The Caspian Pipeline Debate Continues: Why Not Iran?

• Author: Miles, Carolyn

The export of oil and gas reserves from the heavily resource-endowed Caspian states--Azerbaijan, Georgia, Iran, Turkmenistan, Kazahkstan and Russia--is an economic problem that has evolved into a complex network of geo-strategic concerns. The countries whose transit routes are eventually chosen will benefit not only from heavy capital inflows in terms of investment and transit fees, but more importantly, will gain considerable influence throughout the region. This article will focus specifically on the transportation of oil and gas from Azerbaijan and will examine the contentious option of a pipeline route via Iran.

The Azerbaijan International Operating Company (AIOC), a consortium between the Azerbaijani government and 15 international oil companies,(1) is primarily responsible for deciding the direction of the main export pipeline route (MEP), which would originate from the city of Baku in Azerbaijan. The decision on the MEP will have enormous implications for the region's future economic windfalls as well as security. Three routes are being considered for the MEP: (1) a pipeline west through Georgia then to the Turkish port of Ceyhan, (2) a pipeline west to the Georgian port of Supsa where tankers would carry shipments through the Bosporus strait or (3) a pipeline south through Iran (see Map). Due to low oil prices, political events and financing constraints, the AIOC has been unable to reach a consensus on which of these routes to choose.

The third possibility--that of a pipeline south through Iran--has been dismissed by the AIOC as a result of the United States containment policy toward Tehran. American objections have consequently swayed investment from Iran to Turkey and Georgia. The U.S. government's opposition continues despite the many potential benefits of an Iranian route, including possible future reconciliation between the United States and Iran; an inexpensive route that would quickly benefit the Caspian countries and industry players; and the potential for economic development as the catalyst for significant political change in Iran. Nevertheless, firms--both U.S. and non-U.S.--are increasingly turning to Iran because of reasonable construction estimates, changes in that country's political environment and its geographic proximity to Azerbaijan.

Choosing an Iranian route, however, does not come without risk. The memory of terrorist acts and the mistrust between Iran and the West prevent serious support of a pipeline southward. Furthermore, Western fears that Islamic revolutionaries may attempt to stir up a religious movement in the Caspian states--further binding the Central Asian states to their neighbor--have intensified U.S. resistance toward an Iranian pipeline. Yet at the same time, political instability in Turkey, ethnic tensions in Georgia and Armenia, potential environmental threats from shipping oil through the Bosporus and high construction costs are factors that are making industry players skeptical about choosing the Baku-Ceyhan or Baku-Supsa options.

As a result, AIOC members are drifting away from the U.S.-preferred route of Baku-Ceyhan. Oil prices are at a historic low because technological advancements have reduced exploration, development and production costs and because demand for oil has decreased as a result of the relatively mild weather in the Northern Hemisphere this past winter. The globally depressed energy industry has forced the AIOC to delay its decision on the MEP until the year 2003, at the earliest. David Woodward, head of the consortium, announced in February 1999 that the consortium itself would reduce operating expenditures by 20 percent in response to low oil prices.(2) With declining profits and depressed oil prices, companies are basing their decisions on the most financially affordable and timely route rather than complying with the geo-strategic concerns of the United States. The recent oil slump has also forced oil and gas companies to reevaluate the significance of the Caspian's reserves and to consider the quickest way to transport oil to Western markets. The United States needs to seriously reconsider its opposition to the Iranian route option.

THE HISTORY AND EVOLUTION OF AZERBAIJANI OIL AND GAS

Azerbaijan's oil and gas reserves have historically attracted the attention of Western investors. Discovered in the late 1840s, Baku's first offshore well is said to have been sunk on the Apsheron Peninsula. These first oil reserves were transported by tanker, rail and subsequently, by pipeline to markets via the Volga River, across the Caucasus and to the Black Sea.(3) With the incorporation of Azerbaijan into the Soviet Union in 1920, all oil and gas were exported through Russian pipelines. Once acquired, Russia ignored the rich oil fields of the Caspian states, particularly those of Azerbaijan and Kazahkstan, as attention focused on the development of oil fields in Western Siberia and the Yamal Peninsula. With underdeveloped resources, Azerbaijan and Kazahkstan became increasingly dependent on Russia for their energy needs.(4) When the trans-Caucasus states achieved independence in 1991, they were ill-equipped to guide their economies, having relied upon Moscow to manage their industries.(5) Beyond their dependence on Russia, the Caspian states were hindered further by the fact that the Caspian Sea is landlocked, which complicated the transportation of resources necessary for development.

Azerbaijan has endured a difficult transition to independence. With gross domestic product falling 58 percent between 1990 and 1995,(6) the economic output of Azerbaijan in 1997 was only one-third its 1989 level. The majority of Azerbaijani citizens continue to suffer from the depressed economy and the lack of public services and social welfare protection.(7) As a result, the government has increasingly relied on its rich resource endowments to finance its budget. The country has 300 to 800 billion cubic meters of proven gas reserves, primarily located offshore in the Caspian Sea.(8) The offshore oil resources of Azerbaijan and western Kazahkstan combined are estimated to be more than the reserves of either the North Sea or the Alaskan North Slope deposits.(9) Inland, according to the State Oil Corporation of the Republic of Azerbaijan (SOCAR), Azerbaijan has 17.5 billion barrels of oil reserves. Most sources, however, estimate that there are actually between three and 11 billion barrels.(10) For instance, despite international attention to the Caspian's plentiful resources, scholars such as Martha Brill Olcott assert that the region's oil might account for less than 5 percent of global oil consumption by the year 2010.(11) Such estimates, although not proven, offer a sobering view to industry players, who are counting on profitable investment projects in the region.

OIL AND GAS RESOURCES AS A MEANS FOR ECONOMIC DEVELOPMENT

The Azerbaijani government is dependent on the development of oil and gas reserves to drive economic development through the influx of foreign direct investment (FDI) and proceeds from oil exports. In 1996 half of the $250 million in foreign investment flowing into Azerbaijan was directed at the oil and gas sectors.(12) An additional $400 million was invested in 1997.(13) The U.S. Department of Energy estimates that $1.6 billion of FDI actually came into Azerbaijan in 1998, and it projects that by 2010, total investment in the country's energy resources could reach $23 billion.(14) For energy companies investing in Azerbaijani oil projects, the benefit lies not only in the vast resources found in the country, but also in the fact that most of the oil extracted will be available for export.(15) It is estimated that Azerbaijani domestic needs consist of 140,000 barrels per day (b/d),(16) with export capabilities estimated at 1 million b/d by 2010.(17) Therefore, international companies continue to enter the region in order to take advantage of what Azerbaijan promises to be a profitable investment. Currently, nine offshore projects are underway between the Azerbaijani government and foreign investors.(18) However, two development projects--the Caspian International Petroleum Company and North Apsheron Operating Company consortiums--were shut down in early 1999 after commercial quantities of oil were not found. The possibility of future closures due to unsuccessful exploration could significantly hinder further foreign investment.

Azerbaijani President Heydar Aliyev has lobbied the participants involved in the oil projects to diversify the foreign investment flowing into the country and to ensure that large multinational corporations are well represented. Most of these projects have been designed under production-sharing agreements in which investors undertake complete production and market risks in their shares of the projects, but maintain absolute title to these shares.(19) Due to the need for immediate financial backing, Azerbaijan has been forced to provide significant signing bonuses to these companies in the form of majority shares, leaving itself with a minority stake in most of the projects.(20) By selectively picking a diverse group of investors, however, Aliyev has ensured his political stability. He has been heavily involved in the development of energy projects, fostering close working relationships with the international companies and governments that are present in Baku. These foreign companies and governments, therefore, have supported his candidacy in presidential elections, seeing him as a reformer committed to increased market openness. Furthermore, his role as president is viewed as vital to guarantee that these companies' projects are seen through to fruition.(21) Recent alarm over Aliyev's health has produced anxiety both about a successor and a future government's commitment to honor existing contracts.

Foreign investment in Azerbaijan has also brought additional international assistance. The World Bank and...