Washington Report on Middle East Affairs, January/February 1999, pages 49, 91

Central Asia

Oil Companies Rejecting U.S.-Turkish Plans to Bypass Iran for Pipeline to Transport Caspian Oil

By James M. Dorsey

Major oil companies, in a move underlining the failure of U.S. and Turkish diplomacy, are dragging their feet on a decision over what route to use to get Caspian Sea oil to world markets. When the oil companies, grouped in an $8 billion consortium called the Azerbaijan International Operating Company (AIOC), do eventually announce their preferred routing, that decision will further highlight the inability of the United States to ensure the independence of the strategically important Caspian Sea basin from both Russia and Iran.

It also threatens to undermine the Clinton administration’s efforts to bolster Turkey as a major regional power and could help accelerate the re-emergence of Iran as one of the region’s dominant forces. Finally, it is also likely to strain relations between Turkey and the United States, with each side blaming the other for the failure.

Securing a major stake for Turkey in the export of Caspian Sea oil is a key to ensuring that America’s Turkish ally remains a crucial regional player that can counterbalance Russia and Iran. Turkey’s failure to become a major export transit route will weaken its regional political and economic muscle as well as complicate its access to a geographically close source of oil.

In a post-mortem on U.S. and Turkish policy in the Caspian, both the Clinton administration and Turkey are likely to be taken to task for failing to commit the money needed to make commercially viable the U.S.-Turkish proposal for an expensive and uneconomical pipeline from the Azerbaijani capital of Baku to the Ceyhan oil terminal on Turkey’s Mediterranean coast.

AIOC is the first multi-national consortium to be founded and to conclude a multi-billion-dollar oil exploration and development agreement with one of the energy-rich former Soviet Caspian Sea states. The consortium, which groups British Petroleum, Amoco Corp., Exxon Corp., Pennzoil, Unocal Corp, Ramco Plc, Norway’s Statoil, Itochu Corp. of Japan, Russia’s LUKoil, the Turkish Petroleum Corp. and Delta International of Saudi Arabia, was destined to take the lead in determining what route would be best for the export of the bulk of Azerbaijani crude. That route would also be used by producers in Kazakhstan and Turkmenistan.

Under its agreement with Azerbaijan, AIOC was to announce its routing decision by the end of October 1998. Yet, as the deadline neared, it became increasingly clear that the oil companies were reluctant to commit themselves to any one route and even more reluctant to commit themselves to an expensive and cumbersome pipeline linking Baku with Ceyhan. Company reluctance was bolstered by the fact that several test wells in Azerbaijan produced gas rather than oil, and by the current oil glut on the world market which is dropping oil prices.

Oil companies already see Turkey as too expensive a transit route.

British Petroleum chief executive officer Sir John Brown recently said a Baku-Ceyhan pipeline would only be feasible if Azerbaijan’s proven reserves increased by a billion barrels or if governments provided “free money” for its construction and operation. He said a 300,000 barrel-a-day pipeline under construction between Baku and the Georgian Black Sea port of Supsa was “enough” for current Azeri needs.

Mr. Brown’s remarks signaled that last minute arm-twisting by both the United States and Turkey would not force the oil companies to get involved in politically motivated pipeline projects that had little chance of being commercially viable. BP last week shrugged its shoulders at a Turkish government decision to no longer purchase BP and Amoco oil for use in state-run refineries because of the two companies’ opposition to the Baku-Ceyhan project. BP said it sold to Turkey less than 1 percent of its global production.

Potentially more damaging is the Turkish government’s announcement that it would not consider Amoco’s bid for a $500 million liquefied natural gas conversion terminal project in the western town of Aliaga. Yet, that project pales against the potential business likely to be generated by the exploration and development of Caspian Sea oil fields. Earlier, Turkey published stricter navigation rules for ships and tankers using the Turkish Straits, which link the Black Sea to the Mediterranean.

Turkey also vowed to reduce tanker traffic next year from about 1.5 million barrels a day, and Turkish Maritime Affairs Minister Burhan Kara warned that Turkey may raise transit fees fivefold.

“Then they will see what happens to their dreams of cheap oil,” Mr. Kara vowed, skipping over the fact that oil companies already see Turkey as too expensive a transit route. If anything, these attempts at arm-twisting highlight three miscalculations that lie at the root of the failure of U.S. and Turkish policy:

• Turkey’s belief that it did not need to do much to ensure that its Baku-Ceyhan pipeline proposal would compete successfully against other proposals. Turkish Energy Minister Cumhur Ersumer earlier this year said Turkey no longer needed to campaign for the Baku-Ceyhan pipeline because it was a done deal. As a result, Turkey did not provide sufficient incentives to compensate for high construction costs as well as high transportation costs per barrel of oil;

• The conviction that the United States could secure on political grounds a decision in favor of the Baku-Ceyhan line, economically the least attractive routing for the export of Caspian Sea oil, while at the same time asserting that oil companies would have to choose the most economically viable option available to them rather than rely on government subsidies;

• The assumption that the prospects for the return of Iran to the good graces of the U.S. were so far off that they would not figure in the calculations of any of the parties involved in the debate over how to get Caspian Sea oil to world markets. Yet, major oil company executives say it is only a question of time before U.S. restrictions will be lifted on energy dealings with Iran.

A recent study by Rice University’s Baker Institute for Public Policy laid out many of the faulty assumptions on which U.S. and Turkish policy were based. The study concluded that transportation of oil through a Baku-Ceyhan pipeline would be the most expensive way of getting oil to market, costing at least a dollar per barrel more than any of the other alternatives. The study estimated total cost of construction of a pipeline from Baku to Ceyhan at anywhere between $3 billion and $4 billion. At a capacity of 800,000 barrels a day, it would cost $2.80 per barrel to ship oil from Baku via Ceyhan to ports in Italy, “The bottom line is clear: any Turkish pipeline is a bad deal for Azerbaijan and the oil companies and Baku-Ceyhan a very bad one,” the study said, asserting that sellers could lose up to $1 billion a year by opting for Baku-Ceyhan.

By comparison, the study calculated that shipping oil from Baku to Supsa and hooking up with an 800,000-barrel-a-day line that would bypass the Bosphorus and cross Thrace from Kiyikoy on the Black Sea to Ibrikbana on the Aegean would cost $1.90 per barrel, or $0.90 less than Baku-Ceyhan.

“The advantage over Baku-Ceyhan, already significant, would be even greater were a larger Thracian pipeline built,” the study said. “This would have the advantage of accommodating Russian as well as Azerbaijani exports.”

The study estimated that a pipeline with a capacity of 1.5 million barrels a day would increase the cost differential compared to Baku-Ceyhan to one dollar per barrel. Turkey has rejected the Bosphorus bypass, charging that it would turn it into a subsidiary of Russian Black Sea ports. Even cheaper would be to move Caspian crude through the Bosphorus itself, an alternative rejected by Turkey for environmental and safety reasons because the waterway cuts through the heart of Istanbul, a metropolis of 11 million people.

“At $1.40 per barrel, the cost of shipping from Baku to Italian ports via an expanded Baku-Supsa pipeline and the Bosphorus is fifty cents lower than Kiyikoy-Ibrikbana and $1.40 lower than Baku-Ceyhan,” the Baker study says.

“Baku-Ceyhan is an idea whose time has not yet come and, indeed, may never come despite Clinton administration suggestions that the likely decision [by oil companies] to use a Supsa route is only a delay, not a final rejection,” the study says.

Baku-Ceyhan’s time is only likely to come if both the United States and Turkey are willing to make the kind of sacrifices necessary to win the geopolitical poker game. That would mean the United States would have to foot much of the bill for building Baku-Ceyhan while Turkey would have to produce a package of incentives, tax breaks and tariffs that would make transportation of oil through the pipeline competitive.

So far neither country seems willing to put its money where its mouth is. The United States last month offered Turkey a mere $823,000 to plan for Baku-Ceyhan, while Turkey still believes that a combination of an Oct. 29 declaration in Ankara by the presidents of Azerbaijan, Kazakhstan, Georgia and Uzbekistan and strong-arm tactics will get it what it wants. The oil companies so far seem unimpressed.