Political Economy of Caspian Oil and the Pipeline Game

¶ … Americans today think about the problems of getting the oil that is needed to run our economy through the rest of this century, they will no doubt find themselves thinking either about drilling for oil in Alaska - since this topic has been so much in the news over the past several months - or establishing peace in the Middle East so that oil may continue to flow from that region to the United States - a topic that has been in the news even more since the September 11 terrorist attacks.

But while both Alaska and the Middle East will no doubt remain at the center of energy policy - or at least controversy over energy policy - for the foreseeable future, we must remember that there are other important sources of energy in the world, and these too exist amid a cyclone of political controversy.

One of the most important of these areas is the oil that lies under the Caspian sea, an area of the world rich in potential oil finds that may or may not be exploited in the future.

Stauffer outlines the potential as well as the key factor that may lead to their never being developed for the Caspian reserves. For while there seems to be little disagreement amongst geologists and petroleum engineers that a supply of oil does indeed undergird this part of the world (although there have been disagreements over the quality and quantity of the deposits), it may well be that it is simply not economically possible to extract it and make a profit. And who would do so without being able to make a profit?

We address here the elementary question of whether new pipelines are in fact economical-are they pipelines or fantasy? If the projects are economically or financially infeasible, then further agonized analysis of national aspirations and interests is moot. Or, if the projects are not economical, then reality forces serious discussion in a different direction: Is there any party willing to subsidize uneconomical pipelines in Central Asia?

The question of the potential profitability of this site is to some extent a technical one. But it also involves political and social issues as well, for economic questions are never simply mathematical ones. They are combinations of the mathematical and the social.

If Caspian Sea oil is to begin showing up at a gas station near you any time soon, it will be because it has flowed through the Baku-Ceyhan pipeline. This pipeline, which was very nearly never built, has been at the center of both economic and political differences over the viability of Caspian Sea oil.

A news report released April 16 predicted the speedy opening of the pipeline:

group of international oil companies led by BP Plc. (BP) is only two months away from completing the detailed engineering for a $3 billion dollar U.S.-backed Caspian oil export pipeline, the general manager of the project said Tuesday.

Once the detailed engineering phase of the pipeline is completed, construction can begin on the line that will carry up to 1 million barrels a day of Azeri oil from the capital Baku to the Turkish Mediterranean port of Ceyhan.

In the past, critics of the 1,730-kilometer pipeline said it would never get built because a string of disappointing exploration results in Azerbaijan proved plenty of gas, but not much new oil. The critics believed that would deter investors and complicate the financing in the project.

Turkey is guaranteeing $1.4 billion for the cost of construction for its section of the pipeline, a fact that reflect the greater support that Turkey has given the project when compared with Russia's support for the pipeline.

To understand the reasons why Turkey has so strongly supported this pipeline while Russia has not requires taking a longer view of oil reserves in the region as well as the historical relationships among the countries involved - although it is perhaps dangerous to rely too much on the historical perspective as to rely upon it too little

The tale always begins with the Russians and British battling over the region in the 19th century. It then warns that the diplomatic intrigue continues today, with new powers and new spies skirmishing over the always "fabulous" oil wealth of the Caspian. The tale is no less true for being so well worn, but now there is something truly new to say. It's too early to declare the game over, with new intimations of oil war and violence in the region all the time, and no one willing to openly concede defeat. But after years of inconclusive wrangling, the Great Game is starting to yield clear national and corporate winners.

This 'great game' has consisted of moves to determine not only who owns the oil under the Caspian Sea, but who will come away with the profits involved in constructing and operating the pipeline that will pump the 70 billion barrels of oil from this region to an energy-hungry world.

Russia was - from the time it was still the Soviet Union - expected to be one of the victors in this game; the fact that this is no longer likely to be the case (which results in large measure from Russia's shrinking political and economic power on the world scene) accounts for its increasingly tepid support of the project. This does not mean, of course, that Russia will lose out entirely. It is in fact hard to lose out entirely when there is so much money to be made.

Russia appears to have beaten a tactical retreat. Its own oilfields are booming, but there's no question its influence over neighbors is weakening. Under former president Boris Yeltsin, Russia tried hard to derail Western oil development in the Caspian by sponsoring mini-wars. His successor, Vladimir Putin, has chosen to give up that fight and accept Western influence as inevitable. Moscow will still make billions from the pipelines that cross its territory, and Russian companies hold lucrative minority stakes in many Caspian fields, often partnered with Americans.

But we find ourselves getting ahead of our story, so let us take a minute to step back and examine that "great game" of Caspian Sea oil politics as it has been shaped over the past century.

Although many Americans may not realize this now, a hundred years ago the Caspian Sea region was in fact one of the most important suppliers of oil to the entire then-still-madly-industrializing world. While it is, of course, impossible to know what would have happened had there not been than unfortunate incident with the Romanov imperial family, it seems likely that if communist regimes had not pushed the Soviet Union into an increasingly isolated position over the course of most of the 20th century that this region would have continued to supply much of the energy that was needed in the West. Had this come about, no doubt the history of the past century would have been written very differently.

However, the cutting off of the flow of most Caspian Sea oil to the West was something that could only be maintained by an intact Soviet Union. Once the Soviet Unin broke up there was immediate speculation on what effect this would have in allowing Caspian Sea oil to once more wash over the West. By the late 1990s, as the political fall-out from the break-up of the Soviet Union began to settle and both new and old nations in the region began to flex their political and economic muscle, the question of building a pipeline to transport Caspian Sea oil out of the region to world energy markets began to be raised.

Because of the complex political history of the region, even the ownership of this inland sea itself is unclear:

One such problem is the question of the legal status of the Caspian Sea. In 1881, after Russia succeeded in occupying all the territories surrounding the Caspian Sea, except Iran, it concluded an agreement with Iran delimiting borders. This Russian-Iranian agreement divided the Caspian Sea between the two countries according to the Astara- Hasangulu line. After the Bolshevik revolution the Soviet-Iranian treaties of February, 1921 and March, 1940 confirmed the earlier agreements.

The agreements divided the Caspian into Russian and Iranian sectors and prohibited Iran from keeping a military fleet. Even though Iran repeatedly called the division of the Caspian unfair, these agreements formed the constitution of the Caspian Sea until the collapse of the U.S.S.R. In 1924, 1927, 1957, 1963, 1972, and 1980 additional agreements and treaties were signed between the U.S.S.R. And Iran. These agreements covered the spheres of trade, navigation and cooperation within the Caspian region. Within the U.S.S.R. The Caspian was divided between the Caspian Soviet Republics (Russian Federation, Azerbaijan, Kazakhstan, Turkmenistan) and each Republic was responsible for its own sector.

After the collapse of the U.S.S.R., Russia took the role of the U.S.S.R. while three new Caspian states (Azerbaijan, Kazakhstan and Turkmenistan) emerged, altering the previous situation with the Caspian Sea. On the surface there was an easy solution: legalization of the new status quo by confirming the previous sea borders of the former republics amongst the newly independent states, just as was done with territorial borders. However, the problem was complicated by political struggles over the new situation.

Among the key political questions that were raised a decade ago was whether the newly emerged Central Asian republics -Azerbaijan, Kazakstan, Turkmenistan, and Uzbekistan - would take their place at the top of the economic food chain of the industrialized world by becoming significant exporters of oil and natural gas. They seemed to have the petroleum reserves to be able to do so, but whether they could build the economic and political infrastructures necessary was very much in doubt.

One of the most important political questions was whether the newly independent republics had enough political muscle to go up against Russia. Each country involved is, of course, trying to get the best deal possible for itself:

Both Russia and Iran want to see the five states share the resources since their immediate offshore waters do not contain significant reserves. At first, Russia took a hard line, opposing any division of the Caspian among the five states.

Since then, Russia has proposed a condominium approach whereby the seabed would be divided into five sections, but the water above shared. This means that to start an oil project, all five littoral states would still have to vote on it beforehand.

Motivated by a feeling that oil and gas development will go on regardless of legal issues and a desire to share in Kazakhstan's success, Russia came to an agreement with Kazakhstan on demarcation lines in August 1998.

Iran, on the other hand, is still arguing for a shared seabed -- either that or a redrawing of demarcation lines that would give Iran a substantial increase in offshore reserves. Turkmenistan is reluctant to agree to divide the seabed because of three reasons: a dispute with Azerbaijan over an offshore oil field, close ties to Iran, and a lack of its own offshore reserves.

Even today, as a pipeline to bring these oil reserves to world markets seems almost a certainty, doubts about the ability of these countries to maintain control of the pipeline and the gas persist.

Much of the continuing doubts about the economic viability of the pipeline stem from the disagreements that exist among experts as to the extent and quality of the gas and oil reserves in the region. The International Energy Agency has estimated that Transcaucasia may have oil reserves of up between 15 billion and 40 billion barrels. The groups also estimates that there may be an additional 70 billion to 150 billion barrels.

The IEA thus compares the Caspian Sea findings not to the oil fields of the Middle East but to the oil fields of the North Sea: "As such, it could be a significant alternative source of oil and gas supply, helping to increase world energy security."

With so much money to be made by all of the countries concerned, one might think that they could relatively quickly have reconciled their differences. This has not proven to be the case: The same political, cultural, religious and economic differences that helped to cause the break-up of the Soviet Union to begin with have proven to be remarkably intractable.

The most problematic of the purely political problems (although of course when dealing with petro-dollars it is probably inaccurate to speak of politics and economics as being separable from each other) was probably a 1998 plan put forth by the Azerbaijan International Operating Co.. The AIOC is an international consortium that has been developing offshore fields; in 1998 it announced its plan to build a main export pipeline for Caspian Sea oil from the region.

The United States at that time - and this continues to be the case today - has argued for an "energy corridor" extending across the Caspian Sea region. This plan backed by the considerable economic and political might of the United States is in fact what has come to be called the Baku-Ceyhan pipeline because of the terminus points of the pipeline - the Azerbaijani capital of Baku and the Turkish Mediterranean port of Ceyhan.

The United States also has advocated that an additional pipeline be built in the region that would lie underneath the Caspian Sea and would funnel gas from Kazakstan and Turkmenistan into the Baku-Ceyhan pipeline. U.S. officials within the Clinton regime - and this remains fundamentally true today as well - have argued that this route makes the most sense politically given the unstable alliances in the region.

The Clinton administration has pushed the 1,200-mile Baku-Ceyhan route as an alternative to the current pipelines through Russia, or any route through Iran. Having the pipeline transit Turkey -- a U.S. ally -- is an important strategic consideration for the U.S., oil experts said.

BP Amoco, Exxon Mobil Corp., Unocal Corp. And other foreign companies have contracts to drill oil in the Caspian Sea. Some companies with contracts in the region have said they favor waiting for more oil reserves to be proven before participating in the Baku-Ceyhan pipeline.

The United States along with other international supporters of this particular pipeline plan has taken the position that this particular method of shipping the oil out of the region would increase the political and economic power of the Caspian republics (because it would give them access to world markets without being dependent on either of the regions political heavyweights, Russia and Iran).

But the U.S. government's history of backing pipelines for political as opposed to engineering reasons has not always proven to be wise, as was proven in a different region of the world a generation ago:

second fantasy which came to naught was the push 20 years ago by earlier administrations for a gas pipeline from Alaska across Canada into the northern continental United States. Termed the Alaska Natural Gas Transportation System, his project would have created market access for the large volumes of natural gas stranded on the North Slope. The orphaned gas is real, but the prospects were not. This scheme foundered for reasons parallel to those which crippled the several Caspian proposals.

Firstly, commercial backing was fragile. Shipping costs for that long distance were very high-marginally acceptable if and only if oil prices remained in the range of $30, the price which prevailed briefly after the oil shocks between 1978 and 1980.

Secondly a competitor stepped in: the Canadians proposed to build the "first leg" of the project, connecting gas fields in northwestern Alberta with pipeline grid into the U.S. Their "leg" was built. It preempted much of the market promised for Alaskan gas, and the linchpin of U.S. natural gas policy disappeared into history. A third effort at pipeline diplomacy also led to debacle, this time U.S. opposition to Russia's mega-project in the late 1970s to build four 56-inch gas pipelines from Siberia towards the west, connecting into Europe. The United States tried to stop the project, blocking sale of U.S.-designed or U.S.-licensed compressors and sending teams to convince Europeans that Russian gas was too risky. The United States was more concerned about European energy security than the Europeans themselves. Administration officials also lectured the Norwegians on the capacity and capabilities of Norway's fields, rather to the amazement of their much more competent Norwegian counterparts.

Many of those outside the region believe that a strengthening of these republics will work to make them more politically and economically stable - conditions that are devoutly to be wished in this region. The major drawback to this particular pipeline plan has always been that it will by all accounts be the most expensive of all the possible plans in terms of construction and maintenance of the pipeline itself.

The AIOC itself has at least at times advocated a shorter pipeline running to the Black Sea port of Supsa, from which Georgian port tankers could then transport the oil through the Bosporus Strait. This plan has been consistently opposed the Turkish government because of the potential environment harm that could be caused by tankers negotiating these treacherous waters.

People in Istanbul could die" if there is an accident, warned Capt. Cahit Istikbal, head of the Turkish Maritime Pilots' Association. "The Bosporus cannot take the load anymore."