The Caspian Pipeline Consortium

Arguably one of the most geopolitically complex and compelling pipeline schemes that Russia became involved in from the mid-1990s was what became known as the Caspian Pipeline Consortium (or CPC). The CPC remains the only pipeline exporting Kazakh crude westwards, and is unquestionably one of the most important oil pipelines in the region.9 It remains a classic example of the simultaneous collision and collusion between states vying for

geopolitical advantage and the commercial and business imperatives that characterise the aggressive manoeuvring of IOCs in the drive to acquire and monetise petroleum.

CPC’s Main Features

 1,510-km pipeline extends from the Tengiz oil field in Kazakhstan to the Novorossiisk-2 Marine Terminal on Russia’s Black Sea coast. It could also serve as an export line for oil from the massive Kashagan field, also in Kazakhstan

 The CPC is currently the only oil export line that traverses Russian territory that is not wholly owned by Transneft

 The throughput of the first phase of the pipeline is rated at 28.2 million tons of oil per year. After all phases of the pipeline have been completed, the maximum throughput of the CPC pipeline system will reach 67 million tons of oil per year

 The first stage of the CPC was opened on 27 November 2001. However, a second stage that is under construction will increase capacity to 1.3 million barrels per day by the time it is completed in 201210

Fig 5.1 CPC routing from Tengiz to Novorossiysk

Source: http://www.cpc.ru/portal/alias!press/lang!en-us/tabID!3357/DesktopDefault.aspx

The fundamental logic of CPC was simple: given that the maximum export capacity of Chevron’s Tengiz production was limited to 30,000 barrels per day (half of the volume required to finance Chevron’s field refit operation) through the Russian-owned and operated pipeline system north to the Russian petroleum intersection at Samara, an alternative high- volume pipeline was urgently needed to monetize the oil in Tengiz. To this end, Chevron proposed and negotiated a deal with Kazakhstan to the sole rights to build and operate a pipeline from Tengiz that could export 700,000 to 1 million barrels per day. At this stage,

Chevron expressed an interest in the opportunity to negotiate for equity in the syndicate at a future date but chose not get involved at the project’s inception.11 Chevron was initially concerned about the high finical burden it would have to bear in relation to the offered equity in the scheme.

Project negotiations

From the outset, the key to CPC was Russia. Initially, eight possible routes outwards from Tengiz were considered, terminating variously at ports in Iran, Turkey and Russia. Notwithstanding the clear reality that a route to Russia’s Black Sea coast was the shortest, cheapest and easiest to construct (not least because some sections of the eventual system were already built as part of Russia’s existing network), the CPC project team was well aware, as were all of the other actors in the region, that Russia was the dominant power in the Caspian and it was easier to have it as part of any eventual scheme rather than in opposition to it.12 That the line was to run through Russian territory not only made this logic axiomatic but also ensured that the highly influential and charismatic Russian prime minister of the time, Viktor Chernomyrdin (also the most powerful of Russia’s petroleum tycoons) would support the scheme. Clearly, however, the potential downside for CPC’s non-Russian partners was Moscow’s eventual total dominance of the project.

During the period October 1992 until January 1996, the CPC project turned into a virtual political and commercial stalemate, which pitted Russia against Chevron, and, inevitably placed Washington and Moscow on opposite sides. In the early stages of CPC’s evolution it seemed the project’s lead negotiator, John Deuss, held all the advantage: he had the backing of Russia; he was effectively the sovereign representative of the Omani government (which was fronting most of the project’s costs in the early stages in return for a sizeable share in the completed line); and, he had the blessing of Kazakhstan’s government to act as the sole driver in the project.13

As Deuss’s standoff with Chevron dragged on (Chevron would not grant CPC with the oil throughput agreement Deuss needed as collateral for his bank loans from the European Bank for Reconstruction and Development (EBRD),14 the impasse was exacerbated by Chernomyrdin’s fundamental dislike of, and opposition to, Chevron’s potential involvement in the project. Russia essentially viewed the Caspian as its exclusive domain, and most of the senior figures in the Russian government were aware that the Tengiz field in Kazakhstan had been discovered by Russian geologists during the Soviet era. Losing the rights to it during the

fall of the Soviet Union seemed bad enough, but eventually seeing it in the hands of a U.S. IOC was seen as a humiliation for many in the Chernomyrdin government. To this end, Russia maintained tight limits on the quantity of oil Chevron could export through Russian pipelines, which threatened the U.S.-dominated Tengizchevroil consortium’s15 financing streams for its development of Tengiz.16

Kazakhstan, meanwhile, already aggravated by Chevron’s refusal to build a new export line for Tengiz in the first place, was becoming increasingly frustrated with Kerr’s persistent unwillingness to enter into an agreement with Deuss to partner in the CPC project. For Kazakhstan, the critical thing was to export the oil; for the Kazakh president, Nazarbayev, stranded oil was obviously useless. Eventually, the Kazakh government appointed the veteran oil deal negotiator, Jim Geffen, as their chief oil advisor; a man who had been instrumental in brokering the deal for Chevron to gain access to Tengiz.

During this period, Geffen had developed close contacts and trust with Nazarbayev’s inner circle, and had introduced them to the oil and diplomatic power brokers in Washington, D.C. Geffen set about building a formidable team to support Kazakhstan in its bid to promote its position against the other powerful actors, not least of which was Russia. Geffen’s appointment marked the beginning of the process to break the deadlock on CPC, and also eventually precipitated the direct participation of the U.S. government.17

As the U.S. interest deepened with its unambiguous backing of Chevron, evidenced by its clear attempts to force Deuss out of the CPC scheme and openly questioning the value of the Omani government’s involvement in CPC, Russian concerns about their level of influence over the project increased. As far as Chernomyrdin was concerned, the U.S. government was gaining too greater foothold in a project, which in his view was rightly Russia’s to shape.18 From an objective stance, given that the majority of the line would transit Russian territory and terminate at a Russian port, the Kremlin’s position was arguably as inevitable as it was geopolitically logical.

Two further developments added to the Russian’s disquiet. Following the accidental death of Deuss’s main sponsor in the Omani government, the deputy prime minister, Qais al-Zawawi, other Omani ministers not previously involved rescinded their support of Deuss; they also reneged on the government’s previous position to fund the 155-mile section of the pipeline connecting existing Russian lines to Novorossiysk.19 Secondly, the decision by Azerbaijan’s

government to build another Early Oil pipeline running direct to the Black Sea coast through Georgia (to complement the line running north to Novorossiysk) indicated to Chernomyrdin that Russia’s dominance of pipeline routing and the petroleum exports from the Caspian was now clearly threatened. The Russian prime minister was now plainly concerned that Kazakhstan, emboldened with firm U.S. government support and the independent move demonstrated by Azerbaijan, would move decisively to find an alternative route for Tengiz oil.

Fortifying geopolitical control over CPC

Chernomyrdin moved quickly to regain strategic position and forged what would become Russia’s lasting advantage in CPC. In order to redefine their position, the Russians now demanded an equity share in the Tengiz field itself to complement their share in the proposed pipeline. As a way of sending an unambiguous message to both Chevron and the U.S. government, Chernomyrdin demanded that it would seek an ownership stake for Lukoil out of Chevron’s existing 50% stake in the field, rather than from Kazakhstan’s share. Though dispatched to acquire Lukoil’s stake in Tengiz, Vagit Alekperov, the firm’s CEO, Lukoil did not have the liquidity to purchase the 5% share needed. Prior to Lukoil’s advance, the Russian government had shut down the pipeline section used by Chevron to export its Tengiz oil in a clear move to coerce the U.S. IOC into negotiations.20

This aggressive action was clear evidence of Moscow’s confidence in the dominance of its position juxtapose those of the other actors: The key existing pipelines that Kazakhstan relied upon for exporting oil were located in Russian sovereign territory. Kazakhstan’s land boundary delineations in the west did not offer options with regards to negotiating or facilitating pipeline route alternatives with states other than Russia. Due to winter ice-cover and very shallow water in the northern sectors and deep waters in the south, the Caspian Sea itself was a geographical feature that complicated the building of sub-sea pipelines that could connect the oil terminals on Kazakhstan’s coast with Baku in Azerbaijan. Furthermore, in terms of minimum (cost effective) terrestrial distances to a favourable export terminal, U.S. actors were well aware that Novorossiysk on Russia’s Black Sea coast was the optimum facility. All of this conflated in such a way that Moscow could apply increasing diplomatic and technical coercion to maximise its advantage in the evolving CPC scheme.

Even if Chevron’s upper management had never fully appreciated the scale of Russia’s power and influence in the region with regards to the control over petroleum conveyance, the

company’s chairman and CEO, Ken Derr, always had. Derr knew that if CPC was ever to become a reality the Russians would always have to be involved. Essentially, CPC was never going to come into being merely because of the U.S. government’s involvement, nor that of the banks or Kazakhstan. The key to the entire scheme remained as it had from the beginning - Russia. They could shut down the only existing export lines that both Kazakhstan and Chevron relied upon to export Tengiz oil, and Russia also controlled most of the in-place line that was to be part of CPC as well as most of the sovereign space for the CPC’s route to the Black Sea.21 Notwithstanding Russia’s geopolitical advantages and aggressive obstructionism, Chevron refused to be pressurized into a sale. The dealings that followed represented a compelling ironic twist for the Russians in their bid to regain the geopolitical initiative over the scheme.

Russian and U.S. NOC/IOC partnership

As the Russian moves remained stalled, an American IOC, Arco, which had been seeking to boost its equity oil reserves portfolio in the region, partnered with Lukoil and offered to finance the newly formed LukArko’s 5% stake in Tengiz. Essentially, a private firm based in the U.S., the country posing the greatest threat to Russia’s continued dominance of the Caspian, had effectively bought its way into the geopolitical game largely dominated by factors such as favourable sovereign territorial control, boundaries and distance, to decide who would dominate the means of export for Tengiz.22

Lukoil’s decision to accept the advances of a U.S. firm could be viewed as a move of considerable flair; however, it also presented the risk of diluting Russia’s holding and leverage at a later date, were the LukArco partnership to become compromised. In the end, the move by the two companies demonstrated the opportunity that could be gained from this unusual, and rather ironic, hybrid Russian/U.S. NOC/IOC fusion. Furthermore, it showed that IOCs and NOCs still have the ability to adapt so as to make use of their capacity for quick transnational manoeuvre in a complex commercial engagement. This factor was not lost on the ‘parent’ governments as they sought to benefit geopolitically from proxy actors in this way.

After another period of awkward negotiations and shifts in the balance of power, and with the addition of other key players in the Kazakhstan/Chevron/U.S. contingent, in the form of Mobil, British Gas and Agip, an agreement was eventually signed in Moscow in April 1996, which would mark the formal establishment of the final form of the consortium. The forming

of the consortium enabled the construction of the pipeline segments that would join the existing Kazakh and Russian sections to form the completed line from Tengiz to Novorossiysk. In its final form, the agreement saw that Chevron, Mobil (later part of ExxonMobil), British Gas (later BG) and Agip would fund the entire cost of the remaining construction in exchange for a 50% stake, with the remainder being shared variously between the governments of Russia, Kazakhstan and Oman. Russia and Kazakhstan received $520 million in exchange for their combined 400 miles of existing line and also received ownership shares of 23% and 20% respectively, whilst Oman received a 7% stake. Arco gained its share as part of its alliance with Lukoil.23

The table 5.2 below offers a concise snap-shot of vital elements of the unusual international complexion of CPC. Considering also that the line is constructed mainly on Russian territory and terminates at a Russian port, what is immediately apparent from the table is the Russian dominance of the CPC’s ownership and operational composition. This dominance was further increased in 2008 after Russia acquired Oman’s share, thereby giving Transneft a commanding 31% stake in CPC. Moreover, a further 15% is held by companies with Russian shareholders - LuKArco B.V. and Rosneft - Shell Caspian Ventures Ltd. Western IOC interests collectively amount to 43.25% (though Russian shareholders are also included in this grouping, as mentioned previously). Kazakhstan maintains the second highest share after Russia with an influential 19% stake in CPC.24

Table 5.2 Eventual CPC shareholder structure

Shareholder Stake National affiliation (if

applicable) & Notes

States

Russia (operated by Transneft) 24% -

Kazakhstan 19% -

Oman (Russia) 7% In September 2008, Russia

agreed to acquire Oman’s full share25

Companies

Chevron Caspian Pipeline Consortium Co.

15% United States

LuKArco B.V. 7.5% Russia & United States Mobil Caspian Pipeline Co. 7.5% United States

Rosneft - Shell Caspian Ventures Ltd.

7.5% Russia & UK/Netherlands

Eni/Agip International (N.A.) N.V. 2.0% Italy

BG Overseas Holdings Ltd. 2.0% United Kingdom Oryx Caspian Pipeline LLC (Kerr

McGee Group of companies)

1.75% United States

Kazakhstan Pipeline Ventures LLC 1.75% Source: Caspian Pipeline Consortium