Publication: Eurasia Daily Monitor Volume: 3 Issue: 118

On June 16 in Almaty, Presidents Nursultan Nazarbayev of Kazakhstan and Ilham Aliyev of Azerbaijan signed a framework agreement to create a trans-Caspian “Kazakhstan-Azerbaijan oil transport system” that would feed Kazakh oil into the Baku-Tbilisi-Ceyhan pipeline. The agreement is being described as “historic” by the signatory parties and others, including the United States, which was a driving force behind this move (Khabar, ANS, June 16).

The signing coincides with the commissioning of the Baku-Ceyhan pipeline, but the trans-Caspian transport system will not become fully operational this year. The system will be limited in its first phase to small-capacity tankers and envisages handling only 7 million tons of oil from Kazakhstan annually starting in 2007, and rising ultimately to 20 million tons per year. This agreement signifies the first serious dent into Russia’s monopoly on the transit of oil from Kazakhstan’s Caspian coast. However, it is still a small dent, relative to Kazakhstan’s overall export potential.

Trans-Caspian shipments by small-capacity tankers should be seen as a short-term palliative. Kazakhstan’s oil output is projected at 150 million tons annually after 2015, largely on the strength of the Kashagan offshore field, which is likely to start commercial production (“early oil”) by 2009. Routing that field’s output via Russia would be unacceptable from the standpoint of energy security for Kazakhstan and its partners in the transit and consumer countries. Shipping it by tanker to Baku would be the least cost-effective option. The necessary solution is a westbound pipeline on the Caspian seabed to handle the volumes from Kashagan. This can begin operating profitably at below 20 million tons annually, though it must be designed to carry a far larger volume. The output from Kashagan could amply support both the Baku-Ceyhan pipeline at its full capacity and a branch line in Georgia to reach the Black Sea for shipment to Ukraine or Romania.

Fulfillment of the “historic” promise is wholly realistic, if this transport system is not regarded merely as an adjunct to Baku-Ceyhan, but as the first significant step toward building the long-planned East-West Energy Corridor on the Caspian basin’s eastern side. Initiated by the United States more than a decade ago, and achieved only on the western shore, the Corridor project also includes:

1) Trans-Caspian westbound pipeline for Turkmen gas.

Turkmenistan’s gas output may well approach 80 billion cubic meters annually at present, from incompletely explored reserves. The trans-Caspian pipeline project envisaged an annual export volume of 16 billion cubic meters annually in the first stage (mainly to Turkey) and 32 billion cubic meters in the second stage (to countries in southeastern and central Europe). This project was shelved in the face of Moscow’s opposition (in tandem with Tehran) and the Turkmen President Saparmurat Niyazov’s prevarications, which largely stemmed from fear of Russian reprisals against himself.

In the current market environment, the gas export potential of Turkmenistan — meanwhile augmented by that of Kazakhstan — increases the commercial attractiveness of this project. Import requirements of the European Union, Ukraine, and Central European and Balkan countries demand the project’s reactivation; and energy security considerations make it imperative. Once the line would reach Georgia, two continuation options are possible and indeed are under consideration already: via Turkey to Greece and the Balkans or via the Black Sea to Ukraine and into EU territory. Russian objections to a trans-Caspian gas pipeline on legal and environmental grounds can easily be shown for what they are: poorly substantiated excuses for imposing a Russian monopsony on Turkmen and other Central Asian gas.

2) Expansion of the Shah Deniz (Azerbaijan)-Tbilisi-Erzurum (Turkey) gas pipeline.

This line is due on stream in 2007. Proven reserves at Shah Deniz, considerably exceeding the earlier estimates, now suggest that exports of more than 20 billion cubic meters per year are realistic. With the Turkish market oversubscribed, Turkey’s primary role in this project can change from that of a consumer to that of transit country for Azerbaijani’s gas en route to Greece and the Balkans.

However, Azerbaijani gas volumes — even if augmented by volumes anticipated from Kazakhstan in the next few years — are too small to meet the needs of markets targeted by Gazprom for its expansion. Governments in those countries do not seem convinced by the argument that they can hold off Gazprom while awaiting supplies from Azerbaijan and Kazakhstan. Those volumes would need to be combined with volumes from Turkmenistan in order to compete with Gazprom.

3) Extending Ukraine’s Odessa-Brody oil pipeline into Poland.

Originally intended to carry Caspian oil via Ukraine for refining in Poland and serving Central European oil product markets, the Odessa-Brody pipeline lacks Caspian oil because Russia stood in the way. Russian oil-producing companies are now using the Odessa-Brody line in the reverse direction. Restoring the line’s originally intended function would necessitate supplies of Kazakh oil via the Black Sea to Odessa and enlarging the pipeline’s annual capacity from 8 million tons to 14 million, which would make it commercially attractive and is considered technically feasible.

Two possible terminal destinations in Poland have been envisaged for this pipeline: the refining center at Plock or the port and refinery of Gdansk. The Gdansk option might now be receding, as the Polish PKN Orlen company has just acquired the majority stake in Lithuania’s Mazeikiai refinery and proposes to target northern Poland’s and northeastern Germany’s market for oil products. This leaves the Plock option for extending the Odessa-Brody pipeline; or — an alternative proposed by some Ukrainian officials — building a refinery at Brody for Kazakh crude oil. This solution would reduce Ukraine’s dependence on Russian crude oil and Russian-controlled refineries.

Opening direct access to eastern Caspian hydrocarbons through the Black Sea region is a natural basis for common U.S.-EU policies on energy security. Establishment of a Washington-Brussels consultative mechanism on Caspian energy policy is a long overdue step. Full-fledged EU involvement can turn the U.S.-initiated Energy Corridor into reality, in which case the June 16 agreement between Kazakhstan and Azerbaijan will have proven truly “historic.”