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Just When You Thought Baku-Ceyhan Was Dead and Buried (5/7)

This week's column continues the discussion, begun last year, of the Baku-Ceyhan main export pipeline (MEP) accords initialled in Istanbul during the November OSCE summit. Although none of these agreements has yet been published, their outline and some of their details have already been analyzed here from available information. Of the four agreements initialled, previous columns this series looked at the MEP agreement itself and the cost guarantee agreement. As suggested earlier in this series, it turns out that the agreement between the investors and the transit states is complex and still subject to further clarification, as a precondition for establishing the definitive terms of the construction contract itself.

Towards the very end of the run-up to the OSCE summit in Istanbul, large delegations from Georgia participated. It is now evident that Georgia was brought into the talks on an intensive basis only after Azerbaijan, Turkey, and the Azerbaijan International Operating Company (AIOC) were confident of reaching a positive conclusion. That delay and subsequent haste have now led to demands from Georgia to revise certain terms of the transit agreement. This week's column analyzes those demands and their implications.

1. Georgia's New Concerns

There are three clauses of the draft to which Georgia objects in particular. First, the draft makes Georgia financially responsible for any natural calamities ("force majeure") that may damage the pipeline. The AIOC has stated categorically that it will not assume any liability in this regard but that its component companies will decide the matter each for itself under its own authority and criteria. Indeed, this question reflects an important issue that could not be resolved before the Istanbul summit. Responsibility for cost overruns on the Turkish and Azerbaijani segments was decided, but it was left unclear who was to be responsible for any cost overruns encountered in constructing the Georgian segment. This problem was hastily resolved so that draft agreements could be initialled in Ankara, and it has now returned in a more specific guise. A tentative solution, with the support of the State Oil Company of Azerbaijan (SOCAR) has been reached that would provisionally make MEPCO (the consortium charged with constructing the pipeline) responsible for such costs. Such a solution can be only a stop-gap, temporary measure. The issue will come up again with respect to the actual operation of the MEP through Georgia.

Second, there is the issue of financial compensation to landowners whose property may be purchased in order to obtain right-of-way to construct the pipeline. The AIOC's refusal to become involved in construction questions is again at issue. Georgia wants MEPCO to be responsible for obtaining the land and settling these matters. This second issue is sometimes confused with the third issue, which is actually separate from it, although it also deals with acquisition of land.

The third issue is the need to take account of environmental security and ecological conservation. Some observers think that these second and third issues together indicate a desire on the part of Tbilisi to dictate the route that the MEP will take through Georgia. Indeed, if Georgia is to be made financially responsible for damages from "force majeure," it is only sensible that Georgia should choose the route of the pipeline. However, the issue is more complicated and involves domestic Georgian politics, for the Georgian parliament has yet to approve the documents agreed at Istanbul. (They will not enter into force and constitute the actual basis for implementing the project until approved by the parliaments of Azerbaijan and Turkey as well.) Even though a pro-Shevardnadze coalition won a majority in the recent parliamentary elections, this does not amount to a rubber-stamp for anything that Shevardnadze may himself propose.

2. Those Pesky Environmentalists

In fact, the speaker of the Georgian parliament, Zurab Zhvania, has for some months been growing increasingly close to non-governmental organizations (NGOs) in Georgia. He has even said that NGOs have the potential to complement state structures and to assist in the firm implantation of democratic structures in the country. This indicates that Zhvania is both eager to seek an autonomous base of political support and genuinely convinced of what he says. Indeed, what he says is entirely correct and, moreover, applies throughout the former Soviet area. It so happens that environmental NGOs are among the most active in the Georgian political landscape, many of them originally modestly sponsored by American non-profit foundations and European international institutions.

Georgia invokes its commitments to the International Monetary Fund (IMF) and the World Bank in favor of its stance on the MEP. This refers to provisions of assistance granted to Georgia by these institutions, which impose the condition of environmental safeguards on various projects and policies. But the other parties to the MEP agreements will not likely be convinced by the legitimate obligations of Georgia to the IMF and World Bank. This is to say that the obligations will not by themselves convince the other parties that Georgia's position is well-founded. Those obligations represent an argument by Georgia in favor of its insistence on the second and third questions, but they do not mean that the other parties will acquiesce automatically in Georgia's demands.

The present situation is the result of the fact that the talks leading up to the Istanbul MEP accords were principally talks among Turkey, Azerbaijan and the AIOC. Those accords were only outline agreements (albeit outlined in detail) of the framework for the project. There was not sufficient time to negotiate certain details, and that is what is happening now. Had there existed a broader transnational forum where Georgia's concerns--including the legitimate environmental concerns emanating from the country's nascent civil society--could have been put on the table earlier, it might have been possible at least to anticipate those points, which at present block the realization of MEP across Georgian territory.

3. "Curiouser and Curiouser"

The situation is further complicated by the AIOC's declaration that it will not participate in the financing of MEP since the consortium is exclusively an oil exploration and production outfit. Rather, according to the AIOC's head David Woodward, the component companies will decide, each for itself, whether and to what extent to participate in MEP construction. This statement appears to include responsibility for any putative reimbursement of land-owners in Georgia.

As pointed out here a few weeks ago, the new find of an impressive gas-and-condensate field at Shah-Deniz raises the issue of Azerbaijan's desire to put this gas into the tTrans-Caspian Gas Pipeline (TCGP) from Turkmenistan. Neither Turkmenistan nor Turkey is especially enthusiastic on that prospect, but it will be negotiated and will not prevent TCGP construction. This could help satisfy Georgia's demand to be allowed to receive fuel supplies via the TCGP. Tbilisi also wants to be able to refine petroleum imported to Georgia via the MEP. This is in line with the demand by the Georgian International Gas Corporation (GIGC) to operate its own segment of the TCGP and participate in businesses connected with the pipeline and collect transit fees, as well as consume some of the gas going to Turkey. Partly for this reason, SOCAR is now in talks with foreign investors about the prospect to refurbish an existing gas pipeline between Azerbaijan and Georgia, to provision the latter with Shah-Deniz gas.

What is involved here, in part, is the continuing struggle with Ajaria, an autonomous but politically integrated part of Georgia, located in the southwestern part of the country on the Black Sea. It is from the Ajarian port of Batumi that Kazakhstani oil is exported from Georgia, after being barged across the Caspian and carried by rail across Azerbaijan and Georgia. Tbilisi wishes to continue to upgrade the port at Supsa, only a dozen or so km from Batumi but located in Georgia proper (actually Mingrelia, another constituent region). This ploy would diminish the amount of oil that Ajaria might have otherwise been able to dispose of by itself, on its way to Turkey. Since Ajaria receives as much as 30 times the transit fee per barrel for Kazakhstani oil transshipped from Batumi, as does Georgia for AIOC oil transshipped from Supsa, Georgia's insistence on sharing in AIOC transit revenue cannot be dismissed as irrelevant.

This is a convenient juncture to remark that some observers are still under the impression that the MEP will go through Javakhetia, an ethnic Armenian area in southern Georgia. All doubt about this question was resolved in December, when Georgian geologists involved in the planning stated authoritatively that the MEP's route through Georgia would be decided with the use of seismological data from the 1990s. This naturally makes good sense from both the engineering and the ecological standpoints. It so happens that Javakhetia is subject to large numbers of tremors of Richter magnitude 4.0 and above, whereas the area to the west is unaffected. As predicted here early last year, the MEP will therefore go through Ajaria instead.

4. Significance for the Trans-Caspian Gas Pipeline

The AIOC's reluctance to demonstrate any autonomy whatsoever of its members contributes to the inefficient promotion of regional energy development. The reason is that this reluctance could lead to renouncing even the distribution, even to other consortium members, of industrial information that BP-Amoco, as the leading member of AIOC, obtains in other venues. If the AIOC as a participant in MEPCO--or BP-Amoco as the leading member of the AIOC--chooses not to cooperate with Georgia and the TCP project, even through sharing information concerning its own requirements, then its potential partners will view this as mere recalcitrance. It is far from clear whether BP-Amoco is powerful enough to impose its corporate development strategy on the AIOC and the Caspian region in general.

All these concerns touch the construction of the TCGP, which would also cross Azerbaijan and Georgia. The concerned parties have apparently learned these lessons of the MEP negotiations, since Georgia has already been brought into negotiations for TCGP construction. Indeed, one of the arguments in favor of MEP and TCGP together is that they could follow the same path, thus diminishing eventual infrastructure and maintenance costs. That said, the most recent public statements of AIOC chief Woodward, including his projections for development of the AIOC's offshore fields in the Caspian, have all been supportive of the conditions of the Istanbul MEP agreements, even while he has sought to minimize the consortium's responsibility with respect to their realization.

The TCGP sponsors do not suffer from AIOC's organizational weaknesses. The TCGP sponsor group comprises only two companies, Shell and PSG, and is therefore much more manageable—and not to mention efficient in the taking of decisions and sharing of information—than either the AIOC or MEPCO. This is one reason why there is rather less controversy over the feasibility of the TCGP than over the MEP, even though it would cost as least as much. (Some estimates for TCP construction reach US$3.5 billion.)

There are also engineering reasons for this. Contracts for provision of natural gas by nature have to be longer-term than those for petroleum. That is because in principle, gas must be piped directly from the producer to the consumer, unless provisions are made for its liquefaction and transport as liquefied natural gas (LNG). That process nevertheless also requires long-range planning, especially for construction and maintenance of the LNG terminals in the exporting and importing countries.

5. Towards a Possible Solution

The AIOC (as indicated by the public statements of its chief) continues to act as if it believes that it can finesse other players into assuming cost and risk. That may be true in the short run. However, the overall business environment for energy development in the Caspian region is changing as a result of the Istanbul accords, themselves a result of the AIOC's statement last October that the MEP was "a strategic pipeline that should be built." This statement was in turn a tacit recognition that the AIOC's own business environment was shifting because of BP-Amoco's stake in the new Shah-Deniz discoveries, if for no other reason.

At present, the TCGP looks likely to be built regardless of what the AIOC thinks or does. Therefore, the AIOC and/or BP-Amoco would do well to consider being a bit more up-front about their own intentions and plans. Such information is no longer a proprietary industrial secret. Rather, it is a component of the business environment of other players. For these players to be aware at least of the general parameters according to which the AIOC and/or BP-Amoco may take decisions enhances the likelihood that these parameters will be accommodated.

The reason for this lies in the nature of Caspian energy development and derives from the principles of management of information under complex organizational systems. For example, the Shah-Deniz consortium includes BP-Amoco as a significant player. But BP-Amoco is also the leading member of the AIOC. Let the reader try to decide, then, whether the Shah-Deniz consortium is part of the "business environment" of the AIOC.

The AIOC has become so accustomed to being an agenda-maker that it does not see the possibility of its becoming an agenda-taker or the risks it runs in being blind to the possibility. Because of the innovative and dynamic leadership shown by BP-Amoco in the international oil industry in general in the recent past, one may well be right to have confidence that it is not a question of whether BP-Amoco will come to such a realization but rather a question of when.

It is necessary to begin to think about the nature of the entity that will operate the MEP. One potential solution to the right-of-way problem would be for the TCGP sponsors to acquire the necessary land in Georgia and lease it to MEPCO and any of its successor entities. The TCGP joint venture could negotiate appropriate conditions with Georgia for this route, taking account of the oil consortium's requirements if its members choose to communicate these rather than merely to protest Georgia's conditions. Indeed, with Bechtel and General Electric participating in the realization of the TCGP project, one may suppose that they can engineer a technical solution if anyone can.

As far as a political and legal solution is concerned, the Energy Charter Conference has elaborated framework criteria for an international operating authority that may be adapted, in whole or in part. Just as in the case of MEP construction, the AIOC will "do the right thing" once it sees that doing nothing is no longer a better choice. Of course, it could also always choose to lead rather than to follow.

Copyright © Robert M. Cutler unless otherwise noted.
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This Web-based compilation: Copyright © Robert M. Cutler
URL:  http://www.robertcutler.org/blog/2000/01/just_when_you_thought_bakuceyh_4.html
First published in FSU Oil & Gas Monitor, No. 64 (11 January 2000): 4&ndash7.

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This page contains a single entry from the blog posted on January 11, 2000 7:48 PM.

The previous post in this blog was Just When You Thought Baku-Ceyhan Was Dead and Buried (4/7).

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