Caspian Fantasy:

The Economics

of Political Pipelines


Thomas R. Stauffer

Summer/Fall 2000 – Volume VII, Issue 2 63

THOMAS R. STAUFFER

Oil Consultant

Pipe-mania is a fashionable, new exercise in Washington. It all but domi nates current discussions of energy in the Caspian region. New pipelines of various types and sizes figure prominently in U.S. diplomatic efforts in the area. Here we propose a set of reality checks for these proposals. The tests are economic. Discussion hitherto usually has addressed much more subtle considerations —the aspirations of the local players, the conflicting interests of the United States and Russia, or the complex geopolitical tradeoffs involved. This article is more modest. We address here the elementary question of whether new pipelines are in fact economical—are they pipelines or fantasy? If the projects are economically or financially infeasible, then further agonized analysis of national aspirations and interests is moot. Or, if the projects are not economical, then reality forces serious discussion in a different direction: Is there any party willing to subsidize uneconomical pipelines in Central Asia?

Several pipelines have become linchpins in the policies of the Clinton administration towards Central Asia and the regional powers, Russia and Iran.

We shall show that all four of the pipelines that figure in U.S. policy efforts are deeply flawed. The proposed Bayu-Cayhan oil line is not worth financing without massive subsidies from some extra-regional power. The trans-Caspian gas line is, in absolute terms, uneconomical. The proposed trans-Afghan gas line, like the Baku-Ceyhan oil route, cannot be financed. The fourth pipeline in the U.S. policy arsenal—a Turkmenistan-Turkey gas line—is no more than a phantom—flawed, too, but in a different manner.

In the next section we outline the parameters that are critical for such an economic evaluation—the criteria that would be used, for example, in the “due diligence” study for prospective investors. We then apply these tests of feasibility to the first three pipelines mentioned above.                   

If these projects are not profitable,
one must ask the question: Who is
willing to subsidize uneconomical
piplines in Central Asia?
 The fourth—the “phantom”

pipeline—is a link between

Turkmenistan and Turkey
often cited by the

administration and outside

commentators.In the concluding
section we set the testable claims
made for these pipelines in the context of earlier U.S. efforts at pipeline politics.

The record is “zero for five:” out of five pipeline-based political gambits the U.S. has failed five times. In every instance, the political thrust was aborted because it butted against economic or financial realities.

One caveat is important—this economic analysis presumes that oil prices will average below $20 per barrel for the next 10–15 years, which is the critical period for testing the economics of pipelines. If one believes that higher oil prices could prevail for any length of time, then the three pipelines would be less infeasible.

The conclusion that all remain uneconomical is less clear, but is nonetheless most likely for the simple reason that higher oil or gas prices would bolster the economics of competing projects as well, while the disabilities of the Clinton administration’s projects would not be affected.


Pipeline Economics: A Primer


The economic feasibility of a pipeline hinges upon a number of factors, some technical, some political, some related to energy markets, some tied to the geology of the source, and some, lastly, ineluctably related to geography.


The “Tyranny of Distance”

Distance is a critically limiting factor for a gas pipeline. Even if all other considerations are favorable, it is much more costly to move energy in the form of natural gas than the comparable amount in the form of oil. The economic reach of gas is distinctly limited. It costs approximately 50 cents per barrel to ship oil in a pipeline over 1000 kilometers, whereas the same energy in the form of gas would cost $2.50–$4.00, a much greater distance penalty.

Long-distance movement of gas by pipeline is a questionable proposition from the start. The Russians built such long pipelines, both from Central Asia and from the Yamal region in northern Russia, but Soviet economic criteria for these were different—and have long been discredited. They were willing to accept much lower rates of return on capital intensive projects, like pipelines, than are today’s free-market entrepreneurs. Thus, a gas pipeline stretching several thousand miles is likely to be uneconomical—either the net value of the gas at the wellhead is to low to permit production, or the delivered cost is too high to attract customers.

Consequently, orphaned gas fields are common. For example, on the Alaskan North Slope some 840 billion cubic meters—30 trillion cubic feet—of gas have long been known. But that gas cannot be marketed because the costs of shipping the gas to Japan or California are higher than the prices in those markets. Similarly, large fields are known in Yakutia and in the waters around the Yamal peninsula in Russia. There, too, distance dominates, and the gas resources remain unmarketed.


Throughput and “Ramp-up”

Economies of scale are also critical. A pipeline must be large, otherwise the unit costs of shipping escalate rapidly. But, the line must also be full—the rate of “ramp-up”—the speed with which the capacity is utilized—must be rapid. If the capacity of the line is not fully utilized within a few years of completion the costs also are much higher.
Therefore, the rate of fill is extremely critical. A pipeline project, if it is to be economically attractive—must be filled quickly. This economic precondition is restrictive: it means that a large, available production capacity must exist at the one end and—simultaneously—a large, unfilled demand must be found at the other. Demand for gas at the outlet and supply of gas at the inlet must match. Both ends are important. A large line is uneconomical if half empty.


Incremental Competition

Another vital question is whether there are smaller-scale, incremental options that compete against the pipelines. The spectre of “incrementalism” is real — the pipelines promoted by the U.S. administration are “lumpy”—they must be built full-scale, or not at all. But, as we shall tabulate below, each of the projects can potentially be undercut, if not superseded entirely, by alternative pipeline routes.

The competitors are cheaper and quicker to build—the spectre of death by “a thousand cuts.”


Wellhead Economics

The viability of a pipeline is inextricably linked to the costs of producing the oil or gas that is earmarked to be shipped. If the production costs are low, then the scheme can suffer higher pipeline charges and still be profitable for all parties.
Conversely, the higher the costs of producing oil or gas at the wellhead, the nar-rower the pipeline’s profit margins are. The commercial risks increase rapidly if the hydrocarbons are already high-cost at the input flange to the pipeline.


Credit Risk Exposure

One idiosyncratic aspect of the Caspian gas projects is the question of the creditworthiness of the prospective customers. This is an additional element of risk because in none of the cases is the putative buyer of the gas sufficiently creditworthy to issue a long-term, bankable, take-or-pay contract.


Financability and political risk

Lastly, political risk, if perceived to be high, can condemn a project. This is especially true for pipeline projects that are longer-lived and are therefore exposed for longer periods to political convulsions. Political risk elevates the feasibility threshold—a risky project must have potential for much more profit to be attractive.

That extra margin is needed in order to offset the uncertainties. This risk is reflected in part as a higher threshold rate of return. In Central Asia the political risk premia are very high, even for relatively short-term investments less than 5 years. The risk premium for a Caspian pipeline project, which is bereft of guarantees or subsidies and which must therefore meet commercial standards, is of the order of 6 to 8 percent. This risk premium can almost double the minimum pipeline charge that is acceptable to investors, and that extra financial burden can render the project marginal or sub-marginal. There is little evidence from the Clinton administration that it has weighed the financial and economic realities in their efforts to promote the Energy Corridor and the several pipeline projects involved.


Baku-Ceyhan Oil Pipeline


The first case is that of the Baku-Ceyhan oil pipeline. This is described as an alternative export route for Caspian producers, liberating them from their dependence on either Iran or Russia. The proposal envisons a large-diameter pipeline with a throughput of 800,000 to 1 million barrels per day (bpd), which starts in Baku, Azerbaijan, and ends at the already-established oil terminal of Ceyhan on the Mediterranean coast of Turkey. The project offers tempting advantages—it bypasses the Bosphorus, which is an important possible choke point. Furthermore, it is uncontested that Ceyhan is a first-class, blue-water port that could

accommodate both the additional volumes and the additional tankers. Third, export via Ceyhan is cheaper because the port serves large tankers, offering lower tanker rates than is possible with the much smaller tankers that can traverse the Bosphorus.

One fatal flaw to the Baku-Ceyhan project lies at the other end—there is a “missing link.” The line does not connect to the large, future volumes of oil from the Caspian. These, if any, are destined to come from the Tengiz area or from the offshore Kashagan prospect now being explored. But the Baku-Ceyhan line does indeed start at Baku. The major source of new oil, however, is 800 kilometers across the Caspian Sea from Baku. Even if the Baku line were built, there remains a comparable obstacle in how to to connect the oil originating in the northeast arm of the Caspian with Baku.

The “missing link” is indispensable. Without large volumes of large enough from the remote northeast corner of the Caspian, there is no credible prospect of oil large enough to fill the Baku-Ceyhan pipeline. If Turkey were to close the Bosphorus, the Baku-Ceyhan line could provide an outlet for local Azerbaijani production, but, again, the bypass pipeline via the Ukraine could easily preempt even those relatively small volumes. In short, the Baku-Ceyhan scheme is an “outlet without an inlet.” Unless other major projects are simultaneously undertaken to span the gap between Baku and the new oil sources, the line is in limbo. The pipeline fails another critical-path test as well. Multiple options for incremental competition are available. New volumes of oil from the trans-Caspian area can readily be siphoned off by a set of competing schemes that enjoy the compelling advantage that each can be commissioned and constructed incrementally. Any one could be undertaken on short notice and expanded in small stages if and when there is additional oil in search of market access. We discuss these in turn.


Swap Exports via Iran

Iran can play the spoiler at its discretion. It alone can kill the Baku-Ceyhan project.

Via Iran are two cheap and quick routes whereby oil from the Caspian can be exported into world markets. The routes are indirect—oil is exported by displacement.

The device is simple and demonstrably feasible. In both cases Caspian oil would be imported into the north of Iran and processed Iran in its own refineries to meet domestic demand, whereupon comparable volumes of Iranian oil would be delivered on behalf of the Caspian producers to buyers who lift that “swap” oil at Kharg Island, Iran’s under-utilized export terminal in the Gulf. The first “swap” route involves an existing but unused gas pipeline that runs from Iranian Azerbaijan past Baku. This line could be upgraded and reversed, and some 200,000–250,000 bpd could be pumped to refineries in Tabriz and Teheran. The cost—excluding Iranian tolls—is less than one dollar per barrel.

The second possible Iranian connection entails the proposed expansion of another existing route. Oil can be sent by tanker from Kazakhstan, Turkmenistan, or the offshore loading platforms in Azerbaijan to the port of Neka in Mazanderan.

A small pipeline, just recently reversed, connects Neka with the Teheran refinery.

However, this route has functioned sporadically in recent years. Iran complains that oil from Kazakh sources is of inconsistent quality—paraffinic and sulphurous, while Kazakh firms hint darkly of U.S. pressure not to use the route, even though it is cheaper,especially since Iran reduced the charges.

The Neka option is currently being pursued. International tenders were issued for the expansion of this route to 330,000 bpd. The status of the proposal at the time of writing is still obscure, and progress is entangled in contract disputes within Iran. The economics are clear, however—the all-in cost is less than $1 per barrel. Iran has priced the traffic at a rate less than competing options while still ensuring a very large profit margin.

Iran holds high trump. Overall costs of swapping via Iran confirm that the Iranians can be devastatingly competitive and still enjoy large profits from either of the two routes, that in the northeast or that in the northwest. Given their intrinsic logistic advantage, they could undercut the Baku-Ceyhan line at will and still make money.


The Existing Trans-Caucasus Pipeline

Competition comes also from the existing, small line that the operating consortium

in Azerbaijan—the Azerbaijan International Operating Company (AIOC)— built from Baku to Supsa on the Black Sea. This option, too, is much less expensive than any new line to Ceyhan. The right-of-way exists, and capacity on this line can be expanded by adding pump horsepower and also by looping the line downstream of the pumping stations. Since the expansion is quick, it, too, could preempt volumes from the Baku project.


The Caspian Pipline Consortium

One competitor is already underway. A major line is close to completion that will connect the Tengiz and Karachaganak fields in Kazakhstan with the Russiancontrolled port of Novorossiysk on the Black Sea. This line has been sized to be larger than near-term production from that corner of Kazakhstan. Further, as

with the AIOC line, it, too, could later be looped and “horsepowered-up” to add still more capacity. Since this line is directly connected to the source fields in Kazakhstan, its geographical advantage is clear. The Caspian Pipeline Consortium (CPC) line is logistically less desirable than the Baku-Cayhan line or the Iranian route because oil is delivered into the Black Sea, rather than to a “blue water” port such as Ceyhan or Kharg Island. But its direct connection to the prospective suppliers in Kazakhstan is compelling.


Transneft capacity

Russia, also, is positioned to be a spoiler. A major threat to the Baku-Ceyhan project is the ease with which Russia itself could siphon oil away from any pos-sible Baku-Ceyhan project. Kazakhstan is already connected into the grid of Russian oil pipelines still run by the state enterprise Transneft. The lines are in place, and, indeed, Russia recently highlighted the possibility of such diversion by increasing the quota of oil that Kazakhs are allowed to export via Russia.

Transneft’s rates are competitive since the route is used up to the level of allowed capacity. One question is how much incremental capacity is available in the piplines

connecting Transneft to the Baltic port or

Given its geographic and
logistical advantage, Iran
could undercut the 
Baku-Ceyhan line at will
and still make money. the major Russian oil export lines into

Europe. There may be bottleneckes,

and parts of the lines are known to

have deteriorated. However, upgrades

of such lines are usually low-cost when

translated into the per-barrel charges per

kilometer, especially when compared

with the costs for any new line. This is
 especially true for Kazakh oil sent through Baku, where the additional port costs plus oil tanker rates—just to Baku—are roughly the same magnitude as the charges for shipping directly into Europe. The constraint on this option is ultimately political. It is a matter of the limits that Russia might choose to impose for geopolitical reasons upon Kazakhstan oil running through the Russian pipeline grid.

 

Baku-Novorossiysk

Theoretically, additional capacity could be available in the pipeline from Baku through Daghestan to Novorossiysk. Transneft recently completed a $150 million bypass on that line to divert it farther from possible Chechen raids. This line shares comparable risks with the Baku-Ceyhan line itself, and its role is viewed as precarious and marginal even though the line does exist and has been used extensively in the past.

The disabilities are not exhausted. Even if the above obstacles were not insurmountable, the fact remains that the Baku-Ceyhan project is most probably unfinancable, since commercial risk is high. Caspian oil production is high-cost, compared to world standards, so much so that its narrow profit margins available imperil its very development. This is compounded by political risk, which looms large in any calculus, since the pipeline from Baku is unusually exposed to interdiction.

Within raiding range of the “Energy Corridor” are distressingly many latent or active hostilities. These insurgencies and wars include: war in Chechnya, unrest in Daghestan, insurrection in South Ossetia, Azeri-Armenian conflict over Nagoro-Karabagh, battles between Abkhazia and Georgia, and obscure dissension in Adzharia.

Last, but not least, the pipeline traverses eastern Turkey where the government has been conducting a murderous war against the local Kurdish population.

It is easy to blow up a pipeline—experience in Colombia, Chechnya, and Yemen has proved to be painfully instructive. It is also easy to repair such damage—provided that crews can gain safe access to the site. This leg, too, is fraught with political hazard.

The political risk adds significantly to the fee needed to finance the pipeline—if the line were otherwise attractive. Given the gnawing uncertainty as to potential supply, the additional costs of linking to Kazakhstan, and the formidable political risks, it follows that the line would be very difficult to construct— even if there were not the multiple, cheaper options noted above. The spectre of such competition is sufficient to deliver the coup de grace to the administration’s project for the Caucasian Energy Corridor, unless it is believed that the United States could somehow guarantee both commercial and political risk.


Trans-Caspian Gas Pipeline


The second in the U.S. quiver of pipelines was the Trans-Caspian Gas Pipeline (TCGPL). This project was proposed to transmit natural gas from the well established gas fields of southeastern Turkmenistan to central Turkey. One early version of this scheme was in fact actually routed across northern Iran, a notion that was anathema to Washington and Tel Aviv, so that the variation advanced by the administration was instead designed to traverse the seabed of the Caspian Sea.

From landfall near Baku the gas line would have followed a route similar to that of the Baku-Ceyhan oil pipeline into northeastern Turkey. Thence, the line would cross Eastern Anatolia to Ankara. Administration spokesmen claimed that the line would be extended into Europe, thereby linking Central Asian energy with European consumers across the U.S.-sponsored Caucasian Energy Corridor.

A consortium of private sector firms—first GE Capital and the Bechtel Corporation, later joined by the Shell group—established a small study and preliminary design group. But no commercial participant invested any material amount of capital, nor did any make any public commitment to do so. The project was scaled at 30 billion cubic meters of gas per year, although private sources indicated that any initial phase, if ever built, would be much smaller—some 16 billion cubic meters per year.

The source of gas does indeed exist. Shatlyk and Doulatabad, the two large gas fields in southeastern Turkmenistan, had long been known and had been exporting between them more than 50 billion cubic meters (1.5 trillion cubic feet) of gas per year to Russia and the Ukraine since the early 1980s. Both fields could have sustained enough production to fill that line to capacity for many years, so—in contrast to the case of the oil pipeline—there is no doubt as to the existence of an adequate supply. In this one respect, the TCGPL is less unattractive than its counterpart, the Baku-Ceyhan project, where the prospect of filling the line was minute.

The stumbling block in the case of the TCGPL is quite different; this project is uneconomical, even though large volumes of Turkmen gas are desperately in search of a paying market. Two considerations suffice to render the project unattractive. First, the transportation cost for the gas would be very high, compared to the market value of the gas when delivered. 2000 kilometers of new, large-diameter line would have to be constructed, including a difficult submarine link beneath the Caspian Sea. Second, the Turkish market is neither large enough to absorb such volumes, nor creditworthy enough to permit conventional takeor- pay contract financing for the pipeline itself.

Detailed financial analysis of the TCGPL shows that a large subsidy would be necessary to overcome the commercial obstacles. The pipeline could not be filled. Official projections of gas demand in Turkey were grossly inflated, but, even more important, Turkey is already committed to large new supplies from both Iran and Russia. Gas from Turkmenistan could only penetrate the Turkish market at a slow rate, over a period of 10–15 years. This would leave the pipeline only fractionally utilized for years, which dramatically erodes the economic foundations of the pipeline.

Three other gas sources are positioned both strategically and economically to squeeze the TCGPL out of the Turkish market, even if the economics could otherwise have been propitious: the Blue Stream pipeline, the Iran-Turkey line, and the Shah Deniz field.


Blue Stream Pipeline

Russia, together with ENI, an Italian state project, has started a competing project, the Blue Stream pipeline. This will bring gas from Russia and Kazakhstan to Turkey via a pipeline under the Black Sea. The sea link is technically difficult, but both partners have compelling financial interests in the project and are positioned to capture an important part of the Turkish market. The route is shorter and the source gas is unusually low-cost. The project developers are financing the pipeline on their own, as has been done with the CPC pipeline. In both cases upstream profits warranted the construction of supplier owned pipelines.


Iran-Turkey Pipeline

A second, major new gas pipeline is being constructed between Iran and Turkey. Iran has completed its segments, which start from the South Pars field in southern Iran and carry gas to industrial and commercial customers throughout Iran. A large spur carries gas towards Tabriz and then on to the Iran-Turkey border near Bazargan and Dogubayezit. Turkey, however, is late in constructing the connecting links to Erzerum and then westwards to Kayseri, Konya and Ankara. Turkish and Iranian sources aver that U.S. pressure slowed down completion and that the United States blocked delivery of large horsepower compressors for the project.

Nonetheless, the line is expected to begin delivering gas early in 2001. Its initial capacity suffices to meet additional Turkish demand for several years, and the line has been designed to permit doubling throughput when required.

The costs of supply to the Turkish border are very low. First, part of the pipeline costs are shared with larger volumes of gas delivered to Iranian users, so the unit transportation costs are relatively low. Second, the gas itself is unusually inexpensive. Because of valuable co-product credits, the wellhead cost of the gas is very close to zero. Thus Iran is well positioned to capture large profits from the project and still be able to undercut the price of costlier competitors, such as the TCGPL, if it were ever constructed.


Shah Deniz

Still a third source of gas jeopardizes the TCGPL. In the last two years a large, “wet” gas field has been discovered in Azerbaijan itself. That field, the Shah Deniz, lies nearly athwart the proposed route of the TCGPL. Gas from the Shah Deniz field benefits from very large credits due to the valuable co-products; indeed the liquids are valuable enough that the field could be developed even if the gas were given away.

Azerbaijani gas is more profitable than—and therefore preempts—any gas from the eastern leg of a TCGPL. This would allow quicker and cheaper Azerbaijani gas to flow to Turkey. It is very low cost and is < > kilometers closer to Turkey than the gas to be transported along the TCGPL. Since Azerbaijan would earn almost ten times as much per cubic meter of gas by selling its own production to Turkey than would be possible simply transporting gas from Turkmenistan, it follows that Azerbaijan’s gas would move first. Hence, the administration’s scheme to move trans-Caspian gas through the Caucasian corridor could be economical, if at all, only decades into the future once more accessible options are exhausted.

Yet the ultimate flaw in the trans-Caspian gas pipeline is its failure to recognize that the Turkey market is a fiction. It is remarkable that U.S. representatives spoke grandiosely about connecting the line onwards to Europe. This is chimerical; the costs to Ankara were already unsupportably high. Any further construction—if reflected in unsubsidized charges—would have meant negative values at the wellhead back in Turkmenistan. Finally, a face-saving ploy surfaced; it was claimed that if Azerbaijan sold its gas directly to Turkey that this was really to be perceived as Phase One of the TCGPL. Since a “Phase Two” is not realizable, the cosmetic language is seriously misleading. Lastly, we note that the western leg of the TCGPL shared all the same political risks as the Baku Ceyhan line except that it would traverse a much smaller sector of Turkish Kurdistan. Thus, even if the project were not commercially infeasible, the extra costs due to political risks would have condemned it to failure in any case.


Trans-Afghan Gas Pipeline


A third pipeline has figured in U.S. diplomacy in Central Asia. Until rather recently, administration officials had touted the possibility of a gas pipeline from southeastern Turkmenistan to Pakistan (TAPL). Naively, many found this scheme appealing. As mentioned earlier, there are large volumes of shut-in gas in the older, major gas fields of Turkmenistan. The prospective source of supply exists; that is incontestable, and Pakistan does indeed need energy.

Further, ironically, the pro forma economics of the trans-Afghan pipeline are positive. The distance is relatively short, and the terrain is not particularly difficult or challenging. Indeed, two private firms squabbled over the rights to construct the line—Bridas, from Argentina, and UNOCAL, a U.S. firm. More detailed financial analyses, in fact, indicate that gas from existing fields in Turkmenistan could indeed be moved to Pakistan at a modest profit to Turkmenistan and at a price consistent with the oil-parity formula demanded by Pakistan.

This project, however, comes a cropper for three reasons. First, and obvious to potential investors, is the extraordinary risk in Afghanistan, where a civil war still rages and the Taliban regime is ill-suited to command any international financing. The pipeline also crosses part of Baluchistan, where the local tribes have honed art extorting money for the protection of roads to a fine art.

Second, there are several competing projects that lurk in the wings. Iran, looking more broadly to commercialize its very large gas reserves in the South, has proposed a line along the Makran coast, across Baluchistan, and connecting to the Pakistan grid near Multan or Sui. This proposal is compellingly more attractive than the TAPL, much to the discomfort of the Clinton administration, because no “third-party transit” is involved. The producer delivers directly into the territory of the buyer. It is not without risk. The line is exposed for 600–800 kilometers through Pakistani Baluchistan where, once again, local rebellions have festered since before independence. Nonetheless, this option is viewed as less risky than that the Afghanistan one.

Two submarine pipelines have been bruited. Both could bring gas from the large North Dome field in Qatar to Pakistan; these proposals have been carried to the stage of semi-detailed engineering study. They are deemed to be technically feasible, and both would bypass Iran or Iranian waters, a feature that Washington and Tel Aviv view as advantageous. Neither is moving forward.

Finally, another option is the modality that India has elected—liquefied natural gas. Instead of building a pipeline, one can liquefy the gas in Qatar or Abu Dhabi, replicating plants that already exist, and ship the gas in cryogenic tankers to Pakistan. The economics of short-haul liquified natural gas trading are favorable, especially since much of the capital is not necessarily dedicated to a single customer, which is the case of the proposed pipelines.

These projects are mutually exclusive, in view of the limited size of the Pakistani market for gas over the next years; one would suffice to meet likely demand growth over the planning period of any project. This constraint is reinforced by the fact that Pakistan’s credit rating is very low, so that financing one long-term gas supply contract would be difficult, let alone two or more. Of these, the trans-Afghan gas pipeline is the least attractive for Pakistan, because it involves the most assets that could be held hostage. None, though, are particularly compelling, for all of the alternatives bear the high risks of dedicating large, lumpy, relatively immobile capital-intensive projects to the Pakistani market.


The “Phantom” Pipeline: Turkmenistan-Turkey


A fourth pipeline has figured in U.S. policy initiatives—a gas pipeline that allegedly links Turkmenistan with Turkey. Even though the United States opposed an early proposal to construct such a line, it seems to have been obliged to rely upon the existence of such a “phantom” pipeline. This is necessary in order to protect Turkey from possible sanctions under ILSA. If that connection exists, it then can be argued that Turkey is not buying gas from Iran but that it is really Turkmen gas that moves to Turkey via a physical swap.

The claim is cosmetic. There is no serviceable pipeline connection between Turkmenistan, on one side of Iran, and Turkey, on the other. There does indeed exist a small-diameter gas pipeline that is shown on some maps. That pipeline, however, is not a transit line. Its use is local, limited to supplying gas to customers along Iran’s Caspian littoral. Policy and technical informants in Iran concur that there is no plan to expand that line, nor any plan to build another.

The paradox is explained as political expediency. The claim is motivated by the need to protect Turkey from any spillover repercussions if Turkey appeared to be flouting the U.S. sanctions. Parties hostile to Turkey, such as the U.S. Armenian lobby, could argue that Turkey is now violating the spirit, if not the substance, of U.S. sanctions against Iran, by committing to buying billions of dollars of gas in the TCGPL. The ramifications could be serious. If Turkey were challenged publicly on the matter, the delicate triangular relationship between Turkey, Israel, and the United States could be jeopardized. Covert diplomacy has failed—Turkey is proceeding with the contract to buy large volumes of gas from Iran, regardless of U.S. pressures and possible sanctions. It is expedient to find an explanation of the contract that forestalls a diplomatic confrontation—hence the invocation of a “phantom” pipeline.

It is true that Iran does import small volumes of seasonal gas from Turkmenistan for a power plant in the northeast. That transaction is extrapolated to imply that the 10–20 billion cubic meters per year that Iran will sell to Turkey is Turkmen gas. Since there is no link—i.e. since there is no mechanism for physical displacement—the claim is without foundation.


Conclusions and Context


None of the three major pipelines is commercially viable—the economic predicates are absent. The results of applying each of the major reality tests are summarized in the table below.

The Baku-Ceyhan pipeline would be economically viable in a perfect, Panglossian world. However, each of the four routes competing with it is more attractive and either just as or less risky. Each competing route benefits from incremental economics, involving less front-end capital and thereby minimizing both commercial and political risk. Even if Turkey were to throttle oil movements through the Bosphorus, the routes through Russia or Iran are still easier and less costly. Furthermore, in the event of restrictions on moving Caspian oil out of the Black Sea via the Bosphorus, there still remains the option of shipping that oil via the Ukraine into Europe. Thus even the spectre of partial closure of the Straits would not rescue the economics of the Baku-Ceyhan project.

The trans-Caspian gas line is condemned by its own economics: the route is too long and the potential market, Turkey, has more competitive options for importing gas. Even though large gas fields in Turkmenistan are shut-in, that gas cannot be attractively delivered to Turkey, the one market for that project.

The trans-Afghan line, tragically, would be economical in an ideal world and a benefit to all three parties. The route is short enough that gas could be delivered to Pakistan at prices that could be reasonable to both buyer and seller.

The political risk of that project, however, is clear. Moreover, insofar as Pakistan can afford to sign long-term gas contracts, there are more economical alternatives that do not bear such an incubus of risk.

The geopolitics of exporting oil or gas from the Caspian are asymmetrical—Iran and Russia can both play the spoilers with respect to oil. The possibility that both could open the valves to Caspian oil is dispositive: a project such as the


Table 2. Pipeline Feasibility

Route

Baku-Ceyhan

Trans-Caspian

Trans-Afghan

Type

Oil

Gas

Gas

Pro Forma Economics

Improbable

Assured

Assured

Input Supply

Four

Four

Three


Baku-Ceyhan pipeline is uneconomical because the two local powers can tap off most or all of the likely new oil production. Since both can expand export routes more quickly than the Ceyhan line could be constructed, each in effects preempts that project, even though neither one might actually implement their competing projects.

Transit revenues to Iran or Russia could be large, but not necessarily the deciding factors. Tolls and fees from an additional 1 million bpd could aggregate as much as $1 billion per year for the two. But cash profits are traded off against potentially more compelling geo-strategic considerations: neither has an interest in enriching Azerbaijan, Kazakhstan, or Turkmenistan. They would sacrifice the transit revenues by only threatening to build alternative routes, but in fact they would not have to do so. However, the advantages of holding their neighbors in thrall might well be more attractive.

The result is stalemate. Much or most of the oil and gas from the Caspian basin may well remain orphaned for the foreseeable future. No European government has indicated willingness to offer the political guarantees or to assume any of the commercial risks of the three pipelines promoted by the United States. The ability of the United States to offer such guarantees is limited—since U.S. suppliers would furnish only a limited fraction of total investment, Overseas Private Investment Corporation or Export-Import Bank funding, even if otherwise available, is commensurately limited. Absent such guarantees or insurance, however, the projects are not financable, and without finance the lines cannot be built.

There are three fantasies in Central Asia: the proposed trans-Afghan oil and gas pipelines; the trans-Caspian gas pipeline from Turkmenistan to Turkey; and the oil pipeline from Baku to Ceyhan. U.S. prestige and diplomatic credibility were linked to each of these schemes. The Clinton administration represented to the host governments and other regional actors that the U.S. was in a position to promote such projects and—it appears—the local players took such promises at face value.

These projects tested both the competence and the credibility of the United States, and all three have either already been aborted or are tottering fatally. Failure should have been foreseen. Not one of the schemes could be shown to be commercially viable. Each is either too expensive or too risky, or both, when compared with alternatives which are on the table. The United States was not able, or not willing, to provide the high subsidies needed to offset that. The pipelines would require—or, rather, would have required—guarantees not merely against political risks but also against commercial risks, a double level of support that is all but impossible. The administration’s reach had exceeded its grasp. U.S. firms could not have supplied significant shares of the project equipment. Thus the usual form of overseas subsidization via conventional export financing—the Export-Import Bank or or the Overseas Private Investment Corporation—was not possible. Similarly, U.S. influence in facilitating multilateral finance was not likely to be effective, since other major governments showed no interest in the projects or were opposed. The Italians even declared publicly that they viewed the trans-Iranian route, which is anathema to Washington and Tel Aviv, as the best outlet for new Caspian oil.

These are not the only instances where U.S. efforts to pursue pipeline politics have failed and backfired. Three more examples can be cited that are important in the diplomatic arena, since our partners remember them. The first is recent and involves our predicating policy on a non-existent pipeline. It arose when Turkey signed an agreement with Iran to import large volumes of gas—directly flouting U.S. sanctions. Turkey proceeded with the project in spite of U.S. pressure, and gas will flow within the next year.

Given Turkish intransigence, the administration needed a cosmetic solution,because both the Armenian and Greek lobbies in the United States were positioned to exploit Turkey’s disobedience for their own purposes. But Turkey held two trump cards. First, U.S.access to the base at Incirlik in southeastern Turkey is vital if the appearance of multilateral sanctions against Iraq is to be maintained. Second, Turkey has embarked upon extensive and elaborate cooperation with Israel. Both considerations are weighed heavily in Washington, and the Turks indicated that both were in jeopardy if the U.S. blocked the gas deal with Iran.

The administration’s solution to the impasse was a virtual pipeline. The State Department argued that the gas destined for Turkey was not Iranian. Rather, it would be gas from Turkmenistan—even though the pipeline into Turkey runs directly from Iran’s own gas fields in the southwestern provinces. Thus, in this version, gas was being “swapped,” and hence the project did not violate U.S. sanctions. Face was saved, and opposition or retaliation by anti-Turkish lobbies

was undercut. Unfortunately, there is no connection between Turkmenistan and Turkey.

A second fantasy which came to naught was the push 20 years ago by earlier administrations for a gas pipeline from Alaska across Canada into the northern continental United States. Termed the Alaska Natural Gas Transportation System, this project would have created market access for the large volumes of natural gas stranded on the North Slope. The orphaned gas is real, but the prospects were not. This scheme foundered for reasons parallel to those which crippled the several Caspian proposals. Firstly,commercial backing was fragile. Shipping costs for that long distance were very high—marginally acceptable if and only if oil prices remained in the range of $30, the price which prevailed briefly after the oil shocks between 1978 and 1980. Secondly a competitor stepped in: the Canadians proposed to build the “first leg” of the project, connecting gas fields in northwestern Alberta with pipeline grid into the US. Their “leg” was built. It preempted much of the market promised for Alaskan gas, and the linchpin of U.S. natural gas policy disappeared into history.

A third effort at pipeline diplomacy also led to debacle, this time U.S. opposition to Russia’s mega-project in the late 1970s to build four 56-inch gas pipelines from Siberia towards the west, connecting into Europe. The United States tried to stop the project, blocking sale of U.S.-designed or U.S.-licensed compressors and sending teams to convince Europeans that Russian gas was too risky. The United States was more concerned about European energy security than the Europeans themselves. Administration officials also lectured the Norwegians on the capacity and capabilities of Norway’s fields, rather to the amazement of their much more competent Norwegian counterparts.

The Russians, however, counter-attacked in the early stage of this pipeline war and prevailed. They leaked to the Europeans that the United States was conducting sidebar discussions with Russia, offering to waive U.S. opposition to the project if Russia agreed to increase the number of exit visas for Soviet Jews.

The discrepancy was embarrassing—on one side the US was arguing in terms of Europe’s energy security and on the other side it was pursuing a contrary policy tailored to domestic political concerns.

The revelations of what was perceived as U.S. duplicity soured the diplomatic environment, but the Russian scheme was destined to proceed in any case.

The prices were eminently reasonable—linked below the price of alternate fuels—and the risk, as assessed by the European buyers, was deemed to be minimal.

The Russians had proven themselves over the preceding 20 years to be difficult negotiators, but also to be reliable and trustworthy, once the agonies of the negotiating process had been consummated.

Pipeline politics have not been a strong suit for the U.S. government.

The score is zero for six. One lesson should be learned from these failures: It is dangerous to predicate policies upon testable data, when the counterparties are in a better position to test those data than the United States is, and when the data are not supportable. Such positions—when they are readily falsifiable—are dangerous and costly in the diplomatic arena. U.S. counterparts may come to doubt Washington’s technical or financial acumen. They may also be insulted, if they believe that their own competence is impugned when they are rebutted with transparently defective analysis. Diplomats argue that credibility is the foundation for negotiation and agreement. Cases such as those dissected here only weaken the administration. W

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