European-Asian Geopolitics – The Implications Of Shifting Supply Chains In Wake Of The Russia-Ukraine Conflict. Part Two: The Caucasus & Iran
European Union supply chain routes through to South and Southeast Asia via the International North-South Transportation Corridor. Is Iran stable enough?
The Russia-Ukraine conflict is imposing significant changes on global geopolitics and is re-arranging the Eurasian political and supply chain map with considerable impact. In this article I examine the key areas that will be subject to significant alterations that impact the Caucasus and Iran.
As I explained in Part One, the prospects of any re-emergence of EU-Russia trade in any format looks extremely dim. The conflict has also shuttered Asian access to European markets via Russia, meaning that supply chains are moving south. Although there is an existing route between Asia and Europe via the Suez Canal, the shipping costs and delivery times are greater than an alternative routes via the Caspian Sea. This however requires multi-modal solutions and far greater regional cooperation between participating countries. There is also a serious issue over the political involvement of a critical component part in this route – Iran. However, in travelling West to East we can first discuss the Caucasus and Turkey. These are the two most pertinent destinations as like the European Union, Georgia and Turkey both have port access to the Black Sea. EU ports at Bulgaria’s Varna, and Romania’s Constanta are now undergoing significant developments. Other EU ports such as in Greece, Italy and Malta (which could position itself as a services hub) are all being developed to service larger volumes of freight – a timely situation being that these will now be expected to take up the bulk of EU-Asian multilateral shipping.
Georgia’s Port at Batumi on the eastern coast of the Black Sea is well developed and is continuing to expand, as is the port at Poti, with Maersk committed to significant development expenditure to increase freight capacity. The problem is not so much with capacity issues, but the connectivity to transport Georgian Black Sea shipments to and from the Caspian Sea at the Eastern end of the Caucasus. That requires rail transportation, and has been subject to both political and infrastructure bottlenecks as this involves the coordination of Georgia, Azerbaijan and Turkey, three countries with historical disagreements now having to keep the peace and try to get along. Also within the mix is Armenia, which has recently had a military conflict with Azerbaijan, although Armenian territory is not part of the direct Georgian-Azerbaijan route.
Nonetheless, the Asian Development Bank (ADB) has stepped in with institutional financing of some US$50 million to help resolve rail connectivity issues, which to some extent takes away the direct political element away from two sovereign governments who do not always see eye to eye. When this is completed sometime in 2023, routes from the main Georgian ports at Batumi and Poti will become far more competitive. It is interesting to note that Chinese investors, always on the look-out for trade opportunities, have been establishing auto-component parts factories in the Georgian Hualing Free Industrial Zone, based in Kutaisi. It is developing as an important connecting hub between Tbilisi (the capital of Georgia) and Georgia’s Black Sea Ports of Poti and Batumi. Chinese investors see it as an ideal hub to match Chinese components with Turkish and Caucasian manufactured parts with exports aimed at the EU markets. Georgia has a significant Trade Agreement with the EU which foreign companies, provided they fulfil the relevant source of origin regulations, may use to boost EU trade. These types of trade windows are well worth seeking out – market research can assist.
Facilities along the Georgian port and rail routes lead to the southern EU to the West, and via rail to the Azerbaijan’s Baku port, to markets via Caspian shipping north to Russia, east to Central Asia and on to China, and south through Iran and the INSTC to markets in East Africa, the Middle East, Pakistan, India and Southeast Asia.
To cater for markets between the EU and Central Asia and onto China; Georgia, along with Azerbaijan and Kazakhstan have formed the Eurasian Rail Alliance to standardize logistics and digital administrative functionality across the Central Asia route.
To give an indication of growing EU-Uzbekistan trade (Uzbekistan also has a significant EU free trade agreement) it is pertinent to note that Georgia-Uzbeki transit trade increased 88% in January-February 2022 compared to the same period in 2021.
The Turkish port of Gemlik, close to Istanbul on the Marmara Sea, has access to the Mediterranean and the BTK railway (which also has connectivity problems) However, Gemlik is a major access port for the southern EU and markets on the eastern Mediterranean such as Israel, and has a Free Trade Zone. Gemlik also links via rail to Azerbaijan and the INSTC ports, giving access to the huge domestic Turkish market as well as to destinations further east. The numbers of port calls to Gemlik from both Turkish and international shipping companies since early March has tripled. It is likely to become a significant destination as Gemlik’s facilities mean that goods destined for either the EU or Asia can be finished in the Gemlik FTZ before the final product shipped to the pertinent destination. Component parts can be sourced from eastern Europe, Turkey, the Caucasus, Middle East and North Africa before being converted into a finished product. That is of significance to numerous industries including cereal and other agricultural products through to light manufacturing and the automotive industry.
The Azerbaijan Port of Baku is becoming a key critical access hub for Asian/EU trade as it is the main conduit for shipments arriving (as discussed above) from the southern EU as well as for shipments coming in from China, (via Kazakhstan), Russia (via the Astrakhan ports), the EU trade friendly markets of Uzbekistan (via Turkmenistan) and markets in East Africa, the Middle East, Pakistan, India and Southeast Asia (via Iran). Baku port turnover was already up 14.6% in 2021, and that can be expected to significantly increase during 2022.
Azerbaijan has been reaching out to its Caspian Sea neighbours to improve and standardize the quality of logistics and facilities. This willingness to engage as been apparent with China already since the outbreak of the Russia-Ukraine conflict already shifting what were China-Kazakhstan-Russia-EU freight trains to Europe, to the southern route China-Kazakhstan-Azerbaijan-Georgia/Turkey-Europe. The only difference being that the latter is multimodal.
This southern route is both cheaper and faster than the traditional Suez Canal route, however it does mean that logistics companies still have options when it comes to getting freight from Asia to Europe and vice versa. Even should the Russia conflict be resolved, this southern route can be expected to be preferred for servicing the southern EU nations, the Balkans (see Part One of this series) in addition to destinations on the Eastern Mediterranean.
Azerbaijan’s strategic significance has taken on such a critical component part of East-West trade that Russia, now cut off from European ports, is also looking to develop closer access via road and potentially rail to Azerbaijan in addition to the existing seaport connectivity via its Lagan and Astrakhan ports.
Baku’s connectivity as a conduit between Europe and China seems assured, with the added bonus of additional connectivity south via Iran and the INSTC, also opening up markets in the Middle East and South Asia. The issue here however for this southern route via the INSTC is one of sustainability, as Iran is heavily sanctioned. Additional interference by the United States in particular with Iran’s capability to transit goods could pressure EU-South Asian freight to once again rely exclusively upon the Suez Canal.
Iran, again as a result of the Russia-Ukraine conflict, has come back into sharp focus as a trade route between South Asia and Europe, through the development of its International North-South Transportation Corridor (INSTC) with which it has been partnering with India in terms of mutual investment and logistics. The concept, which dates back to 2016, was originally designed to allow Iran-India trade to develop – Pakistan lies in-between the two countries, and with India and Pakistan at constant loggerheads, getting transit trade across Pakistan has proved difficult. The answer has been the development of Iran’s Chabahar Port (largely financed by India) on the Persian Gulf, with Iran and India co-financing a rail network to Iran’s northern coastal ports on the Caspian, and giving India a trade and supply chain route also to markets in Turkey and the EU.
That route has now taken on far greater significance for the EU given the Russia-Ukraine conflict closing off Russian access corridors east.
There is also an eastern spur of the INSTC rail network which heads east from Iran and leads to the Afghanistan border. Again, this reconnects India with Afghanistan, another market (along with Iran) it lost direct access to at the time of partition and the creation of Pakistan in 1947. While it is still very early days to be discussing supply chain routes to and from Afghanistan, Iran has been developing a Free Trade Development Processing Zone on its border with Afghanistan at Ghurian, close to Afghanistan’s largest industrial city at Herat. A railway line from Ghurian to Herat is still under completion, and it is hoped that in the future, that will bisect Afghanistan West to East, connect with Kabul, onto Islamabad, the Pakistani capital, and lead to rail links from Iran to China.
Turkmenistan is also looking east to Afghanistan, and is building an Industrial Processing Complex on its border with Afghanistan in Mary Province. Clearly there is some hope that reconstruction of Afghanistan, its eventual industrialisation and strategic positioning as a Central Asian transit hub can eventually start to be realised.
Returning to the INSTC however, much still needs to be completed. At present the North-South rail has still to be finished, although this is expected next year. Meanwhile, the route is covered by road transport, meaning at present the INSTC between Asia and Europe requires three multimodal lines: maritime, road, and rail. At present this is obviously inefficient – but it is operational.
The main sticking point with Iran is the attitude of the United States towards it. The country is heavily sanctioned, mainly due to disagreements over Iran developing nuclear power capabilities. In Washington this is talked up as being an impossible dream, mainly due to Iran’s relationship with Israel, with which it has poor relations. Iranian officials have in the past talked of ‘Wiping Israel off the map’ which has not been helpful. However, Iran needs nuclear power to modernise, and to develop an energy-export industry. That is of special relevance to neighboring Pakistan to the east, which is energy short and with a developing port of its own at Gwadar (part of the China-Pakistan Economic Corridor – CPEC) needs all the power it can obtain. Here is where US sanctions on Russia and Iran may have gone too far: both are so sanctions maxed that there would be little punitive actions left to take should Russia, also in the business of building nuclear power stations, decide to do so for Iran. In terms of regional energy, this would solve a great deal of problems. In terms of US-Israeli relations, immense pressure would be placed on Washington to stop it. Any military or additional actions against Iran could seriously damage the INSTC.
The EU, as is usual, manages to find itself caught in the middle of these situations, and if the worst happens would have to rely solely on the Suez Canal as a supply chain route through to South Asia. Yet a spectre awaits there too: both Russia and China possess nearby naval bases. These are ostensibly there to protect shipping passing through the Suez Canal and past the Somalian coast, but could be used to create blockages. That would benefit the United States, as it would cut Europe off from Asian trade meaning North American manufacturers would perceive Europe as its exclusive market.
The situation then as concerns Iran is a need by the EU to keep open the INSTC and develop transit routes and cooperation with Tehran, while the United States will almost certainly wish to limit that. The likelihood of this happening can be gauged perhaps by 2024-25, when EU energy supplies have been re-established. That is when the INSTC may develop political problems. One has to hope for the best – but these new routes still carry political risk. There would be huge sighs of relief from exporters throughout Asia and the EU if the Russian overland routes can reopen before then.
Part 3 of this series, concerning EU routes through to Central Asia and China, will be published next week. To ensure you obtain your copy, get your complimentary subscription to Silk Road Briefing here
Chris Devonshire-Ellis is the Chairman of Dezan Shira & Associates. The firm assists British and Foreign Investment into Asia and has 28 offices throughout China, India, the ASEAN nations and Russia. For strategic and business intelligence concerning China’s Belt & Road Initiative please email firstname.lastname@example.org or visit us at www.dezshira.com