This week's commentary concludes the theme begun last week on the unstable and constantly changing financial environment for energy development in the Caspian region. Last week I discussed the need for strategic alliances and their strengths and selected issues of financing and feasibility. This week, I explain why financing is not everything and conclude with the relationship between financing and other forms of engineering.
3. Financing Is Not Everything
The Caspian contains promising formations, and crude production should increase in the near future. Industry experts feel that problems of transporting oil and gas need to be solved gradually and that the existence of multiple markets makes a single solution to problems of transportation unnecessary. Everyone is aware of such structural issues as how a project company obtains rights to a project, or what to do about possible breaches of the underlying contract. But the legal system in the host country is today the most significant potential roadblock that can slow down the whole process.
It follows that adequate financing is not all that is required. The three fundamental necessities are an investment-friendly financial climate, guarantees of secure transport and political stability. An examination of these elements in the Caspian region reveals three lessons.
First, the energy consortia cannot do it alone and need help. For years, Chevron was powerless to move the Tengiz and Caspian Pipeline Consortium (CPC) projects forward. A part of the early differences between Chevron and Kazakstan concerned social infrastructure. The energy consortia create massive social costs that political institutions must cover. However, the consortia are also the only major source of investment in social infrastructure necessary to assure the political stability that comes from balanced development. Out of the US$1.5 billion investment projected in the first three years, Chevron hesitated to allocate more than US$50 million for hospitals, schools and other social infrastructure.
Second, states have to seek more information and evaluate it properly. This is because in the post-Cold War international system, there is no holding back the free flow of information or the ultimate ability of people to act on it. The new energy consortia in the Caspian region are not, properly speaking, "transnational" but truly "multinational", in the sociological sense that their leadership teams and their deputies come from a variety of national backgrounds. The practical consequence of this variety is to alter the decision-making culture. That in turn complicates the creation of common understandings. Broad access to more and better information is needed to resolve the resulting ambiguities.
Third, enhanced citizen participation is necessary in countries where the public is increasingly literate, increasingly informed and increasingly politically active. An experienced younger generation that will be capable of taking over greater responsibility and carrying on the work of the present-day leaders in the 21st century is needed. With the post-Cold War international system organizing itself from the bottom up, governments must have people who can respond autonomously to new and unexpected challenges, quickly adapting policies and strategies efficiently to rapidly changing circumstances.
4. Financing's Relation to Other Types of Engineering
Let me highlight three questions that need to be addressed intensively in the future.
First, are transit-country expectations too high, risking disappointment? An agreement with an energy company, for example, could actually be an agreement with a corporation registered in Bermuda that can find excuses not to ship, such as war or terrorism, and is not backed by the energy company itself. The region has high extraction costs. Incremental investment is problematic because of the need for export pipelines. Moreover, the energy consortia tend to prefer development in stages, whereas politicians tend to want "mega-projects." Still, pipelines will not be a source of riches for any country. A pipeline is only a cost of getting energy to market, and the infrastructure has to be as efficient as possible.
Second, how will host governments react if the market leads Western investors to delay development? Commercial considerations include taxes, tariffs, political risk and environmental risk. Successful realization of infrastructure projects in the Caspian region will require unprecedented international cooperation in partnership with the private sector and successful regional intergovernmental cooperation. Western investors must be sensitive to the marketplace. However, a host government concerned only about revenue flows will find this unacceptable. Yet a soft market will cause investors to delay or cutback planned development. Dropping oil prices put all of this into jeopardy. Caspian oil at US$12 per barrel loses money. Cash flows are therefore a non-negligible issue.
Third, how will oil wealth be distributed among and within states after the oil begins to flow? The coming boom might be a blessing to the entire population in the region, but counterexamples in the history of energy development are well known. If the profit from the oil industry benefits only a privileged elite, then there is the risk of political conflicts that could eventually increase political risk, leading to regional disequilibria in power balances and ultimately to greater arms proliferation.
Finally, let me underline that the greatest unmet need is the need for political coordination of the many complex technical aspects. These include integration of production plans with pipeline construction timetables, emphasis on multilateralism, expanded participation including intercultural dialogue, explicit concern with ecological issues and project development to meet specific logistical goals within a strategic framework. The technical problems of constructing the pipelines are inseparable from the political issues of who will build and control the pipelines, who will finance and manage them and where they will be built. The nature and variety of technical and geophysical obstacles require pooling of financial resources and transport facilities.
The complexity of these technical problems means new forms of organization and decision-making are needed. More explicitly, multilateral political engineering is required, with wider participation. Finance is only one aspect of this extremely complex mix of concerns, and it cannot be treated in isolation from them.
Copyright © Robert M. Cutler
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URL: http://www.robertcutler.org/blog/1999/07/finance_issues_in_european_ene.html
First published in FSU Oil & Gas Monitor, No. 42 (27 July 1999); 2.
