Long view of Caspian oil export options tilts to Kazakhstan-China

June 7, 1999
Tengiz oil field is an example of the vast oil deposits in the Caspian Sea region that have led the international oil industry into the thorny geopolitics of exporting Caspian oil. Photo courtesy of Chevron Corp. Caspian region export pipeline politics are looking increasingly to the west. With the Caspian Pipeline Consortium (CPC) and Baku-Ceyhan options dominating the discussion, eastern alternatives are being virtually ignored (OGJ, Apr. 19, 1999, p. 29; Oct. 26, 1998, p. 29).
Richard R. Dion
Tengiz oil field is an example of the vast oil deposits in the Caspian Sea region that have led the international oil industry into the thorny geopolitics of exporting Caspian oil. Photo courtesy of Chevron Corp.
Caspian region export pipeline politics are looking increasingly to the west. With the Caspian Pipeline Consortium (CPC) and Baku-Ceyhan options dominating the discussion, eastern alternatives are being virtually ignored (OGJ, Apr. 19, 1999, p. 29; Oct. 26, 1998, p. 29).

(CPC is a Chevron Corp.-led consortium promoting a pipeline from Tengiz supergiant oil field along the Caspian Sea coast of Kazakhstan to the Russian Black Sea port of Novorossiisk; Baku-Ceyhan is the route favored by the U.S. and some Caspian nations, in which oil would move from Baku on Azerbaijan's Caspian coast to Turkey's Mediterranean port of Ceyhan.)

However, in the near future, two events could dampen this developing trend: China National Petroleum Corp. (CNPC) will complete a feasibility study concerning a Western Kazakh- stan-China pipeline, and Offshore Kazakhstan International Operating Co. (Okioc) will drill wells in the northern Caspian Sea (OGJ, Jan. 26, 1998, Newsletter).

These two events alone could reestablish the discussion of an eastern pipeline. The industry has been quite pessimistic over prospects for such a line, feeling that it is just too long and that, with the current price of oil, it would not be profitable.

With the leap in the price of oil recently, it could begin to look more attractive. In addition, given the other problems that the industry could face with Baku-Ceyhan and CPC, a pipeline to China deserves more attention.

Regional government concerns

CPC's pipeline proposal, despite its relatively easy going thus far, will face future problems, largely due to the centrifugal tendency occurring today in Russian politics.

Russia's 89 regions, oblasts, okugs, and other administrative units have taken advantage of the void in Russian authority and legitimacy that persists in Moscow.

This potential threat to centralized control from these regions was recognized in 1997, with Moscow forcing four regions (Astrakhan, Kalmykia, Stravropol, and Krasnoyarsk) that the proposed CPC line would traverse to create the authority to negotiate directly with CPC or have their federal funding withdrawn. This was 2 years ago, well before the financial crisis of late summer 1998, which is still continuing.

During an official ceremony in Moscow to launch the CPC project, Chevron Overseas Petroleum Inc. Pres. Richard Matzke was among the few present to acknowledge the local challenges that lay ahead of the project.

In early 1998, Matzke and Lukoil Pres. Vagit Alekperov toured these regions, meeting with the local administrations and governors trying to convince them of the pipeline's benefits.

With the financial crisis now having evolved into a continuing political crisis, the central authority in Moscow has lost all respectability and authority. The regional populations are growing their own vegetables to survive through the winter because pensions and other social services from the center are either insufficient or are delayed for many months. As a result, the legitimacy of regional authorities in Russia has been growing over the last several years; given the financial chaos in Moscow and the leaders there, this trend will continue.

This new type of regional authority can be seen in Kalmykia, where the 36-year old governor, Kirsan Ilyumzhinov, threatened to secede from Russia last November because his republic did not receive federal funds. (To emphasize the move's seriousness, Russian President Boris Yeltsin held an emergency session with his closest advisers at the time.) In addition, an opposition journalist investigating alleged official corruption in Kalmykia was killed in June 1998, and one of the men arrested and charged with her murder is a former aide of Ilyumzhinov.

How will these developments affect this pipeline project? Primarily, it will become more difficult to complete the project on time. The regional authorities will be acting on their own, as a type of khan in their region, meaning that each decision affecting the pipeline will have to undergo a rigorous procedure at the regional level.

Multiply this task by four (five when the central authorities are involved), and the project will have to deal with up to five authorities for a variety of issues.

The project's micromanagement will not stop with its completion. As recently witnessed with the existing Baku-Novorossiisk line, the accusation game will start. Chechen authorities in April shut down the Baku-Novorossiisk pipeline, claiming that Moscow did not pay Grozny security fees (about $4 million) it was owed for transit through Chechnya (OGJ, Apr. 19, 1999, Newsletter).

Who is to say that Kalmykia won't siphon off the oil in the long run because Moscow hasn't paid for something earlier promised? This process will definitely make the project more democratic but will extend its duration and eventually increase the pipeline's construction cost and long-term service requirements.

War all around

The Baku-Ceyhan pipeline project faces another problem, largely the civil war in the disputed Azeri enclave of (mostly ethnic Armenian) Nagorno-Karabakh. This war, despite its ceasefire-with numerous violations-over the last 5 years, is not close to being resolved. Azerbaijan will not accept any type of sovereignty for the enclave, while Armenia is pushing for a two-state approach.

Azeri President Heydar Aliyev has promised the territory's return from Armenia's grasp, but, to this point, it has not been seen as possible. Revenues from rising oil exports resulting from the recently inaugurated pipeline from Baku to Supsa, Georgia, will substantially bolster the Azeri state coffers, potentially provoking more hostilities in the long run. Armenia will have to take a calculated risk.

If Baku suddenly has the "wall of money" expected from Baku-Supsa exports, then it could build up militarily, attempting to win back Nagorno-Karabakh. In this scenario, Armenia could launch a preemptive attack (with Russian assistance) against the pipe- line, which runs close to the disputed territory.

This is increasingly likely for two reasons. First, the Baku-Supsa pipeline will become more important than Baku-Novorossiisk, as Russia will have problems with Chechnya and Caspian oil exporter Azerbaijan International Operating Co. will want to spread the risk and please Western capitals (and it is cheaper to export oil via Baku-Supsa than via Baku-Novorossiisk). Second, a large portion of the Baku-Supsa pipeline most likely will also carry Baku-Ceyhan oil, making the route more profitable. That gives it even a more likely pretext for Armenian armed intervention.

These two routes will also have to contend with more terrorism. Turkey's pipeline to Ceyhan became the target of a recent attack in the predominantly Kurdish portion of southeastern Turkey.

In addition, the Baku-Novorossiisk line was the target of a bomb in Chechnya recently. Such terrorist activities can be expected to continue.

Kazakh-Chinese pipeline merits

The advantages of the Kazakhstan-China pipeline route lie in its politics.

Whereas Baku-Ceyhan and CPC have tall orders concerning regionalism, this is Kazakhstan's trump card. President Nazarbayev, for better or for worse, has run Kazakhstan in a centripetal fashion, ensuring his state's cohesion and "streamlining" much of the nation's business through Astana.

Any pipeline across Kazakhstan's territory would have this huge advantage-a largely one-man state able to dictate activities related to this route's development. There would be little in the way of various administrations needing to approve plans, construction costs, or environmental impact assessments. Nearly everything would be done through Astana.

There is ittle doubt that Kazakhstan would (or at least should) be very favorable towards this project. With the recent economic crisis hitting Kazakhstan in April and the subsequent floating of the tenge, much of the population is suffering substantially. A part of Kazakhstan's widely unemployed population could be involved in such a project.

Logistically, the Chinese route is not a tall order. Kazakhstan's terrain is largely steppe, with mountains in the southern area towards Kyrgyzstan. However, the challenging mountain passes in Turkey (for the Baku-Ceyhan line) will provide added technical (but not insurmountable) problems concerning that project's construction and daily operation.

In addition, over the course of the pipeline's lifetime, servicing a Kazakhstan-China pipeline will be significantly easier than confronting any service problems in a mountainous area or in a politically insecure area.

An economic rationale

Does the West Kazakhstan-China pipeline have any economic merit? It does, but it must be rationalized.

With most pipelines going west, talk of a "market" is not appropriate. However, China is the most populous country in the world and will need energy to survive. This line is the only serious alternative where a real market exists.

Coal is China's predominant energy source, accounting for about 80% of the nation's energy. China is also home to about half of the world's 10 most polluted cities. With the eventual switch to cleaner forms of energy, this pipeline will become more attractive.

However, one argument against this route is that industrial centers and the population are too far away, located on China's eastern coast. This seems logical enough; however, looking at the Chinese policy of building cities in the interior just to house its own population weakens this argument.

It is true that the Xinjiang Uygur autonomous region-where the Kazakh pipeline would enter China-is sparsely populated; however, with the total Chinese population expected to peak at 1.3 billion within the next 10-15 years, the province and much of inland China will have a significantly increased population, with energy needed to serve this population.

What should be noted here is that the Chinese route's feasibility will depend on whether this line has the necessary volume. If Okioc finds significant reserves, and its work can be linked with other projects, such as successful oil exploration and development at Uzen and Aktyubinsk and in central Kazakhstan, a rationale for its construction can be justified.

Relative peace?

One possible regional problem is the native Uygur population's potential attacks. The Uygur population constitutes a majority in Xinjiang, and even the Chinese government has admitted that ethnic trouble exists there.

However, this situation could be handled differently than the problem that Turkey has with its Kurdish population. The discussions over Baku-Ceyhan have largely involved private company interests that would participate in the consortium. While the Turkish government has been adamant about the project going ahead (although its role in such a consortium is unclear), it will most likely not be involved with a stake in the consortium but will cover the difference if the construction cost surpasses $2.5 billion.

The Chinese government has shown great interest in the Kazakhstan-China pipeline, looking to become involved in its construction and operation. This is a large advantage for those who want to pass the project to Chinese control at the Chinese border. CNPC is state-owned.

To curtail the terrorist threat, a pipeline consortium could be established that constructs and operates the line only up to the Kazakh-Chinese border. Further payments concerning security and other issues could be dealt with directly by the Chinese government. Given the iron grip that the Chinese government has on the Uygur community, there is a significantly lesser threat with this line than with Baku-Ceyhan.

What about prospects for separatism and possible breakup in China and the attendant threat to such a pipeline? The comparisons with the Soviet Union are misplaced. The Soviet Union encouraged political and civil liberties before economic transformation. The population was frustrated at the economic situation and rebelled, breaking up the Soviet monolith. Moscow's responses to the economy were too little and too late.

China has taken the opposite path: Deng Xiaoping opened China to foreign development investment 20 years ago, and through enormous foreign development investment, China has been transformed. Because of these reforms, China can "afford" to lift its grip on power and proceed on a slow path to a more democratic society, substantially decreasing the threat of implosion.

Food for thought

If Okioc discovers an elephant-sized oil field, and the pipeline feasibility study looks promising, then the industry should seriously reconsider this route.

The Caspian region has drawn so much attention largely because of its complexities, mostly political. With such large investments in the balance, the simplest route should be chosen, even if it is the most expensive at the outset. Often in the energy industry, the bottom line is economics, which it should be. In these bleak days for the oil industry, it is obvious to consider the short-term costs and obligations to shareholders.

However, given the Caspian's complexities and the terms of some contracts (40 years), it might be better to consider the tortoise's approach instead of the hare's.

The Author

Richard R. Dion is an analyst based in Almaty. He is the author of The Future of the Caspian: Prospects for the Region's Oil and Gas Industry, recently published by Petroleum Economist, London. He also wrote an article for Oil & Gas Journal on the prospects for a Kazakhstan-China pipeline in 1997 (OGJ, Oct. 26, 1997, p. 29).

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