling gas at a price linked to oil references.
- Second, in the years following the 2008 global financial crisis, gas prices dropped sharply, as reduced EU demand was exacerbated by oversupply from US shale, together with competition from new fuel sources. Prices have not recovered significantly since that crisis. Indeed, wholesale gas prices in the EU as a whole reached a historic 30-year low in July 2019.
- Third, the gas markets in Europe have developed and become sufficiently liquid, such that hub pricing (where prices are a function of spot prices at a regional level) and indexation has become possible. Pricing in the huge Gazprom-Eni supply contract, for example, is 100% based on gas hub price indexation.
Following the 2008 global financial crisis, and with vast sums at stake, big North-Western European gas utility companies sought to renegotiate (or arbitrate) their now financially punitive oil-indexed contracts with suppliers such as Gazprom, Equinor (formerly Statoil) and Sonatrach, in order to obtain temporary or structural changes to their contracts. These renegotiations included: price cuts; the introduction of spot-price indexation or replacement of oil products in price formulae; increased (downward) flexibility; and reductions in offtake requirements.
DEPA v BOTAŞ
- DEPA (which is to be broken up in 2020, following a first failed privatisation attempt in 2013) presently buys natural gas from Turkey’s BOTAŞ, Russia’s Gazprom and Algeria’s Sonatrach. The gas is imported via pipelines from Bulgaria and Turkey. LNG cargoes are delivered at the Revithoussa LNG Terminal. DEPA then sells that gas on to large consumers and to Greek gas supply companies.
- BOTAŞ is wholly owned by the Turkish state. It owns stakes in several pipelines, and transports and trades in natural gas. It buys in gas from Iran and Russia, with whom it has had its own gas pricing disputes (with the National Iranian Gas Company and Gazprom, in each case with the aim of securing significant price reductions).
In 2007, Turkey and Greece inaugurated a 296 km pipeline connecting their national gas grids (from Karacabey to Komotini). The project was part of the EU’s attempt to reduce Europe’s dependency on three upstream suppliers (Equinor, Gazprom and Sonatrach, which together supply the vast majority of the EU’s gas). Although the pipeline was intended to continue on from Greece to Italy, that additional section was never built due to competition from the Trans-Adriatic Pipeline (TAP), which is due to come into operation from 2020. DEPA entered into a long term agreement to import natural gas from BOTAŞ via the new pipeline. The contractual purchase price for gas in the contract was expressed through a price formula. It included a price revision clause which allowed either party to request a re-calibrating of the price payable by the buyer when certain pre-conditions were satisfied.
The timing of the contract was unfortunate. By 2009, the effects of the financial crisis were in full swing and, in 2011, having made two requests for price revision which were refused by DEPA, BOTAŞ resorted to an arbitration claim before an ICC tribunal seated in Stockholm. BOTAS argued that the price should be adjusted to be based on “Brent”, a reference to the price of crude oil. DEPA resisted this, arguing that the formula should be based on a price index known as “BAFA”, an average price of all gas imports to Germany, set by the German Federal Office of Economic and Export Control.
According to Reuters, despite a partial challenge brought before the Swedish Court of Appeal by DEPA, BOTAŞ was successful, achieving a payout from DEPA of approximately US $181 million.
DEPA then made its own request for a price review and, subsequently, brought a claim under the same price revision clause. It argued again for a change in the basis of the pricing formula. The tribunal found for DEPA this time, reportedly requiring BOTAS to return over-payments to DEPA dating back to 2011. It is not yet known whether or not BOTAŞ will challenge the award.
What next in the Mediterranean?
In January 2018, DEPA announced its intention to end its deal with BOTAŞ. DEPA’s move away from BOTAŞ (and potentially its decision to renegotiate its other contracts with Gazprom and Sonatrach, also announced in January 2018) is in one way just the latest step in the break-up and liberalisation of the European gas markets. However, the decision by DEPA to move away from the commercial relationship with BOTAŞ, despite having successfully rewritten the contract pricing formula in its own favour, is interesting in the context of current geopolitics in the Mediterranean.
DEPA will instead buy 1 billion cubic metres of natural gas per year directly from Azerbaijan via the TAP once it becomes operational (likely in 2020). The pipeline will cross mountains and seabeds to bring Caspian gas into Europe first via Greece and then through Italy. The TAP is part of the ongoing efforts to diversify upstream European energy supply via the Southern Gas Corridor initiative. While political will behind the project is currently high, economic factors such as the cost of transporting the gas to the lower cost markets in Europe (rather than to other possible buyers) have caused some commentators to be sceptical of the prospects of commercial success for the Southern Gas Corridor in the next decade.
Discussions have also been taking place between Greece, Israel, Italy and Cyprus to build an undersea pipeline to bring natural gas from offshore fields in the eastern Mediterranean into Europe.
On 2 January 2020, a formal agreement to build the 1,300 mile, approximately EUR 6 billion “EastMed” pipeline was signed by Greece, Israel and Cyprus. The EastMed will carry 10 billion cubic metres of Israeli-produced natural gas (enough to meet 4% of the EU’s entire energy needs) to Greece. It is then intended that the gas will be carried to Italy via a further pipeline if negotiations with the latter are successful.
The economics of the (hugely expensive) EastMed project are probably less attractive than its geopolitical significance for the key players. If successful, Greece would become a regional energy hub in the Mediterranean, reducing the influence of Turkey as a gas transit nation.
Perhaps recognising this, Turkey promptly announced its own intentions to begin explorations for gas in the eastern Mediterranean, following the announcement of the EastMed deal. This followed its deal with Libya in November 2019, which designated large portions of maritime territory in the Mediterranean as Turkish. The Turkey-Libya deal was described by the EU in an agreed statement, as “infringing upon the sovereign rights of third states… not comply[ing] with the law of the sea and… [not able to] produce any legal consequences for third states”. On 6 February 2020, the US Ambassador to Greece met with DEPA executives and publicly expressed the US’s strong support for TAP and the EastMed pipeline, describing them as critical projects “for regional peace and security”.
Where does this leave us?
If successful, Greece’s new deals could trigger significant shifts in the European gas markets by diversifying the available upstream suppliers, and increasing competition in a market that is moving towards shorter contracts and greater flexibility. However, the geopolitical controversies around the EastMed in particular are likely to continue to cast a shadow over developments. In the meantime, the arbitral tribunal’s award of eight years of back payments to DEPA, together with a new market price formula, has the potential to be a huge boost to the recovering Greek economy. It may also trigger similar claims by other buyers in South-Eastern Europe who are yet to seek to move away from oil references and towards gas references in their contract pricing.