The following is an edited transcript of the twenty-second in a series of Capitol Hill conferences convened by the Middle East Policy Council. The meeting was held on September 15, 2000, in the Capitol Building with Chas. W. Freeman, Jr., moderating.
CHAS. W. FREEMAN JR., president, Middle East Policy Council
The Caspian Sea is at the border of the Middle East. It divides Europe from Asia and the Caucasus (Azerbaijan and Georgia) from Central Asia (Kazakhstan, Uzbekistan, Turkmenistan, Kyrgyzstan, Tajikistan and Afghanistan, and Xinjiang in China). Historically, this region has sometimes controlled the Middle East. It is a historic zone of contention between great powers: Greeks and Persians, Chinese and Arabs, Russians and Turks, and all of the above and modern Iran.
It is also prominent now because, with the end of the Soviet Union, this cradle of the world's oil industry has re-emerged as an important potential zone of exploitation by international oil companies and a source of energy for the world. Everybody is involved- American, Iranian, Turkish, Chinese oil companies, Iraq and the Russians as participants in claims to the Caspian. But how to get the oil out? As President Khatami of Iran reminded us the other day, many people believe, contrary to U.S. policy, that the most direct and cheapest route would be through Iran.
Three years ago, when my predecessor as president of the Middle East Policy Council, George McGovern, convened a discussion of the Caspian region, oil prices were not as high as they are now. Hopes were, however, high for rapid development and settlement of disputes over dividing the Caspian Sea. It is very hard to see, in the three years that have passed, that these hopes have been realized.
DAVID L. GOLDWYN, assistant secretary for International Affairs, U.S. Department of Energy
I'm going to talk this morning about U.S. interests in the Caspian region, which is where all U.S. policy should start; why the Caspian matters to you as energy security, how the United States is working to develop a positive investment climate in the Caspian region, and also to debunk some of the myths about our policy in relation to Russia and also to Iran.
Political stability and democracy are the keystones of U.S. interests in the region. Our primary objectives are well known to you and to my colleagues, but I should restate them: a strong, independent and prosperous Caspian region; strong regional cooperation and the fostering of linkages among the countries; enhancing our own global energy security; and creating a positive investment climate for U.S. and other companies.
With respect to my primary interest, energy security, the Caspian region is important. Proven oil reserves for the entire Caspian Sea area are estimated at between 18 and 35 billion barrels, which is comparable to North Sea or U.S. reserves. Natural-gas reserves are even larger. The proven gas reserves are estimated at 236 to 337 trillion cubic feet, which compares with the gas reserves of all of North America. But if the prospects in the region prove real, they could be equal to a quarter of the Middle East's existing reserves. This will be a, if not the, major source of non-OPEC oil supply in the future, or at least in the next few years. Caspian-region oil production could increase to almost 4 million barrels per day (mb/d) and exports to over 3 mb/d by the year 20 I 0.
So the region's energy potential makes it an important player in the international dialogue on energy security and on the things that are important to us: diversity of supply, transportation and how oil is developed and used. So no U.S. administration can ignore the potential impact of the region on international oil markets. Secretary Richardson has traveled to the region a number of times to Astana, Baku, even to Ashgabat, and to Moscow as part of a dialogue, and witnessed both the Ankara and Istanbul declarations. So his visits, along with the work of John Wolf, special ambassador for Caspian energy development, are part of our efforts to develop close ties with all these nations.
One of the most important U.S. goals, U.S. energy security, would be significantly advanced as the region becomes a reliable supplier of oil and gas to Western markets. Diversity of supply is important to us, and we need not only to avoid over-reliance on one region or one supplier, but it's better to have more rather than fewer chokepoints. And so developing new sources, especially of non-OPEC oil production, will, over the long run, be important for our security, help to stabilize the oil market, and probably reduce prices.
The news in the region, especially recently, has been quite good. Kazakhstan's Kashagan find is very promising. Production of Shah Deniz in Azerbaijan is even better than prospects had implied. Just the other day, there was a deal converting an onshore joint venture in Azerbaijan to a production-sharing agreement. This was between SOCAR and Moncrief Oil.
But the problem in the region, as you all know, isn't really resources; it's transportation. And that goes to the core of our policy. Multiple east-west pipeline routes, we believe, are essential to the security of the region's infrastructure and development and thereby enhance U.S. energy security. Having a monopoly or even an oligopoly of transportation routes is not as good as having multiple routes in competition. Competition is going to give the countries the opportunity to make their own decisions on how to maximize their economic opportunities and also ought to drive down transportation costs. That's why we support multiple east-west pipelines. There are three now: Baku-Novorussisk, Baku-Supsa, and the Caspian Pipeline Consortium (CPC) is well underway. We think there ought to be a fourth, which is ultimately known as Aktau-Baku-Tbilisi Ceyhan, or when we're talking to our friends in Kazakhstan, Ahtel-Baku-Tbilisi-Ceyhan.
I should say something about gas as well. Obviously, the reserves are huge. Turkey is the market in the region, with its own strategic vision of having more diversity of supply. Most of its supply comes from Russia right now. We support multiple east-west gas pipelines as well. The other news is a bit more mixed. Azerbaijan has a lot of gas. Kazakhstan has a lot of gas. Turkmenistan has a lot of gas. And Azerbaijan and Turkey are talking about gas-purchase agreements. I think the Azeris and the companies which support them are in the position of building a gas pipeline, probably with little difficulty. But our hope is that the political difficulties with Turkmenistan and some of the commercial obstacles can be overcome, and that an east-west pipeline can begin in Turkmenistan and reach across the Caspian to Turkey.
Let me talk briefly about another U.S. interest in the region with the opportunities for trade and investment. Obviously, energy-sector development provides opportunity in oil, gas and also electric power. We think that development can lead to a significant trade relationship with all the Central Asian countries. That benefits their development. It also benefits our companies. Western companies are already planning investments of up to $100 billion over the next couple of decades, primarily in Azerbaijan and Kazakhstan. But a Jot of this is contingent, still, on successful exploration and production and agreement on pipeline development. But the magnitude of the region's energy potential is going to provide substantial opportunities.
We're working closely with the countries of the region to advance these objectives, and they know that their potential growth lies in Western markets. Within the administration, the Department of Energy has a dialogue with most of these countries on things like energy-sector reform, energy efficiency, climate change and environmentally sustainable energy development. We've made some good progress on that dialogue. We're also looking at areas where we can be helpful, like developing a regional oil-spill initiative and establishing policies that support balance in energy development. Basically this means encouraging these countries to know the wisdom of using the revenues from oil and gas to diversify their own economies.
But our policy can be helpful. A lot of work needs to be done with these governments. They have to undertake the market reforms that are going to be essential to creating a business environment that supports foreign investment, especially as they try to diversify into and attract investment in non-energy sectors. They have to pay careful attention to issues such as respect for the rule of law, contract sanctity, transparency in the tendering process, customs and tax reform. All those are important to attracting foreign investment and creating a climate of confidence for foreign investors. The administration, mostly through USAID, has provided some support to most of the countries in the region on developing the appropriate legal and regulatory regimes that encourage investment. A big part of what we do is try to encourage the governments there to have the political will to carry through on these commitments. We also work with the IMF and European aid agencies to coordinate our assistance to move these countries as quickly as possible from command economies to market economies.
It's probably worth noting that we're prohibited from providing foreign assistance to Azerbaijan, although we have a political dialogue with them, and the position of the administration is that we'd like to see Section 907 repealed.
I want to talk about two other areas, Russia and Iran. Russian oil development is in America's energy-security interest. Russia is an important part of the evolving regional oil-transportation system. We want Russia to resume its role as an oil power because it's important for supply, for Russia's democracy and for its development. The obstacles to Russia's progress at this point have to do with its internal policies, something we spend a lot of time talking to them about. They have committed to a production-sharing-agreement (PSA) regime, which we think will attract the investment that they need. There has been a lot of back-and-forth in Russia about this. President Putin, at a PSA conference in Sakhalin just a couple of weeks ago, made a commitment that this is the way Russia is going to go. If so, we will see progress in Russia's development, something that we very much support.
As to Iran, U.S. Caspian policy is not anti-Iran, it is pro-Central Asia. It is based on our interest in the prosperity, stability and progress of the countries in that region. There's been a lot of speculation in the press and from industry about where there will be changes in U.S. policy toward Iran. There have been some changes, and they've been positive. The offer of the dialogue of civilizations from President Khatami is important. The United States has responded by increasing some trade and cultural exchanges. But our policy on energy investment in Iran has not changed. So far- and we dearly hope that this will change - Iran's policy with respect to weapons of mass destruction, support for terrorism and active opposition to the Middle East peace process has not changed either.
At times, Iran has also opposed OPEC production increases, which are aimed at stabilizing oil markets. This just underscores the importance of having major non-OPEC suppliers with their own transportation, which doesn't necessarily go through other OPEC countries. In my view also, Iran's policy framework makes their market an uncertain place to do business. I think the Caspian energy exporters advance their own interests if they work at attaining independent access to world hard-currency markets, rather than relying on their competitors on either side.
There's also been some speculation about whether U.S. policy will change after the election in November. I don't think so. Regardless of who wins, U.S. interests in the region are enduring and have bipartisan support. They're also based on lasting and fundamental U.S. national interests. If you look at the Silk Road strategy, there are both Republican and Democratic sponsors. The other day, I went to a ceremony hosted by both senators from Texas and Ted Stevens, chairman of the Senate Appropriations Committee, celebrating this Moncrief PSA agreement. So the support is bipartisan. It's broad and deep and based on U.S. interests. So I don't think we're going to see the election change any of that. We all have an interest in having these countries be independent and stable, and reach out to Western countries.
In conclusion, I would say that, regardless of who wins or whether we succeed, as I hope we will, in improving our relations with Iran, U.S. policy in the Caspian is not likely to change, and U.S. policy interests in the Caspian are likely to remain. Three years from now, when you all look in on the Caspian again, hopefully, we'll be talking about the success of the east-west energy transportation corridor and the prosperity and stability of the countries in the region.
THOMAS R. STAUFFER, international energy consultant
My question addresses two issues that overlap: first, the importance of Kazakhstan, to which you alluded, and second, this matter of the investment climate. Could you discuss the matter of Mr. Giffen [an American entrepreneur under investigation by the Justice Department for oil deals in Kazakhstan. See The Washington Post, September 25, 2000, Al.] and the several investigations by the U.S. attorney into his activities? What are the implications this might have for parties in Washington?
MR. GOLDWYN: I am happy to talk about Kazakhstan. With respect to Mr. Giffen, the short answer is no, I can't really say much about an investigation being undertaken by the Justice Department, which we are not privy to. That will take its own course. Kazakhstan is important. It is, obviously, huge in oil and gas. It's an enormously important country because of its geographic location. We do a lot with Kazakhstan through a binational commission. And I think they are committed to change. I was just with Secretary Richardson in Kazakhstan a couple of weeks ago, talking to them about the importance of market reform. They clearly know what needs to be done, and they are expressing the political will to do it. But a lot of change needs to happen to create the right investment climate there. They are supporters of Baku-Ceyhan and CPC, and they believe in exporting as much of their oil and gas as possible in all directions. Someone asked Secretary Richardson when we were there, "Do you have a view about corruption in Kazakhstan and other places?" And he said, "Yes, we're against it." With respect to Mr. Giffen, I don't know anything about his individual case, but we care about the rule of law.
Q: The Russians seem to feel that the United States is trying to freeze Russia out. Was there any thought given early on, after 1995, to inviting Russian companies, such as Gazprom and Lukoil, to participate in it so as to give the Russians a stake in the east-west pipeline so they'd be less likely to sabotage the project?
MR. GOLDWYN: The short answer to that is yes. Lukoil is in the AIOC consortium, so if things go well, they will be part of the east-west transportation corridor. Russia has a primary concern, which is the CPC, something the United States strongly supports. Chevron has a huge investment in that, and we want it to succeed. We have talked to Russia, from the prime minister on down, about the importance of joining the east-west transportation corridor and joining Baku-Tbilisi-Ceyhan. They have a new find in the north Caspian. The question for them, as for the companies who are invested there, is this: What's the most commercially attractive way for us to export our oil?
They have publicly expressed support for multiple pipelines. From Russia's interest, it would be great if all the multiple pipelines went through Russia. But you could say the same thing of every other country in the region. So we have talked to them. We will talk to them, and we hope th.at when CPC is full and off and running and profitable, and Russia has more oil to export, that it will join Baku-Tbilisi-Ceyhan.
JULIA NANAY, director, Petroleum Finance Company, Ltd.
There's so much talk in terms of pipelines: there is the oil pipeline to Supsa; you can go through Ukraine, you can go through Romania, you can go other ways in this east-west corridor. What would the U.S. position be on those?
MR. GOLDWYN: We support multiple pipelines, and the bypass routes are important to consider as well. The Trade and Development Agency has actually financed a number of feasibility studies about those bypasses. None of them at this point are at the stage where companies are stepping up to actually build them, and there's a question of the right sequence in developing these lines. In the end, the market will determine what's the most competitive. But, in a general sense, the more the better.
Q: I get the feeling that U.S. policy is like a motorcycle race from Baku to Ceyhan. You've got one barrel of oil strapped on your back, and you're driving full speed ahead. I wonder if it isn't time to ratchet it back and let the commercial and financial side of this catch up.
Mr. Goldwyn: There are sort of two relevant factors. One is what do the countries in the region want? They have stated that it is in their strategic interest and in their interest as the owners of at least a portion of this oil to have an east-west route and to support it through Baku-Tbilisi-Ceyhan. That was what the Istanbul declaration and the Ankara declaration were all about. What's in our strategic interests? Our interest as a U.S. administration has been to support them. But there is no question whatsoever that, unless this project is commercially viable, it will not go anywhere. The United States isn't going to finance this line, other than through Export-Import Bank, Organization of Importing Countries, OPIC, TDA. Right now, we are at the stage where it's being tested in the market. As the companies form their own operating consortium, as they look at what the tariff is going to be as they start to invest money in basic engineering and see whether that works, and then in detailed engineering and then try to get commitments for volumes to fill this line so it can be financed, we’ll see what happens.
The test over the next couple of years will be in the marketplace. From a political standpoint, we have done what we needed to do, and we need to continue to support it. But the proof will be in the market.
AMB. FREEMAN: A big question continues to hang over the pipeline's financial feasibility. Do you have a sense of the sustained price of oil at which it is viable? Have you done studies in the Department of Energy that show a break-even point?
MR. GOLDWYN: When oil was $10 a barrel or thereabouts, we were pushing Baku-Tiblisi-Ceyhan just about as hard as we are right now. I think we haven't really done a study of at what price it's going to be competitive. It certainly is competitive right now, and people are interested. But none of our statisticians or anyone else that I know has ever successfully predicted the price of oil over any significant period of time. But I think, if oil settles even to historically median prices, that this pipeline would be competitive.
Q: The last time I studied this Caspian issue, Ambassador Morningstar was promoting Baku Ceyhan and very few, if any, corporations were interested in investing in it. Is there greater corporate interest now?
MR. GOLDWYN: Enormous progress has been made. The intergovernmental agreement has been signed; host-government agreements have been signed. We monitor, but we are on the receiving end of the commercial conversations among the companies there. They have made enormous progress, and they are raising money for basic engineering right now and have adopted a timetable to build this pipeline. There are milestones in there, to be sure, which have to be met or things won't progress, but this pipeline is in the hands of the companies right now, and that's a far cry from where we were in October 1998, when the front page of The New York Times said that this thing was dead and over. It's not dead and over; it's about to be planned for construction.
Q: You mentioned Section 907. Are there any other changes that you think Congress needs to make that would improve the chances of development of these oil resources?
MR. GOLDWYN: I think in terms of legislation, the Silk Road Strategy Act is probably the most important thing. Repeal of907 would really help in terms of Azerbaijan's development. But we've proposed no other legislation that I'm aware of. Our position is that this project needs to be commercially viable. We think there should be Ex-Im support of its using U.S. products, OPIC support. TDA has made enormous contributions already. But this will be commercially financed, not financed by the U.S. government.
MARTHA BRILL OLCOTT, senior associate, Carnegie Endowment for International Peace
You talked about how people often misunderstand U.S. foreign policy. You argue that the key part of our foreign policy is really the advancement of markets and stable democratic societies here, and energy is just a derivative of it. I don't see this in our foreign policy. It seems to me energy has been driving foreign policy and that the administration has tried to use the oil companies to pursue foreign policy rather than the oil companies pushing the administration successfully to pursue their own economic interests. What would be your test? How would you demonstrate that democracy building and promotion of market reforms have been the core of the policy? What sanctions have been applied to states that have behaved in wholly undemocratic ways? What percentage of economic assistance has gone into projects that are not related to energy as opposed to the kind of money you talked about that's going into TDAs? How can we measure the policy? How can you deal with critics like me?
MR. GOLDWYN: It derives from what the strategy is for helping these countries become more democratic and stable. The first place I would start is both with what Secretary Albright has said publicly about these countries and what these countries have said publicly after she's left. There's no question that the message there has been that democracy is important. Where we have felt that elections could be more democratic, where they were not conducted in a fair as way as we thought they should be, the secretary has been public and firm on that point. The second aspect is, where are the dollars? The USAID program, which is our primary source of foreign assistance, is devoted as much to policy reform and democracy, although I don't have the budget figures in front of me. It's all on policy reform rather than completely on energy. But how do you expect these countries to build the civic support, to have the stability to grow as democracies? The only way they can do that is by having some economic prosperity. They don't have much but oil to sell. So, part of it is to try and get the energy sector to develop in a particular way.
But what is that assistance about? It is about respect for the rule of law. It's about passing laws and enforcing them. It's about having an open and transparent process. This is new. And all of it pertains to how you conduct yourself as a democracy. These countries will not succeed if they remain closed or if there is corruption. Companies will take their dollars elsewhere. So I think there is a connection between what we're doing in that sector and the promotion of democracy.
Q: Transportation is an important element, but there's no point in even working on transportation unless you've got the infrastructure right. Most of the money we're spending goes to these big offshore projects rather than the pipelines. We're stuck because we have very few rigs operating in the Caspian. We're stuck because the country is very wealthy in resources. It has huge amounts of oil and gas, and when people turn on their cooker in the middle of Baku no gas comes out. We're delivering free gas to the city, but it doesn't seem to get to people. Our plea is really for more support on the infrastructure side. Unless we get that working, it's pointless trying to export all the oil and gas while the country remains poor. Do you see a window of opportunity on 907, coming after November?
MR. GOLDWYN: I think the administration is committed to repeal. The Azerbaijan government supports repeal. And I think we're going to continue to push that.
AMB. FREEMAN: But, in essence, there's no reason at this point to expect that the political factors that have made Armenia the largest per capita recipient of foreign assistance are going to go away.
MR. GOLDWYN: I hear what's behind your question, but I think if our decisions were really that politically driven, you wouldn't see an entire U.S. policy based on this east-west transportation corridor, to the benefit of Azerbaijan. We're committed to all those countries in the region, and repeal remains the top priority. Internal gas development is important for the prosperity of the people in the countries. It's important to create a market so that somebody uses this gas in places other than just the Turkish market. And we have done some work in terms of helping Azerbaijan, and I think we're starting with Kazakhstan to develop an internal gas market. That will take a lot of change. But it's an important thing to do and it will be a continuing focus of our policy.
Q: A number of oil companies are working very hard to see if we can make this Baku-Ceyhan pipeline work. I just wanted to make that clear in support of David Goldwyn's earlier comment.
Q: There have been a couple of reports that the United States is investigating Conoco for helping National Iranian Oil Company (NIOC) analyze some data. I'm curious why this investigation is going on in the first place if they haven't actually done any investment and why it's just data analysis that's caught the government's attention. Second, is the government still disappointed in the drop in oil prices since the OPEC meeting?
Mr. Goldwyn: I saw the article and the clips yesterday afternoon, but I don't have any independent information on it at all with respect to the Conoco story. I think, with respect to the OPEC decision, you know there was, obviously, a strong reaction to the decision, and we're continuing to encourage the OPEC countries to look at producing more. Things are still a little unsettled, and I think we may see them settle out a little more in the near future.
Dr. Olcott: I was asked to talk about the geopolitics of the region and Russian interests in the area. It's impossible to talk about Russian interests without talking about U.S. policy toward the area and the interrelationship between the two. I would argue that, ironically, at the very time that Caspian reserves are being proven quite large, the great powers are likely to become less interested in the region. As we move into the next administration and farther into the life of the Putin administration, Caspian policy will become less of a focus in this town. I'm not arguing that the oil companies are leaving. I'm just arguing that the Caspian fad may well begin to pass.
One of the reasons for this may well be that the new administration could, and I would argue should, take a more cooperative stance with regard to Russia in the Caspian. The Caspian and, in particular, Central Asia provides an area of Russian and American cooperation on a number of security issues, and if we want to see pipeline development and energy development move fast, a cooperative environment between the United States and Russia would speed it up, not delay it.
For a variety of reasons, the United States and Russia have taken a competitive stance in the Caspian for the past six or seven years. In the very beginning of the period of independence, U.S. policy toward Russia was different and Russian behavior was different, too, in some of these places. But you really have a chicken-and-egg problem with changing this stance.
Part of the problem, I would argue, was Russian behavior. Russia behaved aggressively or quasi-aggressively, especially in the Caucasus. They didn't really behave aggressively in Central Asia; Tajikistan was a mess that both the United States and Russia got into in different ways. But I would also argue that the United States failed to recognize that Russia had overarching strategic interests in the Caspian and that those interests were not going to disappear. No Russian state could define itself without involvement in the Caspian region.
This doesn't mean that Russia has the right to dictate terms to the Caspian states. But it is impossible for a Russian state, be it democratic or non-democratic, not to see the Caspian as part of their primary security interest, and that, for the United States, the Caspian will never be a primary strategic interest. The Caspian has some strategic interest for the United States, but it is of lower order in Russia's scheme of its own strategic interests. When we got angry at Russia for a variety of good reasons, we never really reconsidered what this means for moving in the Caspian. So U.S. Caspian policy fell victim to our desire to contain Russia and exclude Iran. But it also became a good vehicle to find a cheap reward for Turkey. The administration was not bringing much to Turkey, a traditional ally of the United States, and we wanted to be able to strengthen the Turkish position there.
The relationship was also explicitly harmed by Russia itself. Russia initially didn't see the independence of these states as real. It underestimated the capacity of these states to function in the international environment and become real actors. Russia was preoccupied by its own interest in taking control of these resources. They thought the resources were theirs at least to have a piece of. This led to a heavy-handed Russian approach that created strong incentives for the United States to develop this contained Russia policy, fueled by the aggression in the South Caucasus. However, with a new administration, of whichever party, it will become more publicly apparent that the Caspian is an area of big but inaccessible oil and bigger security problems.
The landlocked nature of the Caspian magnifies the infrastructural problems, but it also magnifies the security problems. It makes this a very difficult area for the United States to provide long-term security guarantees for, even if we were talking about that. We're really talking about helping to train people. We demonstrate a capacity to intervene but there's no way we can pull up boats in the region. This realization is beginning to lead, I would argue, to a reappraisal of Caspian policy that we can see signs of, although the administration is certainly not going to come out and say it in the last few months of its existence. There are several reasons for why this is occurring.
First, it's no longer possible to minimize the pervasiveness of corruption in the area. The information coming out of Kazakhstan makes it clear that corrupt practices have shaped the economic policies of these states. Azerbaijan and Turkmenistan may not turn out to have been more honest, just less newsworthy or better at concealment. I don't want to single out Kazakhstan; there has been an atmosphere of corruption pervading the whole region.
Second, it is clear that there are real terrorist threats coming out of this region, especially in Central Asia. And it is also clear that they are the consequence of weak states, states that have opted for stability without political and economic reform, not because of a major or dramatic increase in global terrorism itself, but because these are fertile places for terrorism.
Third, it is really becoming clear that the development of these resources is going to be slow. The next administration is going to have a timetable for Caspian development that corresponds more closely to reality.
Fourth, the change of administration creates new opportunities for cooperation with Russia on common threats. And although there's no assurance they will do this, there's a chance.
Fifth, the change in administration creates the opportunity to bring coherence to a Caspian policy that has really lacked it. U.S. policy toward the Caspian region has come by fits and starts. Democracy is popular in one six-month period, but energy has really driven it.
What about Russia? Russia is also going through a reappraisal as the new president tries to bring new strengths to a new policy. But he also has to confront Russia's new weaknesses. He creates a new opportunity to deal with these states. He doesn't have Yeltsin's baggage; he brings some very important qualities of youth and new thinking to the table. Remember, this is a table in Central Asia. It's not a table in Washington. These strengths are considerable. Russia has a strong sense of shared security interests with the Caspian states, in addition to common borders. Geography makes it impossible for these states to escape Russian influence.
Throughout the eight Caspian states we see going on a re-evaluation of relations with Russia and an improvement of relations across the board. Although it is certainly not ideal from Russia's point of view, and there's still a nervousness on the part of these states. What you see now is a dialogue in the creation of bilateral relations, and not a Russian diktat. The dialogue is of unequal partners, and it's going to be quite a while until these states learn to better defend their interests at the table with Russia, but they have come a long way. Kazakh-Russian relations, in particular, are a very good example of where there is a stronger partner and a weaker partner, but very articulate partners on both sides of the table. This is something new and very important.
This reassertion of Russia, I think, is going to make it very difficult for foreign powers, even the United States, to do much more than mediate in issues in the Caspian area, to do much more than have opinions. They will not be the determiners of the shape of Caspian development. This will become much more apparent when the final pipeline routing is decided on and when the energy companies are actually shipping product out of the region.
Finally, I would argue the non-democratic nature of these states makes Russia a much more attractive potential partner than the United States, and that these states are not going to become anything but non-democratic for the foreseeable future. I'm very sorry to say this. But 30 years of traveling to the region stand behind this statement. It's not clear whether Russia is going to become more democratic, but it is not going to use democracy as any sort of litmus test in the dealings with these states. I think that we have to promote democratization. You can't have stability without it. And what Russia wants is stability through Russian-guaranteed security systems. This is going to become more and more attractive in the region.
The question is whether Russia will be able to deliver and have an interest in delivering. What we see now is a process of redefinition of security relations between Russia and the Caspian states as they look for partnership terms, terms that don't exclude NATO's Partnership for Peace or exclude some training by the Turks. But there's no pretense that there's going to be a Russian withdrawal. What is under discussion are the terms of Russian participation and that they not become abusive. Russia can create a security-driven regional identity in Central Asia in a way that we cannot. Non-democratic states are less easily transformed into enduring regional partners. And in the absence of democratic states in Central Asia and the Caucasus, we're simply not going to see the creation of strong regional cooperative mechanisms that perm it the door to be closed on Russia and Russia's guarantees.
This need not be bad from the point of view of Turkey. Turkey is a natural and realistic partner in economic and cultural areas for many of these states and has strong economic interests that it is going to advance in this region. And the faster Turkey is able to become a partner solely on market-driven concerns, the faster Turkey will be able to assert its role in the stability and not just the economic development of this area. The contacts between informal groups in the Caspian region and informal groups in Turkey are going to be a powerful force toward democratization as we move to another generation. So if we actually allow pipelines to be built where the market drives them, Turkey will find its long-term role in the region nonetheless.
AMR. FREEMAN: I heard you describing a region that has more than its fair share of autocrats, kleptocratic regimes, humanitarian theme parks, oil-rig museums, virtual pipelines and opportunities for corruption. As you suggested, this is the sort of region where American politics can work wonders. We have developed a habit of franchising policies to special interests. That group which is most interested in the results of a policy or most affected by it very often gets to make the policy, appoint the people to administer it, and bar further public debate over the policy. If we get into a region where there are several special interests competing, as I think you've suggested, we have invented the idea of time sharing, so the franchise can go one week to one group and then the next week to the next group. That is hard to term consistency.
Ms. NANAY: Since high oil prices and the dangers posed to Western economies are in the news I thought that it would be a good time to start by addressing what the issues really are here and then lead into the Caspian. The blame for high oil prices seems to be falling on the shoulders of the OPEC countries. They currently produce about 29 mb/d of the world's oil. The world uses about 77 mb/d so that figure comes out to about 36 percent of the world's energy use. Over 60 percent of the world's energy, or just over 46 mb/d, is produced by non-OPEC countries.
At the same time, the only country with significant spare capacity happens to be OPEC's lead producer, Saudi Arabia. You just heard the assistant secretary of energy say that they want to encourage OPEC countries to produce more oil. The only country that can produce a lot more oil is Saudi Arabia. The only reason that Saudi Arabia stands so far ahead of the pack is because the United States has embargoed three significant oil-producing countries - Iran, Iraq and Libya. Had they not been under oil embargoes over much of this last decade, they could have provided the additional spare capacity the oil markets need today.
There would be about 2 mb/d of additional oil on the world markets had the United States not had sanctions against these three countries. If you said to the oil-producing countries of the world today, rev up production by 4 mb/d, there is no way they could do it. Even for Saudi Arabia, with its 2 mb/d of spare capacity, it's questionable how much of that amount is available at the turn of a spigot. I think it would take time. Those who like to see the glass as half-full will be pleased by the argument that Iran, Iraq and Libya deserve to be sanctioned. They will state that sanctions have worked. Those who take a more sober view will see the glass as more than half empty. In the end, the United States may be sanctioning itself.
As to the Caspian region, I've always said that U.S. commercial interests are not factored into U.S. political interests. Now as I look at the Caspian and add in the greater Middle East of the OPEC countries, I can also say that U.S. foreign policy and U.S. energy policy fail to take into account the realities of running our economy. This last decade has saddled us with energy policies that encourage consumption and discourage production. Yet we've done nothing about meeting our ever-growing thirst for energy.
You could argue that the Caspian was supposed to be a panacea for this problem. I suppose, in some way, we could postulate that the reason the U.S. government began expressing such excitement over the Caspian three or four years ago was precisely because it wanted to believe that the Caspian would offer an alternative source of energy. But then when we began to look at maps, we noticed that these are landlocked countries. Creating exit routes out of landlocked countries is difficult under the best of circumstances. When you 're confronted with a region that is sandwiched between two of the world's energy superpowers - OPEC Iran and non-OPEC Russia creating exit routes for oil and gas that don't factor in their interests may be impossible.
Think about it. Iran produces about 3.8 mb/d today; it is the second-largest producer in OPEC after Saudi Arabia. Russia, however, produces 6 mb/d. Iran and Russia each export over 2 mb/d. The Caspian does not rival the potential of Russia and Iran combined in terms of oil and gas. It will take some years before any of these countries pose a serious threat to the energy hegemony of Russia and Iran in this region. As Tom Stauffer has pointed out, it is Kazakh energy resources, and not Azeri or Turkmen, which will provide the battleground of the next years in the Caspian. The largest oil producer is the Caspian is Kazakhstan, which is edging up towards 700,000 bid. It also borders on Russia. So while the United States has focused on the southern Caspian because of its policy of isolating Iran and drawing a line above Iran with pipelines crossing Azerbaijan and Georgia into Turkey, the real energy story of this region is Kazakhstan.
We have heard comments that U.S. policies have been driven by energy. I would argue they've been driven by pipelines. It has been the U.S. government's position to build these pipelines even at a time when it didn't know whether the energy resources would be there. So, in a sense the U.S. government would be happy to see these pipelines built, drawing a line above Iran, even if they stood empty.
What do the countries of this region want? I think it's more nuanced than east-west energy pipeline corridors. I have heard the leaders of this region express some of the things they want. They want money. Initially there was a vision that these countries would become like the Persian Gulf states, where you have leaders in many instances able to buy the support of their populations. Money is not flowing in as quickly as the Caspian leaders would have liked. In the end, they want pipelines that get their resources to market in return for money. And it doesn't matter if these pipelines go north, east, west or south.
I have heard President Nazarbayev many times speak about his desire to work with Iran. And it is only the U.S. government's interest in keeping him away from Iran that has prevented him from exploring the southern route more closely. Now, however, I think that he is beginning to look south more seriously. What does President Aliyev want? First and foremost, I think he wants to resolve his problems with Karabakh. For him, east-west routes are a way to get U.S. involvement in helping him resolve this dispute. Does he ultimately care which way his oil and gas get to market? If it were a question of not getting out in any direction other than north and south, I think he would not necessarily be devoted to just east-west routes.
The other party that hasn't been factored in here is Iran. Obviously, Iran is a huge market of nearly 70 million people. It is a very small user of oil and gas today, but because its population is concentrated in the north of the country, far away from its oil-producing region, Iran is going to need Caspian resources for its domestic markets.
In the end, I agree with Dr. Olcott that Russia is a very important cooperative factor for the United States. The policies that the United States has pursued on this east-west pipeline corridor and on the isolation of Iran have pushed the Caspian countries back toward Russia. They are dealing with Russia much more closely, and, probably during the next administration, the United States will start to work more closely with Russian interests, which are being more forcefully imposed in the region.
Finally, I agree with Dr. Olcott's statement that the U.S. government has been using oil companies to pursue its foreign policy instead of, as in every other country, oil companies using their government to pursue their commercial interests.
AMB. FREEMAN: East-west also includes the important dimension of China. This morning's Washington Post has a story based on travel in Xinjiang by its correspondent. Part of that story has to do with the Chinese national commitment to a pipeline from Urumqi, the capital of Xingjiang, eastward to the Chinese coast. That pipeline is envisaged ultimately not simply as an internal Chinese pipeline, but as one that will connect oil and gas fields in Central Asia through China to markets in Korea and Japan. This is a very long-term project, but it is a reminder that the fastest growing energy markets are around the Yellow Sea. Some developments seem immune to American policy. The Chinese are now building a pipeline in Iran, for example, as part of their effort to ensure their own access to Central Asian resources. Japan and Korea are also active. So it is not simply a case of Americans, Russians, Iranians and Europeans playing in this region. There are some new and important actors from the East as well.
DR. STAUFFER: I focus here on the oil and gas pipelines which have emerged as linchpins of U.S. policy. These are litmus tests of the credibility of that policy. The first question is painfully simple: are they economic? This provides crucial insight into whether they're likely to be built. First of all, there is the matter of the "tyranny of distance." Distance is the name of the game in the pipeline business, particularly for natural gas. The second questions is "what's the throughput?" The bigger the pipeline, the more economic it is. But this brings us to the third point: What is the ramp up, i.e. the critical question of how rapidly you can fill the line. A partially empty line is costly indeed. Fourth is the matter of financing. If the U.S. government is willing to bankroll the pipeline, then it's relatively easy. If not, then one has to look to commercial markets for the capital, which brings us to the fifth point: political risk. This has a profound effect on the feasibility of long-lived projects. There's no indication that has been properly assessed by the administration.
The first scheme is the Trans-Caspian Gas Pipeline. The proposed line would start in southeast Turkmenistan. The route crosses the Caspian Sea and the Caucasus. The idea is to deliver gas to central Anatolia, to Ankara and parts west. The gas source is developed, but it's dry gas. There are no byproduct credits, which means that the economics of that gas production become dicey under many conditions. The gas is there, but whether it's useful or marketable is another matter. Strike one.
Demand is the next issue. We need to know whether or not there's a market for that gas: is there a paying customer? The bottom line isn't terribly encouraging for the trans-Caspian natural gas pipeline. First of all, the Azeris have gas of their own. Their gas would preempt that route before any Turkmen gas. Second, the Iranians have already finished a pipeline to deliver gas to Turkey; the Turks are in the process of tying in their connection. This preempts part of the market. Further, the Russians are expanding deliveries via the Balkans. The Russians also have underway what they call the Blue Stream Project together with ENI, the Italian multinational firm. This project is tied to the attractive economics of the Karachaganak field. In addition, Turkey has such a wide number of options and has written so many memorandums of understanding that one could probably burn them for a month's energy supply for the whole country. Demand for that gas is limited. Strike Two.
In short, on the demand side, the competition is formidable. I may be the only person in Washington who ever actually did a complete financial analysis of that pipeline project. It can't fly; it is too expensive. The netback gas value is too low. Strike three.
But there's another problem The route itself, too, is problematic. It starts in southeast Turkmenistan, comes across to the southwest, goes under the Caspian, through Azerbaijan, and then wanders down through either Georgia or Armenia into Turkey. All sorts of unfriendly, intractable people live along the possible routes. There is a long list of known threats to the Caucasian routes - insurgencies, civil wars, border battles. Dishearteningly, many guerillas operate within an overnight run to some part of that pipeline. Any could hold the pipeline hostage. The administration tells us that the local governments can provide protection, but we've seen the protection they can provide to their own parliamentarians. Strike four - but the team is already out.
The gas pipeline is uneconomic because the tariffs for the pipeline, including government tolls, are so high there isn't anything left at the wellhead for the gas producer. Second, it's unfinanceable because of the political risks. These are class-seven countries for the Ex-Im Bank. And third, it's uncompetitive because there are other routes that are cheaper, easier and faster to construct or already in existence. Without a massive subsidy the project is infeasible. That's zero for one for the administration.
A second scheme is the Baku-Ceyhan pipeline. It connects Baku in Azerbaijan with Ceyhan, a superb port on the Mediterranean coast of Turkey. The port is on deep "blue" water, with spare capacity. It's an excellent oil-export facility. The first problem is geography. The pipeline that the administration is pushing starts in Baku, on the southwestern coast of the Caspian. But the oil is in the northeast Caspian, 1,000 kilometers or so away. Who provides the missing link? Lots of little, shallow-draft tankers? A pipeline through Russia connecting to Baku? Chimerical. An oil pipeline under the Caspian Sea? Would that be environmentally financeable? This link is missing. So even if the pipeline were built with a U.S. government subsidy, a second, major project is needed to connect to the oil source. That project is an investment comparable to, or greater than, the Baku Ceyhan pipeline itself and even less realistic. Again, strike one.
The administration left it out, but this is not the only problem. There are competing routes here. too. The "Iranian connection," the shortcut via Iran, is the Sword of Damocles over the Baku Ceyhan project. The Iranians can, if they chose, build their bypass route in a matter of 18 months, starting from scratch. It could provide capacity for about 800,000 b/d, which would tap off most of any conceivable volumes coming out of the Caspian over the next 10 years or so. Iran can do so at much lower cost, so it is positioned to underprice at will. That market is theirs if they want it, and we cannot prevent other shippers, such as the Norwegians, from taking advantage of that option. Strike two.
Incremental outlets are a second threat. The CPC pipeline, when finished, can relatively easily be expanded. This is true of most pipelines; there is a certain amount of slack in such designs. Similarly, the Baku-Supsa pipeline could be expanded or looped. Lastly, the Russians hold a wild card: they can open the valves on the Transneft oil-pipeline system. If the Russians so choose, they could tap off a couple of hundred thousand b/d, indeed more, of any new oil out of the Caspian quite profitably, almost at will. So there are four easy competing options, each of which is less expensive than the Baku-Ceyhan line and which could be built as spoilers. Strike three.
The reason the Iranian option is so cheap and easy is that Iran has pipelines stretching from the Gulf up almost to the Caspian littoral. Missing are short stretches of a couple of hundred kilometers in the northeast or the northwest. It's duck soup. They would use the oil in the north, shipping less of their own up there, and then they would swap off at the export terminals. Thus the administration's score is zero for two.
The United States has promoted still a third pipeline: the trans-Afghan. It's very difficult to discuss that scheme without giggling. Ironically, that pipeline, in an ideal world, would have been economical. The distances were reasonable, the terrain simple. On the other hand, that pipeline was designed to cross Afghanistan and Baluchistan. It could not pass any test of financeability because of the political risk. That leaves the administration with zero for three.
There are two further cases where the U.S. government has become involved in trying to block pipeline construction or, rather more bizarre, has predicated policy on the existence of a pipeline that is not in fact available. The first is the diplomatic effort to impede Russian gas pipelines into Europe in the 1970s. That exercise failed abysmally but left a legacy of perceived deception and technical naiveté which many European diplomats still remember vividly. The other is the argument by the Clinton administration that Iranian gas being sold to Turkey is in reality a swap of Turkmen gas -- and therefore does not involve Turkey in any violation of U.S. sanctions. There is no workable physical gas connection across Iran, so a "swap" is meaningless. The parties knew, the Europeans whom we approached for support knew, but the administration was oblivious.
U.S. efforts at pipeline politics have proved to be singularly unsuccessful: zero for five. That's a tough burden to carry forward in international diplomacy.
AMB. FREEMAN: No one here should slight the importance of Turkey. It is very easy to understand why the United States government would wish to find helpful things to do with Turkey. It is the only government whose cooperation or at least acquiescence the United States needs to pursue a remarkable combination of interesting policies toward NATO enlargement, NATO's southern flank, the Balkans, the countries of the Islamic Conference, Iran, Iraq, the Caucasus, Central Asia and Russia, without getting into Cyprus and other Greece-related issues. It's an enormously important country neglected by Washington and American politicians at present. I think Dr. Olcott suggested that, in casting about for a way to address this deficiency, people came up with the notion of a pipeline as a good thing to back. What I've heard today raises some questions in my mind about whether, in fact, that was quite as good a way of helping Turkey as some of its authors imagined.
In the event, we are left with a very important point that Dr. Olcott made. It may turn out that this region we've been discussing is a place of big but inaccessible oil. Therefore, it may not be terribly relevant to our present anguish. We've had wild gyrations in oil prices. We didn't seem to be terribly concerned when the Gulf oil producers were in a state of near bankruptcy. Now that prices are pinching us a bit, we are very concerned. That's human nature. But I'm beginning to wonder whether the Caspian region has quite the relevance to these issues that many of us imagine, perhaps with the exceptions that were mentioned, Kazakhstan notably. That doesn't at all detract from the importance of the region for many other purposes, but it does tend to put it in a bit of perspective.
Q: Several regional security regimes have been proposed: the Shanghai Five Russia, China and the states of Central Asia; the Caucasus Four - Russia and the states of the South Caucasus; as well as one pushed by President Aliyev a Caucasus stability pact. Are they realizable?
DR. OLCOTT: Of all the security initiatives, probably the Shanghai Five is the one that has the most long-term potential as a transition device to a new security regime in the area. But any multinational security group is going to be slow to develop. I think the next stage is going to be one of Russian reassertion on new terms in the area. Only Russia's not eager for a solution that separates the Caucasus from former Soviet space more broadly. I like a Caspian security arrangement rather than just a Caucasian one. And the Shanghai Five, I think, will develop slowly as part of China's protection of its own strategic interests in the area. But China's not going to engage in anything that has costs at this point. It would much rather see Russia bear the cost of helping provide Chinese security vis-a-vis increased stability on the old Soviet side of the border. I don't see a contradiction between Russian and Chinese influence in this area yet. That may come in 50 more years. It could take another 20 before the Shanghai Five has any real meaning.
AMB. FREEMAN: One of the most interesting but least-noticed developments over the past 10 years in Eurasia has been the settlement of all of the borders between, for example, Kazakhstan, Kyrgyzstan, Tajikistan and China, and the adoption, through the Shanghai Five mechanism, of a wide range of confidence-building measures, moves toward demilitarization and the like, as well as clear and strong understandings between governments against facilitation of dissident activity - the Uygur rebellion in the case of China, but also dissident activity against some of the arguably not-entirely-democratic regimes that have emerged from the rubble of the Soviet Union.
I started off making a comment that perhaps Central Asia and the Caucasus are not quite as relevant to the problems of global energy supply as some of us had hoped. Given the earlier discussion, I'd like to ask whether there are U.S. policies that might facilitate better access to Caspian Basin energy supplies. If you were asked to advise the incoming administration, what advice would you give?
Ms. NANAY: Kazakhstan definitely has a role to play. It's producing close to 700,000 b/d, the Tengiz field is up at about 265,000 b/d now, and it's going to build up to its peak of700,000 or 800,000 bid within the next 10 years. Tengiz is just one of many fields in Kazakhstan, and Kazakhstan also has a lot of gas, so it's going to be a big contributor. But when you look at where it's located, the big fields in Kazakhstan are up in the northeastern part of the Caspian. How do you get these resources to markets? Eventually, of course, there is Kashagan, the other offshore project. It will take quite a while before its reserves are assessed, but it will probably rival Tenghiz, one of the major oil fields in the world. Iran will have to be factored in, and I think this is what President Nazarbayev understands.
Sitting on the eastern side of the Caspian, it makes very little sense for Kazakhstan to be seriously studying as its first alternative pipeline other than the Russian option a pipeline that would go under the sea, across Azerbaijan, across Georgia and into Turkey. In terms of sequencing pipelines, Iran would be the second-best option. And Turkmenistan has to look north and south. Perhaps China will be the other direction for the eastern side of the Caspian.
DR. OLCOTT: I agree with Julia about Kazakhstan. It's going to be a player in the energy market. And I think one way we advance that is to focus on separating Kazakhstan from the Caspian. U.S. Kazakh policy should just focus on Kazakhstan and not tie it to the broader issues. The fates of Kazakhstan and Russia are so interlinked that there's no way that Kazakhstan, as it becomes a serious economic actor, is not going to reassess its relationship with Russia. You already see signs of Kazakhs investing in Russia and in Ukraine. It may not be a state I'd want to retire to, but Kazakhstan will be a pretty serious state for its part of the world.
What the United States can do to move Caspian energy is first to depoliticize these topics and accept that market conditions should determine pipeline routes and make it clear to oil companies that there aren't going to be U.S. government subsidies. That will make some of these routes die a natural death. We have to get energy moving in as many directions as possible from the Caspian. That's how you deal with monopoly. If energy is running through both Iran and Russia, it is less likely that Iran and Russia will stop the flow of energy at the same time. They become competitors and not just oil states that are allowing oil to be shipped through.
The trans-Caspian oil pipeline and the gas pipeline in particular are a disaster. Russian objections to it on ecological grounds may be disingenuous, but they're not going to disappear. Until the plans for the trans-Caspian pipelines are dropped, you're not going to have a total agreement on the ownership issues in the Caspian Sea, and that is really critical for the Caspian states.
I see Iran as having to come in as some sort of partner in Caspian development. Whatever Iran is doing as a state, there are other states doing bad things, too. Iran is on the Caspian, and it is historically part of the region. It's not going to allow everybody else to get filthy rich and not have a penny of income come to Iran from it. It's unrealistic to expect a state to behave in that way.
U.S. policy has to be decoupled from the question of U.S.-Turkish relations. We have to approach Turkey as an important partner on its own terms. Finally, we really have to take the questions of legal infrastructure more seriously. We have provided some funding in some states. Other states haven't taken too much funding from us on these questions, and even the ones that have not produced transparent regimes. But the long-term viability of the Caspian states depends on the success of economic reforms, which are linked to foreign investment. That may mean closing our eyes to some of the thefts of state, some of which have become firmly held in transparent, legally organized companies. Strong economies are less susceptible to Russian bullying. And without an increased presence of the rule of law in these societies, you 're just not going to get security.
AMB. FREEMAN: I'm from Rhode Island. Our politicians stand ready to offer the post-graduate course on corruption to anyone in the region who feels the need for it.
DR. STAUFFER: Given the history and given our incompetence, the best advice I could offer to the new administration is just to lie low. We touted these pipelines largely as a sop to Turkey and to the aspirations of the junta for reasons which will be discussed elsewhere. The projects failed; they were illusory. We lost by trying, because the proposals were transparently unworkable. We lost also by failing, so there was a double diplomatic cost. There was a fundamental asymmetry between our interests and our capabilities for active involvement in the Caspian and those of the riparian powers, in particular of Kazakhstan, Russia and Iran. This is an area in which our reach and our competence are limited. The others are much more directly involved and have much more at stake. It's hard to see any constructive scope for a proactive role for the United States.
But there's a further wrinkle. It is very much part of the discussion in Europe whether the U.S. entanglement in some of these proposed schemes is tainted by campaign contributions. It is suspected that there's a "fixer" behind each of these projects. Is this really an appropriate situation for the U.S. government? The scope for commissions in such projects is formidable, a couple of hundred million bucks per project. Speaking hypothetically, a small fraction channeled to a national political committee could represent a significant contribution. This is how we're viewed in Europe. Our counterparts read the papers - or Congressional testimony - and extrapolate, rightly or wrongly. My suggestion is that we to cut our losses and cut back engagement.
Q: Having been gone for five years -three in Azerbaijan and two in Bosnia- I'm struck by how people have gotten off the need to restore peace, particularly in the Caucasus region over Nagorno-Karabakh and the Abkazian situation in Georgia. I think we need to get back to where our strengths are, in diplomacy, which is peace making. I would put that as the number one priority. We've also got to get back to building civil society, democracy and the rule of law. That's the only way stability is going to come to these countries, not by maintaining one particular leadership.
Q: Given all the economic and political problems that every one of these routes is facing, which ones have a chance to become realized and actually start production? Second, do you think the energy from the Caspian Sea will sit there until Iran becomes a viable route to the Persian Gulf?
Ms. NANAY: If you look at where Azerbaijan is located, the next pipeline that potentially would make sense is a link to the south, to the Tabriz refinery in Iran. The Kazakh resources are far away, and that oil is going to be very difficult to get to market from Kazakhstan via Baku-Ceyhan. It will take a long time for the field offshore to be developed which could send the oil in that direction, so where do you send the oil? We 're not talking right now about major routes to Iran. We're talking about small routes and swaps. Ultimately, if the commercial forces desire, then you may eventually see a major route. But I think Iran will have to have a role. Otherwise, some oil just doesn't get out.
DR. STAUFFER: Iran is not the key; it is but one of several players. But Iran is a potential spoiler. The fact that the Iranians could build large capacity out of the Caspian both quickly and cheaply jeopardizes the economics of any large, alternative project such as Baku-Ceyhan. That project must command a lot of capacity in order to be economical at all. Geography, again, clearly weighs in against it. Export via Iran is the easiest route. There's an existing line that actually could be upgraded relatively easily to bring oil out of Azerbaijan to Tabriz in northwestern Iran. The notional capacity is about 200,000-240,000 bid, which is significant incrementally. Swapping would enable Azerbaijani companies to pick up oil at Kharg Island, where it has a higher value. Another alternative is the present route from Baku to Supsa (Georgia), which could be expanded if there were a need, in theory. Similarly, the route bypassing Chechnya could be also be expanded at relatively low cost (but at great risk), as could the pipeline that's coming in from Tenghiz. Thus, there is the possibility of incremental competition. The economics of incremental pipelines are very much more favorable. There are multiple competing options, each of which is cheaper and faster than the Baku-Ceyhan project.
However, it is not entirely clear that the Iranians want to do play this role. I think their strategy is as follows. If there is to be new export capacity out of the Caspian, they want to be involved, but their preference is to see nothing. The reason is obvious. From the point of view of the Iranians and the Russians, increased oil exports from the Caspian countries increase the wealth of those countries and decrease their relative bargaining power or geopolitical leverage. So the preferred strategy is stalemate. If something has to be built, then the Iranians will do it. The beauty of this, from the point of view of Iranian strategic planners, is that, by being ready to go, they can kill other options or delay them.
Q: I don't know what the Iranians' motivation is, and my understanding from earlier information was the Iranians' tolling charges were much too high, so there was no interest in taking crude through Iran as long as those charges were as high as they were. The route that really does make the most economic sense is not Baku-Ceyhan, but Baku-Supsa, then by tanker through the Bosporus. Oil is going through the Bosporus now, Tenghiz oil. Russian oil goes through the Bosporus. The Turks have said Azeri oil can't go through the Bosporus. For companies in the consortium, that is a competitive disadvantage, obviously. And if that is the way the situation plays out, then all of the problems that have been discussed this morning remain exactly where they arc.
Ms. NANAY: I disagree with Tom about Iranian interests. I believe that one of Iran's interests is to get some energy resources flowing to their northern markets. The Caspian countries are competitors. It is a question whether these countries should be marketing oil through big producers, but in the end, for Russia, as well, particularly on the gas front, both of these powers will need the resources of the Caspian for their domestic markets.
Q: How serious is the Caspian demarcation issue? Is there something that countries, pa1ticularly perhaps Iran, are attempting to maneuver around? Or is there anything that is going to affect the infrastructure developments in the region?
DR. OLCOTT: The Caspian ownership issue is not just a question of demarcation, it's what model of ownership you take. If you say it has to be developed in common, as the Iranians have claimed, then you can't demarcate it. But the question of the ownership of the Caspian is critical. It's not something that they're going to go to war over, but financing for certain projects is much more difficult to get if they lie in disputed territory. The Kazakh-Russian agreement on demarcation and ownership and on the notion of shared development of controversial resources or having a quid pro quo is the model that the Russians are working hard to put forward. The inability to get full agreement of all the partners gives Russia a leverage that they use. Each of these Caspian states has a whole shopping list of issues that they're dealing with Russia on, and they are interconnected. So if you get Caspian ownership off the table, it means that the Turkmen and the Russians can deal with a limited number of issues that they have differing positions on. But Russia, with Turkmenistan, is playing a very strong hand, which is only going to get stronger. As long as it can buy Turkmen gas cheap, it can sell that to the Russian domestic market and sell Russian gas for much higher prices abroad. Both Transneft and Gazprom are coming our way transformed. They are going to fundamentally reshape Russia's role as a player in the energy markets.
Ms. NANAY: I think the basic disagreement in the legal dispute on the Caspian between Russia and Iran is over demilitarization. If you go along with the Russian version - let's divide the Caspian, but not divide the waters - which Iran is against, the Iranians fear that the Russians will be able to move their military down the Caspian. This is one of the issues that will continue to divide the two. I don't think Russia will agree to divide the waters of the Caspian. The Bosporus is an issue, though it may not be as big an issue as it's being made out to be. But I have a feeling that it's going to be made a much bigger issue. The idea of Azeri oil going through the Bosporus will be very much opposed by the Turks.
DR. STAUFFER: I'd like to pick up on something that Dr. Olcott mentioned: the implications of the demarcation issue for financing. In all the international arbitration I've been involved in, one principle has emerged: anyone who invests in disputed territory has no claim for compensation; the party assumes the known risk. This uncertainty cannot be ignored in any due-diligence report. It greatly increases the difficulty of financing a pipeline which crosses disputed terrain because of the fact that there is no recourse whatsoever if anything goes wrong.
Q: I'd be interested in the panelists' comments on two issues: Dagestan's instability and the possibility of a Ukrainian bypass into Eastern Europe.
DR. STAUFFER: The possibility of a Ukrainian bypass is real. The Ukrainians, as far as one can tell from press reports, are well along in completing construction of a pipeline across their territory that circumvents the Bosporus. Their pipeline starts at a port very close to Odessa and connects with the Druzhba oil pipeline into Central Europe. This is one way of getting around any constraints on passage through the Bosporus. I suggest that there is every reason to expect that the Turks are going to clamp down on oil traffic through the Bosporus for probably legitimate as well as illegitimate reasons. A transit route through the Ukraine is itself fraught with risk; the history of squabbles between Russia and the Ukraine over gas transit is not very happy. Nonetheless, the Ukrainian bypass is an option that permits one to get oil out of the Black Sea, which might be coming from the Caspian, without having to worry about transiting the Bosporus. It is serious because that line is close to being finished.
DR. OLCOTT: I think that stability in Dagestan is going to remain a question mark as long as Chechnya is disputed. Afterward, should there be a point when Chechnya is not disputed, then Russia's going to choose to increase its security presence in Dagestan. It is always going to pose a risk to the stability of pipeline routes, but the Russians, 1 think, are going to be willing to expend money to try to protect them. Terrorism or religious activism is present in this region and it's not about to totally disappear.
Ms. NANAY: Stability in Dagestan will be a problem as long as Russia doesn't get what it wants from President Aliyev. Azerbaijan's shift towards the Russian camp is also facilitated by instability in Dagestan.
Q: A lot of what we've heard today presupposes a Russia that's getting stronger. One could argue that Russia is a weak state and may be getting weaker. Then it would be less able to pressure either the Central Asians or the nations of the Caucasus. The second implication of this is that China would be able to develop its ties to Central Asia. If Russia, which is only boosted now by the high price of oil, begins again to have serious economic problems, and China continues to grow, it's going to attract the Central Asians and probably much more rapidly than we've talked about here.
DR. OLCOTT: Strength and weakness are relative terms. Decline takes a long time, and it's not clear what muddling through is going to look like in Russia. I think that Central Asia's risk is that Russia's interests are changing as it continues to cut back its military. What you see if you look on the economic side are increasing ties between Russia and these states and ties between non-state actors, in the creation of multinational firms. Some of them are even American, but they are Russian-owned all the way across the board Russians from America or Israel and Russians from Russia and Russians from Kazakhstan or Kazakhs from Kazakhstan. You see this pattern of Russian economic reassertion that I think is going to grow more powerful as Gazprom and Transneft reorganize.
So I agree that Russia is getting weaker, but I think that it still remains the strongest power in that region. I don't think China has the interest. It may have the increasing capacity, but its concerns are with the development of Western China before it reaches out to any sort of more active policy in Central Asia. The Central Asians may choose to appeal to the Chinese, but the Chinese aren't going to dump massive amounts of capital into Central Asia. What they've done on the pipeline, which we didn't talk about, is place-holding. They want a future stake in the region. They have an interest in developments across the region to the Middle East, and they want to hold their place at the table for when they're ready to invest in it.
Ms. NANAY: I think Martha's right. The movement of Russian firms back into Kazakhstan is quite significant in all areas, Russian and Israeli firms are both very actively involved in Kazakhstan now. J\s for China, its interests really are in developing energy resources. Iran and Iraq would figure much higher on its radar screen than the Central Asian countries. Maybe that's because the Kazakhs don't really trust the Chinese. And I think they've had serious problems in their relationships on the energy front until now.
AMB. FREEMAN: The premise of the pipeline the Chinese are building from Xinjiang to their east coast is that throughput will be supplemented by Kazakh energy supplies. If the only source of energy were Xinjiang, it would not justify that pipeline. The project is on hold, but likely to proceed. The second point I would make is that China is characteristically passive in the region. There was a period after the independence of the Central Asian states when many Chinese companies established sales offices in Almaty and other capitals. All of those, almost without exception, have now withdrawn due to problems with organized crime, which everyone else has experienced as well. The position of the Chinese now seems to be that they're very happy to sell to Central Asian purchasers as long as those purchasers come to them. But they do not wish actively to stroll around in the region themselves. So I think the notion of China as an attractive force has great merit, but it is a very passive force in many respects, even apart from residual suspicions of China by countries that grew up under the influence of the Russian view of the Sino Soviet split.
Q: In Europe, we are very much for your unilateral sanctions. Keep those. But ILSA (the Iran Libya Sanctions Act) is going to expire in less than 11months. The investment part of it is already dead after the EU-U.S. agreement of 1998. But what still stands and has deterrent power is the oil pipeline investment part of it. What do you think is going to happen if lLSA expires'? Most people think that it will not be revived. Rut what is the administration going to do then on the pipeline part of it?
Ms. NANAY: I wish I knew. I was more positive two months ago. Today, I'm confused on how it will work out. My general impression is that there is no momentum for renewing ILSA, but you hear different things. It's hard to know what will happen over the next year. I hope it expires and I also hope that U.S. investment bans will be gone as well for Iran.
AMB. FREEMAN: I noted with some interest the commercial approval of lLSA that you voiced, even as politically you opposed it. Keeping unilateral sanctions on is a very great benefit for foreign companies. I thank you for your candor, sir.
DR. STAUFFER: The sanctions have had less effect than one might think. On my last trip to Iran. I spent the better part of a week trying to find out where the U.S. sanctions had actually hurt Iran in recent years. I talked to engineering companies, the NIOC, the gas companies, the foreign ministry. No one could come up with a material impact. They were unable to answer the question of whether it made any real difference whether ILSA was continued or not, because, with one significant exception, anything they wanted to do, they were able to do. That one exception is access to very large-capacity gas compressors. But they can buy smaller ones and manifold them. So the sanctions in that respect were a nuisance, not an obstacle.
As a final comment I would like to note a trend in U.S. foreign relations which I find rather sad, having been involved in teaching diplomats in one way or another for some 30 years. The correlation between policy and fact today is close to zero or maybe even negative. Even more unfortunate is the reason for this deplorable trend. Ignorance is safe. It's much better for the policy maker to be ignorant than to be caught having pushed forward a policy in spite of documentation in the files that does not support the decisions for which he might be accountable. This practice of protective ignorance has been honed to a fine art in the last decade.
DR. OLCOTT: 1 hope that the change in administration will lead to some new reflection on how best to advance U.S. interests in the Caspian. I don't think the current administration has done as good a job as it might have in advancing our interests in the area, both with energy and with the overall understanding of what we have to do to help this area become market economies with at least aspiring democratic regimes. I agree that working in multilateral settings to have the ethnic conflicts settled should be the first priority with regard to the Caspian, before energy development. Ms. NANAY: Sanctions on Iran hurt the Caspian and they hurt the United States. Having been to Iran six times since April of 1998 and having gotten to know a little bit about how that country's oil sector functions, I can say that many of the people that work in NIOC were educated in the United States. If there is one thing they wish for, it is for U.S. companies to come back. One of their big frustrations is the fact that the companies that they would like to work with are being excluded from the market. That's not to say that they don't want to work with the Europeans, but they would like greater competition as well in their oil sector. For the Europeans, it's a perfect situation right now, and, if it continues, many of the big opportunities will be closed off for the United States. In the end, U.S. commercial interests and U.S. interests in general will suffer. In the Persian Gulf, just as in Turkey, the United States has very big interests that it is not keeping its eyes on.
AMB. FREEMAN: The region that we have been discussing is rich in many things, oil and gas being merely two of those. It is a region of enormous historical importance with vibrant cultures recovering from a period of eclipse by Russian and then Soviet imperialism. It is a region defining its own identity, distinct from the countries around it - whether Russia, Iran, China, Europe or Turkey. And it is a region rediscovering its religious heritage, one hopes in positive ways. One of the issues the incoming administration might want to look at is how it organizes itself to deal with this region. To treat it as an extension of Russia is anachronistic. To incorporate it, as CENTCOM has done, into the area of responsibility for the commander-in-chief of the central command but not to put any resources behind that is anomalous. To neglect the political quarrels of the region is both to fail to act on our strongest suit and to risk the very disorder that could draw outside powers back into conflict in a region that seems tailor-made for great-power contention.
Finally, I think it is fair to say, as David Goldwyn did, that whatever all of these other factors may add up to, the people of the region, in the end, will rise or fall economically by how countries like the United States come to grips with energy policies that allow them to benefit from what God has endowed them with in the ground.