Taking Shortcuts: Uzbekistan’s Path to the Global Energy Market

by Simon Schmidt

Among the Central Asian states, Uzbekistan is mainly regarded as a second-tier energy player. Kazakhstan’s vast oil resources and Turkmenistan’s natural gas fields received primary attention by international energy companies. So far the double-landlocked country is characterized by high reliance on gas for domestic consumption, unprofitable energy trade agreements with its neighbors and high investment concentration. Despite these challenges, in May 2013, during the 17th Uzbekistan International Oil & Gas Conference that took place in the capital Tashkent, Uzbekistan’s ambitious goal to triple natural gas exports by 2020 was yet again renewed by the country’s political and business elite. Recent developments do indeed give reasons for a detailed and critical assessment of Uzbekistan’s prospects and measures to become a major actor in the global energy market.

Natural Gas Export Ambitions: Looking East

Uzbekistan’s proven natural gas reserves add up to 1.1 trillion cubic meters, ranking the country fourth among post-Soviet states. Production is above earlier levels but has been decreasing since the 2008 peak, amounting to 56.9 billion cubic meters, reflecting a marginal year-on-year decrease. The state-owned energy company Uzbekneftegas (UNG) reports that 47.9 billion cubic meters – 80 percent of produced gas – are consumed domestically. Uzbekistan heavily relies on natural gas to sustain heating and electricity supply, with 75 percent of electric power being generated in natural gas-powered thermal power plants. For end-consumers in Uzbekistan, natural gas is highly subsidized. For residential households, one cubic meter costs 139.8 soms (2150 Uzbek soms = approx. 1 USD) which is roughly USD 0.07. Despite a continuous increase of gas prices in the recent years, this low level still prevents producers from making a profit on the domestic gas market, thus justifying their foreign orientation.

With only 20 percent of gas production remaining for trade, Uzbekistan is a modest energy exporter. Half of these exports are going to Russia with the rest flowing to neighboring states such as Kazakhstan, Kyrgyzstan, and Tajikistan. Gas trade with the latter two is yet unable to generate significant profits since Uzbek-Tajik and Uzbek-Kyrgyz gas trade is conducted through barter agreements that are renegotiated every year: Gas is exchanged for water and electricity. Tensions over Tajikistan’s plans to construct the Rogun Dam, which could potentially curtail Uzbek water supplies and hurt its large cotton industry, even resulted in gas transfer cuts by the Uzbek side at the beginning of 2013.

Uzbekneftegas states to have been able to increase its energy exports by 81 percent in 2012, bringing in a total of USD 5 billion and leading to a national budget surplus of USD 2.23 billion.

Uzbekistan’s strategic central location makes it a crucial transit country. The Central Asia-China Pipeline, which began operations in December 2009, connects Turkmenistan’s eastern gas fields through Uzbekistan and Kazakhstan to western China and the interconnection with China’s West-East pipeline. China National Petroleum Corporation (CNPC) recently announced that the pipeline’s capacity will be increased from 30 bcm/y to 40 bcm/y. In August 2012, Uzbekistan commenced supplying gas through this pipeline, the same year when construction of a third line in the Uzbek section began. Uzbekistan is thus planning to become a supplementary supplier to China, the world’s largest energy consumer. Partly due to the Central Asia-China Pipeline, Uzbekneftegas states to have been able to increase its energy exports by 81 percent in 2012, bringing in a total of USD 5 billion and leading to a national budget surplus of USD 2.23 billion. Prospects of expanded gas trade with China is thus of central significance for Uzbekistan’s political elite.

Foreign Investment: Enough to Stop Depletion?

Heightened pipeline capacities alone do not guarantee a higher share of Uzbekistan in the global energy market. Proven gas reserves have decreased since 2010 and the country is facing depletion of natural gas fields unless big deposits are discovered or consumption can be decreased. The former challenge has virtually solely to be taken up by the country’s state energy venture Uzbekneftegas and its few foreign partners. These are first and foremost companies from Russia, and to a lesser degree from China and South Korea.

Figure 1: Existing and planned gas pipelines in Central Asia. U.S. Energy Information Administration 2012.

Lukoil, the largest foreign energy operator in Uzbekstan, recently announced its intention to produce 4.4 billion cubic meters of gas in Uzbekistan in 2013. The company’s Vice-President Leonid Fedun also communicated plans to supply China with Uzbek gas at competitive prices. However, Lukoil seems to be more interested in milking the Uzbek cow instead of pumping money into costly exploration projects. Investments amounted to USD 149 million up to the end of the first quarter in 2013, marking a decrease of USD 96 million year-on-year.

Chinese and Korean state-owned energy companies have become increasingly active and have even teamed up with Lukoil in exploration and production projects. But optimistic estimations see production on some fields to start in 2016 with the rest being expected to commence even later. Current exploration projects hold comparably low foreign investment and are also unlikely to yield any gas in the near future, thus being unable to stop Uzbekistan’s gas depletion any time soon. Increased and more diversified foreign investment would be necessary to reverse this situation.

Uzbekistan is ranked 154th out of 186 countries in the World Bank’s “Ease of doing Business.”

The current concentration of investment activities has come on the heels of a continuous withdrawal of other energy companies before. First, Zeromax GmbH, a Swiss private energy company, mysteriously shut down and ceased all business operations in 2010, after having been the first and one of the largest foreign investors in the country. Next, Malaysia’s state-controlled company Petronas pulled out of its share of a production sharing agreement of the Aral block, ceding its 20 percent share to Lukoil for an undisclosed sum in February 2012 and withdrew from an exploration project in Surkhandarya Region. Petronas also decreased its share in a gas-to-liquids plant, which was anticipated to be built together with Uzbekneftegaz, in 2013.

Table 1: Natural gas production projects with foreign investor participation

Table 2: Natural gas exploration projects with foreign investor participation

On paper, foreign energy companies are able to enjoy various tax exemptions when entering the Uzbek market through a joint venture or concession agreement. But the energy sector remains heavily centralized with UNG controlling most exploration, production, and downstream operations. Furthermore, Uzbekistan is ranked 154th out of 186 countries in the World Bank’s “Ease of doing Business” report of 2013 – frightening off Western companies in particular.

Promoting gas alternatives: Go green or go coal

As novel gas deposits will not be ready for full-scale utilization soon, decreasing consumption levels is the country’s second leverage to unfold export potential. So far, Uzbekistan is one of the most energy intensive countries with more than 60 percent of the primary energy mobilized being lost in processing and delivery systems.

Figure 2: Energy intensity by country in koe/$05p

As illustrated in Figure 2, Uzbekistan has already been able to decrease its energy intensity over the last years. However, the country is still ranked significantly higher than the CIS average, which amounted to 0.34 koe/$05p in 2012. In order to further decrease the economic costs of Uzbekistan’s energy sector, it is necessary to foster efficiency programs. In this regard, the country conducts a number of measures together with international development banks. Together with the World Bank, the government is to introduce a series of energy efficiency measures designed to save the country more than USD 2 billion over the coming years through the implementation of the “Energy Efficiency for Industrial Enterprises Project”. Upon completion of the initial project phase, 50,000 MWhs are anticipated to be saved. Next, the state-owned power generation company Uzbekenergo announced a tender to modernize electricity metering systems in three regions of the country, for which the International Finance Corporation will provide USD 180 million, and Uzbekneftegaz on its side is planning to spend USD 500 million on energy-saving technologies.

The Uzbek leadership also increasingly recognizes the need to develop alternative energy. In March 2013, Uzbek President Islam Karimov issued a decree that aims at fostering research, pilot development and practical use of alternative energy sources in Uzbekist an. The country possesses considerable solar energy potential with climate conditions being among the best of CIS states for solar collector deployment. In June 2013, it was announced that Uzbekenergo will construct a solar plant with the capacity of 100 megawatt in Samarkand Region of Uzbekistan, making it the largest in Central Asia after completion. Additionally, biomass potential amounts to approximately 3,500 MWh due to cellulose waste of 7-10 million tons resulting from enormous cotton production. Last, hydropower generation in Uzbekistan amounts to 6.3 billion kWh with available potential being two times higher.

In June 2013, it was announced that Uzbekenergo will construct a solar plant with the capacity of 100 megawatt in the Samarkand region of Uzbekistan, making it the largest in Central Asia after completion.

While green energy sources still need to be developed to have a pivotal impact, coal plants area already available. In July 2013, the Uzbek government issued a resolution directed at having Xorazm Region, with a population of 1.5 million people, use coal instead of natural gas. This development follows speculations that the country is already facing domestic gas shortages due to increased export and outworn networks. Several regions of the country reportedly experienced gas and electricity shortages during the 2012-2013 winter, causing the Uzbek government to redirect Russia-bound flows to households facing severe cold for 40 days. Increased coal supply is also anticipated for seven other regions and coal production is planned to be increased 2.9-fold by 2020 up to 2.4 million tons annually.

Target-oriented, credible political commitment to reforms in the energy sector and a favorable business climate can be regarded as the two main pre-conditions to attract crucial investment and technology for intensified resource development.

Uzbekistan’s Outlook: Facing Trade-offs

As pointed out, Uzbekistan’s energy sector is characterized by several structural flaws that make it hard for the political leadership to considerably raise gas export without accepting compromises. In the short-run, existing investment will hardly suffice to stop depletion and alternative energy sources will not start to pay off. Improved energy efficiency and modernization efforts can be credited with continuous decreasing energy consumption, but domestic liberalization and deregulation measures are unlikely to be initiated by the political elite. While the Uzbek Ministry of Finance has approved a slight gas price increase for Uzbek end-users, a considerable lift of subsidies would mean the loss of a lot of political capital. One can rather expect the Uzbek leadership to vigorously pursue its goal of tripling gas exports until 2020. As the Uzbek leadership tries to transform its country into a recognizable energy player, supply cuts in rural areas are likely to reoccur in the upcoming winter periods and increased reliance on coal is to be expected. Prospects of energy trade with China outweigh concerns of power shortages inside the country and do not pose the threat of alienating the domestic population as a result of price increases.

Target-oriented, credible political commitment to reforms in the energy sector and a favorable business climate can be regarded as the two main preconditions to attract crucial investment and technology for intensified resource development. Efforts by companies from Russia and China will probably pump up production in the mid-run but in order to ensure the long-term steadiness of output levels, a deregulated energy sector and diversified sphere of investors are conditions under which innovation can thrive. A high natural gas price is currently the driving factor behind Uzbekistan’s quest for shortcuts to the world energy market. Perhaps it can also lead to an increased willingness of Uzbekistan’s decision-makers to engage in more fundamental reforms, thereby unfolding the country’s potential.

Simon Schmidt is an alumnus of the International MA program in Russian and Eurasian Studies of the European University at St. Petersburg and is currently enrolled in a postgraduate program at the University of Glasgow focusing on political and economic dimensions of energy and natural resources in Central Asia and the Caspian Sea region.

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