Robert M. Cutler on Energy and Eurasia

The CPC pipeline itself has cost $2.6 million to construct—or nearly twice the originally estimated cost—and involves eight oil companies, including Chevron and ExxonMobil as well as the governments of Kazakhstan, Russia and Oman. It will have an initial capacity of somewhat less than 600,000 barrels per day (bpd). Numbers offered by various parties for its eventual full capacity have ranged from 1.0 to 1.5 million bpd.

1. First, a bit of recent history

Restrictions by Russia on oil exports from Kazakhstan created doubts about the viability and future of investments around the Caspian Sea almost as soon as the USSR disintegrated. In 1993, Russia limited exports of Kazakhstani crude oil, saying that oil from the Tengiz field had too high a level of mercaptans, a family of sulphur compounds that corrodes pipelines. As a result, TCO had to build a treatment plant to extract hydrogen sulphide from the crude oil before putting it into the pipeline system.

From the beginning, Chevron wanted a direct pipeline to a port, but disputes arose over which port it should be, who should pay for construction, and how to build the pipeline. The conduit from the Tengiz field to the Black Sea was first to have been built and managed by the CPC, in which Chevron originally had no stake; rather, the CPC was a joint venture among Kazakhstan, Russia, and the Oman Oil Corporation.

Chevron nevertheless found itself being asked to finance most of the then-projected $1.4 billion cost of the project, since Russia and Kazakhstan had no cash; the US company was, however, offered only a minority stake in the pipeline. The bulk of its share would instead have gone to Oman Oil, which owned 33% of the CPC under the old structure, but whose financial participation would be minimal, and whose presence in the consortium Chevron never liked. This impasse led Chevron in May of 1994 to slash its 1994 investment budget for Tengiz by 90%.

2. A piecemeal approach to pipeline construction emerges

The CPC was in the very beginning a victim of its own organizational problems, which made financing impossible to find. Significant here were the tendency of the CPC's erstwhile chief to try to run things with minimal consultation and the consortium's failure to engage even in informal consultations with local organizations and governments concerning energy development policy.

Consequently, in early 1995 Russia and Kazakhstan agreed to construct a $400 million section of the pipeline, This first phase was to be a 150-mile line from Kropotkin in the north Caucasus to a new Black Sea terminal near Novorossiisk, which was due to open in 1997. The consortium intended for this link to justify itself economically without Tengiz oil. Russia planned to ship 200,000 barrels per year through it to cover costs.

However, financing for the remaining 750-mile link to the Tengiz field remained still a problem. Kazakhstani officials suggested that British Gas and Agip might join Chevron in financing. They also officials asserted in the early 1990s that they were being pressured by the administration of George Bush (Senior) to sign with Chevron in order to be received at the White House and obtain US backing for bilateral and international economic assistance. If true, this would help explain why Kazakhstan was at the time unsympathetic to Chevron's protests concerning its share ownership and financial responsibilities for the pipeline to Novorossiisk.

Another factor in the differences between Chevron and Kazakhstan, which nearly led President Nursultan Nazarbaev to cancel the deal and open bidding on the project to other Western oil companies, was social spending. Out of the $1.5 billion worth of investments expected in the first three years, Chevron balked at allocating more than $50 million for hospitals, schools and the like. This did not accord with the culture of the country, where in Soviet times it was the social duty and legal obligation of all major enterprises to provide such social infrastructure.

It is not well known that between 1995 and 1998 the United States, through its embassy in Almaty, did a considerable amount of work to convince people that the CPC pipeline could in fact be built and to assist in the restructuring of the consortium so that it could find financing. (Rumors and reports to the effect that the US has opposed to the CPC because its pipeline goes through Russia are simply not true.) Reorganized the CPC nevertheless was, and construction proceeded, although not all physical infrastructure was fully finished by the time oil began to be pumped into the line.

3. Back to the present

Pumping was halted in May of this year, supposedly to remove water that had been used for hydro-testing of the line, but reports began to circulate later in the month that the filling of the pipeline had also been suspended because of a dispute with Russian customs authorities over tariff treatment of the oil.

However, the CPC contradicted this, saying that Kazakhstan and Russia had a customs agreement. It appears that this agreement was no more than an initial understanding that had not been translated into proper documentation. Nevertheless, by mid-June the oil had reportedly crossed nearly all of Russia's Astrakhan region, which forms part of the coast of the northern Caspian Sea, and was ready to continue on its way across the republic of Kalmykia in southern Russia. This oil represented a bit less than one third of the quantity necessary to fill the pipeline.

A hint as to the real problem was given in June by a Chevron official, who stated that CPC members had agreed to set up an oil-quality bank that would export a new standard grade of oil called CPC Blend, which would indeed be a blend of oils from Kazakhstan and Russia. The Russian provinces had all along wanted to export their own oil output through the CPC, but their oil is of a grade inferior to Kazakhstan's. An oil-quality bank is an established mechanism that divides revenue according to the market value of the oil that each producer contributes to the blend.

It appears that some of the bureaucratic blockage stemmed from Transneft, the Russian state pipeline monopoly, which has viewed the CPC from the beginning as an unwelcome competitor. Transneft has dragged its heels to impede work wherever possible and has encouraged other to do the same. Some reports have suggested that the pipeline operator viewed establishment of an oil-quality bank as a dangerous precedent that could be later extended, to its own detriment, through the Russian pipeline network. Undoubtedly, Transneft also wanted to see whether it could gain a stake in the eventual management of the CPC line itself.

4. On with the show

The date for loading the first tanker in Novorossiisk was set originally for June 30, then postponed indefinitely, then set for August 6, then postponed again, then reconfirmed for August 6 (even though the first tanker will not be filled before the end of the month at the earliest), then once more postponed indefinitely. On August 4, Chevron announced following a meeting of CPC shareholders in Moscow that agreement on an oil-quality bank had been reached. The statement did not name an exact date for shipping to begin from Novorossiisk but used the phrase ".

Another CPC shareholder present at the Moscow meeting warned that problems still lay ahead, noting that the consortium would have to "explain" the oil-quality bank idea—which is a new phenomenon for the Russian energy sector—to the Russian authorities. This participant gave the earlier report about customs problems some credibility by hinting that they were in fact related to the oil-quality bank issue. In particular, he identified Russian tax officials as being among those who could not understand why producers of lower-quality crude could get a lower share of export revenue even if they pumped more volume.

It is also likely that the producers of Urals Blend petroleum, a lower grade with high sulphur content that historically reaches markets through Novorossiisk, did not want to forego exports through the new pipeline, although such abstention would have made CPC Blend of higher quality and hence more valuable.

5. Conclusion

There has been speculation that Russia has held up the opening of the CPC in order to compel Kazakhstan to renounce its intention to export oil, later in the decade, through the Baku-Tbilisi-Ceyhan (BTC) pipeline from Azerbaijan to Turkey's Mediterranean coast. If so, the tactic was unavailing. According to news reports, Azerbaijan's President Heidar Aliev was the first person with whom Kazakhstan's President Nazarbaev spoke in Sochi at the early-August informal meeting of heads of state of the Commonwealth of Independent States (CIS). The first thing Nazarbaev told Aliev was that Kazakhstan confirmed its adherence to its previous statements in support of the BTC pipeline, which the Kazakhstani president is seeking to transform, with US encouragement, into the Aktau-Baku-Ceyhan (ABC) pipeline.

Indeed, according to Elizabeth Jones, currently assistant US secretary of state for European affairs (and previously senior advisor for Caspian basin energy diplomacy), work is under way to develop an intergovernmental agreement between Kazakhstan and Azerbaijan covering the commercial principles for Kashagan oil and eventually gas across Caspian. From the viewpoint of the United States, such efforts fall under the rubric of moving the countries concerned towards the market while promoting the Caspian region as a reliable source of energy.

The countries concerned, she said, would "need to ensure transparency of pipeline rules and of the regulations for calculating costs, as well as decide what the supporting costs would be and provide for barging arrangements." Jones should know whereof she speaks. She was also the US ambassador to Kazakhstan during the years between 1995 and 1998, when the CPC was restructured with American encouragement so as to achieve financial feasibility.

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First published in FSU Oil & Gas Monitor, No. 144 (6 August 2001): 4–6.