CENTRAL EUROPEAN PROJECTS COULD ALTER OIL MOVEMENT PATTERNS

Etienne H. Deffarges, Donald J. Howard, John E. Treat
Booz Allen & Hamilton
San Francisco

Several oil transportation projects are set to transform the flows of oil in Central Europe, with potentially important implications for crude oil and product prices in the region.

These projects are spurred by the desires of the newly opened economies of Central Europe to diversify their sources of oil supplies away from the U.S.S.R. and by expectations of economic growth in this region.

Today, Central European countries (Poland, Czechoslovakia, Hungary, Yugoslavia, Romania, and Bulgaria) rely heavily on Soviet crude supplies. Of the 1.7 million b/d of crude oil consumed by these six countries, about 55% is imported from the U.S.S.R. This is down significantly from the more than 75% import dependence in the mid-1980s.

This dependency on U.S.S.R. crude-for countries that either have a history of indigenous production (Romania) or access to Middle East or North African supplies (Yugoslavia)-testifies to more than 40 years of centrally planned economics in which Moscow provided the energy and raw materials and Central European countries delivered finished goods.

Since the end of World War 11, the pipeline flow of crude oil and products from Western to Central Europe has been almost nonexistent.

In fact, the Western European crude and product pipeline network itself is a rather poorly integrated system, with only limited interconnections between northern and southern networks and no real competition across the major flow routes.

For example, crude and products flowing south from Rotterdam and Wilhelmshaven do not compete with flows moving north from the main Mediterranean ports.

Beyond providing supply diversification options away from the U.S.S.R. for Central European countries, the many pipeline projects considered by these countries are likely to have an important secondary effect: creation of an integrated network for the whole of Europe and increased competition for crude and product supplies throughout.

EUROPEAN TRANSPORTATION

There are today three very distinct oil and product transportation networks in Europe (Fig. 1).

In Northern Europe, the pipeline network is anchored around Rotterdam in The Netherlands-the largest port in the world-and Wilhelmshaven in Germany. Crude and products flow from there to the northern and central areas of Germany and to Benelux.

The Rotterdam-Rhine pipeline (RRP) and the Northwest Oil pipeline (NWO) can bring up to 700,000 b/d of crude to the Ruhr area, the largest industrial region of Germany.

The Rhein-Main Rohrler tung (RMR) can deliver an additional 250,000 b/d of refined products to central Germany (Ludwigshafen).

The major economic area around Paris is directly supplied from the French port of Le Havre, its refineries, and a separate set of product pipelines (Trapil).

In southern Europe, the ports of Fos-sur-mer (near Marseilles) and Genoa can together supply up to 2.4 million b/d to France, Italy, Switzerland, and southern Germany.

The Southern European Pipelines (SEPL) can transport up to 1.3 million b/d of crude from Fos to central and eastern France, and the Central European Pipeline (CEL) can carry up to 1.1 million b/d to Northern Italy, Switzerland, and Ingolstadt in southern Germany, where it connects with the Trans-Alpine pipeline (TAL).

Thus, crude landing in Fos or Genoa can flow al I the way to Mannheim (via Strasbourg on the SEPL) or Ingolstadt and Karlsruhe (on CEL and TAL), but the lack of a crude oil pipeline between Mannheim and Cologne (end of the RRP line) prevents any major north-south connection for crude flows (on the assumption that no crude is transferred down the Rhine to southern pipelines).

Similarly, almost 2 years after the fall of the Berlin Wall, there remains a virtual wall between the Western European pipeline system and Central European countries. No crude oil or products can flow between the Friendship (Druzba) pipeline system (a three-pipeline configuration) and the eastern ends of TAL and AWP (Table 1).

The only exception to the current absence of east-west flow is the result of the reunification of Germany, the eastern part of Germany being connected to the northern branch of the Druzba network-but not, despite close proximity to the Czech border, to the Druzba I line.

This situation makes it difficult for Poland, Czechoslovakia, Hungary, Yugoslavia, Romania, and Bulgaria to implement credible supply alternatives from their current dependence on Soviet crude (Fig. 2).

LESS SOVIET OIL

Political, economic, and technical factors all contribute to render obsolete the historical Soviet-Central European trading relationship.

Politically, with the end of the Comecon, the Soviet Union is no longer willing to protect its foreign allies against the volatility of world oil prices. This means payments in hard currency instead of rubles and the end of decades of relatively comfortable trading terms for Central Europe.

The Soviets now require hard currency payment for crude but are, in fact, extending some barter terms to the Central European countries.

During the necessary transition phase, Central Europe becomes a low-priority destination for Soviet oil exports because the Soviets would much rather earn desperately needed dollars selling crude to countries which can afford to pay in hard currency.

Economically, all Central European countries are experiencing difficult transitions to market-based systems and have serious problems (debt, inflation, deficits, shortages of hard currencies, etc.). If they must start paying in dollars for their energy imports, then they will want at least to achieve better supply diversity and reliability in exchange for the additional economic burden.

Furthermore, there are some serious technical problems in the Soviet Union which, all other things being equal, would in themselves be enough to reduce the flow of crude oil going to Central Europe dramatically.

Production woes (aging basins, high water-to-oil ratios, severe corrosion problems as a result of excessive use of water flooding, and inefficient service-supply capabilities) and serious maintenance problems on the Druzba pipeline system have caused U.S.S.R. oil exports to Central Europe to fall from a high of 1.6 million b/d in 1989 to a projected less than 1 million b/d for 1991 (including eastern Germany).

Therefore, all Central European countries have compelling rationales to shift their U.S.S.R. supply dependency to more balanced oil-import schemes. The catch is that this much desired diversification carries a hefty price tag and involves historically charged political issues.

The cost of a span connecting one of the Northern or Southern European pipeline networks to a crude oil line in Central Europe, even if it is only 100 km long or so, can be more than a $100 million. It is therefore not surprising that of all the former Soviet client states in Europe, eastern Germany is the most likely to achieve supply links to non-Soviet supplies.

(Transportation options for eastern Germany include new spurs to the ports of Wilhelmshaven, Rostock, and Gdansk. Rostock is a shallow port and may not prove to be a viable option.)

Even more daunting than the cost of new proposed crude oil and product links are the political issues involved in Central Europe. The conflicts between Yugoslav republics, current tensions between the Czechs and Slovaks, Slovaks and Hungarians, Hungarians and Yugoslavs, all undermine the current supply arrangements.

For example, the Czechs feel that Czechoslovakia's geographical position at the tail end of both the Druzba I and the Adria pipeline systems may allow the Hungarians (and the Slovaks if relationships between the two main regions of Czechoslovakia continue to deteriorate) to extract hefty transmission premiums from them.

As a result, new pipeline spurs may be built to alleviate perceived dependencies on ethnic or cross-border rivals at the expense of optimal distribution economics. It is therefore difficult to predict which new pipeline project will contribute to improving the crude-supply economics of the region, as opposed merely to developing out of political rivalries.

The list of transportation projects currently in the planning stage to enable Central European countries to achieve both supply diversification objectives and a reduction in perceived dependency from regional rivals indeed looks impressive on paper (Table 2).

TRANSPORTATION PROJECTS

Many of the proposed projects involve constructing new pipelines or utilizing existing infrastructure to increase flows from Western Europe to the east (Fig. 3).

Another significant project involves dredging a new canal to link major existing waterways. In addition, more unusual opportunities result from the radical changes in the political and economic climate of Central Europe.

Perhaps the most likely pipeline project to be completed is the project to link the Czechoslovakian Slovnaft refinery at Bratislava with OMV's Schwechat refinery, a mere 60 km away in Austria near Vienna. Both a crude and a product connection are being considered.

The Schwechat refinery is connected to the Adria-Wien pipeline (AWP) which branches off from TAL and transports crude northward from the Italian port of Trieste: up to 80,000 b/d of crude supplies could be moved to the Bratislava refinery this way. The products line may be extended to the Danube refinery near Budapest.

Another very likely pipeline project being considered is the connection of TAL at Ingolstadt with the northwestern Czechoslovakian refineries in Litvinov and Kralupy. These refineries are currently being supplied through a branch of the Soviet Druzba 1 line.

The 300-km interconnect could deliver up to 200,000 b/d of crude from the Italian port of Trieste to Czechoslovakia and could displace nearly 80% of Soviet imports to this country. This project is expected to go ahead if the Czechoslovakians can obtain financing for the $250 million project-potentially from the World Bank, the European Community, or the European Bank for Reconstruction and Development, or a combination of these sources.

In conjunction with the proposed TAL spur is a project to reverse the flow of the Druzba 1 pipeline within Czechoslovakia.

Currently, about 250,000 b/d of Soviet crude flows west through the line from the Czech-U.S.S.R. border to the southern refinery in Bratislava and the northwestern refineries of Litvinov and Kralupy.

With reversal of the line, crude from TAL could flow southeast to the Bratislava refinery, through the proposed spur to northwestern Czechoslovakia.

In eastern Germany, several new transportation links are being planned to improve the region's connections with Baltic Sea ports and the overall crude pipeline network in Germany.

Spur lines are under consideration to connect the PCK refinery on the Oder River at Schwedt, Germany, to the Baltic ports of Rostock or Gdansk, as well as to the major German oil import terminals in Wilhemshaven.

TAL SPUR

There is also a proposal to build a new spur to the TransAlpine pipeline to move additional supplies from Trieste via Austria to southern and eastern Germany. These projects parallel planned upgrades of the former state-owned East German refinery sector.

More speculative pipeline projects are also emerging from the drawing boards:

Upgrading the Adria pipeline which carries crude from the Adriatic port of Omisalj, Yugoslavia, northeast to Hungary. The upgrade would increase the capacity of the line within Hungary by 50%.
Constructing a new product pipeline from the refineries at Hamburg to Dresden. Deutsche Shell is leading this project in conjunction with other leading oil companies.

In addition to the previously mentioned projects, two crude-supply alternatives have emerged from the easing of Cold War tensions and the political reshaping in Central Europe. One proposal concerns converting the NATO product pipeline system in Germany-which connects refineries, storage facilities, and airports-to commercial use. The system is 3,500 km long and has 865,000 cu m of storage capacity.

The end of the Cold War could allow this former strategic defense pipeline system to create a products link between northern and southern Europe.

Strategic petroleum storage facilities in the U.S.S.R. and the five former East German states could also change the crude supply picture over the longer term.

The Soviet Union has put up for sale 1.5 million cu m of crude-storage capacity, located in Hungary, Czechoslovakia, Poland, and former East Germany. This storage was used to guarantee fuel supplies for the Soviet military in Eastern Europe. With the withdrawal of Soviet forces, these storage facilities will be sold.

An additional 700,000 cu m of storage reserved for the East German national army are being offered by the German Treuhand agency-responsible for privatizing former East German state-owned assets.

The most significant long-term change in Central European crude supply may result not from a new pipeline, however, but from the dredging of a canal which would connect the Rhine-Main rivers with the Danube.

The canal would extend less than 100 km from the end of the Main River just south of Nuremburg to the Danube River near Regensburg.

This canal would connect the Rhine basin with Central Europe and allow unimpeded barge traffic from Rotterdam to Czechoslovakia, Hungary, Yugoslavia, and Romania.

This project has been partially funded by the European Economic Community and is expected to be completed by September 1992.

TRANSPORT OVERCAPACITY

If all currently planned crude-oil transportation projects are completed, significant excess capacity of crude supply could exist for many of the Central European countries considered here (Fig. 4).

We estimate that upon completion of new pipeline links to bring them crude oil landing in the Adriatic Sea (Adria upgrade or TAL spur) or the North Sea (New Rhine-Main-Danube waterway), total crude transportation capacity to Central Europe could increase from approximately 2 million b/d today to more than 2.6 million b/d.

This would be for a total demand for imports that today barely exceeds 1.2 million b/d and could fall to less than 1 million b/d towards the end of this year.

One predictable consequence would be to transform the Druzba system from the dominant carrier into the marginal supplier of crude to the region.

At the extreme, current projections indicate that upwards of 1 million b/d could flow through the new pipelines and waterways, leaving the Druzba network to carry 200,000 b/d or about 15% of its current throughput.

The best example of large potential overcapacity resulting from current pipeline projects is Czechoslovakia, which is at the crossroads of many of the proposed new links (Fig. 5).

Today, Czechoslovakia imports about 300,000 b/d, and the estimated capacity of the Druzba 1 network bringing U.S.S.R. crude oil to the country is about 400,000 b/d. Proposed projects would add 500,000 b/d:

300,000 b/d from the TAL spur and the Druzba backhaul project
80,000 b/d from the Bratislava-Schwechat connection
120,000 b/d through the Adria upgrade-on the assumption that the current capacity of this pipeline would be enough to meet both current Hungarian and Czechoslovakian needs.

Assuming about half the current Druzba capacity is lost as a result of reversal of flow between Bratislava and Prague (Druzba overhaul project), this still would leave Czechoslovakia with 700,000 b/d of import capacity. Given the current level of crude imports, this would imply a capacity utilization of only 45%.

RATE, PRICE WARS

With current capacity utilization of the major European crude pipelines already low (Fig. 6), the potential construction of many new links across Central Europe has significant implications for transport prices and, foremost, oil pricing dynamics in Central Europe.

Given the option, Central European nations would prefer to diversify crude supplies. But just how much more are they prepared to pay (or are even capable of paying) to gain access to those supplies?

The answer to that question and the future availability of Soviet export volumes is likely to dictate how much Soviet crude will be displaced by western supply lines over the longer term.

The expansion of North-South and East-West links and trade may have significant impact on the way crude and products are priced in Europe. To put it in U.S. terms, what will be Europe's Cushing, Okla., for crude oil? Will Rotterdam's traditional pricing role be challenged by intensified competition from the products trade in Central Europe?

The main issue, then, is how much are the Central European nations willing to pay to achieve supply diversification given the sunk costs and the relative underutilization of the already built Soviet oil transport system.

Relative to this key question, whether new oil supplies to Central Europe would flow from Rotterdam-Wilhelmshaven or Genoa-Trieste is a less important issue because most of the competition will take place between Soviet and western landed crudes, not between Northern and Southern European pipelines.