Publication: Monitor Volume: 7 Issue: 98

Earlier even than anticipated (see the Monitor, March 29, Fortnight in Review, March 30), Western companies in the Caspian Pipeline Consortium (CPC) and in the Tengizchevroil consortium are experiencing a rough ride on the Russian stretch of the Tengiz-Novorossiisk pipeline. The difficulties seem to originate in the familiar Russian mix of bureaucratic muddle and shortsighted pursuit of unfair advantage, to the detriment both of the business partners and of the Russian side’s own long-term interests.

Officially commissioned by CPC on March 26, Tengiz-Novorossiisk is the first international pipeline dedicated to moving Caspian oil to world markets. It signifies a big head start by Russia in the competition over the transit of Caspian oil. Kazakhstan’s giant Tengiz onshore field, developed by the Tengizchevroil consortium, is the main source of oil for the CPC’s pipeline in its first phase through 2010. At the moment, the pipeline is being tested and is supposed to be filled with oil. The first commercial oil consignment was scheduled to reach Novorossiisk in June. That schedule has now been thrown back by two sets of Russian difficulties.

The first centers on the issue of a quality oil bank. Novorossiisk has all along been the export terminal for the inferior-grade Urals Blend, a mix of oils from various Russian fields. The CPC pipeline, however, carries Kazakhstani oil of superior grade. The quality differential generates a significant price differential. At Novorossiisk, the Kazakhstani oil is due to be mixed with the Russian oil for export to international markets in the form of a newly created CPC Blend.

In situations like this, oil companies create an oil quality bank–a mechanism to apportion the export revenue among the individual producer companies that contributed to the blend. Under this system, each producer is compensated for the market value of its own oil in accordance with the quality and current price of that oil, higher or lower than the blend.

Western companies in the CPC and Tengizchevroil consortia, as well as Kazakhstan, had all along made clear that creation of an oil quality bank is a sine qua non to this project. Yet the Russian side dragged its feet, managed to see the pipeline officially commissioned in the absence of an oil quality bank and is still stonewalling. Such tactics suggest an attempt to profit unfairly from the higher quality of the Kazakhstani oil supplied by Western producers.

The second set of difficulties involves customs and tax issues. While official statements on this subject are not clear, there is no agreement yet regarding Russian customs duties on the oil at the Kazakhstan-Russia border, or taxation on the Russian stretch of the pipeline. Western and Kazakhstani members of both consortiums are urgently seeking a signed agreement on oil transportation on Russian territory. They also are calling on the Russian government to direct its State Customs Committee to observe the initial understandings on tax breaks for the oil at the border and to sign an agreement on customs procedure for the oil in transit.

Two weeks ago CPC consortium members went public to announce that they had, sometime in April, stopped filling the pipeline with oil and suspended the hydrotesting. They did so when the oil reached the Kazakhstan-Russia border, at which point the Russian difficulties began.

The pipeline runs for a total length of 1,580 kilometers and cost US$2.6 billion to lay. Its scheduled throughput capacity is 8 million tons in 2001, 28 million tons per year through 2010 and 67 million tons per year in a follow-up phase. The CPC consortium includes Russia with 24 percent interest, Kazakhstan with 19 percent, and Oman with 7 percent; the American companies Chevron and ExxonMobil with 15 percent and 7.5 percent, respectively; LukArco–a partnership of Russia’s Lukoil with Atlantic Richfield, the latter now a part of British Petroleum Amoco–with 12.5 percent of CPC; Rosneft Shell–a Russian-Anglo/Dutch partnership for this project–with 7.5 percent; Italy’s Agip and British Gas each with 2 percent; Kazakhstan Pipeline Ventures with 1.75 percent; and Oryx Caspian Pipeline with another 1.75 percent.

Russia stands to earn a windfall in transit revenues and collateral benefits. That consideration has apparently not dissuaded the Russian authorities from engaging in unhelpful behavior from the outset. It should, however, ultimately induce Moscow to correct the behavior.