Caspian Oil: Cooperation Or Competition?
Richard H. Matzke, President
Chevron Overseas Petroleum
Caspian Oil & Gas Summit
Centre for Global Energy Studies, London, England
Also see a press release regarding this speech.
You might not know it from the headlines, but 1998 has been a very significant and productive year for the Caspian oil industry. In fact, this was the year that many of us knew would come, but did not know when - the year that the Caspian oil industry began to achieve what we might call critical commercial mass. And I think a review of the year's highlights bears this out.
During 1998, Azerbaijan International Operating Company lifted its first tanker of crude at Novorossiysk -- and AIOC's production of "early oil" is forecast to reach 100,000 b/d by year's end. Meanwhile, the important AIOC Western Pipeline across Georgia to Supsa overcame some difficult cost issues and moved ahead, with startup expected in April.
I want to mention that also in Georgia during 1998, Chevron and the company Caspian Transco agreed to improve and operate a smaller pipeline from Khashuri to Supsa and on to the port of Batumi. And this link will be critical to the plan to keep Tengiz Field exports growing while the Caspian Pipeline is being built.
As many of you know, Tengiz is now averaging about 210,000 barrels per day. And despite reduced cash flow from low oil prices, the Tengiz partners OK'd a $500 million work program for 1999, continuing to work toward boosting capacity to 260,000 b/d within the next couple of years.
To the north, we saw the Karachaganak project suffer a slowdown due to payment problems from sales to Russia . . . but they're working to resolve that situation. And more importantly, project director Vincenzo di Lorenzo re-affirmed in October that the Karachaganak partnership plans to continue its $1.8 billion development program, which could boost output to more than 50 million barrels a year by 2001.
Meanwhile, the Caspian Pipeline Consortium put effective new leadership in place, and it obtained the critically important local permits from the four Russian regions it will cross. The strong relationships and deep knowledge of the consortium member LUKoil were a key to that success.
I'm pleased to report that we're very close to the go-ahead on this pipeline, which will add an initial 560,000 barrels of export capacity per day. It's going to be an essential component of the transportation infrastructure which the Caspian oil industry needs for the long term. Final CPC approval by the Russian central government is long overdue, but the CPC partners expect that approval any day now.
The consortium plans to start ordering pipe from the Russian mills as soon as we have a clear and final federal approval of this project. And once we get started, we intend to have this pipeline shipping Tengiz crude to markets in 2001.
There were other high points in 1998 as well. The BP-Amoco merger was a major event, both for the business world and the Caspian oil industry in 1998. Also important, a new national company -- Kazakoil -- joined the major players in the region. Phillips Petroleum and Japan's Inpex bought stakes in the northern Kazakhstani offshore from Kazakoil for the reported price of $250 million each -- quite a vote of confidence in the Caspian.
Texaco acquired a 65 percent stake in North Buzachi, where there's more than a billion barrels of oil in place. The T5050 deep well was completed in the Tengiz Field during September, probing for important new information about this giant field.
It is also important to note that in July, Mobil and Monument announced a new production-sharing deal for Garashsyzlyk in Turkmenistan a complement to the PSC these partners already hold at Nebitdag. And Monument this year began exporting crude by way of exchanges with Iran, at a lower cost -- I might add -- than the other route through Baku.
Meanwhile, in the Azeri offshore, the partnerships holding concessions continued to gather and study seismic data, confront rig shortages, pinpoint their targets and test a few prospects as well. On the Absheron block, for example, Chevron, Total and SOCAR completed their 3-D survey and moved ahead on building a rig scheduled to start service by the year 2000.
As for Russian waters, LUKoil said last month that it was planning to move a rig out of Astrakan for an exploratory test in the North Caspian. And word came from CIPCO in late October that the third well at Karabakh has struck oil. This is great news after the disappointing results of the first two exploratory wells. And we should know more later this month on the potential of that discovery.
The countries and companies involved in the Caspian oil industry seem to be finding the right balance of cooperation and competition. More specifically, they're cooperating regionally in the near term to build an industry to compete globally in the long term.
Indeed, cooperation is one of the distinguishing elements of the modern Caspian oil industry as it continues through its formative years -- shared struggles, shared needs, shared priorities and shared solutions. Of course, competition is alive and well within the industry also. We need only to look at the rival pipeline proposals -- or recall the intense contest to win the Azeri offshore blocks -- to see that.
The Caspian oil industry was once just a question mark on the post-Communist landscape. But today, the industry is becoming a regional force. It has developed momentum -- and markets -- of its own.
Before this happened, an economic crisis in Russia might have cast a cold and deep shadow over the Caspian oil industry. But today, the Russian crisis has thrust the industry into the limelight and defined it even more sharply. And in a reversal of history, the industry today is showing its potential to drive geo-political events, rather than be driven by them.
Of course, we must give full weight to the serious situation with world oil prices. Everyone invested in the Caspian industry will have to watch the trend closely and decide day by day how much risk is too much. Still, I think it's essential to recognize that in 1998, for the first time, oil prices became as important as oil politics in the Caspian. And in fact, this has helped the industry to re-focus on fundamentals.
During the year, as the value of barrels dropped, the value of efficient operations increased. As oil prices fell, the need for world-class commercial standards -- especially in export projects -- grew more urgent. Low prices also underscored again the need for stable terms and conditions and a secure tax and business environment.
Low prices sent the emerging Caspian oil industry a powerful message that it needed to hear: Isolation on the world map can not provide insulation from world oil market trends . . . or global investment requirements.
Personally, I believe that the Caspian has the potential to compete against virtually any other attractive area of the world. Nevertheless, Caspian projects -- more than ever -- must seek the path of competitive performance. This is the only way to deliver the rates of return which will give both lenders and partners solid reasons to keep investing.
Let me turn now to the issue of oil transportation. Throughout the past two years, Caspian pipelines have been the subject of top-level diplomatic debate as well as international headlines. I contributed to the discourse myself last year when I gave a talk to investment analysts that covered 10 different pipeline proposals.
That was fashionable at the time, but in retrospect, the very idea of multiple lines was way ahead of reality. This is even more true today -- now that times are tougher in the oil business -- and any pipeline that can't be commercially justified is going to have a hard time finding friends with money.
My own view is that the industry should focus now on five priorities for oil distribution and export:
- First, continue to develop the diversified shipping by rail, sea, and river, and by the Transneft system and exchanges as well. Tengizchevroil, in particular, has used these options to prove that the Caspian oil industry could get along fairly well in the short term -- and even grow -- without a "Main Export Pipeline."
- Second, keep filling the Northern Pipeline and make it a permanent success.
- Third, complete the Western Pipeline across Georgia and get it running. It makes a lot of sense and the industry is going to need it.
- Fourth, complete the Eurasian Transco pipeline link from Kashuri to Supsa to Batumi, which I mentioned earlier, to help keep the Tengiz expansion on schedule.
- And fifth, complete the Caspian Pipeline from Tengiz to Novorossiysk and make it an oil-export success story. This pipeline is the key to unlocking the treasure of Tengiz. But just as important, the Caspian oil industry must have a pipeline that fully involves all the Caspian players -- both companies and countries -- and especially Russia. The CPC project meets that test better than any other option.
As for the Baku-Ceyhan pipeline proposal, let me repeat what I said two weeks ago in Washington D.C.: After the Caspian Pipeline, a new line through Turkey would be a logical next step to provide market access to the anticipated large new reserves from both the east and west sides of the Caspian. This pipeline could also relieve future pressure on the Bosphorus Straits.
Of course, we must keep costs and operating expense uppermost in our minds when considering major, long-term export projects. Future options for expanding capacity along both the Western and Northern pipeline routes must be fully considered, especially in light of the low oil prices and low profits.
However, with new discoveries and production growth -- plus the right mix of financing, shippers and owners -- the Baku-Ceyhan will become a viable commercial option for Caspian oil exports. I believe the time has come to replace rhetoric with action with regard Baku-Ceyhan. So I say: let it remain a contender . . . because the regional oil industry's health depends on sustaining a competitive tension between shippers both before and after new pipelines are built.
Now let's look at the Caspian oil industry in light of the Russian economic crisis. Some say Russia's problems will hurt the industry. And indeed, both Tengizchevroil and Karachaganak are dealing with short-term payment problems for their production. In addition, some loadings at Black Sea ports have been delayed due to cash shortages and the banking collapse. And we don't know yet whether Russian oil companies can still fund their shares of Caspian exploration and development projects.
So there has been an impact -- no question about it. But I'd like to offer another way of looking at things. Let's not ask how Russia can hurt the Caspian oil industry. Let's ask how the Caspian oil industry can benefit Russia, along with the other Caspian countries.
To answer that, let's first consider some key elements of Russia's track record in participating in the Caspian oil industry. Transneft was difficult to work in the early days but despite this, Caspian production from AIOC, TCO and other projects, found space on the Transneft system . . . or worked out deals for exchanges. Looking back, certainly Russia could have been more helpful. But still, over time, there has been significant and positive engagement.
The AIOC Northern line was started up and is running today, with exports made possible by exchanges with Transneft. This is a prime example of a new commercial relationship between countries and companies with mutual benefits all around. Meanwhile, the Caspian Sea ownership issue has moved slowly, but Russia is working to resolve it, as we saw this year in its demarcation agreement with Kazakhstan.
The Russian rail system has worked closely with Tengizchevroil -- and continues to do so today -- to facilitate exports by tank car. It has not been an optimum solution, but forward motion nonetheless. In fact, nearly 2 out of every 3 Tengiz barrels shipped to date has moved by rail, and recently we've seen rail rates becoming more competitive.
Also this year, tariffs on Transneft became more transparent, simpler and more competitive. And the proposals to expand the Friendship Pipeline could mean more Transneft capacity for Caspian crude in the not-too-distant future.
I've already mentioned the management turnaround at the Caspian Pipeline Consortium during 1998, and LUKoil's help with that and the local permits. This was strong evidence that the Russians are serious about this world-class commercial project which will benefit the entire region. And while Russian proposals for moving more Azeri crude were late to arrive, it now appears Russia and Azerbaijan are moving closer to seriously discussing those proposals.
So where does this leave us? Sir Winston Churchill said 60 years ago: "If we open a quarrel between the past and the present, we shall lose the future." Clearly, it's not too late for Russia and the Caspian oil industry to look to the future . . . to see all the benefits that can be gained as Russia becomes a more committed partner. So again, let's ask the question: How can the Caspian oil industry benefit Russia?
The first answer to that is: The Caspian oil industry is already benefiting Russia in a big way by being one of its steadiest and most solvent customers. Tengizchevroil alone spent more than $260 million on Russian goods and services since 1993, and Russian economists say that for every TCO dollar, another two are generated for Russian GDP.
Building the Caspian Pipeline will create 4,000 construction jobs. Once the line is operating at full capacity, Russian economists forecast that its total economic benefits could support as many as 100,000 direct and indirect jobs. And the Russian central and regional governments will receive $33 billion, including over $23 billion in the form of tax revenue, over 40-years.
In recent years, the Caspian oil boom has also created a universe of opportunities for Russian oil companies to invest in exciting prospects with technically sophisticated and powerful new partners from every corner of the global oil industry. This will continue.
A growing Caspian oil industry could also help Russia by providing new export revenue for Transneft, which could do more to boost oil exports to the near abroad and Europe. Richard Hildahl, a consultant with Energy Resources Group, has advanced the concept of a "virtual pipeline" -- a mix of exchanges and relatively low-cost upgrades at key points in the system. This would make room for more Caspian barrels without cutting capacity for existing export customers. The more barrels on the system, the greater the prospects for lower tariffs, which in turn, could attract more volume.
Beyond that, the Caspian could help supply Russia's internal oil needs in the future. Whether you believe that Russian production will shrink or consumption will grow -- either, or both -- Caspian oil could become an important supplemental supply for Russia.
At this point, some of you may be thinking my perspectives today are too optimistic. But it seems to me that if the Caspian oil industry can grow against the odds during the past five years, then it should be able to do the same during the next two or three years. Even with prices and profits down, we have good reasons to believe 1999 will be another year of forward momentum.
In 1999, at long last, the Caspian Pipeline will break ground and begin construction, and the AIOC Western pipeline will establish itself as a vital new export option.
BP and Statoil will complete the first well on Shak Deniz in the Azeri offshore -- and a second well is scheduled for the year. Also in 1999, the first OKIOC exploratory well in the northern Kazakhstani offshore will begin drilling -- an extremely important event for the industry. And the T5050 deep well completed in the Tengiz Field this year will undergo its first flow test. Meanwhile, the Caspian nations will keep working on a boundary agreement for the Caspian Sea.
And the U.S. and Iran will keep working on a future relationship which I hope -- in time -- will help ensure Iran's positive involvement to help build a commercially-sound Caspian oil industry. I hope also that the U.S. government will recognize that blocking investment in Iran by U.S. oil companies puts one of the United States' most vital industries at a serious disadvantage while achieving little for international relations. And I'm sure the European companies are enjoying the absence of American competitors for major new deals with this giant Middle East producer, especially Total, and also Elf and Eni, who may sign a contract later this year to manage the Dorood Field for Iran.
I'd like to turn my observations on the Caspian oil industry now to exploration. 150 years ago in Chevron's home state of California, gold was discovered in the foothills of the Sierra Nevada mountains. It set off an economic surge that historians now know as the Gold Rush, and it changed California forever. J.S. Holliday wrote a famous book about it, entitled: "The World Rushed In."
One could give the same title to a book about the Caspian oil industry during the 1990s. The competition to rush in and make E&P deals with Caspian countries has been both dramatic and historic. Unfortunately, every boom brings elevated expectations with it. We're all aware of the disappointing exploration results in the Caspian this year. One Wall Street Journal headline a month ago said the following: "Dry Wells Belie Hope for Big Caspian Reserves."
We might have expected people to start saying things like that, given the wild speculation about the region's potential. Perhaps the most famous recent projection was the U.S. government's estimate that Caspian reserves could total 178 billion barrels. Others, such as Wilfrid Kohl of Johns Hopkins University, put the potential as high as 218 billion barrels. With numbers like that, and plenty of geo-politics to fan the flames, it's no wonder there's been so much heated debate about multiple, large-scale pipelines.
I'd like to see us take a more realistic perspective. The simple fact is, the oil industry has barely begun to explore the Caspian. John Grace, an American geologist who has modeled the Caspian's future development, describes the over-sized forecasts about Caspian reserves as "petro-fantasies" which can be fulfilled only by years of very substantial investment and good luck as well.
Whether you use Mr. Grace's model or another, I think it's clear that making bold and extreme statements about so many billions of undiscovered barrels has been premature and not especially productive. The eager outside world and the rest of us will have to accept that it's going to take quite a while to find out what's down there. The Caspian offshore, particularly the Azeri offshore, has a long history of shallow-water activity, and now it wants to enter a new period of deeper-water exploration and production. The trouble is, even though we've got plenty of great prospects, we have too few drilling rigs capable of testing them.
The industry is working on the problem -- a prime example of cooperation in the region. Altogether, the industry is looking at somewhere between $600 million and $800 million in shared investment to establish an essential fleet of semi-submersible rigs. One rig is working now, another is almost ready, and two more are expected to start service in the year 2000.
So we aren't going to know today -- or next year -- how much more oil is hidden beneath the Caspian region. Actually, this would be true even without a rig shortage. None of the prime offshore areas of the world -- the North Sea, Gulf of Mexico, West Africa and the others -- have revealed their oil and gas treasures in just a few years or a few wells. The Caspian region will be no different.
Looking back on these past five years or so, I realize why the outside world has placed such high strategic importance on Caspian reserves and their destiny. And I understand the reasons for all the big-time, long-term speculation, and all the geo-politics. But frankly, I think its healthy that the Caspian oil industry is coming back down to earth -- back to fundamentals -- and focusing on the serious commercial priorities of the next two-to-three years.
What's important is not the year 2010 or even 2005. But instead 1999, 2000 and 2001. It's not important right now whether Caspian exports will provide a political offset to Middle East crudes in the world market a decade from today. The exploration and development process will answer that question in time. What's important now is making sure the Caspian oil industry can keep building today -- even in a very difficult oil-price environment.
I believe this can happen, partly because this industry means so much to the countries of the region. It means far more, in fact, than its barrels will ever mean to the world market. The leaders of the Caspian expect a tough and viable oil industry to help them to build their national economies. This is the only industry that has the immediate potential to play a major role in making these emerging nations economically whole.
With that priority so clear, there is really only one course for the companies and countries building the Caspian oil industry. They must continue to cooperate as partners and work to build a regional enterprise that is truly competitive. They must build an industry that can grow -- an industry which will be truly resilient in the global oil industry for the long term. And I believe they are well on the way to achieving that.
Updated: November 1998