The Caspian: Finding a way out

Extracting and delivering such abundant natural resources to international markets is, however, no mean feat. Formidable geographical and political challenges face companies which dare, but those that do may strike a substantial jackpot.

Of the five countries comprising the Caspian Sea region, three are landlocked – Azerbaijan to the west and Kazakhstan and Turkmenistan to the east.

Since Soviet times these three countries have been reliant upon Russia to provide an export route for their natural resources to enter international markets, and, to a lesser extent, Iran. If the Caspian energy industry is to flourish, then export routes must be diversified and agreements reached between all parties. Resolving such issues is critical.

Reserves

Whilst the Caspian region possesses significant oil and gas reserves, identifying reliable figures is a difficult business as politics plays a central role in what figures go public. 2006 EIA estimates of proven oil reserves in the region range between 17 and 49 billion barrels along with proven gas reserves at around 165.8 trillion cubic feet (TCF).

Uzbekistan’s reserves are absent from this estimate, and Russian and Iranian figures include only those reserves found in the Caspian Sea itself, so the actual figure is likely to be even higher.

Andrew Neff of Global Insight, a business intelligence firm, stresses prevalent manipulation of energy figures and the huge extent to which they have been politicised.

“Especially in the former Soviet Union countries, we really haven’t seen any change in figures of proven reserves in the last five or six years which makes absolutely no sense,” says Neff. Whilst discoveries have undoubtedly been made in recent years, when reflecting upon historical data suspicions arise. Azerbaijan serves as a prime example.

According to BP’s Statistical Review of World Energy, in 2002 Azerbaijan’s ‘proven reserves’ of oil were 7 billion barrels – this figure has remained exactly the same ever since.

Similarly, proven reserve figures for Azerbaijan’s natural gas have remained at their 1999 level of 1.28 trillion cubic metres (TCM) – dipping only temporarily to 1.26 in 2005 and 2006.

“Either they are discovering the same amounts of oil at exactly the same time as they are producing or they are fudged in the first place,” declares Neff. “No one wants to be the outlier in the Caspian so they over exaggerate…it’s the herd mentality in the energy industry”.

Whilst doubts may certainly be raised in regards to the accuracy of reserve figures, Neff admits that fields once not considered economically viable have now become feasible for production.

“With increasing oil prices I think we’re going to see more and more proven oil reserves being declared even without them having discovered more,” stresses Neff.

Whereas a decade ago Azerbaijan was the main focus of foreign energy investment, President Heydar Aliyev signing “the deal of the century” in 1994 with an international consortium headed by BP, production of both oil and gas throughout the region has increased markedly in recent years.

In terms of oil, Azerbaijan last year produced 868,000 barrels a day according to BP figures. Despite fears of a near peak in production for Azerbaijan, BP last month announced it may produce more oil than originally anticipated in the three Caspian Sea Fields it operates – know as Azeri – Chirag – Guneshli (ACG).

BP had previously estimated reserves at 5.4 billion barrels, but this figure has now risen to 9 billion barrels, thereby sustaining peak production through 2009 – 2019.

Despite BP figures estimating Kazakhstan’s proven oil reserves to be around 39.8 billion barrels, 2007 oil production was around 1.4 million barrels daily. Unlike Azerbaijan, Kazakhstan’s reserves are yet to reach anything like maturity – if anything at all.

The discovery of the Kashagan oil field in the north Caspian was widely heralded as the biggest discovery since the 1970s – with recoverable reserves that EIA estimates between 9 and 13 billion barrels in the Agip KCO consortium project.

Despite such enthusiasm, the field is yet to produce a single barrel. The project has been plagued with problems – huge delays and a soaring budget now estimated to be around US$169 billion.

As Neff points out, much blame for expanding costs and delays must be laid with the geology of the field. The recoverable crude oil contains around 16% hydrogen sulphide, and the field is ‘over pressured’, forcing workers to carry emergency breathing equipment at all times.

Complicating matters further is the harsh climate, which in summer rises above 40 degrees Celsius and crashes to -40 in winter, which results in shallow water freezing.

Regardless, if such issues can be overcome then the Kazakh government hopes their oil export figures will treble over the next 15 years.

In the case of Turkmenistan, natural gas is by far their greatest energy asset, although, until recently, largely untapped. Proven natural gas reserves as of 2007 were 2.67 TCM, according to BP statistics.

Production has risen significantly over the last few years – most recently standing at 67.4 billion cubic meters. The Caspian shelf located in Turkmenistan’s waters contains a staggering amount of untapped potential that many international energy companies – particularly in the West – are looking to invest in.

Many are still, however, somewhat hesitant to invest in Turkmen energy. “There’s the bureaucracy and the operational risk of dealing with Turkmenistan and Turkmen officials who are mainly still in the Soviet mode,” says Neff. Julia Nanay of PFC Energy, an energy advisory group, identified additional problems for Turkmenistan’s hydrocarbon development.

Like Azerbaijan ten years ago, Turkmenistan will undoubtedly face problems in finding a skilled workforce, equipment and training. They are going to need the help of their neighbours and the international oil industry. I have a feeling there’s going to be a lot of catching up to do.”

In the region at large, both oil and gas are largely exported from the Caspian in their unrefined forms due to both the price incentive to do so and the relative ease. In regards to gas, Neff notes that sour gas is fairly common in the eastern Caspian and as such, in-country refining proves necessary.

In June this year SOCAR – the Azeri state energy company announced its plans to replace Soviet-era oil and gas refineries, situated in Baku, with a new complex. SOCAR aims to raise between US$31.20 billion – $34.32 billion to fund the project that will potentially have capacity for 20 billion cubic meters (BCM) annually. Regardless, Neff argues that despite this development refining activities will amount to a negligible figure.

Maritime disputes

Despite a range of positive developments in regards to discoveries and production in the region, many stumbling blocks still remain. Disputes over maritime borders remain static and largely unresolved. As such, many overlapping or contested fields remain unexplored and resources untapped.

Whilst there is no multilateral agreement between the five countries, Kazakhstan and Russia took a positive step-forward in 2005 – signing a 50/50 production sharing agreement to cover fields in the North Caspian.

There is potential that since Kazakhstan and Russia have set a precedent and made an agreement between themselves for developing the Caspian off-shore, there is a strong possibility for a deal between Turkmenistan and Kazakhstan and Turkmenistan and Azerbaijan,” says Nanay.

“I don’t think there’s any strong will on the part of Russia or Iran to settle,” adds Nanay, “they don’t need to”. It seems that Iran remains the biggest problem for any multilateral agreement on division of the Caspian – they claim 20% of the seabed, despite likely possessing around 13%.

As Neff suggests, it seems likely that with the depletion of Azeri resources they may be the ones eventually forced to make concessions to Iran in order to secure a bilateral agreement to develop overlapping fields. As Nanay notes, this seems unlikely unless relations with the United States can be normalized. “At that point you could see a new dynamic.”

Resource nationalism

With increasing oil prices the region has seen host governments reasserting themselves and vying for greater control over their resources – alarming many international investors. Kazakhstan has, most notably, been the target of charges of resource nationalism, particularly with reference to the Kazakh government’s alleged intrusion into the resource laden Kashagan oilfield.

The relationship between the Agip KCO consortium and the Kazakh government has been turbulent with both sides claiming the other is deliberately delaying the project – the initial start-up date of 2005 has most recently been put-back until 2013.

In reaction, the Kazakhs last year revoked the operating license of Eni, the major Italian stakeholder in the consortium, demanded a substantial bonus from the consortium and, in January of this year, demanded a more significant share in profits for Kazmunaygas, the national energy company. In a largely unprecedented move last month, ExxonMobil chief executive Rex Tillerson spoke out against Kazakh government meddling.

It is time for the government of Kazakhstan to stop delaying the project, to be supportive of the consortium, and see the project through to a successful start-up.”

Kazakh President Nursultan Nazarbayev, was quick to rebuff such claims, proclaiming that he was merely defending the interests of the country. Neff supports such assertions. “There can be nationalism to a certain extent, but I don’t see there being a Latin American style full-nationalism – that would be foolish.”

It seems that governments are angling for a more substantial share of revenues. They do, however, remain acutely aware that there is a fine-line between this and antagonizing companies to the extent that they feel they have to leave.

In fact, Neff points out that with the new leadership of President Gurbanguly Berdymukhammedov since February 2007, Turkmenistan has been actively encouraging foreign investment.

Previously, Dubai-based Dragon Oil, a subsidiary of ENOC, had been one of the only foreign companies operating in the country – signing a Joint Venture agreement in 1993 – and all natural gas was exported to Russia via a Soviet-era pipeline. With western encouragement, however, Turkmenistan has been opening for business.

In August 2007 construction began on the 7000 kilometer Turkmenistan – China gas pipeline agreed between Turkmenneft and China’s CNPC, and German oil and gas group Wintershall has begun exploration.

Additionally, the government has hinted at its potential involvement in supplying gas to the Nabucco pipeline which would export gas to Europe whilst bypassing Russia.

However, with Turkmenistan still being what Neff terms “a black box mystery” investors may understandably remain hesitant.

Transit routes

The greatest hindrance to the continued development of the Caspian energy sector is the creation of new and diverse transit routes to take products to the international market. “Everything is connected to exit routes and who controls them because they’re all landlocked. The struggle is over who is going to supply these exit routes and in what timeframe,” argues Nanay.

The construction of Azerbaijan’s BP-led Baku – Tbilisi – Ceyhan (BTC) and Baku – Tbilisi – Erzurum (BTE) pipelines provides a strong precedent for further development of export routes. Such routes have allowed Azerbaijan room to develop their energy industry independently of Moscow.

Extending the energy corridor further east to Turkmenistan and Kazakhstan has proven to be one of the most prolific issues in the Caspian energy sector and the effects of doing so would be far-reaching.

It is undoubtedly Russia who has most to lose from transit export diversification. As a result, they have been actively seeking to curtail such developments.

Of late, Russia’s Gazprom appears to be on a shopping spree for gas with President Medvedev making visits to Turkmenistan and Azerbaijan in early July. Above all else, Russia fears losing its unrivaled access to Turkmen gas which it is significantly reliant on to maintain control over Ukraine and energy hegemony over Europe at large.

Turkmenistan and Kazakhstan, in particular, have been empowered with both Europe and Russia vying for over pipeline routes to deliver its energy to global markets. Desperate to persuade Turkmenistan to stand by old Russian alliances, Medvedev agreed to raise the price it pays for Turkmen gas to international market levels by 2009.

Beginning with the BTC and BTE pipelines from Azerbaijan, the west has been actively seeking to gain ready access to Caspian oil and gas without including Russia. Talks continue between Azerbaijan, Turkmenistan and Kazakhstan over the prospect of a trans-Caspian pipeline to potentially connect with Azerbaijan’s existing lines.

Problems do, however, stand in the way of such an export path. As Neff explains, without any legal maritime border agreements, it is extremely difficult to develop a trans-Caspian pipeline.

Even though technically speaking if it went through Azeri and Kazakh waters then you wouldn’t need any transnational agreements, the governments of both countries don’t feel politically empowered enough vis-à-vis Russia to be able to take on such a project.

This despite the support that the US and Europe – it seems that they’re not willing to antagonise Russia to that extent,” says Neff.

Such problems are only aggravated by the considerable differences in varieties of both gas and oil throughout the region. Most significantly, Azerbaijan’s oil is very light – somewhere in the region of 33/34 API. In contrast, much of the oil from Turkmenistan and Kazakhstan is particularly heavy.

This difference creates problems for those wishing to transport oil through Azerbaijan’s pipelines – combining the different oils would likely reduce the quality of the Azeri light.

Whilst many assume the west to be Russia’s greatest rival in its quest to buy-up Caspian gas, China has reared its head and is now flexing its financial muscles. Along with Uzbekistan, Turkmenistan and Kazakhstan have also signed agreements with China’s CNPC to construct a pan-Central Asia pipeline and the project is now underway.

The project will supply energy-hungry China with Caspian Sea gas, the majority of being sourced from Turkmenistan. “The pipeline will provide Kazakhstan and Turkmenistan with a vital safety valve against Russian dominance,” says Nanay.

Such diversification of transit routes and encouragement of international investment are critical to the future development of the Caspian and must be encouraged. Both Neff and Nanay agree that what is really needed is further cooperation between all countries in the region.

Whilst it is extremely unlikely that Iran or Russia will help, Azerbaijan, Turkmenistan and Kazakhstan can, and must, work together and allow each other’s energy an exit route out of their countries.

One thing that will not change soon is the level of corruption in the region. “Especially with these high oil prices, it’s going to be even more difficult to control how the money is spent and who it goes to. Corruption’s just a fact of life now,” admits Nanay.