Turkey's Evolving Energy Landscape and Geopolitical Implications

1. Turkey’s expanding energy outreach and its geopolitical implications Mehmet ÖğütçüThe Brussels Energy Club 8 November 2012

2. Issues for discussion • Changing dynamics in world energy and geopolitics • Turkey’s economic fundamentals • Energy emerging as a “soft-belly” • Quest for energy security • Increased domestic production and efficiency improvements • Diversification of suppliers: Russia, Iran, Azerbaijan (and trans-Caspian), Iraq, LNG and others as suppliers • Fuel diversification including renewables • Overseas investment in equity oil and gas • Turkey’s EU accession and energy dimension • Turkish strategic energy priorities vs. foreign policy actions • Key messages

3. Changing geopolitics: A new world order in the making? • The talk of a new world order is no longer a fantasy. Happening. • Failure after 9/11 to put in place an effective global policy, Iraq and Afghanistan setbacks, energy dilemma, food and water crisis, worldwide economic crisis and rise of the BRICs. • All these have created much broader balance-of-power implications. • We are back to great-power politics, shifting alliances and spheres of influence in favour of Asia-Pacific. • The West is no longer in charge alone. Russia, China, India and the rest of G-20 are set to shape the new emerging world system in finance, politics, environment and energy. 9

4. “Game-Changing” developments in world energy • A powershift is underway in world energy, with the rise of new consumers and changing NOC and IOC balance of interest • Tight supplies, but also new unconventional fuels, nuclear, LNG and technologies • Environmental concerns and climate change are omni-present • Energy security, yes but for whom • Price volatility and underinvestment causing supply crunch • New geopolitical dynamics and risks unfolding

5. World primary energy demand: up and up 5

6. Energy security, yes but for whom? • Various definitions, depending on who’s talking: producers, transit countries, consumers or investors. • “Reasonably priced, reliable, timely and environmentally friendly” energy. • Energy security is intertwined with the environment, economic, foreign and social policies of an economy. • Political vs. Financial costs; Opportunity vs. Risks involved. • Malacca Strait, Strait of Hourmous, Bosporus, critical infrastructure • New definition is required. Energy Security 5

7. Natural gas as a “game-changer” • With the advent of shale gas, LNG and emergence of new producers, new pricing arrangements, natural gas is becoming a key game-changer. • It offers key advantages for promoting energy security • Gas is available and flexible – it can meet energy needs in domestic markets or via LNG and long-distance pipelines • Unconventional reservoirs are opening up new possibilities • Many alternative suppliers dot the horizon • Fuel substitution to gas reduces emissions • New price mechanism away from oil-indexation 7

8. EU-27 gas demand/supply outlook to 2030(SOURCE: ENI) 8

9. Indicative costs for potential new sources of gas delivered to Europe, 2020 ($/MBtu) 23

10. Ukraine Romania Russia Caspian Sea Black Sea Bulgaria Georgia Istanbul Azerbaijan in case, you do not know where it is… Now our main topic… Armenia Ankara Turkey Aegean Sea Syria Cyprus Iran Mediterranean Sea Iraq Strategic location 3

11. 8.9% 1,000 6.9% 10% 5.5% 5.0% 4.7% 4.5% 800 5% 0.7% 600 0% 913 847 (4.8%) 400 781 742 736 659 617 526 (5%) 200 0 (10%) 2006 2007 2008 2009 2010 2011E 2012E 2013E Nominal GDP (US$bn) Real GDP Growth (%) 13.5 12.2 11.4 10.6 11.5 10.4 10.1 9.2 8.6 9.5 7.6 7.0 7.5 5.8 4.6 5.5 3.5 3.5 1.5 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11E '12E '13E • GDP per capita (‘000 USD) • Top 20 OECD Countries’ Real GDP Growth (2011E-2017E) • Nominal GDP (US$bn) and GDP growth (%) Sound economic fundamentals Although economic conditions deteriorated rapidly in early 2009, the come back was very strong in 2010 Turkey is the fastest growing economy in Europe with an 8.9% real GDP growth in 2010 Source TUIK, SPO, Medium Term Economic Programme 2011-2013, October 2010 Avg. annual real GDP growth Source State Institute of Statistics, Treasury Source OECD Economic Outlook No:86

12. 25 22.1 20.2 19.5 20 15 10.0 8.9 8.4 10 2.8 5 1.7 1.1 0 1993- 2003 2004 2005 2006 2007 2008 2009 2010 2002 avg. Macroeconomic overview • Foreign direct investment ($ in bn) • Export Growth (Avg. annual growth rate 2001-2009) • Current account & trade surplus / (deficit) Despite a fall in foreign direct investments in the recent years current level remains much higher than historical figures Collé en image Source Central Bank Republic of Turkey Source SPO, Medium Term Economic Program 2011 - 2013, October 2010 Source Turkstat, IMF World Economic Outlook, April 2011 9

13. Economic growth prospects • World’s 20 largest economies (GDP based on Purchasing Power Parity, USD trillion) • Europe’s 20 largest economies (GDP based on Purchasing Power Parity, USD trillion) Turkey is the 16th largest economy in the World in terms of GDP based on PPP Turkey is the 6th largest economy in Europe in terms of GDP based on PPP Source IMF, World Economic Outlook, April 2011 6

14. Demographics • Turkey’s population evolution (m) • Population breakdown by age groups (2010) • Urbanization in Turkey • Population breakdown by age groups (2050E) By 2025 the population will have risen to 85.4m, growing with a CAGR of 1.2% over 30years Turkey has one of the youngest populations in Europe with c.26% of Turkish in the 0 - 14 age bracket The average age of the 72m people is only 29 years, against 40 years in the EU Urbanization is an increasing trend in Turkey with the share of urban population in total increasing from 44% levels in 1980 to 76% in 2010 CAGR ‘95 – ‘25: 1.2% Source Turkstat Source UN Source Turkstat Source UN Turkey’s favourable demographic outlook is a key driver of future economic growth 5

15. ISE Top 20 companies • Market value breakdown • Sector breakdown of Top 20 companies by market cap 1 Banking sector has the highest weight in the ISE-100 index in terms of market capitalisation, accounting for 48% of the Top 20’s total Source FactSet Note 1 As of 23/06/2011

16. Turkey’s energy: low in supply&efficiency and high in demand • Energy is Turkey’s achilles’ heel and soft-bely for the next decades to come • Limited domestic production and international investment • Liberalisation agenda, still incomplete, with heavy subsidies and taxes • Energy trade: biggest contributor to the current account deficit

17. Turkish Electricity Sector Natural Gas is the primary source of electricity generation in Turkey. Especially, private sector relies heavily on imported natural gas. This trend should change in line with private sector’s increasing focus in hydro and coal-fired power plants. Sector State-owned Company, EUAS Source: EÜAŞ

18. WindCapacityandUtilisation Turkey’s Wind Atlas

19. Solar EnergyPotential • Average annual solar radiation:1,311 kWh/m². • Average annual sunshine duration:2640 hours. • Technical potential :405 000 GWh, (DNI> 1800 kwh/m2-year). • Economic potential :131 000 GWh, (DNI> 2000 kwh/m2-year). • Solar energy is used especially as a thermal energy in Turkey. • 400,000 Toe solar heating produced by 11 million m2 collectors, second in the world. • annual production capacity is 1 million m². • Total installed photovoltaics capacity is approximately 1000 kW and • But it is expected to increase PV usage next future.

20. …and need for massive investments • Turkey needs to spend $128 billion on energy investments by the end of 2020, including $92 billion on new power generation facilities, to keep pace with its rapid-growth economy, but the government can only set aside $500 million a year from its tight budgets. • Electricity demand in Turkey has increased almost 10 percent, the world’s second highest growth rate after China. And half of it produced by gas-fired power plants. • The government must spend about $4.5 billion annually on new power projects and $1 billion annually for power transmission to avoid an energy crisis. • Privatization is viewed as the key for Turkey’s future energy development.

21. Turkey’s “regional hub” credentials • Bosporus Straits are a major shipping "choke point" between the Black and Mediterranean • Turkey's port of Ceyhan is an important outlet both for current Caspian and Iraqi oil exports • Also, a growing gas destination for Russia, Azerbaijan, Iran and KRG as well as possibly Eastern Mediterranean Seas. • But it is not yet a hub as we understand it • For a genuine hub similar to Austria’s Baumgarten, much more remains to be done…regulatory framework, physical infrastucture, market liberalisation… 21

22. At the juncture of energy routes Turkey's strategic location makes it a natural "energy bridge" between major producing areas in the Middle East, Russia and Caspian Sea regions on the one hand, and markets in Europe on the other.

23. Multitude of energy routes and supply sources • Turkey aims to meet growing domestic demand for energy by developing a multitude of energy routes, in particular the “Southern Corridor” • This is to ensure that sufficient supplies reach Turkey for its own consumption and that the country becomes an “energy hub” for Europe. • Turkey is expected to use 48-50 bcm of natural gas this year and around 70 bcm by 2020, making it one of the largest natural gas consumers in the world. • Russia, Iran, Azerbaijan, Qatar, Nigeria, and Algeria are the main sources of Turkey’s gas. Iraq’s KRG will add to Turkey’s gas supply in the future. • Turkey would have much to gain if gas from the eastern Mediterranean were also transported to Europe through its territory.

24. Regional outreach in search of supply security • Why are the Turco-Russian energy links still of paramount importance? • Will TANAP and Trans-Caspian pipelines threaten Russia’s national security? • Iran: how far can Ankara and Tehran endure the troublesome energy relationship? • Crucial links with Iraq: Baghdad or Erbil? • Could the East Mediterranean controversy turn into a hot confrontation? • Any room for Trans-Atlantic and European partnership in energy?

25. Caspian exports reaching international markets TANAP, Light Nabucco, Trans-Caspian, Bosphorus By-pass, Iran, new Kazakh shipments 22

26. KRG oil and gas wealth: how to reach markets TPAO was expelled from southern Iraq and Turkey set up a new national oil company for northern Iraq

27. The Eastern Mediterranean gas discoveries: collaboration or confrontation • From the melting and resource-rich Arctic to the eastern Mediterranean, the South Atlantic to the East China Sea, legal wrangling, diplomatic posturing and military sabre rattling are all on the rise. • Cyprus, split by one of Europe’s most intractable ethnic conflicts, is now the focus of another contest, over who will control the significant natural gas wealth found in nearby waters. • Beneath the seabed of the Levant Basin near Cyprus is an estimated 122 tcf of gas, about as much as the world consumes a year. • The northern part of the basin lies in Cypriot waters, with much of the rest in Israeli or Lebanese waters. • So far, the EU has been eager to diversify its gas supply sources and routes, but it has been rather quiet on the eastern Mediterranean gas finds and their possible contribution to EU energy supply security, as a fifth gas corridor or as a new leg to the Southern Gas Corridor. • The question is whether the gas discovery will become an incentive for the two sides to cooperate, or yet another obstacle to reunification of the island.

28. EU’s energy security through gas • ¾’s of the gas traded across the EU arrives and departs via pipelines.  Pipeline dependency leaves the EU vulnerable to supply shocks.  • Whilst supply can be met by three predictable suppliers in the long run; Norway, North Africa and Qatari LNG much still depends on the presence of a steady supply of gas from Russia. • Gas is the “simplest solution” to the EU’s energy security challenge as • Nuclear option is out of steam; construction of gas power plant is easier than alternatives; • it is relatively clean in  terms of CO2 emissions; • it can be used as a back up to wind power and • it is interchangeable with coal fired plant. • Sharp decrease is expected in EU gas consumption between now and 2020, with serious implications for supplier countries such as Russia.  15

29. Turkey’s EU accession and energy dimension • Who wants to be a member, after all? • Better to divorce from the accession strait-jacket and develop practical arrangements? • Energy dimension of the Turkish-EU relations • Southern Energy Corridor • Turkmenistan vs Azerbaijan and Russia • Energy chapter blocked • European Energy Community • Iran sanctions and alignment on Russia • Energy markets liberalisation and investment opportunities for EU firms • Climate change A better EU approach lies in better understanding Turkey’s drives and priorities and seeking alignment for a durable, “win-win” relationship with Ankara as well as using Turks’ leverage in the broader Middle East, Eurasia and Southeast Europe.

30. Conflict with foreign policy goals? • We cannot treat energy in isolation from geopolitics as the recent history has shown. • Energy is just one, but a determinant, element of foreign and security policies as the lifeblood of the economy. • There should be no room for threats or blackmail each time a problem emerges to "cut back the flow of energy," "close down the borders" or "punish political actions by economic sanctions.” • Today’s Turkey brings a lot more foreign policy capacity to the table, but it may not be an easy fit with the US and Europe’s interest in forging common strategies on Iran, Iraq, Syria and Russia. • Turkey could face difficulties in expanding its influence without having a firm footing in the West at the same time. • Turkey’s foreign and security policies are increasingly in competition with its energy interests that require alignment with Iran, Russia, Iraq/KRG, Israel/Cyprus on East Med.

31. Key messages • Factor in the changing dynamics in world energy system (and security) • No threats or black-mailiing to use energy • Physical and legal/institutional framework for regional hub • Investor friendly business environment • Alignment of foreign policy, energy, environment, finance, trade/investment and technology strategies • Develop “energy giants” through PPP and international alliances • Develop fresh perspectives, human capital and not get stuck in obsolete paradigms • Need for an integrated energy strategy and management