Three weeks ago, the first article in this series discussed how the economic and physical geography of Kazakhstan has constrained and conditioned President Nursultan Nazarbaev's choices for export routes for Tengiz oil. It gave a series of reasons why the once highly-touted route to Xinjiang province in western China was unlikely to be constructed. It also observed that although earlier this year Almaty set this autumn as a time by which a definitive choice of an export route should be made, it was just as likely that no such decision would be in fact taken. Events over the last three weeks appear to confirm that no definitive choice will soon be made. The principal reason is the opening of new possible export routes. The present article discuses these developments and why have occurred.
Part of the conventional wisdom some time ago was that the fall in the price of oil after the Asian financial crisis would lead international energy companies to lose interest in the entire Caspian Sea basin by rendering oil production in the region uncompetitive. Clearly, that was wrong. The price of oil is back up and looks to stay there for now. Another part of the conventional wisdom was that the Baku-Ceyhan export route was dead because of low oil prices. This is not quite so. The role of the Asian financial crisis is more profound. It conditioned indirectly one important factor leading to Kazakhstan's current stance, but by itself it could not have produced the present situation.
1. Makhachkala and Izmir
The conflict in Dagestan would seem to threaten the Caspian Pipeline Consortium (CPC) line from Tengiz to Novorossiisk. Certainly, Dagestan has destroyed any remaining shred of faith the Azerbaijani leadership had in Russia's "northern route" from Baku. It was recently confirmed that while some Azerbaijani oil did arrive at the Russian port of Novorossiisk in 1998, none of that oil was put into the pipeline at its other end in Baku. Despite disclaimers all around, oil has continued to be siphoned out of the pipeline by freebooters in Chechnya, a fact that had long limited President Aslan Maskhadov's local authority.
Russia had just begun successfully to transport a few trainloads of oil through Dagestan to an-other line terminating in Novorossiisk when the fighting in Dagestan flared up. Elements of the Russian internal security apparatus even believe that the decision to abandon use of the line through Chechnya, which deprived local warlords of their stolen oil profits, was an important factor explaining the events in Dagestan. The apartment bombings in Moscow therefore raised significant questions about whether the integrity of the CPC line across southern Russia could be guaranteed.
As such, one would think that the Baku-Ceyhan project looks better if the Russian line is not secure. However, Ankara's need to fund reconstruction and recovery efforts following the earth-quake of August 18 has led many to assert that there will be no funds available to guarantee against construction cost overruns on the Baku-Ceyhan project. Confidence in this project has fallen further still.
Over the past few years, Azerbaijan, Georgia, and Turkey made good progress in negotiations to set up an international-legal, financial and technical framework for construction of the Baku-Ceyhan pipeline. This framework is mostly in place, but the final issues of guarantees for con-struction costs remains unresolved.
The Turkish government, with U.S. encouragement, undertook earlier this year to guarantee any costs over its own estimate of US$2.4 billion (about two-thirds the level of the high-end es-timates made by other interested parties). However, as the actual route had not been chosen at the time of Ankara's announcement, some of the figures contributing to this total were subject to dispute.
In particular, the length of the actual route was variable. This opened the question of whether more compressor stations than planned would be necessary. If so, the Turkish estimate could easily be exceeded by at least 10 to 20%. Attempts were made to devise formulas according to which greater volumes of oil would yield higher percentages of revenue and vice versa. This is-sue became the single most important outstanding unresolved question.
Then, the Azerbaijan International Operating Company (AIOC) shifted its emphasis from seek-ing guarantees against cost overruns to seeking explicit guarantees as to volumes of oil. Azerbai-jani oil by itself—even at projected peak output—would not be enough to make the Baku-Ceyhan line economically justifiable. Meanwhile, just recently, the head of the joint venture operating the Tengiz field announced that, in view of his group's long-standing commitment to the CPC pipeline, it was impossible to commit to putting Kazakhstani oil into the projected Baku-Ceyhan line.
The head of the AIOC thereupon stated to the press in Baku that it made no sense to plan pro-duction in the absence of a pipeline. (What this meant to the audience in Baku was that capital investment made no sense in the absence of a pipeline.)
3. The Real Significance of the Asian Crisis
The AIOC's chief is the head of British Petroleum, David Woodward: and therein lies the real significance of the Asian crisis. What the crisis did was to promote consolidation in the international energy industry in general, and BP's acquisition of Amoco in particular. That consolidation gave BP a larger share of the AIOC , altering slightly but definitively the decision-making culture within the consortium.
Amoco had straddled the fence between the criterion of economic criteria on the one hand and, on the other hand, an indulgence towards Washington's geopolitical insistence on the pipeline for strategic reasons. As a U.S.-based company, Amoco was keeping the jury out on Baku-Ceyhan, waiting for a definitive sign that it would not work before deciding against it. With Woodward in the driver's seat of AIOC, this changed. A new demonstration was required: that Baku-Ceyhan would work.
It would be an overstatement to say that the location of BP's headquarters determined the con-sortium's new tilt away from Baku-Ceyhan. However, this helped to constitute a context where such a tilt, which had begun to develop along with plans to expand the Baku-Supsa early oil pipeline's capacity, was ever more likely. BP-Amoco's position now has been confirmed by the official statements of none other than John Wolf, the new U.S. special representative for Caspian affairs.
4. Natural Gas in Azerbaijan]
This summer also saw the discovery of large natural gas deposits in the Azerbaijani sector of the Caspian. These would seem to put Azerbaijan in a position to compete directly with Turkmenistan, whose gas resources were only recently the subject of an agreement for exploitation and export across the bed of the Caspian Sea to Turkey. In fact, depending on the volume of Azerbaijani gas that is also fed into the pipeline, they could help to facilitate the trans-Caspian project by guaranteeing its economic feasibility.
However, one of the cards that Azerbaijani President Heidar Aliev is playing (probably more rhetorical than real) is to insist on a comprehensive solution to the problems of delimiting national Caspian sectors before the trans-Caspian gas pipeline is built. This is partly a ploy for favorable resolution of a territorial dispute with Turkmenistan over a particular offshore field. But if pressed home, it would guarantee that resource development came to a halt, for Iran continues to insist that the Caspian not be divided into national sectors but be treated instead as common territory.
Of course, Aliev's position would mean dropping consideration of plans for an undersea oil pipeline that would transport Tengiz oil through Baku as well. Production levels in Tengiz remain low in relation to the actual reserves in the ground. That means that there is more time to look for export routes other than the one through Baku and Novorossiisk. Still, there is more to the story.
5. The INOGATE Agreement
If you asked most people what INOGATE was, they would probably guess that it was some kind of political scandal. It is, however, an acronym for the European Union's "INterstate Oil and GAs Transport to Europe" program. In July, an umbrella agreement sponsored by INOGATE was signed in Kyiv. On the basis of the Energy Charter Treaty, this accord provides for a Eura-sia-wide international legal regime--and associated technical protocols--to govern the construc-tion of whatever pipelines in the end are chosen.
Therefore, it is perhaps not surprising that Nazarbaev has floated the idea of the construction of a pipeline through central Russia to the Lithuanian Baltic coast. Soon after the INOGATE signing, the Kazakhstani president visited Bulgaria and tried to give a new impulse to the Burgas-Alexandroupolis line. At about the same time, a group of Western specialists in Bucharest pronounced plans for a pipeline that would pass from the Romanian Black Sea port of Constanta through Hungary and Slovenia to Trieste technically feasible.
Ironically, this verdict is due in part to the far-seeing initiative of former Turkish President Turgut Özal in promoting the Organization for Black Sea Economic Cooperation (OBSEC) in the late 1980s, when the Soviet Union still existed. Without that initiative, the Constanta-Trieste line would not be possible. That is so for the following reason. Earlier this decade, the institutional progress of OBSEC was stunted by political disputes over the location of a future central bank. Romania, presiding over the organization at that time, wanted the bank in Bucharest. In the end, the bank was established and is now run out of the Greek city of Thessaloniki, and it has a Turkish governor.
The compensation given to Romania for losing the bank was twofold. First, an OBSEC program to enhance telecommunications and especially fiber-optic capacity around the Black Sea region was launched. This program improved conditions in a sector where Romania is perhaps the worst-off of all Black Sea countries, a legacy of the Ceausescu years. Second came the refurbish-ing and modernization of the Constanta port. These programs were supported and assisted by the European Union.
What this all this means for Kazakhstan, then, is that the number of possible oil export routes has multiplied despite the Asian financial crisis, the resulting price slump on world oil markets (which have now recovered) and the consolidation of the international energy industry.
The moral of the story is that when it comes to Caspian energy, facile explanations of past events and simple projections of current trends into the future are both to be distrusted. To paraphrase Hamlet's friend Horatio, there are more things in the world than are dreamt of in conventional economics. Of course, the scandal over diversion of international assistance to Russian reform should teach us that.
Copyright © Robert M. Cutler unless otherwise noted.
See reprint info if you want to reproduce anything in any medium.
For individual, non-commerical use only.
This Web-based compilation: Copyright © Robert M. Cutler
First published in FSU Oil & Gas Monitor, No. 51 (28 September 1999): 5–6.