Despite Political Obstacles, Energy Work Progresses Around Caspian Sea

Downtown Baku is becoming a business center for Caspian Sea oil activity.

• Caspian Pipelines [163,697 bytes]
• Azerbaijan must accommodate 1 million refugees from its war with Armenia over Nagorno Karabakh. This woman lives in a refugee camp in the Sabirabad District. [13,728 bytes]
• New investment is breathing life back into the historic oil producing region around Baku.[10,374 bytes]

Virtually all international oil giants and a number of independents, followed by service companies, are in or are fiercely trying to get projects in the non-Russian Caspian states of the former Soviet Union. The countries lag well behind Russia in the development of democratic institutions and irreversible guarantees for individual freedoms. But their strong central governments and autocratic leaders have provided both legal frameworks and investment protection sufficient to permit major oil and gas projects to go forward with foreign partners.

Azerbaijan, Kazakhstan, and Turkmenistan occupy a region subject to political volatility and ethnic conflict. Each country is vulnerable to outside influence and intervention that can derail its current developments and scare away Western energy companies. Moreover, despite highly publicized and well-contested production sharing agreements (PSAs) and planned foreign investments of approximately $60 billion, no major export pipeline exists from the region, although modest volumes of oil are getting to markets through Russia and Georgia.

Yet Central Asia and the Caucasus remain the most active arena today for competition for oil and gas resources, on one hand, and for political and geostrategic influence, on the other.

Nowhere is the competition for the region's petroleum resources more visible than in Baku. Downtown Baku is a giant construction site-an unmistakable sign of growing economic activity and a strong statement of investor confidence. Many companies have set up offices in Ichari Shahar (Inner City), the historic part of Baku, with U.S., European, Russian, and Turkish flags flying over newly renovated buildings. With approximately 5,500 expatriates permanently based in the city and a few hundred more coming in and going out every day, Baku is quickly being transformed into the Caspian region's financial and transportation hub.

Azerbaijan has adopted an open-door policy for foreign direct investment in its economy and in the oil and gas sector. The country's leaders perceive its revitalized oil and gas industry as an engine to restart a stagnated and imbalanced economy inherited from the Soviet period. Moreover, leaders are well aware that the presence of U.S., British, French, Russian, and Japanese companies is a sure sign of Azerbaijan's continuing independence. They have used every opportunity to attract more companies from different countries.

President Heydar Aliyev's 1997 visit to the U.S. was viewed as a major success and vindication of his pro-independent and pro-Western policy. Aliyev received red-carpet treatment in New York, Washington, D.C., Houston, and Chicago and met in the White House with President Bill Clinton. The trip featured the signing of four major oil contracts worth a total of $8 billion.

Kazakhstan, catching up with Azerbaijan in attracting investment, is the other likely major oil producer on the Caspian shores. Although major companies like Chevron, Mobil, Lukoil, British Gas, and China National Petroleum Co. are established in Kazakhstan, early expectations of Kazakhstan's becoming a leading former Soviet republic open to foreign investments have proven to be premature.

Two important factors have significantly hindered President Nursultan Nazarbayev's ability to act more independently in attracting foreign companies to participate in the country's oil and gas development: 1) a sizable Russian-speaking minority, amounting over one third of Kazakhstan's 17 million population, and 2) lack of a viable pipeline bypassing Russia. Both factors have given Russia strong leverage over Kazakhstan's oil strategy and, consequently, the country's future direction.

Turkmenistan, unlike Azerbaijan and Kazakhstan, has been a source of frustration to international investors until recently. Blessed with vast amounts of natural gas onshore, Turkmenistan yet could become a major supplier of natural gas and, possibly, oil to Western markets in the next decade.

Several factors have contributed to Turkmenistan's slow start:

• Geography and an unfriendly and unstable neighborhood affect Turkmenistan's behavior.
• President Saparmurad Niyazov has opted to court Russia, and sometimes Iran, sending conflicting signals to international companies as to the country's future direction.
• Siding with Russia and Iran on the issue of the legal status of the Caspian, Turkmenistan has in effect put itself in a camp against Azerbaijan and Kazakhstan, effectively alienating potential bidders for oil and gas projects within its borders.
• Niyazov's personal cult at home, approaching those of medieval kings, and associated apathy among the Turkmen population have scared away potential companies.

Obstacles to development

Industry estimates also reflect uncertainty on total recoverable reserves, ranging from as low as 25 billion bbl to as high as 200 billion bbl.

However, the region lacks the social and technical infrastructure needed to ensure rapid development. Among the more important deficiencies is the lack of a major transportation route to take oil and gas to Western markets. In addition, the Caspian region presents a number of obstacles to effective petroleum development, such as regional conflicts and political and social instability. Cooperation among regional countries will be crucial to overcoming these roadblocks.

Regional development also requires achievement of short- and long-term objectives. One short-term objective is to evacuate "early" Azeri oil and Tengiz oil to Western markets. Although with certain difficulties and often disruptions, both Chevron and Azerbaijan International Operating Co. (AIOC) seem able to secure transportation for limited initial volumes of crude from Kazakhstan and Azerbaijan. A long-term objective is to become a major energy-producing region.

To achieve these goals, local governments and international oil companies must overcome two sets of issues. One set includes political issues, including determining the Caspian Sea's legal status in a fashion acceptable to everyone involved. The other issues are financial, including funding for high-volume oil pipelines.

Resolution of issues like these will require political will from all producing and transit countries, patience from oil companies, and support of Western governments, including some direct financing in certain cases.

Although most Central Asian and Caucasian countries have elected presidents and parliaments, the elections have neither consolidated nor legitimized the current political leadership. The countries have strong leaders but weak governments with only embryonic democratic institutions.

Widespread corruption plagues the governments, causing cynicism among the rulers and a sense of hopelessness and apathy among the ruled. Moreover, with no clear rules and an inherent winner-take-all orientation to politics, the countries face unpredictable succession issues. With the exception of Armenia, the countries would have no regional or distant power rushing to their rescue if attacked. Although there is no serious power vacuum such as the one that prevailed in the early 20th century, the region has a thin security umbrella.

Turkmenistan

Among the least reformed of the former Soviet republics, Turkmenistan's economy is shrinking faster than many others in the region. The situation represents a bizarre blend of idealism and pragmatism, typified by "Turkmenbashi," or leader of the Turkmen, as Saparmurad Niyazov has labeled himself, promising his people that the country will become "a new Kuwait." Turkmenbashi's picture is everywhere in this desert nation of 5 million people, and visitors and shoppers find his name on everything, from the international airport in Ashghabat to a yogurt can in a grocery store.

But Turkmenistan's misfortunes come not only from Turkmenbashi but also from geography. Its only pipeline outlet for natural gas now is controlled by a main commercial competitor, Gasprom of Russia. Gasprom moves its own gas to lucrative Western markets and delivers Turkmen gas to Armenia and Ukraine, which do not have the money to pay for it.

Fed up with nonpayments and low prices that Gasprom was paying, Turkmenbashi complained and received a bitter lesson: In March 1997, Gasprom stopped delivering Turkmen gas altogether through its pipeline network; negotiations so far have not resulted in resumption of deliveries.

Seeking a route to bypass Russia, Turkmenistan has considered a number of pipeline options, all of which offer political, security, financial, and ecological constraints.

The most-publicized prospect is a pipeline from Turkmenistan to Pakistan via Afghanistan, with possible extension to India. On Oct. 25, 1997, six international companies led by Unocal and the government of Turkmenistan formed Central Asia Gas Pipeline Ltd. (CentGas) in formal signing ceremonies in Ashghabat. But security and financial constraints place this project in the high-risk category, largely because of the need to transit Afghanistan, which is locked in a bloody civil war.

Except for the leader of war-torn Tajikistan, Niyazov was the last Central Asian head of state to be invited to Washington, after nearly 7 years of independence. His reception was less enthusiastic than those of his fellow leaders from the region, probably because of his poor record on human rights and democratic reforms. When asked after a speech at Johns Hopkins University's Central Asia Institute on Apr. 21 why he didn't permit freedom for opposition parties, Niyazov replied, "I was asked the same question in New York and frankly still do not understand the question. There are no opposition parties in Turkmenistan. That is why I cannot give them freedom. There are none."

Described by a human rights group as the most repressive country in the former Soviet Union, Turkmenistan is not only a one-party state but also a one-man state. In 1994, 99.9% of the Turkmen people voted in a national referendum that their leader need not bother holding presidential elections in 1997 and extended his term in office to 2002. Since then Turkmenbashi has turned down "popular demands" to become president for life.

Kazakhstan

The economy has shown signs of recovery; hyperinflation has relaxed. Last year the country's oil production returned to its Soviet era peak of 530,000 b/d. Western oil giants followed by Chinese, Japanese, Malaysian, and Turkish companies have gained strong ground in Kazakhstan, investing approximately $2 billion in the country's oil and gas sector in 1997 alone.

The most-publicized and one of the largest projects of all, Tengizchevroil (TCO), celebrated its fifth year of operations in early April in the provincial capital of Aturay. The event was attended by some 450 Kazakh government officials and community leaders.

TCO's crude oil production from giant Tengiz field has risen every year from approximately 20,000 b/d in 1993 to 140,000 b/d in 1997 and almost 190,000 b/d since then. The TCO consortium plans to raise output to 240,000 b/d by mid-2000.

Chevron, operator of TCO, has been creative in exporting its share of oil through a cumbersome combination of rail, barge, and pipelines to Azerbaijan, Georgia, Finland, Estonia, Ukraine, and farther west.

To export all potential output from Tengiz, the Caspian Pipeline Consortium (CPC) must complete its well-publicized pipeline. Internal disputes over personnel among consortium members, difficulties in obtaining rights of way and land allocation, and delays in preparation of some technical documentation have pushed pipeline completion to the end of 2001. The 940-mile CPC pipeline, most likely to be the first substantial evacuation route from the region, will run from Tengiz field in Western Kazakhstan to Russia's main Black Sea terminal at Novorossiisk and have initial capacity of 560,000 b/d, later rising to 1.34 million b/d. The cost of the pipeline is believed to be around $4.5 billion at maximum capacity.

Nazarbayev's shift toward authoritarianism in 1995-96, a concurrent reshuffle of top government officials, the lack of confidence in policy continuity, and controversial statements about the future of privatization in Kazakhstan have caused concern among Western businesses and slowed investment. Recently, Nazarbayev abruptly fired the head of Kazakhoil and the Minister of Energy, Industry, and Trade. Both Minister Asygat Zhabagin and Kazakhoil Pres. Baltabek Kuandykov had served in those positions only since October 1997.

Nurlan Kapparov, the new head of Kazakhoil, 28, is an English-speaking former private businessman. Mukhtar Ablyazov, 35, the new minister, is a former academic and businessman.

The changes could be interpreted as Nazarbayev's desire to get more closely involved in economic matters, to get rid of more-experienced and potentially threatening members of the old guard, and give young, educated, English-speaking "New Kazakhs" opportunities in state economic management. Nazarbayev was the first Central Asian leader to recognize the need for radical changes in management style and fresh talent in government.

His changes might also result from a recognition that most of Kazakhstan's skilled laborers and technocrats are Russian speakers, not ethnic Kazakhs. Russian-speaking skilled laborers have been gradually emigrating to Germany, Russia, and elsewhere, leaving Kazakhstan with a dilemma.

Since 1992, Kazakhstan has sent 300 of its brightest students to U.S. and European universities and management schools every year under a special presidential scholarship program. Many of these "Young Kazakhs" are now back in the country and ready take responsibility for reforming their homeland. Most of them have no significant Soviet experience and readily grasp Western business and management culture.

The personnel changes might be aimed also at battling widespread corruption among the government officials. According to an international organization monitoring corruption, Russia, Kazakhstan, and Azerbaijan were ranked as the worst in the former Soviet Union. A high-ranking American diplomat based in the region said, on condition of anonymity, that corruption in Azerbaijan was worse than in Kazakhstan. A Kazakh official has acknowledged that "corruption is deeply rooted in Kazakhstan and poses a threat to the republic's national security." Nazarbayev has gone as far as saying "anyone taking bribes is considered an opponent of the president's policy."¹ An anticorruption campaign set to begin in Kazakhstan may result in further dismissals. A draft anticorruption law has been discussed in the Parliament, which is expected to pass the law this summer.

On the issue of U.S.-backed pipelines, Nazarbayev has been less enthusiastic than Aliyev. Although Clinton won Nazarbayev's support for a non-Iranian evacuation route during his visit to Washington last November, the understanding was conditional. Nazarbayev insisted that if by October 1998 the U.S. government does not come up with financial support for a non-Iranian pipeline, Kazakhstan will decide its pipeline routes according to its own national interests.

Speaking in Almaty recently, Kazakhstan's Foreign Minister Kasymjomart Tokayev stressed, "Our president and myself have repeatedly said that we do not rule out Iran as a route to export oil," reconfirming their earlier statements.²

Azerbaijan

Since Sept. 20, 1994, when the AIOC deal was signed, Azerbaijan has signed and ratified at least nine offshore PSAs and numerous onshore contracts. More are likely.

In the context of where Azerbaijan was only 5 years ago and its tough geographic neighborhood, it is an impressive achievement, even for someone with Aliyev's broad experience as a government leader.

Nevertheless, the country hasn't solved its main problem-resolution of the Nagorno Karabakh conflict. With the election of hardline Robert Kocharyan as president of Armenia in March 1998, prospects for peace envisaged by the Organization for Security and Cooperation in Europe (OSCE) Minsk group negotiations have dwindled.

Aliyev is well aware that the "no peace-no war" status with Armenia over Nagorno Karabakh is not sustainable. The social and psychological pressures from 1 million refugees and internally displaced persons remain burdensome.

Aliyev and former Armenian President Levon Ter-Petrossian had accepted a two-step, phased settlement plan worked out by the Minsk group. They understood the importance of compromise, and both made significant concessions, some of which are probably too sensitive to make public.

Aliyev's calculations were simple but bitter: Azerbaijan has effectively lost the military battle and does not have an effective fighting force. With oil revenues Azerbaijan can create a real army capable of liberating lost territories, but that would take years. The continuing burden of the refugees, increasingly visible income disparities between the rich and the poor, and pressure from the opposition create immediate needs for action by a president who faces elections in October.

Ter-Petrossian's calculations were complex but realistic: Armenia occupied 20% of Azeri territories and, with Russia's support, has created a capable army. Armenia enjoys financial and political backing of its influential ethnic lobbies in Washington, Paris, Moscow, and elsewhere, but no single country has recognized Nagorno Karabakh as a separate state, including Armenia.

Armenia's military successes add up to a pyrrhic victory. The international community has made it clear that it will not legitimize territorial gains made by force. As a result, Armenia has isolated itself from the regional development that will transform its neighbors in the next few years. Moreover, Armenia has closely allied itself with Moscow and Tehran, both with dubious intentions toward Armenia and the region.

Therefore, Ter-Petrossian called upon his countrymen to think about the future. He was quickly overthrown in a bloodless coup by hardline forces.

Allegiances

Tehran's relations with Moscow, ranging from arms trade to accord on many Caspian issues, are flourishing. Both Moscow and Tehran have special interests in the region, not least of which is to block American penetration of Central Asia and the Caucasus.

Officials of both countries are deeply resentful of the U.S. and highly suspicious of American intentions in the region. They wish to have oil and gas pipelines go through their territory and jointly desire to limit U.S. presence.

Iranian pragmatism

Iran is the largest trading partner of Armenia, which has become Tehran's foothold in the Caucasus. Relations between Tehran and Yerevan are booming, thanks to their mutual hatred of pro-American Azerbaijan.

To Iran and Russia, Armenia represents an outpost in the southern Caucasus. In effect, increasing contacts among Armenia, Russia, and Iran have created a trilateral anti-Western bloc in the region. The Treaty of Friendship, Cooperation, and Mutual Security between Armenia and Russia signed in Moscow on Aug. 29, 1997, entails arming Armenia and giving Russia an outpost in the region.

Official Baku views the treaty as a normative formation of a military union between the two countries directed against Azerbaijan.

Russian arms

According to Azeri sources, these missiles are now in operation. When Moscow denied the charges, Baku produced copies of Russian documents as evidence of illegal arms transfers to Armenia. According to Azerbaijani Deputy Foreign Minister Araz Azimov, "Now the Russian side is more interested to find out how these documents have become available to Azeris rather than how weapons were transferred to Armenia."

Iran also uses Armenia as a stepping stone in order to reduce U.S. influence in the southern Caucasus. More than 500 km of Azerbaijan's external borders, including 130 km of Azeri-Iranian border, are now controlled by Armenia. Armenia uses this portion of the occupied border as a transit point for trade and military materiel.

With Kocharyan's election as president of Armenia, use of Russian transferred arms has become a possibility. It was as "president" of the self-declared "Nagorno Karabakh Republic" that Kocharyan proclaimed, "Not one drop of Azeri oil will flow from the Caspian to international markets."

Armenia, which enjoys considerable support in the U.S. Congress, has violated its commitments to the CFE Treaty by acquiring missiles and heavy weapons from Russia.

U.S.-Armenian relations

U.S. aid to Armenia since 1991 thus matches the cost of the 1994-96 Russian arms deliveries to the country. Furthermore, in January 1998 Armenia was exempted from a U.S. law prohibiting aid to countries occupying territory of other countries and was allocated $87.5 million under a presidential waiver approved by Congress for fiscal 1998.

In contrast, Section 907 to the Freedom Support Act of 1992 bars any U.S. government bilateral assistance to Azerbaijan. Although in 1997 some modifications were made to the measure to provide modest assistance to Azerbaijan for democracy-building and electoral reform, the Azeri government is calling for full repeal. Armenia now occupies 20% of Azeri territory, and Armenian officials have hinted that they might keep some Azeri territory after the conflict is resolved. The Clinton administration has repeatedly stated its opposition to Sect. 907 but has not sought a waiver, which it may do under the law.

Renewed conflict?

In a Moscow meeting of the Commonwealth of Independent States in late April 1998, Aliyev and Kocharyan issued a joint statement reaffirming their support for peaceful resolution of the conflict.

When Kocharyan returned to Yerevan, however, he stated that he had "made very clear his position to President Aliyev"-a statement interpreted as rejection of the OSCE Minsk proposals. A few days later, Armenia's new foreign minister, Vartan Oskanyan, stated that the OSCE proposals are "absolutely unacceptable to Armenia and to [Nagorno] Karabakh" and called outright for "eliminating the [OSCE's] Lisbon principles" from any future agreements.

Azerbaijan's view is that it has already made concessions by accepting the OSCE proposals and cannot accept any agreement changing its borders or placing Nagorno Karabakh outside its control.

The Armenian government's position may cause a resumption of hostilities. There are already signs of renewed tensions. Armenia holds the upper military hand, thanks to Russian arms deliveries. It also has been bypassed by the current regional development. The feeling of isolation and hardship among Armenians may put pressure on officials to renew military conflict, which could derail economic development and stop the flow of oil.

Caspian legal status

Azerbaijan and Kazakhstan favor sectorial division of the Caspian. Russia, Iran, and Turkmenistan want to explore Caspian resources according to what they call a condominium approach.

The northern part of the Caspian abutted by Russia seems to be promising for oil and gas exploration, but prospects are long-term. The low promise of areas off Turkmenistan and Iran inclines those countries to struggle for a sharing of the Caspian's petroleum wealth.

For Russia and Iran the issue of the Caspian Sea's status is also an important geopolitical question. With various degrees, both countries consider the Caucasus and Central Asia their spheres of influence and oppose Western presence.

Recent developments in the debate over the Caspian's legal status suggest progress toward a resolution. Azerbaijan and Kazakhstan, now joined by a reluctant Turkmenistan, seem to have persuaded Russia to agree on sectoral division of the Caspian Sea.

This is significant for Russia, the foreign ministry of which proclaimed after Azerbaijain signed the AIOC contract in September 1994 that "unilateral actions in the Caspian Sea are illegal." Since then Russian companies have become participants in several major projects offshore Azerbaijan and are positioning themselves to get concessions off Kazakhstan and Turkmenistan.

Russia has gone as far as to agree to divide the seabed into national zones, reserving the water column and resources on the seabed to joint use. An agreement between Russia and Kazakhstan dividing their respective national zones at the seabed was scheduled to be signed in late April 1998 in Moscow but was postponed until early July when President Boris Yeltsin will visit Kazakhstan and in any case remains uncertain.

The policy shift reflects a change in Moscow's strategy towards the region. Moscow realizes that Caspian Sea hydrocarbon reserves will be developed with or without Russia's consent and that such development may not necessarily be bad for Russia.

Although Azerbaijan has stated that the Russian-Kazakh deal is a significant step forward, it will not join the announced agreement. Baku insists on division of not only the seabed but also the waters and surface and wants the Caspian Sea demilitarized, an offer not likely to be welcomed by Russia or Iran.

The dispute over the Caspian's legal status nevertheless seems to be approaching its end. With Russia, Azerbaijan, and Kazakhstan on one side, Turkmenistan and Iran have little choice but to join the agreement.

Questions over ownership probably will be answered in a fashion acceptable to most of the littoral states. The governments then will be able concentrate on the larger struggle over control of evacuation routes.

Pipeline to Turkey?

U.S. policymakers do not want Caspian oil and gas production to depend upon Iran for transit to Western markets. Kazakhstan's Nazarbayev has stated tentative support for the Baku-Ceyhan route but made clear that the Iranian route remains an option.

Azerbaijan's Aliyev has voiced stronger support for the U.S. position. During official celebrations of his 75th birthday on May 10, he said, "I declare today that the main oil pipeline will go along the route Baku-Georgia-Ceyhan."³ Aliyev later stressed that a proposed pipeline from Baku to Ceyhan will cross "only" through Georgia, ending speculation that it might go through Armenia.

The announcement bolstered Georgia's chance to become a transit route for at least Azeri oil. With financing in place and sufficient throughput volumes, this pipeline could become a top contender because of its superior capacity and the fact that it avoids the environmentally sensitive Bosphorus.

The Baku-Georgia-Ceyhan pipeline faces a number of obstacles, however. Most importantly, it needs to have adequate volumes and a competitive cost structure to attract financing. These may require more discoveries and a pipeline across the Caspian.

Russia and Iran have objected to the Turkish route and will certainly increase their efforts to block a trans-Caspian pipeline on environmental grounds. Another uncertainty is when, and if, Iran and Iraq fully return to the world petroleum market and what effect greater output from them would have on the competitive position of Caspian production.

Developments like renewed Armenian-Azeri fighting, civil unrest in Georgia, and Kurdish insurgency in Turkey would also postpone or even block construction of the Baku-Georgia-Ceyhan pipeline. Recent Turkish army operations against a Kurdish terrorist group are reported to aim at securing southeastern Turkey for the pipeline. Most supporters of this pipeline argue that to make up the difference between the cost of the Baku-Georgia-Ceyhan pipeline and the cost of alternative routes, some kind of direct assistance is needed from Washington.

The future

On balance, the region will continue to develop in fits and starts, with slow development of democratic institutions. The major regional players, particularly Russia and Iran, cannot be fully ignored and must be accommodated in some fashion. Oil and gas will eventually move out of the region in large quantities, but it will do so under conditions that meet both economic and political requirements. As a result, some combination of multiple exit routes which balances both strategic and regional interests represents a likely outcome.

Once one or two export pipelines are built, most companies will regard the Caspian as well on its way toward becoming a favorable petroleum province.

References

1. ITAR-TASS, Moscow, Apr. 24, 1998.
2. News World Communications Inc., May 6, 1998.
3. Azerbaijani TV, Channel 1, Baku, May 10, 1998.

The Author

Elshan A. Alekberov is a principal of LPI Consulting Inc. He provides a broad range of analysis and advisory services on the former Soviet Union, ranging from evaluations of the oil and gas sector to political and strategic risk assessments in Central Asia and the Caspian basin. A native of Azerbaijan, Alekberov holds a PhD from the Plekhanov Moscow Institute of National Economy and a master's degree from the Paul H. Nitze School of Advanced International Studies of Johns Hopkins University.

Copyright 1998 Oil & Gas Journal. All Rights Reserved.