Caspian Reserves Luring Operators

Dada Gorgud semisubmersible at work in the Caspian Sea for AIOC. The unit has been used for drilling on Azeri-Chirag fields as part of the ACG field unitized development. Photo by Oleg Litvin for AIOC, courtesy Amoco Corp.

A 1997 U.S. State Department report estimates there are 178 billion bbl of proven and possible reserves in the Caspian republics of Kazakhstan, Azerbaijan, and Turkmenistan.

International oil companies (IOCs) are risking billions of dollars on Caspian area E&P.

But there are two major problems: First, ownership of the petroleum beneath the Caspian Sea is subject to conflicting national claims by the Caspian republics and Russia. Second, there is only one small export pipeline-limited to Kazakhstan production-that can transport Caspian oil to the world marketplace, and it's controlled by Russia.

The Russian petroleum export system is already jammed with Russian production. Russia considers potential large-scale production of Caspian oil as a threat to its control over the region and as competition to Russian producers. It wants continued control of all existing and future export pipelines from the Caspian area.

Resolving these two big problems will involve breaking Russia's domination of the Caspian.

Kazakhstan

In Kazakhstan, the $20 billion, 6-million bbl Tengiz project involves major players Chevron Corp., Mobil Corp., and Lukoil of Russia among other participants. Chevron has already spent more than $1.3 billion.

The Karachaganak project is an $8 billion, 1.89-billion bbl/19.2-tcf project involving Agip SpA, BG plc, and Texaco Inc., with Lukoil likely to take a 15% share.

The Kazakhstan gas pipeline system is now being operated by Bridas of Argentina, Gaz de France, and Enron Corp.

Central Asian Petroleum Ltd., owned by Indonesia's Seldco Group and Medco Energy, as well as Japan's Mitsui, has purchased Mangistaumunaigas, a government production association. Investment reportedly will be $1.5-2 billion over the next 5 years.

Amoco Corp., China National Petroleum Corp., and Malaysia's Petroliam Nasional Bhd. (Petronas) are finalists for the tender to develop the enormous Uzen Field.

Other E&P projects involve Mobil, Elf Aquitaine, Texaco, Japan National Oil Corp. (JNOC), and various independents.

Offshore Kazakhstan, the Kazakstancaspishelf (KCS) consortium is composed of Agip, BP/Statoil, Royal Dutch/Shell Group, BG, and Mobil.

Preliminary seismic results have yielded estimates of 60 billion bbl of oil and 70 tcf of gas. This is a longer term project, with production not immediately anticipated.

Azerbaijan, Turkmenistan

Off Azerbaijan, the Azerbaijan International Operating Co. (AIOC) is a consortium of 12 partners, including BP, Amoco, Exxon, Unocal Corp., Pennzoil Co., and Lukoil.

This $8-10 billion project ($1.3 billion has been spent or committed) would develop three fields containing 4 billion bbl.

Azerbaijan has recently signed contracts with Total, Elf, Mobil, Amoco, Unocal, Itochu Corp., Turkey's Turkiye Petrolleri AO (TPAO), Saudi Arabia's Delta Oil Co., Germany's Deminex, Agip, and Iran's OIEC.

These include the North Apsheron, a 9-billion bbl field, and Shah Deniz, a 2.1-billion bbl/14-tcf field (which Iran's OIEC is also involved in, along with BP and Statoil).

A consortium of Japanese companies, lead by JNOC, is also negotiating for development of the Yanan Tava and Atashkax oil fields.

Onshore, Turkmenistan has 113 tcf of proven gas reserves and substantial crude oil.

Bridas and Larmag of the Netherlands signed E&P agreements in the early 1990s.

Monument signed a production- sharing contract in 1996 covering a large portion of western Turkmenistan, and Mobil has joined the effort.

Offshore Turkmenistan, Petronas signed a production-sharing contract last year to develop three fields in the Caspian, reported to have aggregate reserves of 6 billion bbl.

Turkey's TPAO also signed an E&P agreement for the offshore.

Caspian ownership

Ownership of the Caspian underwater petroleum resources is cloudy.

The Russian section likely contains little petroleum, while the waters off Azerbaijan, Kazakhstan, and Turkmenistan contain immense quantities of petroleum.

For obvious reasons, until recently, Russia maintained the entire Caspian Sea was a "legal condominium" to be shared among all coastal Caspian Sea nations (including Russia), and that Azerbaijan, Kazakhstan, and Turkmenistan had no right to conduct independent petroleum activities anywhere in the Caspian offshore.

Russia's ambassador to Azerbaijan warned the Azeris that Russia will not accept unilateral development of Caspian Sea resources by Azerbaijan, and that Caspian petroleum development and transport issues will not be resolved until the legal status of the Caspian Sea is settled.

A few months ago, however, Russia made an enormous concession with its "doughnut" proposal. It suggested each Caspian Sea coastal nation would have exclusive rights to a 45-mile zone off its coast, and that the resources beyond 45 miles would be shared as a legal condominium.

Iran, whose offshore waters also do not appear to have much potential, is fully supporting Russia.

Kazakhstan and Azerbaijan continue to want the entire Caspian Sea split in sectors with no legal condominium. Turkmenistan appears to be supporting Kazakhstan and Azerbaijan, while objecting to the Azeri deal with Lukoil and Rosneft to develop the contested 375 million bbl Kiapaz offshore oil field.

Azerbaijan and Turkmenistan both claim Azeri and Chirag fields, which are being developed by AIOC under a contract with Azerbaijan. The ownership of several other "super-giant" oil fields is also in question.

General principles of international law provide that "seas" can be partitioned, while "lakes" are treated as legal condominiums. Although it appears that, under international law, the Caspian Sea would be categorized as a "lake," pursuant to international practice, some lakes have also been sectioned off. So international law does not provide a self-evident resolution.

The IOCs have made a heavy initial investment in the Caspian, which they will strongly resist giving up in the face of Russian demands.

Russia's influence

The Caspian CIS nations want varying degrees of political and commercial independence from Russia, but recognize that economic mutual dependency forged during the Soviet era continues to be reality.

The Caspian nations must be cautious in their dealings with Russia, whose military dwarfs their own and upon whom they continue to be economically dependent.

Since the Soviet Union broke up in 1991, the economies of the CIS and the standard of living for the people of the Caspian republics have substantially worsened. The aggregate GDP of the CIS is only 60% of what it was in 1991.

In Kazakhstan, the government is struggling to provide basic social needs, utilities have broken down, and government wages have gone unpaid. The situation in the other Caspian CIS nations is similar.

Much of the reason for the sagging economies of the Caspian area is due to the fact that Russia controls all commerce in the region, including pipelines, waterways, marine terminals, railroads, and electricity transmission.

Russia's control of the oil shipments is by far the most telling.

There is only one crude export pipeline operating from the entire Caspian area, the 200,000 b/d Atrau-Samara pipeline that connects Kazakhstan to the Russian crude oil export pipeline system.

Kazakhstan, for example, is dependent upon Russia to permit the export and sale of any Kazak crude production. Russia also dictates where all Kazak export production will be sold, forcing the sale of some Kazakhstan production to CIS refineries at less than world prices.

Because Russia's export system is itself jammed with Russian production, it limits the amount of Kazak crude it permits to transit Russia.

Another example is Turkmenistan. In the late 1980s, Turkmenistan exported 2.8 tcf/year of gas. In 1997, that volume is expected to be less than 8 bcf, and Turkmenistan will receive payment for only about one-fifth of that in cash.

Russia does not permit Turkmen gas to go to hard currency markets. Instead, Russia sends Turkmen gas to poor nations, such as Ukraine, which cannot pay for it.

Although Russian oil companies mostly have been privatized, Transneft (controlling crude oil transport), and Gazprom (gas transport), are still government-controlled entities. They are going to promote only those projects that allow Russian pipeline control to persist.

Export routes

Progress toward the "unlocking" of Caspian petroleum has been made.

But the first major new Caspian crude oil export pipeline for Kazak oil and one of the first two "early oil" pipelines for Azeri oil will cross Russia and be under de facto Russian control-providing Russian oil companies with preferential treatment in Caspian petroleum projects outside of Russia.

The Caspian Pipeline Consortium (CPC) is planned as a 940-mile, $2 billion, crude export pipeline from the Tengiz area of Kazakhstan through Russia to the Russian port of Novorossiisk on the Black Sea.

About 30% of the pipeline will utilize existing segments in Kazakhstan and Russia that must be refurbished. Initial capacity is scheduled to be 500,000 b/d, which may be expanded to 1.34 million b/d by 2014.

Political and financing problems have delayed this project since 1992. On May 16, Russia finally approved an agreement that provides for a consortium of IOCs, including Mobil and Chevron, to pay 100% of the costs in return for 50% of the equity.

Russia will hold 24%, Kazakhstan 19%, and Oman 7%. Russia's 24% stake alone is estimated to provide Russia with $23 billion in tariffs over the next 40 years.

Russia's 24% government share is supplemented on the IOC side by the privatized Russian companies Lukoil and Rosneft holding an additional 12.5% and 7.5%, respectively, in partnership with ARCO and Shell, respectively. (It has been reported ARCO and Shell will finance the Lukoil and Rosneft shares.)

It remains to be seen if Russia's various political and commercial factions will lend the project the level of support necessary for a timely completion. Russia's crude export system is already experiencing difficulty handling all of the excess Russian production resulting from the reduction of internal consumption caused by the declines in the economy.

It also is unclear how much difficulty will be encountered tankering this new capacity from the Black Sea through the Dardanelles Straits at Istanbul to world markets.

Even at full capacity, CPC will not nearly accommodate the combined production capacity of Kazakhstan, much less that of Azerbaijan and Turkmenistan.

Pending completion of CPC, Kazakhstan is upgrading the Kazakhstan marine terminal at Aktau. It has swapped oil with Iran by delivering crude to Iran's Neka marine terminal, on the southern Caspian, in exchange for Iranian oil at the Persian Gulf. It also has exported some volumes of oil via rail.

Early oil lines

There are two pipelines for Azeri "early oil."

AIOC is financing the Azerbaijan-Russian pipeline, an 850-mile, 100,000- b/d, $50 million project.

The export terminal is Novorossiisk in Russia on the Black Sea. Most of the pipeline was preexisting. Only two new sections have had to be built (about 10 km and 17 km) and equipment added to permit the flow to be reversed.

Reequipping the port at Novorossiisk will cost $100 million. Excepting the work at the port, all construction is reported to be complete.

With a nod to Russian influence in the area, AIOC agreed to this Russian- controlled route as a supplement to the other early oil route through Georgia. However, when Azeri oil was pumped to the Russian border in February, Transneft was unable to take delivery due to the political uncertainties with Chechnya (recently at war with Russia).

Chechnya is demanding that it be a signatory and an equal partner in the sharing of pipeline tariffs in connection with any transit agreement permitting Azeri oil to flow through its territory.

AIOC also is financing the Azerbaijan-Georgia pipeline, a 550-mile, $315 million project. The export terminal is Supsa in Georgia on the Black Sea. Again, much of the pipeline is preexisting. Only about 90 miles of new pipeline will have to be laid.

This pipeline is two-thirds finished, and is scheduled to be commissioned late in 1998. This 100,000 b/d project would be the first Caspian area crude line that does not run through Russia.

But the project is vulnerable to Russia's military presence in Georgia and to the internal conflicts between Georgia and its provinces of Ossetia, Adzharia, and Abkhazia.

Future export lines

The next big issue facing the Caspian republics is the route of a new crude oil export pipeline outside of Russian control.

Pressure is building for a new primary export crude oil pipeline to accommodate significant AIOC Azerbaijan production that will soon be coming on line and is scheduled to reach 800,000 b/d in 2010.

A route through Turkey direct to the Mediterranean Sea (bypassing Russia and the Black Sea) may be selected. Although AIOC was to choose the primary route by last June, it has postponed the decision.

The Russian government, including Transneft and Gazprom, does not want to lose control of Caspian petroleum exports.

Also, export of large volumes of light Caspian oil would hurt competing Russian production, which is generally heavier and more expensive to produce.

Russia would like to see the next Caspian oil export line go through Russia to the Black Sea. That approach would, however, perpetuate the conflict of interest Russia has, occupying the role of both pipeliner of Caspian crude and competitor of Caspian crude producers.

Another problem is that movement of oil via Black Sea marine terminals is limited by how much oil can safely be tankered through the Dardanelles Straits. Turkey may obstruct passage for environmental reasons or to promote its own route.

Russia has countered with a proposal for a pipeline from the Black Sea to a Greek port on the Mediterranean, bypassing the straits.

Any Russian route from Azerbaijan would also have to cross the Dagastan province of Russia, as well as Chechnya. Dagastan has political aspirations similar to those of Chechnya. The potential for terrorism directed against such a pipeline would be significant.

Other routes

A new export pipeline via Iran to the Persian Gulf might be the shortest and the most cost efficient of the available alternate routes.

The closest link of the existing Iranian pipeline system is only 70 miles from offshore Azerbaijan fields. And, unlike other potential routes, including the Turkish one, it is not exposed to immediate disruption due to war or insurrection.

The U.S., however, as part of its anti-terrorist policy against Iran, continues to use its influence (and new U.S. laws targeting companies investing in Iran) in an effort to block any project that might benefit Iran.

An alternate route from Azerbaijan through Georgia to the Black Sea is threatened by the conflicts in Georgia, and faces the problems associated with heavy Black Sea crude oil tanker traffic.

Azerbaijan has threatened to withdraw consideration of the Georgia route due to allegations that Georgia has been diverting refined oil products imported from Azerbaijan to Armenia, against which Azerbaijan (with Turkey's support) has put in place a strict trade embargo.

A $3 billion gas and crude oil pipeline project from Turkmenistan (which could also carry Kazak oil) to Pakistan and India via Afghanistan is being promoted by Unocal and Delta. Bridas is proposing a competitive line along the same route.

The potential for terrorism directed against such a pipeline would have to be considered as high. Yet Unocal and its partners are approaching the project on a very serious basis.

A 3,900-mile route from the Caspian to China's eastern coast is even being considered. It would be the longest in the world.

Japanese oil companies have reportedly offered to finance a feasibility study due to Japan's long-range concern over future Chinese coal burning, causing severe degradation of Japanese air.

This route, which could cost in the range of $8-12 billion, becomes almost "thinkable" if it is considered that, beginning with the 21st century, a 5%/year increase in Asian/Pacific oil demand is forecast.

Turkish route

A route from Azerbaijan via Georgia to the Turkish port of Ceyhan on the Mediterranean is perhaps the best bet as the next Caspian export pipeline.

Pressure is building for a new primary export crude oil pipeline to accommodate AIOC Azerbaijan production, which will soon be coming on line and which is scheduled to reach 800,000 b/d by 2010.

A route from Azerbaijan via Georgia to Ceyhan, a Turkish port on the Mediterranean (bypassing Russia and the Black Sea) may be selected. This pipeline might also export Turkmenistan and Kazakhstan oil shuttled by marine tanker or piped across the Caspian Sea.

The U.S., in an effort to support President Boris Yeltsin, advocated the Russian/Black Sea route for the CPC. For the second primary export crude oil pipeline, however, the U.S. has been touting the "Turkish route."

In May, Turkey announced it had agreed with AIOC that a 900,000 b/d crude pipeline would be built from Baku in Azerbaijan through Georgia to Ceyhan, at a cost of $2-2.5 billion. Last week, AIOC hadn't confirmed the deal.

The pipeline potentially would be threatened by the conflict between Azerbaijan and Armenia; internal conflicts between Georgia and its provinces of Abkhazia, Ossetia, and Adzharia; and Turkey's conflict with its Kurdish population.

Russia and Iran have supported Armenia over Azerbaijan. Turkey has backed the Azeris. This is one significant reason why Azerbaijan seems most inclined toward this route through Turkey.

The future

In the most likely future scenario, Russia will continue to recognize the political and commercial independence of the Caspian republics (and independent development of Caspian petroleum).

Russia will do so in return for initial export pipelines (Kazak CPC and Azeri "early oil") going through Russia and for privatized Russian oil companies continuing to be awarded with preferential treatment in connection with Caspian petroleum projects.

Russian acquiescence to the next Caspian area crude oil export pipeline (after CPC) being outside of Russian control may require granting Russia an attractive resolution of the legal status of the Caspian Sea issue.

Politics, as much as economics, will determine which direction the next big Caspian area crude oil export pipeline (after CPC) will go. But it may be from Azerbaijan via Georgia to the Turkish port of Ceyhan on the Mediterranean Sea.

Although the result of the competition between privatized Russian oil companies (and the Russian banks that finance them) and the centralized Russian government will have a significant impact on future developments, the unlocking of Caspian petroleum will require vast amounts of financing, much of which will have to come from international development agencies.

And it is clear that when Caspian oil is truly unlocked-and vast amounts of petrol dollars begin to flow into Caspian nations' coffers-the current geopolitical balance of the area will be significantly altered.

Frank C. Alexander Jr. is a Houston area petroleum consultant and attorney working on international projects. He entered private practice in 1992 after working with Arabian American Oil Co. and Union Texas Petroleum. He has been involved in numerous international petroleum transactions and drafted one of the first E&P agreements between Kazakhstan and an international oil company. Alexander is a director of the Association of International Petroleum Negotiators, and chairs AIPN's education and model provisions committees. The latter is preparing model form provisions for production- sharing contracts, tax and royalty contracts, and service contracts. Working drafts are due to be presented in Kuala Lumpur Sept. 18 and in London next March.

Copyright 1997 Oil & Gas Journal. All Rights Reserved.