Azerbaijan's strategy: include many stakeholders

Pipeline diplomacy may eventually keep the peace

Victor Schmidt
International Editor

Most Viable Oil Pipeline Routes - Baku to the west. [66,586 bytes]

The Middle East and Caspian Sea regions offer some of the most contorted landscapes and political relationships on earth. In the Caspian Basin, the number of people groups and subgroups are as numerous as the constantly shifting coalitions vying for attention and resources.

But this region contains the blood of the world's economic strength - petroleum - and major quantities of it, and that quantity continues to grow as more Caspian Sea reserves are added. Global economic powers fought over resources there in two world wars and are vying to secure a piece of the pie once again.

This time the competition focuses on the Caspian Sea. And this time, the competition is economic, rather than military. Much of that competition has a referee - Azerbaijan - caught between four leading powers in the region: Iran, Turkey, Russia, and China.

To its credit, the Azeri government has turned this apparent weakness into strength by creating broad-based operating coalitions through production sharing contracts. Twelve companies from seven countries were drawn into the region when the USSR collapsed in 1991and are helping to maintain the peace, spread the financial burden, rebuild a crumbling infrastructure and share a piece of the oil wealth.

Many stakeholders

The Azeri strategy is to include many stakeholders thereby protecting the interests of all. Igor Effimoff, Pennzoil's representative in Baku, explains: "Azerbaijan recognized earlier than most others (Caspian boarder states) the ingredients necessary to attract international capital. The others are learning very rapidly."

President Aliyev and his energy ministry have done a masterful job of retaining the ethnic sphere, created by the former USSR, for operating the oil fields. By opening the new country to the international oil community, the Azeris drew in world powers, especially the US and UK, and kept regional powers off-balance. They established economic relationships, began redevelopment and shipped "first oil" to the west. Everybody wins - well done. That does not mean all is going smoothly or that all problems are solved. It is the end of the beginning of a new oil era in the region.

The Azeris have managed to create new facts on the ground in their territory, new wells in actively producing fields, and to generate export dollars. This ground truth undergirds their position of the Caspian as a "sea," with strict territorial limits between itself and the other nations, rather than a "lake," where all resources are shared.

Kazakhastan will drill an offshore well soon and will likely see its best interests served by a similar stance (it controls one-fourth of the coastline). Dagastan, immediately north of Azerbaijan, opened its shelf for licensing, claiming specific tracts as under its control. Turkmenistan, across the Caspian to the east, will shortly begin to develop its large offshore fields, further supporting the view of specific territories for oil development. Oil does not move around the Caspian as sturgeons do.

Pipeline diplomacy

Getting the oil to market is the real trick. Which markets to serve and the timing for new infrastructure are critical decisions for the viability of any pipeline project. Markets for crude exist in all directions from the region:

West to Europe
North to Russia
East to China
South to southern Asia

Each of these regions will require oil from the Caspian, but their needs will come at different times. The early markets are in Europe. For projects to develop stable cash flows, they must serve markets that can generate hard currencies.

Shipment by rail cannot meet the volumes expected to flow from the region. Rail capacity is only 20-40,000 b/d of oil. It was suitable as an early demonstration of oil flow and cooperation, not as a long-term solution.

Most pipeline projects under consideration will be built toward the west - to the Black Sea or the Mediterranean. Turkey wants to limit tanker traffic through the straits and is pushing for a large pipeline connection to the Mediterranean Sea. Europe and the US prefer this option.

Three projects from Turkmenistan are being considered: one to the east to serve China, one southeast to Pakistan, and one south across Iran to the Indian Ocean. The continuing U.S. embargo with Iran complicates any discussions, as does expansion of existing routes through Russia. Azerbaijan and the other Caspian states also want multiple pipeline options to further distance them from Russia and provide access to different markets.

The first oil shipped from Chirag Field to the Black Sea in November 1997 was by a former Russian product pipeline from Baku through Tikohoretsk to Novorossiysk. The pipeline had to be upgraded and its flow reversed at a cost of $50 million.

Frank Verrastro, Pennzoil Vice President for Government Affairs, commented on the situation: "For us (Pennzoil) on the early oil side, the reason we were willing to go with the early oil line before committing to a main export pipeline was to demonstrate to ourselves and our shareholders that we could actually get the oil out." Most Russian pipelines operate at about 50% capacity and have not been pressure tested for higher throughput, though Russia claims they can handle higher flows safely. Low capacity allows them to shift pipeline flow, when repairs are necessary.

Verrastro said a second pipeline is being built, extending west from Baku through Tiblisi, then to Supsa on the Black Sea. The line, which will cost $250 million, will be completed by the end of 1998. A port facility at Supsa is also being build. He suggested that the five most viable routes are:

Baku to Novorossiysk (on the Black Sea, now active)
Baku to Supsa (on the Black Sea, under construction)
Baku to Ceyhan (on the Mediterranean)
Baku to Turkey via Georgia (to the Mediterranean)
A bypass of the Turkish Straits via Bulgaria & Greece (west to Europe)
A bypass of the Turkish Straits via Turkey (southwest to the Mediterranean)

The first two Black Sea pipelines, delivery to Novorossiysk and Supsa, will send up to 300,000 b/d into that market. Most of this oil will back-out oil tankers from the west carrying about 200,000 b/d into the Black Sea. So the early oil will not materially affect tanker traffic through the Turkish Straits. As oil production grows, new pipeline routes will be needed. An export pipeline must be able to move at least one million b/d.

An interesting side development is the Eurasian Transit Corridor being considered by Azerbaijan, Georgia, Kazakhstan and Ukraine. The countries are discussing a form of cooperation that will open central Asia to Europe. Economic links of many types are being considered. Assuming a stable relationship or treaty develops, direct access to a unifying Europe could spur expanded trade and secure pipeline routes across south central Asia.

Mideast relationships

In other activities in the Middle East, OPEC continues to sell into a soft market after raising its overall production quota to 27.5 million b/d. This drove the world oil price down to below $16.00 per barrel during January.

Even with the threat of military action against Iraq, security of oil supply is not at risk. Saudi Arabia and the other members of OPEC still have excess capacity to feed growing demand, but will have to continue to invest in expansion. The Gulf States are opening to international oil companies for service work but not for equity positions.

Also, Iran is attempting to improve its political relationship with the US, with little effect thus far. Internal divisions between the clerical and political leadership will have to be settled before any real policy changes or improvement can take place.

Iran has good relations with Azerbaijan. It helped protect refugees by building settlement camps, when the Armenian war forced people to flee. In addition, Iran helped supply Azerbaijan when the Russians closed the border in an attempt to punish President Aliyev. The Azeris included Iran in one of the Caspian Sea consortiums that had no US corporate participation.

Iran recently opened a 200-km pipeline from Turkmenistan's Korpedzhe Field (onshore) to Kord Kuy to move natural gas into northern Iran. This is a "seed" that could grow into a major transport system to the south and east for both onshore and offshore production. Turkmenistan seeks access to the world markets and already has close ties to Iran and Afganistan.

Iraq continues its resistance to the United Nations demilitarization demands. Tensions are on the rise again with the US making threats, diplomatic pronouncements and military preparations.

US President Bill Clinton has warned of a major military strike, rather than surgical strikes to take out chemical, biological, and nuclear stockpiles. The US Congress indicated it would authorize action if it were requested.

The US is not waiting to line up allies as the previous administration did. The US position is that Iraq has had more than enough time and opportunity to comply with UN demands and has violated enough resolutions to warrant a military strike.

The serious problems in the Mideast and the proximity of armed intervention may eventually impact world crude prices, as well as enhance the value and difficulty in moving oil out of the Caspian Sea region. Long term, tensions will continue to affect political manuevering in the Mideast and gradually involve Central Asia. Or perhaps not, if Azerbaijan's success can influence the key players.

Caspian oil flows from rickety arrangement

First oil from the Azerbaijan International Oil Company (AIOC) development consortium flowed out of Chirag Field in November 1997 from an upgraded platform built by 11 companies. The consortium is developing the field from fixed platforms in 600 ft of water due to the lack of infrastructure to support subsea operations.

Drilling has been active for the last year, completing the exploration and appraisal portion of the project. Two development wells are active with a third development well being drilled, according to a Pennzoil spokesperson. The consortium expects to complete a new well every 45 days.

Dozens of wells will be needed to fully develop the fields. Azeri and Genushli fields will be explored and developed over the next five years as Chirag field is brought fully into production. The goal is to pump 800,000 b/d of oil by 2006. Such large production flows will require new pipelines.

Pennzoil has a part in the CIPCO exploration consortium with LUKoil, AGIP and AGIP/LUKoil (joint venture) developing the Karabagh Block. The first well tested gas last November and a second well is planned for April 1998. There is only one semisubmersible, the Dada Gorgud, available for any deepwater work.

A number of groups have formed a rig-sharing club to schedule their separate exploratory work. This tight situation will not change soon. A second semisubmersible, the Shelf 5, is being refurbished but will not be ready for use until late 1998. This is a good situation given the political difficulties of exporting produced oil through existing pipelines and the delays in getting new pipelines built. It also emphasizes the Azeri strategy of encouraging everyone to work together and share the pain as well as the gain.

There is a boomtown atmosphere in Baku with activity picking up stream. People are excited about growth and the additional revenue flowing through the city. More jobs are available and new shops are opening.

Igor Effimoff, Pennzoil's representative in Baku, commented: "Pennzoil has made a long-term commitment to Azerbaijan and to the region." The company is seeking additional opportunities to extend its holdings.