3 FOREWORD The Caspian region contains some of the largest undeveloped oil and gas reserves in the world. The intense interest shown by the major international oil and gas companies testifies to its potential. Although the area is unlikely to become “another Middle East”, it could become a major oil supplier at the margin,much as the North Sea is today. As such it could help increase world energy security by diversifying global sources of supply. Development of the region’s resources still faces considerable obstacles. These include lack of export pipelines and the fact that most new pipeline proposals face routing difficulties due to security of supply considerations,transit complications and market uncertainties.There are also questions regarding ownership of resources,as well as incomplete and often contradictory investment regimes. This study is an independent review of the major issues facing oil and gas sector developments in the countries along the southern rim of the former Soviet Union that are endowed with significant petroleum resources:Azerbaijan,Kazakstan,Turkmenistan and Uzbekistan.Caspian Oil and Gascomplements other IEA studies of major supply regions,such as Middle East Oil and Gas and North African Oil and Gas.It also expands on other IEA studies of the area, including Energy Policies of the Russian Federationand Energy Policies of Ukraine. The study was undertaken with the co-operation of the Energy Charter Secretariat,for which I would like to thank its Secretary General,Mr.Peter Schütterle. Robert Priddle Executive Director 5 ACKNOWLEDGEMENTS The IEA wishes to acknowledge the very helpful co-operation of the Energy Charter Secretariat, with special thanks to Marat Malataev,Temuri Japaridze, Khamidulah Shamsiev and Galina Romanova. This project was made possible in part by voluntary contributions from the governments of Norway and the United States. The IEA would like to thank Jonathan Stern,London,for advice on gas matters. Special thanks is given to the following IEA staff:Fatih Birol and David Knapp for assistance on various chapters, Nina Kousnetzoff for assistance in collecting data, Bertrand Sadin for preparation of the maps,and Bríd Deely for principal secretarial support. 7 TABLE OF CONTENTS FOREWORD 3 ACKNOWLEDGEMENTS 5 TABLE OF CONTENTS 7 LIST OF ILLUSTRATIONS 17 LIST OF TABLES 18 MAPS 21 INTRODUCTION 29 OVERVIEW 31 THE REGION 31 RESERVE BASE 32 PRODUCTION AND EXPORT POTENTIAL 32 IMPORTANCE AS ALTERNATIVE SOURCE OF SUPPLY 34 OIL AND GAS IN THE ECONOMIC DEVELOPMENT OF THE REGION 34 INVESTMENT 35 The Energy Charter Treaty 36 OIL AND GAS EXPORT ROUTES 36 Inherited infrastructure 36 The need for new pipelines 37 Multiple pipelines 37 Export markets 37 Transit and the Energy Charter Treaty 38 Selected oil and gas export proposals 38 Proposals for oil exports 38 AIOC oil pipelines from Azerbaijan 38 CPC oil pipeline from Kazakstan to the Black Sea via Russia 38 CAOP oil pipeline from Turkmenistan to Pakistan via Afgahanistan 39 CNPC pipeline from Kazakstan to China 39 Trans-Caspian oil pipeline from Kazakstan or Turkmenistan 39 Non-pipeline alternatives 39 Proposals for gas exports 40 Gas pipeline from Turkemistan to Turkey via Iran 40 8 Gas pipeline from Turkmenistan to Iran 40 Trans-Caspian gas pipeline from Turkmenistan 40 Gas pipeline from Turkemistan to Pakistan via Afghanistan 40 Gas pipeline from Turkmenistan to China 40 The Turkish Straits 41 Iran 41 ENVIRONMENT 42 LEGAL STATUS OF THE CASPIAN SEA 43 PROJECTIONS OF OIL AND GAS PRODUCTION, DOMESTIC DEMAND AND EXPORTS 45 SUMMARY 45 SUPPLY SCENARIOS 46 Azerbaijan 46 Kazakstan 48 Turkmenistan 49 Uzbekistan 50 DOMESTIC DEMAND AND EXPORTS 50 Summary 50 Azerbaijan 54 Kazakstan 54 Turkmenistan 55 Uzbekistan 56 NOTES ON METHODOLOGY 56 Energy demand estimates 56 Energy 56 “Non-energy industry”and “non-industry” 57 Activities in the household sector 58 Energy export estimates 58 Specific assumptions and data biases 58 Losses 58 Heat and electricity demand 59 Value added per unit of energy output 59 Net indirect taxes 60 Energy use per unit of value added in non-energy industry 60 Households 60 STATISTICAL ANNEX 63 MARKETS FOR CASPIAN REGION OIL 85 SUMMARY 85 WORLD OIL MARKET OUTLOOK 86 9 Introduction 86 Growing dependence on Persian Gulf oil 86 Asia-Pacific demand 86 New alternative suppliers 87 World oil demand 87 Demand outlook 87 World oil supply 88 Gulf-OPEC 88 Russia 89 Atlantic basin 89 Supply outlook 89 FUTURE WORLD OIL TRADE 89 Overview 89 Mediterranean markets 91 Black Sea markets 93 The Chinese market 94 MARKETS FOR CASPIAN REGION GAS 97 SUMMARY 97 MARKETS FOR CENTRAL ASIAN AND TRANSCAUCASIAN GAS 97 Former Soviet Union 98 Ukraine 99 Russia 100 Turkey 101 Iran 103 Central and eastern Europe 104 Western Europe 106 Pakistan and India 108 Pakistan 108 India 109 China and Japan 109 Summary 111 COMPETITORS 111 Established competitors in western Europe 111 Norway,Netherlands and United Kingdom 111 Russia 112 Algeria 114 New competitors in Europe and elsewhere 114 Iran 114 Middle Eastern and African competitors 115 Asian competitors 117 PROSPECTS FOR LNG AND LPG EXPORTS 117 10 INVESTMENT FRAMEWORK 121 OPPORTUNITES FOR PRIVATE RISK INVESTMENT IN THE OIL AND GAS SECTOR 121 Activities open to all qualified companies 122 Licensed activities 122 Joint ventures 122 Purchase of privatised assets 123 LEGAL CONTEXT FOR INVESTORS 123 Standard assurances for foreign investment 123 Additional guarantees 124 Petroleum exploration and production regimes 124 Independent arbitration 125 Land 126 Incorporation 126 Taxes 127 Accounting 127 Pipeline regulation 127 Price controls 127 Social obligations 128 Privatisation 128 INVESTMENT CONTEXT BY SUB-SECTOR 129 Oil and gas production 129 Petroleum storage and transmission 129 Oil refining 129 Oil product distribution 130 Oilfield equipment and services 130 ENERGY CHARTER TREATY 130 MARINE TRANSPORTATION IN THE CASPIAN AND BLACK SEAS AND THE TURKISH STRAITS 133 THE TURKISH STRAITS 133 New rules and recommandations for the Straits 134 Oil flows through the Turkish Straits 135 Bypassing the Straits 136 MARINE TRANSPORTATION IN THE CASPIAN AND BLACK SEAS 136 Caspian Sea 137 Kazak oil exports 137 11 Turkmen oil exports 138 Azeri oil exports 138 Port constraints 138 Overview of selected Caspian oil ports and expansion plans 139 Tanker capacity 140 Volga-Don canal and river system 141 Black Sea routes 141 Kazak oil exports 142 Turkmen and Azeri oil exports 142 Proposed export pipelines to the Black Sea 142 Overview of selected Black Sea ports and plans for their expansion 143 Selected import capacity in the Black Sea 144 LEGAL STATUS OF THE CASPIAN SEA 147 BACKGROUND 147 THE RESPONSE OF THE OTHER LITTORAL STATES 148 INTEREST 149 FURTHER DEVELOPMENT OF THE RUSSIAN POSITION 150 BORDER DISPUTES 150 COUNTRY CHAPTERS AZERBAIJAN 151 SUMMARY 151 ECONOMIC BACKGROUND 152 The first years of stabilisation and transition 153 Structural reforms 153 Price and trade liberalisation 153 Privatisation and demonopolisation 154 Payment arrears 154 The Banking system 154 Long term outlook 155 OVERVIEW OF THE ENERGY SECTOR 155 Electricity 155 Coal and shale 156 ORGANISATION OF THE OIL AND GAS SECTOR 156 OIL RESERVES AND PRODUCTION 157 Oil reserves 157 Oil production 157 12 Oil fields 158 Oil prices 159 OIL REFINING 159 Refineries 161 Azerneftyag refinery 161 Azerneftyyanadjag refinery 161 Environmental concerns at the refineries 161 Distribution of oil products 161 Consumption of oil products 161 OIL TRANSPORTATION AND TRADE 162 Crude exports 162 AIOC pipelines 162 The northern route 163 The western route 164 Ceyhan route 164 Main oil 165 Exports of oil products 165 Oil storage 166 GAS RESERVES AND PRODUCTION 166 GAS PROCESSING,TRANSMISSION AND DISTRIBUTION 168 Gas processing 168 Gas transmission and distribution 168 LPG 170 Gas consumption 171 Gas pricing 172 Non-payments for gas 172 GAS TRADE 172 Gas transit 173 INVESTMENT 174 Offshore investments 175 Azeri,Chirag and Guneshli 175 Karabakh 176 Shakh Deniz 177 Dan Ulduzu and Ashrafi 177 Lenkoran Deniz and Talysh Deniz 178 Yalama 179 Oguz 179 Apsheron 179 Nakhichivan (D-3) 180 Inam 180 Kyurdashi 180 13 Major offshore deals under negotiation 181 South Caspian Archipelago 181 Shallow Guneshli 181 Yanan Tava-3,Atashgah and Muga Deniz 181 Umid 181 Abikh Bank 181 Kyapaz 182 Offshore tender 182 Onshore investments 182 Legislation 184 Rights to land 184 Investment protection 184 Concessions/licensing regime 185 Privatisation 186 Privatisation – general procedures 186 Prospects for equity investment in the oil and gas sub-sectors 187 Taxation 188 ENVIRONMENT 189 OILFIELD EQUIPMENT AND SERVICES INDUSTRY 189 Fabrication yards 190 Seismic services 192 KAZAKSTAN 193 SUMMARY 193 ECONOMIC BACKGROUND 195 Macro economic policies during the first years of transition 195 Price,trade and foreign exchange liberalisation 196 Privatisation 196 Non-payment 197 The financial sector 197 The tax system 197 IFI loans 197 Technical assistance 198 New national capital 198 OVERVIEW OF THE ENERGY SECTOR 199 Coal 199 Electricity 200 ORGANISATION OF THE OIL AND GAS SECTOR 201 OIL RESERVES AND PRODUCTION 203 OIL REFINING 204 Atyrau 205 14 Shimkent 206 Pavlodar 208 New refineries 209 Oil product consumption 209 OIL TRANSPORTATION AND TRADE 209 Planned internal oil pipelines 210 Oil transportation tariffs 211 Oil export 211 Oil pipeline quotas 212 Oil export by rail 213 Proposed oil export pipelines 213 Caspian Pipeline Consortium 213 Project details 215 Rights of way 215 Capacity quotas 215 Evolution of CPC provisions 216 Projected tax revenues 217 Shares in the CPC and financing plans 217 CPC administration 217 CNPC pipeline to China 218 Via Turkmenistan to Iran 219 Transcaspian pipeline 219 Via Azerbaijan and Georgia 219 Swaps with Iran 220 GAS RESERVES AND PRODUCTION 221 GAS PROCESSING,TRANSMISSION AND DISTRIBUTION 222 Gas transmission 223 Investment needs 225 Gas distribution 226 GAS TRADE 226 INVESTMENT 227 State Committee for Investments 229 Foreign investment methods 229 Major exploration and production projects 230 Tengizchevroil 230 Kazak Shelf 231 Karachaganak 232 Uzen 233 The Temir blocks 233 Other major joint ventures in the oil and gas sector 234 Privatisation 235 Legislative basis 235 Privatisation in practice 236