U.S. Department of Commerce
Office of the Counselor

Evaluating Oil and Gas Transportation Options in the Caspian Region

Remarks by Jan H. Kalicki

Counselor to the U.S. Department of Commerce and
U.S. Ombudsman for Energy and Commercial Cooperation
with the New Independent States

for the Caspian Energy Retreat, London, England

November 28, 2000

Good afternoon. It is a pleasure to be back in London for this third annual Caspian Energy Retreat. I would like to address my remarks today on "evaluating oil and gas transportation options in the Caspian region." As we all know, this subject is evolving in nature, with recent upstream discoveries and downstream developments creating a complex picture that often requires taking a broad view of the region's energy development into account. In the coming decade, sizable oil production capacity will be added in the Caspian, especially offshore Azerbaijan, Kazakhstan and also Russia. Baku is destined to serve as an oil and gas transportation hub for the region. Turkey also will play a vital role as an oil export route to Western markets and as a consumer for Caspian gas.

Just to preface my remarks, I should note that with the recent cliff-hanging election in the United States, we have come to a "changing of the guard" in Washington. Many of the U.S. officials that you have seen visit the Caspian region, including myself, will be moving on or serving in different capacities in the new Administration. From a personal standpoint, I have found my work on energy and commercial issues in the Caspian region immensely rewarding. Even with the changeover of Administration, though, I believe that there will be a general continuity of U.S. policy towards the Caspian, especially regarding issues such as commercial dealings with Iran. Now in the brief time that I have today, I would like to discuss in greater detail how we see the development of oil and gas resources and transportation routes proceeding in this dynamic region.

On the right track with the BTC pipeline

On the oil side in the Caspian, impressive progress has been made on the BTC pipeline project during the past year, starting with the conclusion of the Framework Agreements in November 1999 and culminating last month with the signing of the Azerbaijani Host Government Agreement (HGA) and Funding and Cooperation Agreement by eight of AIOC's partners. With these signings, a de facto pipeline sponsors group has been created under BP Amoco's leadership. This group will help to form the basis of a formal Main Export Pipeline Company (MEPCO), which we hope will involve the participation of the remaining AIOC partners as well as third-party producers in Azerbaijan and Kazakhstan.

The U.S. role so far has been to encourage the various parties in their negotiations. At this critical phase, however, U.S. financing and credit agencies stand willing to discuss their possible role in supporting the U.S. investors in the BTC pipeline. In early December, members of the sponsors group will meet with senior executives from the U.S. Overseas Private Investment Corporation (OPIC) and the U.S. Export Import Bank. Both of these organizations can be expected to play beneficial roles in providing financing, political risk insurance, and export credits to U.S. investors and U.S. financial institutions involved with the project.

Kashagan: The Need for Oil Export Pipeline Capacity

The issue of having secure, cost effective access to export markets is especially important for oil producers on the eastern side of the Caspian. To date, the Atyrau-Samara pipeline as well as alternative oil export methods such as rail and tanker have been key in moving Kazakh and Turkmen oil to a variety of regional and world markets. During the coming decade, however, production capacity additions in Kazakhstan will outstrip existing export outlets. Already, we have seen export constraints challenge the Tengizchevroil (TCO) venture, where until recently, production from the Tengiz field had been held to less than 200,000 barrels per day (b/d) by limited access to the Atyrau-Samara pipeline and other constraints. The Caspian Pipeline Consortium's (CPC) pipeline, with its start-up next year, will go far to overcome these export limitations.

The Offshore Kazakhstan International Operating Company's (OKIOC) recent discovery of the Kashagan field is likely to change fundamentally the long-term oil export picture for Kazakhstan. The super-giant Kashagan field -- with initial recoverable reserve estimates of more than two billion barrels -- is one of the world's largest oil finds in the past twenty years. Although an additional two-well drilling program is planned this year, questions surrounding the size of the Kashagan field's reserves probably will not be answered definitively for another two to three years, after further appraisal and delineation wells are drilled in this complex geological structure. The high flow rates of the Kashagan East-1 well and its similarity to the Tengiz field lead many observers to believe that Kashagan may be capable of producing at peak rates of 500,000 barrels per day (b/d) to one million b/d or more.

With this kind of potential production capability, the Kashagan field will need a new export outlet -- one that both offers a potential for large throughput and is cost competitive with alternative routes. When will this export capacity be needed? Some industry estimates point to initial production volumes from the Kashagan field -- possibly 100,000-200,000 b/d -- soon after 2005. As in the case of offshore Azerbaijan, a means to export this early output should be beneficial to providing the revenue stream needed to ramp up production capacity at the field. In addition, there are substantial additional volumes - perhaps 200,000-300,000 b/d - that we anticipate will be developed from projects in Kazakhstan and that will not be able to be handled by the CPC pipeline, which we also strongly support. All these are projects where the BTC pipeline can and should come into play.

Synergies Between Kashagan and BTC

With 2005, or a little after, in mind for initial volumes from Kashagan, the real synergies between OKIOC's coming need for a near-term, economically viable export outlet and the desire for third party volumes for the BTC pipeline become apparent. Some industry observers have analyzed the BTC pipeline project and questioned whether there presently are sufficient proven oil reserves in the Caspian to support this project. As with pipeline projects elsewhere around the world, achieving a high and lengthy plateau throughput rate in the shortest time possible after start-up is critical to recovering capital costs and paying off lenders. The bottom line in pipeline economics is that every barrel of throughput matters.

With peak output of 800,000 b/d from AIOC's Azeri-Chirag-Guneshli development anticipated to last about six years, third party volumes will be needed to boost and extend plateau rates at the desired level of one million b/d. Sufficient volumes needed to accomplish this are already proven in the Caspian region. A number of non-AIOC producers located onshore and offshore Azerbaijan as well as in Georgia could take advantage of the BTC pipeline to export their volumes. Further successful exploration planned during the next year at the offshore Kurdashi, Lenkoran, Alov, and Oguz prospects could add a significant amount of exportable oil volumes after 2005.

The real near term synergies, though, are for producers in Kazakhstan and the companies that will participate in MEPCO. We hope these two groups will work closely together, as there are substantial additional volumes - perhaps 200,000-300,000 b/d - that we anticipate will be developed from projects in Kazakhstan and that will not be able to be handled by CPC. These projects could benefit from the advantageous tariffs which could be derived from using a cross-Caspian barge system linked to the BTC pipeline.

By utilizing the BTC pipeline, producers in the eastern Caspian could obtain cost-competitive and direct access to Mediterranean and world markets. Oil producers in Kazakhstan should seriously consider joining with AIOC in the BTC pipeline's engineering and design studies. Now is an ideal time. These two parties should decide on the next steps together - with the same obligations and opportunities - but any who are hesitant should be able to negotiate a more limited involvement, even though their corresponding benefits of using the BTC pipeline will be less, too. Russia has offshore Caspian projects that could benefit by use of the BTC as well. Lukoil, with two discoveries in its offshore Severny block, could have sizable production volumes after 2005. Some of this production could be exported via the BTC pipeline. This would further alleviate oil traffic in the Bosporus and congestion along certain pipeline segments inside Russia. Russia's participation in the BTC pipeline would place it as a partner with some of the world's leading oil companies in what will be a landmark project based on an unparalleled level of international and regional cooperation among governments and companies.

What other alternatives exist for large oil export volumes from the Caspian, such as those that will come from AIOC and the Kashagan field? With the issue of the increasingly congested Bosporus Strait looming before us, oil companies will have to consider very seriously whether to risk the use of this passage as a primary export route. By 2010, we estimate that two fully loaded 150,000-dwt tankers will have to negotiate the Strait each day, possibly closing the passage to two-way traffic for hours. The environmental risks associated with an accident - and the resulting insurance costs and shipping delays - will be challenging issues from both financial and public relations standpoints.

Other options of bypassing the Bosporus have questionable project economics when compared to those of the BTC pipeline. Bypasses around the Bosporus may cost up to $1 billion or more and would involve additional unloading and reloading of tankers. The potential for oil spills would be increased as would the operational and demurrage costs - especially in bad weather. A recent proposal to build a multi-billion dollar pipeline from Kazakhstan to Iran - solely to supply Iranian refineries that would need upgrades in order to process Caspian crude efficiently - is unlikely to be a feasible and economic option in the long-term, especially when one considers the alternative advantage of obtaining a secure stream of hard-currency export revenues from world markets. The single, cost-competitive tariff associated with the BTC, along with access to ultra large crude carriers (ULCCs) in the Mediterranean, ensures that the BTC pipeline will provide the near-optimal export scenario for large volumes of Caspian oil exports for the indefinite future.

Exporting Caspian Gas to Turkey and Beyond

The synergies of Caspian energy development and transportation apply to natural gas as well as to oil. Azerbaijan and Kazakhstan contain proved gas reserves of approximately 2.6 trillion cubic meters. Turkmenistan and Uzbekistan hold twice this amount. This is an impressive and valuable resource base. We have worked hard in the region to spur development of a trans-Caspian gas pipeline (TCP) that would link the gas resources of Turkmenistan and offshore Azerbaijan to growing markets in Turkey. Unfortunately, we could not establish a unified vision at that time, but we do hope that in the future, Turkmenistan will join us in what we believe will be the development of a Caspian-wide gas utilization and export grid. As the last senior U.S. official to meet with President Niyazov on the TCP, I am convinced that it remains in the strong long-term interest of Turkmenistan, which, like Kazakhstan, can continue its energy exports to and through Russia as well.

Right now, our focus is on the increasing momentum of bringing gas resources from offshore Azerbaijan to Turkey, Georgia, and possibly Europe. Drilling programs are underway or soon will be at three prospects in Azerbaijan's gas-prone southern sector of the Caspian Sea. The Shah Deniz field undoubtedly will be the landmark gas field development that will justify establishment of an export link from Azerbaijan to Turkey. Reserves at the Shah Deniz field are pegged tentatively at up to 700 billion cubic meters (bcm), or enough to supply Turkey with a significant portion of its incremental demand after 2005. Under high growth rate projections, Turkey's gas demand could increase from about 15 bcm per year last year to more than 50 bcm per year by 2010.

Turkey's Botas currently is in advanced stages of talks with the Shah Deniz partners on securing a gas supply agreement, which we expect to be concluded shortly. We have supported these talks based on the underlying belief that the Caspian offers an ideal gas supply source from the perspectives of diversification and security of supply. In addition to bringing in gas from the Caspian, Turkey is seeking to boost its imports from other sources. It is important to remember that Russia already supplies about three-quarters of Turkey's gas and that the Blue Stream pipeline brings with it unprecedented technical challenges and potential environmental risks. Iran is another potential gas supplier to Turkey, but while companies may see the commercial opportunities in courting Iran, regional leaders should be aware that their best political and economic interests may not coincide with those of Iran. Whatever happens in Washington in January, I am confident that our position towards Iran will remain firm and unchanged.

The exciting road ahead

With engineering underway on the BTC pipeline, continued drilling at the Kashagan and Shah Deniz fields, and Azerbaijan and Turkey progressing well towards concluding a gas sales agreement, the next several years should witness even greater momentum with respect to Caspian energy development. During the next year, continued exploration in Azerbaijan's offshore sector likely will lead to further sizable oil or gas discoveries that will boost further prospects for regional energy trade and economic integration. Our view is that as we participate in the region's energy development, we should work to ensure that the benefits of such development include economic diversification and the establishment of stable, market-oriented and democratic states. Of course, none of this will occur without sound management of new revenues by the governments, including a real effort at reinvesting them wisely and in fighting corruption.

There is some progress on this front, including Azerbaijan's decision to establish a national oil fund and Kazakhstan's announcement that it will do the same. But much more is needed to develop law-based and democratic states, and there should never be any question that the United States and Turkey stand with the interests of the people in these countries, and with the cause of independence, security, regional cooperation, and economic integration of the Caspian with the West. I am proud of the support that our two nations have shown for the Caspian region's freedom and economic development. My experiences have left me with a continued sense of optimism and excitement and the strong belief that the best is yet to come. Thank you very much.