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A ceremony took place at Sangachal, south of Baku in Azerbaijan, on May 25 to mark the commissioning of the Azerbaijan section of the Baku-Tbilisi-Ceyhan (BTC) oil pipeline. It was attended by Presidents Ilham Aliev of Azerbaijan, Ahmet Necdet Sezer, of Turkey, Mikhail Saakashvili of Georgia, Nursultan Nazarbayev of Kazakhstan, U.S. Energy Secretary Samuel Bodman, the European Commissioner for Energy Andris Piebalgs, Prince Andrew of Britain, British Petroleum President Lord John Browne, BP Azerbaijan President David Woodward and official representatives of 30 countries.

Some oil industry pundits concluded that a new Persian Gulf, the Caspian Sea, could now deliver its riches to the West unhindered by Russia or Iran. This was the start of a process which would bring massive volumes of oil to the Western markets, breaking the stranglehold of the Middle East and ensuring adequate supplies at reasonable prices for years to come. Some of us are not so sure.

Problems

The construction of a 1,768-kilometer pipeline designed to carry oil from the Caspian to the Mediterranean was first mooted 10 years ago, and its construction has not been without its problems. Many of the banks and financial institutions, which have stumped up the cash were initially wary about its prospects and considered the projected cost of $3.6 billion too low. In the event they were proved right because it will cost well over $4 billion. However an over-run of $400 million is small beer for a pipeline of capacity 50 mn t/yr, which can be raised to 90 mn t/yr when all the pumping stations have been built, and is expected to carry perhaps 3 billion tons of oil over 40 years.

The pipeline has also been completed late. It was supposed to be ready in January in time for the production of the first ton of oil from the giant Azeri oilfield in the Caspian, with the first tanker leaving Ceyhan in June. Azeri came on-stream in time, but the oil had to be pumped through the two existing pipelines from Baku to the Black Sea, for export via Novorossiisk in Russia and from Supsa in Georgia. The first tanker will sail from Ceyhan this November. However a delay of five months for a 40-year pipeline is no great problem.

Is there enough oil?

There are two big clouds on the horizon that nobody at the ceremony dared think about. Will there be enough oil to fill the pipeline, and how will Azerbaijan’s two neighbours, Russia and Iran, react? Will these two factors conspire to make the BTC pipeline one of the oil industry’s biggest white elephants?

There are two extreme views on Caspian oil reserves. One view, peddled by the political leadership of Azerbaijan, Kazakhstan and Turkmenistan and by some U.S. politicians guided more by wishful thinking than hard facts, is that the Caspian is indeed a new Persian Gulf with perhaps 11 billion tons of recoverable oil. One figure frequently encountered is 365 million tons a year; that is how much oil the Caspian is eventually expected to produce. While only 10 percent of world production, it is enough at the margin to drive oil prices down and keep them there for years to come. The other view, consistently expressed by the Russians and now increasingly accepted by some of the companies which have spent money on drilling dry wells, is that the Caspian potential has been exaggerated for political purposes.

Most of the supposedly huge oilfields were actually discovered by the Soviets in the 1970s, but it was never considered that the Caspian would be more than a minor player in the USSR’s oil plans behind the dominant Western Siberia. Even Eastern Siberia and the Russian Far East were seen as a better bet. And, although some of the geologists who found oil in Western Siberia actually came from Azerbaijan, none of them ever questioned the decision to expand into the frozen wastes of Western Siberia at huge distances from the consumers while practically ignoring the Caspian, only a short distance from major export markets. The Russians conclude that, while Azerbaijan’s sector of the Caspian has significant reserves, they are not enough to fill the pipeline. Kazakhstan has enough oil to fill it for a lengthy period, but it has better options to the east and south as well as the north, and will not save BTC from economic disaster.

The truth, as usual, lies somewhere between the extreme views. Azerbaijan’s Azeri, Chirag and Guneshli fields probably have enough oil to keep the pipeline running with a respectable usage rate for 10-15 years, and some of the other prospects in the Azerbaijan sector of the Caspian may provide significant volumes of oil. Kazakhstan has very large reserves and, if it could be persuaded to support the pipeline with 20-30 mn t/yr of oil, then there would be no problem. The persuasion process has been continuing for a number of years, and a formal inter-governmental agreement was supposed to have been signed prior to the May 25 ceremony. However it was not and, although Kazakh President Nazarbayev told the ceremony that the pipeline should be renamed “Aktau-Baku-Tbilisi-Ceyhan” — with Aktau being the Kazakh port from which this 20-30 mn t/yr would be supplied — he pointedly remarked that Kazakhstan has “other options”.

Kazakhstan

The Kazakh factor is critical. The assumption is that the giant Kashagan oilfield in the Kazakh sector of the Caspian will export its oil to the West from Aktau, initially by tanker, and later by an Aktau-Baku-underwater pipeline. After all, some of the participants in the “Agip KCO” consortium developing Kashagan are also members of the BTC company, which has built, and will operate, the BTC pipeline. It would make sense for them to use their own pipeline. With recoverable reserves of 1.25 billion tons, Kashagan is expected to produce 22 mn t/yr during the first phase, 45 mn t/yr in the second phase and 60 mn t/yr in the third phase, raising Kazakhstan’s total oil output from 59.4 mn tons in 2004 to 150 mn t/yr by 2010.

Kashagan was supposed to have started production in 2005, but after an agreement whereby Agip KCO had to pay Kazakhstan a fine for failing to meet its contractual deadline, the start-up was postponed to 2007, and 2008 now looks more likely. The problem stems largely from the slow pace of progress in creating the necessary infrastructure, especially the construction of the artificial islands from which the oil wells will be drilled. Painfully slow progress is being made in the development of other major fields. Russians and Kazakhs thought they had got round the impasse between the five Caspian littoral states over the carve-up of the Caspian’s resources by agreeing to the joint development of oilfields in the northern Caspian. Kurmangazy, with recoverable reserves of 1 billion tons, is not expected to start production before 2015.

A production-sharing agreement between the Kazakh Government and Russia’s second largest oil company, the state-owned Rosneft, should have been signed in 2004, but a new Kazakh law imposing more stringent conditions on foreign investors came into force at the beginning of 2005 and has delayed the signing of the agreement. Both sides hope that a suitable compromise can be reached for the agreement to be signed before the end of 2005, and it is then hoped that Total’s Total Kazakhstan subsidiary will take up part of the 50-percent stake belonging to Kazakhstan’s state-owned KazMunaiGaz oil company. Better progress is being made by Tyub-Karagan Operating Company BV, a joint venture set up by Russia’s largest oil company LUKoil and Kazakhstan’s KazMunaiGaz. It will work the Tyub-Karagan field with 324 million tons of oil and nearby Atashsky. The first exploration well is being drilled at Tyub-Karagan and the seismic survey of Atashskii has been completed.

Oil production is due to start in 2011. LUKoil has also joined with KazMunaiGaz to set up the Caspian Oil and Gas Company joint venture to explore and develop the Khvalynsk field, and the TsentrKaspNefteGaz joint venture between LUKoil and Gazprom has signed an agreement with KazMunaiGaz to explore the promising Tsentralnoye block. A consortium of Korean companies led by Korea National Oil Corporation has signed a protocol on the exploration and development of the Zhambyl block and ONGC Videsh of India has been offered two promising Caspian blocks. They include Block D, which consists of the existing Rakushechnoye-More oilfield and eight potential prospects near the port of Kuryk.

Kazakhstan is understandably keen to keep all its oil-export options open by supporting all the pipeline projects. A key factor influencing the government’s strategy is the likelihood that Asia, and especially China, will be the driving force behind the world oil market for the foreseeable future, and Kazakhstan is ideally placed to serve this market. It would not make sense to sign a long-term commitment to supply oil to the Mediterranean, if Kazakhstan will be able to sell every drop of oil it can produce through pipelines to the east and south.

That is why President Nazarbayev resisted enormous pressure to sign a contract in time for the May 25 BTC ceremony. This does not mean that Kazakhs will not use the BTC pipeline. They have more or less committed themselves to the supply of 7.5 mn t/yr to be shipped from Aktau to Baku in new 12,000 dwt tankers, and a series of five vessels have been ordered from the Vyborg shipyard in Russia. The French oil company Total has proposed the construction of a new oil port in Azerbaijan on the Pirsagat Peninsula and a pipeline over 43 kilometers to Sangachal so that Kashagan oil can be pumped into the BTC pipeline. However the shipment of 20 mn t/yr looks over-ambitious, and vague plans to build the underwater pipeline are fraught with technical and political difficulties, not least the likely objections from other Caspian states on environmental grounds.

Azerbaijan

The BTC pipeline project foresees its capacity eventually reaching 90 mn t/yr, but Azerbaijan is not likely to have sufficient oil reserves to sustain this level of output. It is doubtful whether it can fill the existing 50-mn t/yr capacity, because only the Azeri-Chirag-Guneshli project undertaken by the AIOC consortium is likely to produce large volumes of oil. The Chirag field has reached its projected peak of 7.25 mn t/yr, all of which is being exported through the Baku-Supsa pipeline.

The first phase, central section, of the Azeri field came on-stream in February and is expected to yield 4.8 mn tons this year, will bring total production by Azerbaijan to 20.29 mn tons compared with 15.55 mn tons in 2004. The Central Azeri platform will produce a total 193 mn tons during its lifetime and its peak production rate has been set at 18.7 mn t/yr. The field was supposed to start up in conjunction with the BTC pipeline, but delays to the latter mean that the oil is being pumped through the alternative pipelines to Novorossiisk and Supsa. Phase two foresees the western section of Azeri starting production in 2006 and the eastern section in 2007, and Phase 3 anticipates the deepwater section of Guneshli producing from 2008. Phase 2 involves a maximum 20 mn t/yr and, when Phase 3 is operational, AIOC expects to be producing a total 50 mn t/yr.

There has to be a question mark over whether they can achieve this target and, if so, then for how long. In all, the three fields are expected to yield 5.4 billion barrels (about 740 mn tons) over a period of 30 years, and this suggests that 50 mn t/yr cannot be sustained for more than three years. That is why the search for oil from other sources is so vitally necessary. However, work at other fields seems to lurch from one disaster to another. SOCAR has announced that the first exploration well drilled by LUKoil at the D-222 (Yalama) prospect has proved dry. A depth of 4,480 metres has been reached and, although drilling could continue to the projected depth of 4,500 metres, it is not expected to yield anything.

At one stage, there were 22 contracts signed by foreign companies to explore and develop blocks in the Azerbaijan sector of the Caspian. With the exception of the Shah Deniz gasfield, they have all proved to be disappointing and many have been abandoned. It looks increasingly unlikely that, apart from AIOC, anyone is going to find any worthwhile oil in the Azerbaijan sector of the Caspian. The possible inability to fill BTC raises a tricky question about the other pipelines.

Having built Baku-Supsa, AIOC will want to keep it operational, especially with the U.S. pressure to patronise Georgia’s facilities. The Russian electricity utility Unified Energy Systems has been buying up large chunks of Georgia’s electricity sector and Gazprom is eyeing its gas pipelines, so the United States will not want AIOC to abandon Georgia’s only oil pipeline and reduce Western influence still further. The Baku-Novorossiisk pipeline has a capacity of 9 mn t/yr according to its Russian owner, Transneft, (or 6 mn t/yr according to SOCAR), and SOCAR’s contract to use it foresaw throughput eventually rising to 5 mn t/yr. It has been stuck at 2.5 mn t/yr since the contract was signed and SOCAR, with oil output sinking gently from 9 mn t/yr, say that they cannot produce enough oil to meet the terms of the contract.

Russia

Azerbaijan has tried to entice Russia into dropping its hostility to the BTC pipeline by offering to pump Russian oil to Ceyhan at very favourable rates. This would involve reversing the flow in the Baku-Novorossiisk line so that Russian companies could pump up to 9 mn t/yr of oil to Baku, and then on to Ceyhan for export. This might have seemed attractive in early 2004, when Russian exports were being restricted by a shortage of capacity in pipelines leading to the ports. This problem has been resolved with the expansion of the pipeline system to Primorsk in the Baltic Sea, the use of the Ukraine’s Odessa-Brody pipeline in the reverse direction, and the greater use of the railways leading to the oil ports. The continuing problem of congestion in the Bosphorus, and the unhelpful attitude of Turkey to this problem, is to be circumvented by the construction of a pipeline from Burgas in Bulgaria to Alexandropolis in Greece to avoid the Bosphorus. One advantage of this scheme is that 300,000 dwt tankers can be loaded at the Greek port for despatch to North America. At present, tankers with a maximum of only 150,000 dwt can pass through the Bosphorus.

Iran

The Iranians, like the Russians, see BTC as a geopolitical stunt by the United States to weaken Russia’s economic grip on the Caspian. They are happy to do their bit to ruin the pipeline’s profitability and are offering an expanded swap scheme whereby Caspian states tanker oil to Iran’s Neka port for processing in its northern refineries while Iran exports an equal value of its own oil to Asian consumers from the Persian Gulf. Neka port, and the pipeline leading to Tehran, have been expanded from 6 to 10 mn t/yr and work has started on their further expansion to 18.75 mn t/yr.

The swap scheme attracted 5 mn tons in 2004. Iran is also keen to start on the construction of a pipeline from Kazakhstan’s Mangistau Peninsula southwards through the oilfields in Turkmenistan’s Balkan Province and then through Iran to the Persian Gulf. They say it would be cheaper to use than BTC and, more importantly, would allow Caspian states to export directly to China and east Asia. There is no doubt that the BTC pipeline will load its first tanker at Ceyhan in November, but the commercial viability of the pipeline is far from clear.