Natural Gas Transits and Market Power: The Case of Turkey.

• Author: Schulte, Simon
• Position: Report

1. INTRODUCTION

   The Southern Gas Corridor (SGC) consists of planned pipeline projects that connect the natural gas producers in the Caspian region and the Middle East (Azerbaijan, Turkmenistan, Iran, Iraq and Israel) with the natural gas markets of the European Union (EU). The EU promotes the SGC for two reasons: (1) it would like to diversify its natural gas supplies and (2) it aims to close its growing supply gap that arises due to decreasing indigenous production. Turkey has a key role in realizing the SGC, since Turkey's geographical location is between the producing countries and the EU. This crucial role of Turkey is widely discussed in the literature. (1) Compared to Ukraine, which is a single-source transit country for Russian gas only, Turkey has the potential to become a multi-source transit country fed by several suppliers from the Caspian region and the Middle East or Russia. The goal of the Turkish government, however, is not only to aim for a pure transit role for Turkey, i.e. allow upstream producers the access to the Turkish transmission network and to the EU downstream market, but rather to use its multi-source advantage for actively trading in the natural gas markets, as is outlined in Skalamera (2016):

   Turkey, however, bargained hard against a straightforward transit role, intending instead to take over the role of a hub, which means that it would buy gas arriving at its borders, consume what it needs, and sell on the balance at profit. However, this perception is far away from the economic definition of an energy hub. (2) In economic terms, the Turkish perception means that Turkey wishes to use its geographical location to exercise market power in the European natural gas market (transit market power). If the natural gas producers have market power themselves, Turkey's plans would give rise to double marginalization (Tirole, 1988). This perspective is missing within the current discussion about the SGC although it could potentially eliminate the economic benefits of the entire project.

   Hence, the research objective of this paper is to investigate possible implications of Turkey's strategic behavior for the EU natural gas markets and for the economic feasibility of the SGC project. The global natural gas market model COLUMBUS (Hecking and Panke, 2012) is extended and applied in order to simulate strategic behavior of transit countries like Turkey. (3) In a simulation for the year 2030, a case with Turkish market power is compared to competitive Turkish transits, i.e. a scenario in which upstream producers have to pay only transportation costs to ship gas through Turkey to European markets. Besides varying the Turkish behavior, different market structures in the European upstream market are considered, i.e. an oligopolistic upstream market and a competitive upstream market, in order to derive a comprehensive understanding of Turkey's role in the SGC.

   The structure of the paper is as follows: In Section 2, a review of literature that is is relevant for the analysis is given. A stylized theoretical model to discuss the problem of Turkish transits is developed in Section 3. Subsequently, in Section 4, the global natural gas market model COLUM-BUS and its inputs are described. Afterwards, the model calibration is discussed. Based on the calibration, Section 5 focuses on the model results and discusses the implications of Turkish transit market power for the EU. Finally, Section 6 concludes.

2. LITERATURE REVIEW

   There are four different streams of literature to which this work is related to: (a) literature about gas market modeling based on non-cooperative game theory, (b) literature about natural gas transits, (c) publications about Turkey's energy relations, and (d) literature focusing on double marginalization.

   The first literature stream is based on simulation models that are programmed as mixed complementarity problems (MCP). As the COLUMBUS model that is used within this work, MCPs allow the simulation of market behaviour and thus to consider different forms of competition on different stages of the value chain. An early study is provided by Boots et al. (2004) in which gas producers are represented as oligopolists in a static model called GASTALE. The model considers downstream traders that act either oligopolistically or competitively. The study shows that successive oligopolies in gas markets lead to high prices - similar to the case of successive oligopolies in the SGC in this study. Later on, a dynamic version of GASTALE is developed by Lise and Hobbs (2009) that consider the SGC producers Azerbaijan, Iran and Iraq as potential suppliers for Europe. A further early work is Gabriel et al. (2005a). It also considers the natural gas supply chain as a MCP in which the traders marketing gas of the producers had market power. Several existence and uniqueness results are provided as well as illustrative numerical results. Gabriel et al. (2005b) considers more in-depth numerical simulation of a version of this model for the North American natural gas market. In a later contribution by Holz et al. (2008), a static model named GASMOD is applied to analyze the European gas markets with regard to their market structure. Using data of 2003 they analyze different combinations of competition in upstream and downstream markets and come to the conclusion that Cournot competition in both markets (double marginalization) is the most accurate representation to model the European gas market. In Section 4.3, a similar calibration exercise is done for the years 2014 and 2016. In later research, Holz (2009) extends the static GASMOD model into a dynamic version.

   Within the stream of literature that focuses on gas transits, Yegorov and Wirl (2010) analyze games that appear in the context of gas transits. They distinguish between games with a transit country as a net gas exporter (such as the case of Turkem gas transits through Russia) and with a transit country as a net gas importer (such as Turkey). They conclude that the game structure arising from a transit problem is not absolute but depends on geography and international law. Furthermore, von Hirschhausen et al. (2005) analyze Ukrainian market power for Russian gas exports to Central Europe. They focus on the effects of an alternative Russian export route to Central Europe, the Yamal pipeline via Belarus and how cooperation between Ukraine and Russia could have made the investment into the Yamal pipeline unnecessary. Dieckhoner (2012) analyzes Ukrainian transits from a security of supply perspective discussing potential diversification options for Europe like the Nabucco pipeline. Later, Chyong and Hobbs (2014) introduce a strategic European natural gas market model to analyze a gas transit country. They apply their model to investigate the case of the South Stream gas pipeline. The question of Ukrainian transit market power is hereby important for the profitability of this offshore pipeline. Transit market power is represented by a conjectured transit demand curve approach. However, the conjectural variations of the transit country are chosen as a calibration parameter and vary between 0 and 1. This approach is common in natural gas market modeling but also often criticized, e.g. by Perry (1982), Dockner (1992) and Smeers (2008). Within the literature about transit problems, there are further cooperative game theory approaches: Hubert and Ikonnikova (2004), Hubert and Suleymanova (2008), and Hubert and Ikonnikova (2011), for instance, analyze market power of transit countries within the Eurasian supply chain. Furthermore, they examine strategic investments into alternative infrastructure projects to bypass the transit countries and reduce their market power. However, the above-mentioned works focus all on Ukraine, a single source transit country fed by Russian gas only. In the study at hand, the potential multi-source transit country Turkey that would not be dependent on a single dominant exporter is in the focus of investigation.

   Within the literature about Turkey's energy relations, there are geopolitical and economic contributions. Cagaptay (2013) discusses geopolitical factors associated with different potential gas suppliers for Turkey. Skalamera (2016) finds that there are many obstacles for Turkey to become a gas hub. Furthermore, Berk and Schulte (2017) show that Turkey's potential to become an important transit country for the European natural gas market is strongly restricted. Moreover, they quantify different drivers that could increase Turkish transit volumes and therefore its importance as a transit country.

   Apart from a specific gas market context, there are works that discuss options to avoid double marginalization. Joskow (2010) analyses different factors that impact the decision of companies to either rely on markets to source supplies or to integrate vertically. Double marginalization would be a neoclassical factor favoring vertical integration. In the context of this study, competitive access for upstream gas producers to the Turkish transmission grid would lead to the same shipment quantities through Turkey that vertically integrated companies, i.e. upstream producers owning pipelines through Turkey, would choose. Besides the neoclassical double marginalization approach, which focuses on the implications of market power for market efficiency, Joskow (2010) also mentions Transaction Cost Economics (TCE), which focuses on the implications of market power for firms' efficiency. According to TCE, firms could rely on different contractual relations that minimize other firms' bargaining power, e.g. vertical integration, joint ventures, long-term contracts. The conditions of those contractual relations depend on the degree of asset specific investments required for a given market and the extent to which firms are locked-into already binding contractual relations. In the context of our study, which has a market efficiency...