Running on empty

A map showing the two proposed pipelines

The reasoning is simple but the roadmap is not. The coming era of fuel shortages has some simple remedies but implementing them is far from simple.

Pakistan has entered a phase in its life where it will become increasingly dependent on imported fuel to sustain itself. Natural gas accounts for more than half of all the fuels consumed in Pakistan, and all of this natural gas – this precious resource that fires our stoves, geysers and heaters, generates our electricity, fuels our cars and makes the feedstock for our fertilizer which feeds our food supply is produced indigenously.
But now those domestic reserves are running out. From 2010 onwards, the biggest gas fields in Pakistan have entered their period of decline. And as the decline accelerates, the gap between supply and demand for natural gas is projected, according to the Petroleum Institute of Pakistan, to increase almost eight times by 2025.

Pakistan has no choice but to look for alternate sources of supply for natural gas, and it is here that there is a problem. Natural gas is not easy to transport over long distances, unlike crude oil for instance. It is either transported in pipelines, which require very large upfront investment, or through special vessels that carry it in deeply refrigerated environments, and which require special terminals for loading and offloading, adding tremendously to the cost.

The only alternative to importing natural gas is to accelerate local exploration activity which is difficult considering the security environment in those areas where gas reserves are most likely to be found, for example in district Kohlu in Baluchistan or Kohat in Khyber Pakhtunkhwa. Furthermore, exploration is also expensive and the parties carrying out the exploration work need proper incentives. No incentive is better than the price at which they will be allowed to sell the gas they discover. If that price is kept artificially low to make gas cheap for domestic consumers, then credible exploration firms will not be interested in coming to Pakistan.

Besides, exploration is a long term proposition. Even if there is a gas find today, it can take many years for it to come online and even when it does, it will only plug a small portion of the deficit that we are experiencing. This year the peak deficit between the supply and demand of natural gas crossed a record high of one billion units. The best that domestic finds can provide, even in another five years, is less than one third of that and by that time the deficit would have crossed three billion units.

It is abundantly clear now that Pakistan has no choice but to start making arrangements for the import of natural gas. And here there are three principal options. First is the import of Liquified Natural Gas (LNG). Second is the import of gas from neighboring Iran. And the third is the pipeline from Turkmenistan, known as TAPI, an acronym for the four countries that are envisioned to be partners in the venture: Turkmenistan, Afghanistan, Pakistan and India.

Just consider the major pipelines, that is, the second and third options, for now. Each of them has its peculiar advantages, and each one presents huge geopolitical risks.

A pipeline from Iran has the advantage of being close by. According to the Iranians, a large part of the infrastructure required to operate this pipeline has already been built on their side of the border. All that is required is for the Pakistanis to build their portion, which would consist of a receiving station and compression facility in Quetta, and a long pipe running from Quetta to Shikarpur, where Sui Southern Gas Company (SSGC) already operates a large compressor. From here, the gas can enter into the SSGC system, and get piped up to the Sui Northern Gas Pipeline (SNGPL) network that serves Punjab and Khyber Pakhtunkhwa.

Technically it is quite a straightforward project. Some of the pipeline infrastructure will need to be laid between Iran and Quetta and Quetta and Shikarpur and some of the existing SSGC and SNGPL network will need to be upgraded to handle the enhanced volumes that will flow through them. None of this presents a huge challenge.

Pipeline security for the portion that lies in Balochistan is, however, a problem. Already the government of Pakistan is having a difficult time protecting the network of pipelines that comprises the Sui system which runs through Pir Koh and Loti. Attacks on this infrastructure are common and Sui gas field itself presents the look of a facility under enemy attack. Simply approaching Sui gas field by road is a hazardous journey and even paramilitary soldiers lie low in the back of their vehicles, guns at the ready, as they make the turning off the Indus Highway just north of Kashmore onto the 47-kilometer stretch that goes straight to Sui.

The field itself has multiple private security firms, as well as paramilitary security, and an extended outer perimeter that makes it difficult to even come close to the field facilities. Still, the field has come under rocket attack on numerous occasions in the past. Protecting a large and strategically important pipeline that runs 785 kilometres, much of that through Balochistan, will be a far bigger challenge and nobody yet knows how the government of Pakistan will manage that.

But by far the biggest challenge presented by the Iran pipeline is financial. There is an upfront cost of almost 7.5 billion dollars attached to the project. Neither of the two countries involved have that kind of money.
This means the project will need to be financed either by private funds or by another government like Russia or China. And this is where the big problem comes in, because the project brings together the world’s most unreliable supplier (Iran) with the world’s most unreliable customer (Pakistan). This means no private party will want to take the risk of putting up the investment, nor is any government likely to wilfully violate the sanctions placed upon doing business with Iran.

Also doing business with Iran is already quite difficult. For example, in Pakistan there is only one bank that will open a letter of credit (LC) for business transactions with Iran. Even after an LC is opened, time delays are long and service charges huge. On July 1, 2012, the full force of the European Union (EU) sanctions will take effect and shipping insurance will become impossible for vessels carrying Iranian crude as well. This is likely to negatively hit Iranian government finances.

Additionally, any central bank doing business with Iran’s central bank will be denied access to the American financial system, so countries will be forced to choose who they want to retain as potential business partners, Iran or the United States. Countries that import substantial volumes of Iranian oil, such as India, Sri Lanka and South Korea, are seeking exemptions from the American law governing transactions with the Iranian central bank but the US is reluctant to provide the exemptions.

t is difficult to see how any country would be willing to massively increase its exposure to an Iranian project under these circumstances. In the outgoing fiscal year, for instance, both Russia and China have backed away from earlier expressions of interest in the project. Gazprom, the Russian government owned oil and gas giant, was formally “invited” by the government of Pakistan to participate in the project in February 2012, and by May, eight weeks later, they had signaled their regrets. The same thing happened with the state owned Industrial and Commercial Bank of China (ICBC), which had showed interest in arranging financing for the project. The ICBC also backed out in mid-March. Both reversals came shortly after the passage of the EU sanctions legislation.

The Iran-Pakistan pipeline project can only become viable once Iran’s growing isolation from the western world is halted and reversed. As such, the project is hostage to the geopolitical tensions that entangle Iran, and progress depends on how much can be achieved through the ongoing talks with the International Atomic Energy Agency to address western fears that Iran is in pursuit of nuclear weapons capability.

Even if problems at Iran’s end are addressed, and the tensions begin to unwind, the financial viability of the pipeline project is still doubtful due to Pakistan’s dwindling credibility as an energy customer. The circular debt is testament to the inability of the Pakistani government to pay its energy bills, to honor its contracts, to live up to the terms of its “sovereign guarantees.”
Much of the circular debt, which had been put at slightly less than 400 billion rupees in mid-March, grows out of price misalignments in the power sector. For this problem to disappear in a sustainable way, like it has from the petrol and diesel supply chain, serious price reform will be needed for electricity and natural gas. Such reforms could see the price of electricity triple by the time they are completed, a fact no political government is ready to face.

Given these powerful weaknesses at both ends of the pipeline project – a supplier who might be shut out of global trade and payments networks and a customer who has no ability to pay his bills – the Iran-Pakistan pipeline project can only exist on paper.

The other pipeline project – TAPI – is better positioned in some respects because it enjoys the enthusiastic backing of the United States. In May, all countries that are part of the project signed a Gas Sale and Purchase Agreement, which spells out the quantities of gas each country will be entitled to and, most importantly, specifies the mechanism through which the price will be determined.

Pricing for TAPI gas is no different than it is for the Iran-Pakistan pipeline gas: the price will be linked to a price basket of various types of oil, excluding those whose price tends to show a lot of volatility, or fluctuation, over a long period of time.

But as with the Iran pipeline, this project is also held hostage by the geopolitics of the region. The pipeline originates in the Daulatabad field in Turkmenistan, one of the largest in the world, and enters Afghanistan from Herat. From there it runs along the road that connects Herat with Kandahar, and then into Quetta and onwards to Multan. The total journey is almost 1,700 kilometres long. One has only to see the number of violent incidents and militant attacks that the road from Herat to Kandahar has seen over the past five years, and then the road from Kandahar to Quetta, to understand how difficult a proposition this actually is.

Pipeline security is key to making this a viable project, and security in Afghanistan will be far from being a viable proposition in the decades to come.

The reasoning that is driving Pakistan to seek gas imports from its neighbours is simple and compelling. As the shortages of indigenous gas increase year after year, the search for alternative supplies will gather steam. But the road from our western neighbours to the industrial heartlands of Sindh and Punjab is a treacherous one. Pakistan will need to adjust the paradigm within which it has searched for its geopolitical security in these same lands in order to bring in the vital fuel that keeps the country going.

From here on, the trade off between energy security and national security through “strategic depth” becomes increasingly stark. If Pakistan can play its part and cooperate with the world to bring stability to Afghanistan then we can have a shot at finding energy security in an increasingly energy-starved world. But if the country remains wedded to antiquated notions of “national security,” we risk losing the very nation we are trying to secure.

Khurram Husain is a business and economy journalist based out of Karachi. He can be reached at khurram.husain@gmail.com, twitter: @khurramhusain