CHAPTER 12 TRANSBORDER INFRASTRUCTURE PROJECTS: CPC PIPELINE, A CASE STUDY

• Jurisdiction: United States

International Resources Law and Projects
(Apr 1999)
CHAPTER 12
TRANSBORDER INFRASTRUCTURE PROJECTS: CPC PIPELINE, A CASE STUDY
Karen Ostrander-Krug
Almas N. Zhaiylgan
Marla Valdez ¹
Krug & Sobel, LLC
Denton Hall
Denton Hall
Denver, Colorado, USA 80293
621 — 17 ^th Street, Suite 777
(303) 308-5990
Almaty, Kazakhstan
Republic of Kazakhstan
480100 Almaty
38 Dostyk Prospect, Ste. 703
(7 3272) 617-422

April 1999

Table of Contents

SYNOPSIS

I. OVERVIEW — CBC PIPELINE CASE STUDY

Geopolitical Considerations

Economic/Producer Company Consideration

Blending the Two Approaches

II. CASE STUDY

Case Study: The Caspian Pipeline Consortium (CPC)

History of the CPC Pipeline

How CPC Works

How the CPC Overcame the Obstacles

The Legal Basis, Permits and Approvals

Tariff and Rates

Political and Other Risks

Current and Future Revenue Control—How Expansions Will Be Addressed in the Future

List of Figures

FIGURE 1 Proposed Caspian Export Pipelines

FIGURE 2 Changes in Shareholder Ownership

———————

[Page 12-1]

A transborder natural gas pipeline may, on its surface, seem like a simple straightforward project. However, there are many issues, political, technical and economic, that must be overcome. Most of the pipelines built today are not transborder, they are intraborder and just connect at the border of two or more countries, each country piece with separate ownership and governed by the rules and regulations of separate governments. This creates an added layer of political risk and uncertainty for any company wishing to utilize multiple pipelines. The separate pieces of the pipeline are not treated as a "system" and the pieces may be governed and unilaterally changed in the future. There is no certainty that, for example, ten years in the future a producer's hydrocarbons can be transported through the multiple states under terms, conditions or rates that even remotely resemble the circumstances today. As an example of intraborder pipelines, none of the pipelines between Canada and the U.S. are transborder; they stop at the border of each respective country.

The most desirable pipeline, at least from a producer company's perspective, is a transborder pipeline with one set of owners and one set of rules. This is also the most difficult structure to obtain because it requires the countries and/or companies to agree on one set of principles, rules and regulations. There are several such pipelines in existence today.² This paper focuses on a case study of the Caspian Pipeline Consortium ("CPC") project. This proposed transborder pipeline is to be built spanning from Kazakhstan, through Russia to the Black Sea. It is a very strategic pipeline for Central Asia. This pipeline has had many political, technical and business issues confronting it and is probably the most highly publicized transborder pipeline in our history. Although the CPC pipeline has had a difficult start with many issues needing attention, it continues to persevere. It has overcome many complex problems and is proceeding to be built. The only way to understand and appreciate the range of problems is to understand the project.

[Page 12-2]

I. OVERVIEW CPC PIPELINE CASE STUDY

Geopolitical Considerations.

Many issues arise with any transborder project; there are no simple answers. Any new oil or gas pipeline from the Caspian area will greatly influence the region's future geopolitical orientation. Transborder pipeline infrastructure is a relatively enduring way to link countries together. Agreements, treaties and alliances can, to varying degrees, be ignored, disavowed or reinterpreted, while pipelines outlive the circumstances that produced them as "steel umbilical cords"³ that the together economic interests and often link political interests as well.⁴ This political aspect of pipelines is well understood by the countries that border on the Caspian region, as well as those inside it.⁵

Foreign policy concerns related to the regional balance of power, national security, and potential economic benefit have led four external powers to strive for export pipelines to be built across their territory: Russia, Iran, Turkey and China. A fifth county, the United States, has increased its own efforts to influence the pipeline choices, while several other countries are vying to be involved more indirectly in the transportation of Caspian oil (this group includes Ukraine, Romania, Bulgaria, Macedonia, Albania and Greece). In the middle are the Caspian states, seeking to take advantage of their influence over pipeline choices to advance their own prosperity, security and independence. Meanwhile the companies that will actually finance, build and use the pipelines are debating the technical and commercial details of the various options.⁶

This competition over pipeline routes is the central focus of most of the literature on Caspian energy politics. There are several proposed Caspian pipelines outlined in Figure 1. For the various countries the competition over pipelines boils down to the question of whether Russia will be able to maintain its current near-monopoly on the transport of oil and gas from the region. If new oil and gas pipelines go only through Russia, then Russia might be able to increase its control in Central Asia and the Caucasus. If new pipelines are built in other directions, Russia's predominance in the region will be undermined. The official U.S. policy is characterised by the stated objective of

[Page 12-4]

"promoting the independence and sovereignty of the Caspian states" by supporting a diversification of pipelines routes away from the the monopoly control of any one state.⁷

[Page 12-3]

FIGURE 1 Proposed Caspian Export Pipelines

Issues	Baku-Novorossiysk	Baku-Supsa	Baku-Ceyhan	CPC	Trans-Caspian	Chinese	Afghanistan	Baku-Iran	Aktau-Iran
Length	1,411 km	926 km	1,500 km	1,200 km	2,850 km	1,667 km	1,667 km	300 km	1,200 km
Cost	$2.5 billion	$1 5 billion	$3 5 billion	$4 5 billion	$2.5 billion	$3.5 billion	$2.7 billion	$400 million	$1.1 billion
Supply	Azerbaijan	Azerbaijan	Azerbaijan	Kazakhstan	Kazakhstan, Turkmenistan	Kazakhstan	Kazakhstan, Turkmenistan	Azerbaijan	Kazakhstan, Turkmenistan
Throughput	1.0 million b/d	1 0 million b/d	1.0-2.0 million b/d	1.3 million b/d	1 million b/d	1.5 million b/d	1 million b/d	800,000 b/d	250,000 b/d
Technical	Not challenging, Existing pipeline	Not challenging Existing pipeline	Challenging	Not challenging	Challenging, Surface of sea bottom, Deep water	Not challenging	Not challenging	Not challenging	Not challenging
Demand	East Europe	East Europe	West Europe	East Europe	East Europe, West Europe	China	Asia/pacific	Asia/Pacific	Asia/Pacific
Offtake	Europe	Europe	Europe	Europe	East Europe, West Europe	China	Asia/Pacific	Asia/Pacific	Asia/Pacific
Financial	Oil blended with Russias	Oil not blended with Russias, Lowest capital costs	Oil not blended with Russias, Shortest route to Mediterranean FROM Baku, Most expensive option — needs subsidies	Oil not blended with Russias, Delays and cost overruns problematic	Must guarantee throughput	Rail cars might be cheaper	Not financeable	Buy-back arrangement, Lack of recent financing, U.S. sanctions	Buy-back arrangement, Lack of recent financing track record, U.S. sanctions
Risks	Transit thru Russia & Chechnya, Weather at Novorossiysk, Bosporus straits congestion, Ensures passage through Volga-Don canal	Abkhazian problem, Bosporus straits congestion, Russian influence on Georgia	Direct access to Mediterranean Sea, Ceyhan port can operate all year, Strong support from US & Turkish governments, Close to Armenia & Kurdish rebels	Earmarked only for Tengiz	Transit thru Azerbaijan, not Russia, Depends on Azerbaijan MEP, Numerous transit countries, Legal status of Caspian Sea	Environmental, near Lake Balkhash, Chinese need local infrastructure	Force majeure	Competitor, OPIC's second largest producer, Legal status of Caspian Sea	Competitor, OPIC's second largest producer, Legal status of Caspian Sea

Iran is another important concern for the balance of power perspective, but there is a sharp divide over how it fits into the picture. Iranian export routes from either side of the Caspian Sea have the advantage of directness, and they do not pass through areas where Russia can bring substantial political or military pressure to bear. However, the U.S. has taken a very strong position opposing any pipeline development through Iran.

Turkey is another key player in the regional balance of power. The idea of building a pipeline from Baku to Ceyhan has gradually grown into a top foreign-policy priority for Turkey. Such a pipeline would not only bring economic and political benefits, but it would also divert new Caspian oil away from Black Sea ports, thus preventing the possibility of large increases in tanker traffic through the Bosporus. Steady growth through the Bosporus give Turkey two choices: first, stand by while environmental risks escalate: or second, pick an open fight with Russia by challenging the Montreux Convention.⁸ Already the Bosporus has become a point of contention between Russian and Turkey, and one of the focal points for their rivalry in the Caucasus. Russian diplomats tend to see Ankara's Bosporus gambit as nothing more than an attempt to win the Baku-Ceyhan line:

[The] Bosporus is a purely political problem: There are no real insurmountable technical or ecological problems here; it is simply that the Turks want to force the oil community to choose the Baku-Jeihan [Ceyhan] option for the transportation of "big-time" oil from Azerbaijan.⁹

China is the final external player whose position in Central Asia (though not the Caucasus) warrants attention. It is a relatively new entrant into pipeline competition, which China joined in earnest in 1997 when China National Petroleum Corporation (CNPC) won a...