Analysis of the Caspian oil scene

Despite all the hype about Kazakh oil, Kazakhstan's participation in the BTC remains uncertain. Earlier statements made by Kazakh officials notwithstanding, Kazakhstan is now leaning more strongly towards the Iran route for exporting oil from the newly discovered giant Kashagan field. With the Iran option closed for the foreseeable future, the BTC still has a chance regarding "early oil" from Kashagan.
The BTC option for early oil from Kashagan, however, faces serious challenge from a "Russian solution," which involves the use of the CPC (Caspian Pipeline Consortium) pipeline that runs across Russian territory. A new geostrategic rivalry between Turkey and Russia in the Caspian region is thus in the making.
Ever since the Organization for Security & Cooperation in Europe (OSCE) summit in Istanbul in November 1999, Kazakhstan's participation in the BTC has remained in question. During the OSCE summit, Kazakhstan President Nursultan Nazarbayev signed a protocol pledging Kazakh oil for the BTC. Subsequently, Nazarbayev clarified that the protocol was meant merely to signify intention, since new oil deposits in Kazakhstan had not yet been confirmed. That was before discovery of the giant Kashagan oil field off the Kazakh coast in the northern Caspian.

The discovery of oil in Kashagan East-1 by the Offshore Kazakhstan International Operating Company (OKIOC) in July 2000 heightened interest in Kazakh oil exports. While senior Kazakh officials indicated their preference for multiple pipelines, at times hinting at the Iran route as their favoured choice, there was widespread expectation that Kazakhstan would join the BTC.
The expectation was dampened early in October 2000 when Kazakhstan commissioned TotalFinaElf, a shareholder in the OKIOC, to study the feasibility of exporting Kashagan oil through Turkmenistan and Iran. The French-Belgian company had earlier expressed its preference for the Iran route.
Hopes for Kazakh participation in the BTC gained momentum shortly afterwards when Nazarbayev, during Turkish President Ahmet Sezer's visit to Kazakhstan, raised the prospect of extending the BTC eastward to Aktau, a Kazakh sea port on the Caspian coast. The idea was warmly welcomed by Turkey and Azerbaijan, and received strong backing from the United States. This was followed by then Kazakh Prime Minister Kasymzhomart Tokaev's declaration at the World Economic Forum in Davos in January 2001 that Kazakhstan was committed to the BTC.

A further encouraging development took place in March 2001 when Nazarbayev, under urging from the United Stares, signed a Memorandum of Understanding (MoU) in Astana confirming Kazakhstan's intention to join the BTC. American officials hailed the document as a very positive development for the east-west energy corridor long promoted by US
It did not take too long, however, for Kazakh officials to "clarify" that Kazakhstan favoured multiple routes, and that the BTC was only an option, no more. To top it off, Kazakhstan signed an MoU last summer with the Kashagan consortium to study the feasibility of a subsea pipeline across the Caspian from Aktau to the Iranian border. In the ensuing months, Kazakhstan further distanced itself from the BTC. While not ruling out the project, senior Kazakh officials became more ambivalent about their country's commitment to the BTC.
In December, Kazakh officials created a working group with Italy's Agip to study the feasibility of exporting "first oil" from Kashagan through the CPC. This pipeline, officially inaugurated in November, runs across Russia from the Tengiz field to Novorossiisk on Russia's Black Sea coast. The initiative heralded a serious threat to the BTC concerning early oil from Kashagan.

Kazakhstan's intentions became further muddled when, early this year, it was reported that Kazakhstan was to be involved in Ukraine's Odessa-Brody oil pipeline (became operational in December) -- later denied by a Kazakhoil spokesperson. Separately, representatives of Kazakh oil companies told Azerbaijani President Heydar Aliyev in December that they would not participate in the construction of a subsea pipeline from Aktau to Baku, citing high cost concerns.
The OKIOC took the name Agip Kazakhstan North Caspian Operating Company (KCO) early last year after shareholders designated Agip as the field operator. In March 2001, Agip KCO discovered oil in Kashagan West-1, effectively confirming the commerciality of the Kashagan field. The consortium is comprised of Agip (operator), British Gas, ExxonMobil, Shell, TotalFinaElf, Inpex, Phillips, BP, and Statoil. The last two are selling their interests to other investors.

Until recently, the reason behind Kazakhstan's gradual shift away from the BTC was not clear. Why was Kazakhstan, despite prior declarations from its senior officials that the country would join the BTC, now cool to the idea? Pieces of the puzzle began to fall into place in December, first in Astana and later at a talk Nazarbayev gave in Houston.
During a keynote address to a small group (including this author) at the James A. Baker III Institute for Public Policy at Rice University in Houston in late December, the Kazakh president stated that the "efficiency of the Baku-Ceyhan is not proven," and that the oil companies would make the decision on export routes for Kashagan oil. The statement was rather revealing. Also revealing was Nazarbayev's down-playing of the importance of the Iran route. The President refrained from calling this route the preferred option for Kazakhstan, noting that it was (merely) an option.
This was in stark contrast to the position he had held earlier in the month at a joint press conference with US Secretary of State Colin Powell in Astana. On that occasion, Nazarbayev, while saying that he backed the BTC, called the Iran route "most beneficial" for Kazakhstan. Nazarbayev, however, received no support from Powell on the Iran option, and the two agreed to disagree.

Viewing these developments in context, several conclusions become evident.
One, in questioning the "efficiency" of the BTC, Nazarbayev was reflecting the opinion of Agip KCO (the assessment related to Kazakh oil only). The consortium must have concluded, at least on a preliminary basis, that the Iran route was the most cost-effective for Kashagan oil.
A second conclusion is that senior Kazakh officials, including Nazarbayev himself, while personally inclined to favour the BTC, have decided to leave the choice of export routes to the oil companies. It is essentially a hands-off attitude, and it makes Kazakh officials' support of the BTC appear half-hearted. In this context, it is no coincidence that Kazakhstan's ambivalence towards the BTC became more cogent after Agip KCO was formed early last year, and the consortium started thinking seriously about the development of the Kashagan field and the options to export the crude.
A third obvious conclusion is that Nazarbayev now finds himself in a predicament. The Iran route, that he said is most suitable for Kashagan oil, is strongly opposed by the United States. Nazarbayev can ill-afford to ignore the US position on the issue.. That explains why the President, at his Houston talk, down-played the importance of the Iran route. With the memory of his public standoff with Powell fresh in his mind, and with ex-US Secretary of State Jim Baker in the audience, Nazarbayev was careful not to step on sensitive political toes by emphasizing the Iran route; it was a matter of diplomatic finesse.

While the contribution of Kazakh oil would be advantageous for the BTC, its absence would not adversely affect the commerciality of the project. This was made amply clear by Lord (John) Browne, CEO of BP, during the "Story of Three Seas" conference in Istanbul last summer. Lord Browne declared that the BTC is commercially viable even without Kazakh oil. BP leads the Azerbaijan International Oil Company (AIOC), developing Azeri-Chirag-Guneshli fields (ACG) in Azerbaijan, and the BTC sponsor group, and is a major shareholder in both.
David Woodward, President of BP Azerbaijan, said in December that oil companies investing their own funds in the BTC could expect 20-30 % profit -- an attractive return by oil industry standards. LUKoil's own analysis reportedly indicates 24 % profitability. Currently, detailed engineering studies for the BTC are underway, and construction is due to start in June for completion in early 2005. Some 41 companies have pre-qualified to bid for construction in the Turkish sector.

As a project, the BTC has reached the point of no return, in terms of practicality and economics, and would not be deflected even if the Iran option became available. What would be affected by Kazakh oil, however, is the BTC's output. Without Kazakh oil, and unless new Azeri oil reserves are discovered in the near future, it is unlikely that the BTC will reach the planned 1 mm bpd peak capacity.
It would still have been possible if the Shah Deniz gas-condensate field in Azerbaijan could have been fully developed in synergy with the ACG fields, making condensate liquids from the former to be contributed in maximum amounts to the BTC. The opportunity was missed when Turkey agreed to purchase Shah Deniz gas from Azerbaijan last March in amounts that make it impossible to fully develop Shah Deniz in synergy with ACG. The volume of gas Turkey contracted to purchase from Azerbaijan is significantly below the production capacity of Shah Deniz.
The contribution of Kazakh oil to the BTC would also be helpful in attracting new investors to the project. New investors have been encouraged to join the BTC to reduce Azerbaijan's national oil company SOCAR's current 45 % stake in the project to 25 %. After the sponsor group was formed in October 2000, Italy's ENI (parent company of Agip), with 5 % interest, was the only new (non-AIOC) company to join the group, although ChevronTexaco, TotalFinaElf, and LUKoil (member of AIOC) have also considered joining. More recently, Shell and Russia's Yukos have expressed interest.

Oddly enough, a Kashagan-BTC nexus, while not favoured by Agip KCO, may still materialize to a limited extent, but that would require overcoming competition from the CPC. The envisioned connection is one that involves transport of "early" Kashagan crude from Aktau to Baku via barges and tankers across the Caspian.
As it became obvious from President George W. Bush's State of the Union address last month, when he called Iran one of the "evil" countries, Tehran-Washington relations have lately taken a turn for the worse. The prospects of US sanctions against Iran being lifted in the foreseeable future are therefore almost nil. While this may not deter Kashagan consortium members such as TotalFinaElf and possibly Agip from expanding business with Iran (TotalFinaElf was the first foreign oil company to ignore US sanctions, entering Iran in 1995), it would be a hindrance for American firms ExxonMobil and Phillips, and a disincentive for other members of the consortium.
With the Iran impasse in the background, the consortium members are in no hurry to finalize their decision on the choice of export pipeline(s) from Kashagan. They will want to wait out political developments involving Iran. They have added incentive to delay their decision pending developments in Afghanistan and its neighbours, that, given stability, could influence pipeline choice.
On the other hand, Kashagan production ("early oil") is scheduled to start in 2005, and the consortium must soon decide on a suitable export route for this oil. A temporary solution for early oil is needed, leaving the decision for a more permanent solution, involving pipeline(s), for a later date.

One way to transport early oil is to use tankers and barges from Aktau to Baku. To facilitate this alternative, the United States has financed studies aimed at upgrading port facilities at Aktau and Dubendi, the latter a tiny port on the Absheron peninsula in Azerbaijan.
The Aktau-Baku surface transport solution for early oil, however, faces competition from the CPC, which Kazakhstan is also considering. The CPC's capacity is at present 600,000 bpd, and will eventually be expanded to 1.34 mm bpd by 2015. Although Kazakhstan currently faces the under-utilization of its pipeline network to the tune of 280,000 bpd, as production from Karachaganak's gas-condensate field increases and other Kazakh fields go on-stream, the excess capacity may disappear by 2005.
If this materializes, the CPC's capacity expansion could be expedited by 2005 to accommodate early oil (probably as much as 200,000 bpd) from Kashagan. If excess capacity continues, the CPC could readily receive early oil from Kashagan. In either case, the CPC would pose serious competition to the Aktau-Baku surface transport alternative.

If the CPC alternative is implemented ("Russian solution"), Turkey would be the obvious loser, both strategically and economically. To a lesser extent, Azerbaijan and Georgia would be on the losing side as well. The final decision on Kashagan's early oil may depend as much on cost considerations as geopolitics.
Here, the US role may be crucial. Although American-Russian relations have improved since the Sept. 11 terrorist attacks, and US has supported the CPC, the United States would be loath to see greater Russian dominance on the Caspian oil scene, and be equally reluctant to see its efforts to promote the east-west energy corridor stymied.
A compromise solution, splitting Kashagan's early oil between the BTC and the CPC, is not out of the question. That could mean the BTC receiving some 100,000 bpd peak contribution from Kazakh sources.

Beyond early oil, the transport of Kashagan crude, depending on reserves, will require construction of one or more pipelines, through Iran, Russia, Afghanistan and possibly China. With (recoverable) reserves possibly as high as 10-12 bn barrels of oil, two or three pipelines appear likely.
The Russian route may involve a bypass option to the Bosphorus (e.g. the Albanian-Macedonian-Bulgarian project known as AMBO), linkage to Ukraine's Odessa-Brody pipeline, or exit at a Baltic Sea port. ExxonMobil and ChevronTexaco, both big players on the Kazakh oil scene, are seriously considering underwriting the AMBO project.
A trans-Caspian subsea pipeline connecting Kashagan to the BTC, while favoured by the United States, currently stands little chance because it is opposed by the oil companies. Russia, too, is against such a pipeline, purportedly on ecological grounds; not surprisingly, Iran is opposed as well.

Regardless of which pipeline route(s) is (are) selected, huge financial stakes, coloured by geopolitical considerations, even intrigue, will be involved in the export of Kashagan oil. The financial stakes will be further magnified by virtue of the fact that Kashagan also holds significant gas reserves linked to oil production. The export game will be interesting to watch -- certainly no less interesting than the one witnessed with Azeri oil.
In the meantime, a simmering rivalry between Turkey and Russia, which is likely to intensify over time, will liven the scenery. WhileTurkey stands a fair chance regarding early oil from Kashagan, its chances of becoming one of the main transit routes for Kazakh oil appear slim.