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A Caspian Pipeline Decision

Yusuf Toprak

Jul 1, 1999

During the last 5 years, there has been-and still is-an ongoing debate on how to exploit oil and gas reserves in newly-emerged Central Asian republics. The question is not restricted to business; it was a question of politics and strategy as well. Several countries have been actively involved in the debate: Turkey, the United States, Azearbaijan, Armenia, Russia, and Iran are some of them. At the heart of this debate is, the Caspian pipeline route decision, an oil pipeline extending from Baku to a port, after which the oil will be transferred to the market by' tankers. This article investigates the strategic dynamics of this route decision, So far, Azerbaijan and the oil companies did have not announced a final decision. 

THE CASPIAN PIPELINE DECISION

After the break-up of the Soviet Union and the emergence of independent states, the Caspian region has become a magnet of interest for different powers, including China, Russia, Turkey, Iran, and the United States. Five states border the Caspian Sea: Russia, Azerbaijan, Kazakhstan, Turkmenistan, and Iran. Kazakhstan and Azerbaijan have vast oil resources around the Caspian Sea, while Turkmenistan has significant natural gas reserves. However, as the region is landlocked, pipelines have to be constructed to transfer these resources to external markets. Since these three states have neither the expertise nor the financial resources for oil exploration, extraction, and transfer, they have to rely on foreign investment. After the pipeline is in place, the cash flow generated by oil and gas exports will be of great importance in the economic development of these states.

But not so fast. The situation has proven to be a very complex one involving the status of the Caspian Sea, regional disputes, and the conflicting economic and political interests of the countries involved. Due to the complexity of the decision and the billions of dollars at stake, the Azerbaijan International Operating Company's (AIOC) feasibility report was delayed three times last year, which also delayed any decision of the final pipeline route.'1 This article investigates some of the issues surrounding the Caspian oil pipeline debate.

RESERVES

First, just how much oil is lying under the Caspian Basin? Early estimates of around 200 billion barrels predicted that the region would be another Persian Gulf.2 However, exploratory oil wells turned out to be disappointing. A conservative study by the James Baker Institute estimates proven reserves at 15 to 30 billion barrels.3 On the other hand, some experts argue that these numbers are misleadingly low. A reasonable estimate would be somewhere between 60 and 100 billion barrels. More than half of these reserves lies under Kazakhstan, and most of the rest lie elsewhere.4

Two main oil pipelines will be built and brought on line to serve the region up to 2010. At the present time, the only pipeline that has reached the final stages of negotiation is the Caspian Pipeline Consortium (CPC) pipeline for oil from Kazakhstan to the Russian port of Novorossysk.5 After this, the decision concerning the main oil export pipeline route from Baku (Azerbaijan) to a port, from where the oil will be transferred to external markets by tankers, gets complicated. There are competing proposals for this route from Baku, which include6:

  • Novorossysk: To the north, a main oil export pipeline across Daghestan and Chechnya to Russia's port of Novorossysk.

 

  • China: To the east, there is a proposal to build an oil pipeline from eastern Kazakhstan's Uzen field to western China as part of an overall $9.5 billion deal supported by CNPC, China's state oil company CNPC.

 

 

  • Supsa: To the north again, this route links Baku to Supsa, a Georgian port on Black Sea.

 

 

  • Ceyhan: To the west, oil pipelines transiting from Baku to Ceyhan with links to cross-Caspian lines from oil and gas fields in Kazakhstan and Turkmenistan. The route originates in Baku, enters Georgia, and reaches the southern Turkish Mediterranean port of Ceyhan through eastern Turkey.

 

 

  • Iran: To the south, an oil pipeline from the Caspian states across Iran, to a new port on the Gulf of Oman. Shipping oil by tankers or another alternative from Tabriz to Ceyhan has also been proposed by Iran.

 

All of these pipeline options are technically possible; most are commercially feasible at some volume. We now turn to the specifics of those routes.

THE ALTERNATIVES

China: This route has not been considered seriously by either the states or the companies. First of all, Chinese companies cannot provide competitive deals, possibly due to the recent economic recession. Second, the pipeline will be much longer and more expensive than the other alternatives. Third, China is primarily linked with Kazakhstan, and for transferring oil from Azerbaijan to Kazakhstan (or directly to China) some real challenges remain: the pipeline has to pass either under the Caspian Sea (which is itself highly questionable, given the debate over the Caspian Sea's status) or pass through disputed territories. Fourth, Asian markets are not the best place to export oil, since European markets will probably pay more.7

Supsa: For early oil, TEKFEN (a Turkish construction company) began construction of a 380 km. pipeline from Baku to Supsa. But as this pipeline, completed and opened in April 1999, will not be sufficient for the main export, a larger one along the same route should be built. Should this route be chosen, it will be the shortest route and, not surprisingly, the cheapest. Its price tag is $1.2 billion.8 The construction cost may be lower if the pipeline passes trough Armenia, rather than going around it. However, the long-lasting conflict between Azerbaijan and Armenia makes this unlikely.

On the other hand, Georgia is not an ideal pipeline-transit country. Since achieving its independence in 1991, numerous territorial conflicts and separatist movements have taken place, all of which increase the risk of pipeline sabotage and other political risks. Russia currently supplies military support to Abkhazia in its independence struggle against the Georgian government.9 With the reestablishment of Russia's extensive military basing rights in Georgia, the support apparently ceased, but most experts argue that Russia is still supporting, either directly or tacitly, regional instability to block pipeline alternatives through Georgia and to promote its own route (Novorossisk).

Another problem with the Supsa route relates to the Bosphorous Straits of Turkey. According to the 1936 Montreux Convention, tanker passage through the Straits is free. However, Turkey points to tightening political and physical constraints, as well as sharply increasing tanker accidents threatening the environment in Istanbul,'10 its most populated city. Turkey can certainly make the passage extremely difficult for tankers within the convention, by requiring extensive precautionary measures and removing their passage priority, causing tankers to wait for days before passing through the Straits. Most experts argue that Turkey is using the straits as a political lever to promote its own route (Ceyhan). But still, this uncertainty adds another variable to the calculation of pipeline companies.

Novorossisk: The 452 km. pipeline,11 which is estimated to cost $2 billion,12 starts at Baku, reaches the Russian Black Sea port of Novorossisk across Daghestan and Chechnya. Although cheap, this pipeline still faces the Straits problem mentioned above.

Although avoiding Georgia, this route has its own problems. Disagreements on distributing transit fees between Russia's central and regional authorities may hinder negotiations. Russia does not have a particularly bright history regarding pipeline management. Moreover, the transfer may be subject to frequent disruptions due to instability in the north Caucasus. If Russia decides to bypass Chechnyian territories by an extension through Daghestan, there will be an added risk of pipeline sabotage by the Chechens.13 All these, when added to overcrowded port facilities and poor weather conditions at Novorossisk, make this route even less attractive.

Furthermore, there are political and economic factors to consider. From an influence point of view, most Central Asian republics have been under Russian influence for centuries. They still have economic, cultural, and military ties with Russia, which is anxious to maintain its influence in these republics for both security and economic reasons. Those republics dependent on Russia will pose much less danger, not to mention benefits from economic relations. On the other hand, the Central Asian republics want to be less and less dependent on Russia and discover their own identity by stepping out of the shadow of a now-defunct empire. Not surprisingly, the Azerbaijan government has expressed its reluctance concerning the Novorossisk route more than once. From a strategic point of view, Russia wants to keep her monopoly for oil transfer in the region so that it can be used as a strategic lever in the future. Economically, transit fees will be more than welcome in an economically depressed Russia. Furthermore, Russia will be able to purchase at lower rates than those in the international markets.

Ceyhan: The total length will be approximately 1,730 km (468 km in Azerbaijan, 225 km in Georgia, and 1,037 km in Turkey14). It is also an expensive alternative; estimates place its total cost at around $3 billion. The latest feasibility study, undertaken by a German company, put a price tag of $2.3 billion.15 The oil will serve to offset Turkey's energy shortages, as well as giving it the economic advantage of transit fees.

The Ceyhan route has been favored by Azerbaijan, which wants to avoid giving Russia any influence over its resources. Azerbaijan is also seeking to avoid the proliferation of political Islam (from Iran) in Azerbaijan, thus undermining the possibility of an Iranian route. As for the Supsa route, it has the same Straits problem mentioned above. Thus, President Haydar Aliyev has repeatedly and publicly expressed his willingness for the Ceyhan route.14 However, his final decision will depend on the AIOC's feasibility report. It is therefore considered unlikely that he will insist on Ceyhan route, if companies find the Ceyhan route to be economically less attractive. After all, the companies and not Azerbaijan are going to pay for the construction. The final route decision therefore will be a joint decision of the AIOC and President Aliyev.

The United States has also been publicly favoring the Ceyhan route.16 The reasoning is as follows:

  • The pipeline goes directly into the Mediterranean Sea, thus avoiding straits and the Persian Gulf. This will serve to of the supply of energy, which is an American goal. So far, a significant number of major fields lie in the Persian Gulf; unfortunately, the United States does not have the best of relations with some of the states in that region. Russia already has control over Kazakh oil and it would be unwise to leave Azeri oil to the Russian monopoly.

 

  • Turkey has been the United States' ally in the region for a long time, and is closer to United States than Russia and Iran.

 

 

  • As a democratic country and a supporter of free-market economies, Turkey's influence on the Central Asian republics would be much more positive than that of Russia and Iran. The proliferation of Iranian-style political Islam may be particularly dangerous, whereas Turkey's secular version of Islam is much more preferred, according to the Clinton administration.

 

From a security viewpoint, the Turkish Army has been securing eastern Anatolia since 1998 against the activities of the Kurdish terrorist organization PKK. The organization's leader Abdullah Ocalan was recently captured in Kenya, which has considerably improved the prospects for regional security. On the other hand, Georgia's problem with instability is also valid for Ceyhan.

Iran: Iran has proposed several routes. In general, those routes are less expensive than Ceyhan but more expensive than the other alternatives. There are no acute instabilities in the region. However, American sanctions directly affect Caspian pipeline development in Iran, notably through the Iran-Libya Sanctions Act (ILSA). The goal of the 1996 law is to press for a change in Iran's foreign policy, which was widely criticized as being supportive of terrorism and weapons proliferation as well as undermining the Middle East peace process. In practical terms, the ILSA prohibits direct foreign investment in Iran's energy capability and infrastructure, and applies to America business as well as third parties.17

The United States remains strongly opposed to an Iranian route. As mentioned, such a route is not in the best interest of Azerbaijan either, due to the concerns of Iranian-style political Islam.

CONCLUSION

In recognition of the growing stress on the Ceyhan route, Georgia has aligned with Turkey, Azerbaijan, and the United States to push for the Ceyhan alternative. On the other hand, Armenia has aligned with Russia and Iran to oppose the Ceyhan route (or for that matter, any route) that will benefit Azerbaijan (its enemy). The Armenian government argues that Azerbaijan will use the money from oil exports to increase its military build-up against Armenia. Iran and Russia are opposing the Ceyhan route, for rules out their own routes. As clearly seen, Russia, Armenia, and Iran have no common interest whatsoever, except blocking the Ceyhan route to promote their own conflicting interests.

On the other hand, companies are in an awkward situation. The United States and Azerbaijan are increasing their political power on the companies for the Ceyhan route, whereas companies find this route more expensive when compared to other options. They also argue that current proven oil reserves do not justify the construction of such an expensive pipeline. They say that the oil found may never be able to fill the pipeline. Another factor is that oil prices are at their lowest level in 20 years. The expenses will not be justified unless oil export profits justify the main export pipeline expenses. Thus, they are playing a wait-and-see game, to see whether more oil will be found or whether oil prices will increase. The debates around the Caspian pipeline are likely to continue next year, and a win-win deal involving all the Caspian states seems nowhere near.

FOOTNOTES

  1. David Filipov, "Caspian Port's Oil Gush Trickling," Boston Globe, 10 February 1999, sec. A, p. 1.
  2. R. E. Manning and J. A. Meyers, "Dream of Oil Drives Diplomacy," Los Angeles Times, 1 November 1998, sec. M, p. 2.
  3. The James A. Baker III Institute for Public Policy, "Unlocking the Assets: Energy, and the Future of Central Asia and the Caucasus. A Political, Economic and Cultural Analysis," Rice University Research Report (April 1998): 1.
  4. The Energy Information Administration, "International Energy Outlook: 1998," Research Report (1998): 34. http://www.eia.doe.gov/oiaf/ieo98/home.html
  5. Heslin, S., Key Constraints to Caspian Pipeline Development: Status, Significance and Outlook. Research Report for The James A. Baker III Institute for Public Policy, Rice University (1998): 4.
  6. Ibid., 4, 5.
  7. The James A. Baker III Institute for Public Policy, "Unlocking the Assets," 3.
  8. http://www.gasandoil.com/goc/contract/cox7l803.htm
  9. H. Cemal, "Petrol Cografyasinda Yeni Kavsak Noktasi Turkiye," Sabah Turkish Daily Newspaper, 3 October 1998.
  10. Heslin, Key Constraints to Caspian Pipeline Development, 16.
  11. "Kazakhstan Approves an Oil Pipeline Study," Journal of Commerce, 30 October 1998, sec. A, p. 10.
  12. Cemal, "Petrol Cografyasinda Yeni Kavsak Noktasi Turkiye."
  13. Heslin, Key Constraints to Caspian Pipeline Development, 7.
  14. "Five Nations Endorse Caspian Oil Pipeline," San Francisco Chronicle, 30 October 1998, sec. A, p. 14.
  15. "Baku Ceyhan'a bir adim daha," Yeni Yuzyil Turkish Daily Newspaper, 7 July 1998.
  16. "Four Former Soviet Republics Join Turkey on Pipeline," The Orlando Sentinel, 30 October 1998, sec. A, p. 20.
  17. "U.S. Has Impact on Pipeline Route from Caspian Sea,' Wall Street Journal, 30 October 1998, sec. A, p. 17.
  18. Heslin, Key Constraints to Caspian Pipeline Development, 17-19.