Since the early nineties, when it was defined the ‘New Middle East’, the Caspian Sea region has become a major focus for the energy strategy of the leading international players. However, it hasn't always lived up to expectations due to a variety of issues, foremost among them the status of the Caspian Sea, competition between the coastal states, and climatic and environmental conditions. In 2003, the US Energy Information Administration (EIA) estimated that the Caspian Basin could have up to 48 billion barrels of oil and 292 trillion cubic feet of proved and probable gas reserves. In comparison, the picture for the Middle East area is considerably different, with reserves of over 803 billion barrels of oil and about 2,827 trillion cubic feet of natural gas. This estimate includes Iranian reserves and shows that, while certainly significant, the resources of the Caspian could hardly pose a threat to those of Persian Gulf countries.
Since the early nineties, when it was defined the ‘New Middle East', the Caspian Sea region has become a major focus for the energy strategy of the leading international players
All eyes are on the area
Regardless of comparisons, the Caspian Basin remains an interesting region, not just for companies operating in the hydrocarbon sector but also for a series of state and transnational actors. The United States has long been watching developments in the area and was one of the first countries to set its sights on it, with companies like Chevron and ExxonMobil. The European Union, for its part, has long been seeking to diversify its energy supplies in order to reduce its dependence of Russian gas. Turkey, too, has been closely monitoring developments in the area and can rely on the good relations it has built with the two coastal states of Azerbaijan and Turkmenistan. The Caspian Sea area has also become a focus of interest for Asian countries such as China, India and Japan, all of which (albeit for different reasons) are looking for new sources of gas and oil supplies. The Caspian Sea area is a hub of constantly developing gas exploration and extraction projects. The natural gas sector in particular could enable the region to increase global production by 27 percent over the next ten years. Turkmenistan has proven natural gas reserves of 17.5 trillion cubic meters, and, according to the EIA, it is the country with the greatest potential to contribute to production growth in the sector in the years ahead. Turkmenistan's increased production will be primarily sustained by the coming into operation of new exploitation phases of the vast Galkynysh field (in the north-east of the country), the second largest in the world after South Pars, in the Gulf, with reserves estimated by Turkmenistan's authorities at 27.4 trillion cubic meters. The recent discovery of a new field in Chelekbay is also significant and fully confirms the country's abundance of natural resources and growth potential. This new field, situated near Galkynysh, whose discovery was announced by the authorities in Ashgabat in December 2016, is thought to have an extraction potential of around one million cubic meters per day.
Potential markets for this wealth
Buyers will have to be found for all this gas, and China is at the top of the list, having played a major role in fostering increased production by providing capital investment, technology and transport infrastructure. This relationship, however, has turned Turkmenistan into a debtor nation vis-à-vis China to the tune of billions of dollars, turning out to be a double-edged sword. The so-called ‘Line D’, the fourth section of Central Asia-China Gas Pipeline (CACGP), which already delivers 72 percent of Turkmenistan's gas exports, was expected to take ten years to complete. And with the project’s completion, CACGP could reach an annual delivery capacity of 85 billion cubic meters of gas, a considerable increase compared to the current 55 billion. But there have been many challenges along the way, and construction work on Line D was suspended indefinitely in March 2017. The new line was due to run through Uzbekistan, Tajikistan, and Kyrgyzstan, and reach north-western China. The countries along the pipeline path would not have benefited from Turkmen gas itself but would have gained revenues by charging transit fees. The project’s suspension, albeit temporary, puts a strain on Turkmenistan’s struggling economy, which is mostly based on exports of gas whose prices have fallen sharply in the last three years. In addition to its debt with China, as yet the only buyer of Turkmenistan's gas, there are also problems with Russia, one the leading actors in the Caspian Basin. In early 2016, Moscow canceled its supply contract with Turkmenistan due to the failure to reach a price agreement. With Ashgabat demanding USD 240 per one thousand cubic meters of gas, Gazprom negotiated two new deals with gas rich Uzbekistan and Kazakhstan at the price of USD 140 per one thousand cubic meters. To make matters worse, Turkmenistan lost its deal with Iran early this year when the latter decided to invest in internal electricity production. In order to diversify its sources of revenue, Turkmenistan is focusing on two alternatives: India, via Afghanistan, and the European Union via the Caspian Sea and Azerbaijan. While these prospects are appealing, they are also highly complicated. Firstly, Ashgabat needs to attract investments for its infrastructure, which has to be built from scratch. The first option, due to the unstable and uncertain Afghan theater, makes India seem more distant than it is from a purely geographical perspective. The second option is bedeviled by the persisting problem of the status of the Caspian Sea and, without a solution to this question, Russia will never agree to the construction of a trans-Caspian gas pipeline that would become a serious competitor for its supplies to Europe.
The decisive role of Russia
Russia's soft power in the area, thus far, remains very strong and hinders Turkmenistan's great potential. Russia is currently very interested in developing its continental resources in order to expand its gas and oil extraction potential. In recent years, as one of the world's largest hydrocarbon exporters, Russia has begun to seek a viable alternative to eventually replace its western Siberian fields, whose production levels are gradually and inevitably declining. This alternative is the Caspian Sea, bordered by the Russian region of Astrakhan, famous for its hydrocarbon deposits consisting of natural gas and condensate as well as oil. Its onshore resources amount to almost 6 trillion cubic meters of gas and over one billion tons of liquid hydrocarbons. Unlike Azerbaijan, Kazakhstan, and Turkmenistan, Russia decided to begin development of its offshore oil and gas fields in the Caspian Sea quite ‘late in the day’. During the Soviet era, the northern and central areas of the Caspian Basin, over which Russia has exclusive sovereignty and hydrocarbon exploration rights, were not deemed very promising. The emergence of the Astrakhan region as a ‘land of conquest’ for Russia’s energy players is therefore fairly recent. LUKoil did not start its exploration program in the northern portion of the Sea until 1994, and for many years it was the only large company operating in what was regarded as a low profit area.
Nevertheless, by as early as 2000 Russia’s exploration activities started to score its first successes. That year, LUKoil announced the discovery of the Yuri Korchagin field, followed by seven more over the next eight years: Rakushechnoye and 170 Kilometer in 2001, Khvalynskoye and Sarmatskoye in 2002, Vladimir Filanovsky in 2005, and Morskoye and Tsentralnoye in 2008. The reserves are estimated to contain a total of 4.7 billion barrels of oil equivalent. The first to be discovered, Yuri Korchagin, has proven reserves amounting to around 29 million barrels of oil and almost 64 billion cubic meters of natural gas. So far, according to its own calculations, the Russian company LUKoil has invested 45 billion rubles (equivalent to EUR 640 million at the current exchange rate) in this field, underscoring the importance being attributed to it. The Vladimir Filanovsky field is the largest oil reserve discovered in Russia in the last 20-25 years, with estimated reserves of 290 million barrels of oil equivalent. A few months ago, it was announced that the fifth well was put into operation. LUKoil operated on its own in the area for many years, while Gazprom and Rosneft arrived on the scene at a later stage. The former joined LUKoil in the development of the Tsentralnoye fields, while Rosneft bought the Lagansky drilling block in 2013 and, a year later, began the joint construction of a drilling platform in Rybachya with LUKoil. The last field was discovered in Velikoye in 2013. Estimates of the latter's reserves are still underway but according to preliminary data they could contain up to 300 million tons of oil and 90 billion cubic meters of gas.
Despite these encouraging figures, there are several challenges facing the Russian economy. Although it has come out of recession this year, it is still fragile and beset by the international sanctions imposed on Russia following its annexation of Crimea. A major challenge has to do with climate. The northern areas of the Caspian freeze over in winter and share the typical desert conditions of the Central Asian steppes in summer. These extreme temperature changes have negative impacts on exploration and drilling activities. Added to this is the region's relative shortage of special equipment and qualified personnel to construct and manage offshore facilities - a significant factor in holding back investment by new companies in the Caspian and one of the reasons why LUKoil is still the leading company operating in the region.
Developments in Kazakhstan
Russian companies have thus decided to open their doors to another state actor in the region: Kazakhstan. Moscow and Astana have a solid relationship and Kazakhstan is undoubtedly Russia's main ally in Central Asia. In late 2016, the Russian government authorized the establishment of the Central Oil and Gas Company, a joint venture between LUKoil and Gazprom (both with a 25 percent share) and the Kazakh company KazMunaiGaz (with 50 percent). The company is engaged in developing the Tsentralnoye field, situated in the Russian sector of the Caspian Sea. Cooperation between Russia and Kazakhstan goes back to October 15, 2015, when the two countries signed a Memorandum of Understanding that includes the rights to exploitation of the Caspian seabed. Kazakhstan, moreover, participates in the exploitation of the offshore field of Khvalynskoye, also operated by LUKoil, whose current reserves amount to some 322 billion cubic meters of gas, 18.4 million tons of condensate, and 242 million tons of oil.
Kazakhstan is also acting independently, however, participating in development projects in the Caspian Sea without Russia. In October 2016, production was resumed at the giant oil and gas field of Kashagan. Discovered in July 2000, Kashagan has been described as the biggest field to be discovered in the last thirty years, the largest outside the Middle East, with an estimated production close to that of Ghawar in Saudi Arabia, recognized as the world's largest field in terms of conventional (i.e. excluding shale) production. The project partners are China National Petroleum Corp (8.33 percent, acquired in 2013 for USD 5 billion by ConocoPhillips, through KazMunaiGaz), Inpex (7.56 percent) and, each with a share of over 16.81 percent, Shell, Exxon Mobil, Total, KazMunaiGaz, and Eni, which was responsible for the initial development phase.
The project has met with several challenges, however. Kashagan has faced the same environmental problems as the Russian fields, with harsh winters and very hot summers, not to mention high transport costs for the materials, and the corrosion caused by the polluted waters of the Caspian Sea, which forced the consortium to replace the pipelines with more expensive new ones in nickel alloy. As a result, the consortium incurred significant cost overruns with respect to initial estimates and was forced to suspend its activities, which were resumed in October 2016 with a delay of over ten years. Kashagan has often been described as a ‘great challenge’ but, once the hurdles are overcome, it could become one of the main drivers of Kazakhstan's development. In recent years, the country has been described as a ‘launch pad’, but its rise has been hamstrung by its geographical position, controversial political situation, and strong ties with Russia.
Kashagan, however, is not the only field in Kazakhstan; there are also long-running and well-established operations such as the Tengiz field. It was discovered in 1979 near the northeastern shore of the Caspian Sea and was immediately deemed one of the greatest hydrocarbon discoveries in recent history. Attracted by its prospects and taking advantage of the dissolution of the Soviet Union, several companies decided to invest in the field. Since 1993, Tengiz has been operated by the Tengizchevroil consortium, which has a 40-year right to the field. The consortium's partners are Chevron (50 percent), Exxon Mobil (25 percent), Kazakhstan Petroleum (20 percent), and LUKoil (5 percent). Today, Tengiz accounts for 45 percent of the country's overall oil production. Another giant field for oil, condensate and natural gas production is Karachaganak, situated in western Kazakhstan, in the so-called Pre-Caspian Basin. Its estimated production is approximately 230 thousand barrels of oil and 26 million cubic meters of natural gas per day. It is operated by the Karachaganak Petroleum Operating consortium, with Eni and Shell as joint operators, each holding a 29.25 stake. The other partners in the consortium are Chevron (18 percent), LUKoil (13.5 percent), and KazmunaiGaz (10 percent). 51 percent of production is delivered to the Orenburg facility in Russia, and the rest is exported to Western markets through the Caspian Pipeline Consortium and the Atyrau-Samara pipeline, which is directly connected to Russia's export network. The Caspian Pipeline Consortium is one of the leading examples of collaboration between Russia and Kazakhstan, as well as the many other international players involved, and enables the oil produced in the Kazakh fields to be exported to the Western partners. Among these fields is Tengiz, which has been directly connected to Russia's Black Sea port of Novorossiysk through a pipeline that opened in 2001.
Western countries, however, are not the only recipients of Kazakhstan's hydrocarbon production. Large-scale Chinese companies, just as they did in Turkmenistan, also set their sights on the country's main energy production projects. Thus, in 2013, CNPC acquired 8.4 percent of the Kashagan consortium, paying over USD 5 billion to KazMunaiGaz. Also, in early 2016, the China Energy Company Limited bought a 51 percent stake of KMG International – the international branch of KazMunaiGaz – while the China Investment Corp holds an 11 percent share of KazMunaiGas Exploration Production, another subsidiary of the Kazakh state-owned company.
Regardless of comparisons, the Caspian Basin remains an interesting region, not just for companies operating in the hydrocarbon sector but also for a series of state and transnational actors
External and internal challenges
This overview of the hydrocarbon reserves of three of the leading actors along the rim of the Caspian Basin shows not only the vastness of the reserves but also the great challenges involved, particularly in terms of the very high costs to investors. The fall in oil and gas prices in recent years has forced investors to maintain a fairly strict discipline with regards to capital distribution. It has also caused considerable problems to the economies of the Caspian countries due to their heavy dependence on hydrocarbon exports. Sanctions against Russia and Iran have certainly not helped matters, given the high level of interdependence between the various coastal states. This is one of the reasons why countries such as Azerbaijan, Kazakhstan, and Russia have chosen to adhere to the oil production cuts proposed by OPEC producers in 2016, in hopes of fostering an increase in oil prices. The problem is exacerbated by the fact that, thanks to the so-called ‘shale gas revolution’, the United States – one of the actors with the keenest interest in the vast Caspian Sea hydrocarbon reserves – is close to achieving the energy self-sufficiency it has so eagerly pursued. The European Union, by contrast, in its constant efforts to find new energy sources in order its dependence on Russian gas, has turned towards Azerbaijan and the Southern Gas Corridor, and is focusing closely on the great discoveries in the Eastern Mediterranean. Exports to China are not sufficient to offset the shift in perspective of some of the main energy importers. Beijing's energy demand remains high, but new transport infrastructure will need to be built in order to meet it.
External factors are compounded by internal challenges, including Russia's soft power, competition between the various state actors in the area, and the legal status of the Caspian Sea. The long arm of Moscow, for instance, has been the cause of many of the problems currently facing Turkmenistan, seen by Moscow as a dangerous competitor for Russian supplies. Russia is likewise the main stumbling block in reaching agreement on a Caspian Sea convention.
The dissolution of the Soviet Union opened the way for the initial claims regarding the status of the Caspian Sea. The issue concerns whether the Caspian should be legally defined as an international lake or an enclosed sea. If it were declared a sea (enclosed, but nevertheless a sea), the 1982 Treaty of Montego Bay would apply. Accordingly, the coastal states would have jurisdiction within 12 nautical miles, but beyond this they would be able to exploit an exclusive economic zone extending up to 200 miles from the baseline. If in legal terms the Caspian were a ‘sea’, the principle of the so-called ‘median line’ would apply whereby sea borders are determined by a line every point of which is located at an equal distance of 12-nautical miles from the coastlines. In this case, the Caspian Sea would be subdivided into sectors resulting in the allocation of 30 percent of the total area to Kazakhstan, 20.6 percent to Azerbaijan, 19.2 percent to Turkmenistan, 15.6 percent to Russia, and 14.6 percent to Iran. If, however, the Caspian were legally defined as a ‘lake’, the coastal states would only be able to exercise their exclusive territorial rights within 12 miles of their baselines, while beyond that there would be joint exploitation and an international authority would be appointed to coordinate the extraction and division of seabed resources
This issue reveals how each coastal state has its own individual needs, interests and priorities, which often clash with those of its neighbors. Iran, for instance, has a low level of oil and gas production in the Caspian, whereas Azerbaijan is totally dependent on it. It is therefore not surprising that the Baku and Ashgabat authorities are among the main promoters of the signing of a convention. According to the latest official statements, agreement has already been reached over 70-80 percent of the convention, which could be signed at the next summit of the leaders of the five coastal states due to be held this year in Astana, Kazakhstan, on a date that has yet to be announced.