The Bush School of Government and Public Service Texas A&M University US-Ukraine Business Council Pipeline Politics in Eurasia and Its Implications for International Security Washington Workshop September 3, 2009 Pipeline 101 Alignment of Interests Edward C. Chow Center for Strategic and International Studies

Stakeholders Producing countries Producing countries Producing companies Producing companies Consuming countries Consuming countries Consuming companies Consuming companies Transit countries Transit countries Transit companies Transit companies Competitors with other routes Competitors with other routes Other interested parties – e.g., USG, lending institutions and construction contractors Other interested parties – e.g., USG, lending institutions and construction contractors

Producers’ Interests Governments Highest economic value for subsoil rights Highest economic value for subsoil rights Dependable and diverse export routes Dependable and diverse export routes Geopolitical balance Geopolitical balanceCompanies Highest comparative netback to the wellhead for oil & gas production Highest comparative netback to the wellhead for oil & gas production Lowest-cost, dependable and diversified transportation Lowest-cost, dependable and diversified transportation Financial exposure commensurate with commercial interests Financial exposure commensurate with commercial interests

Consumer’s Interests Governments Economic and dependable supply Economic and dependable supply Diversity of supply Diversity of supply Geopolitical balance Geopolitical balanceCompanies Low-cost transportation of oil & gas Low-cost transportation of oil & gas Contract flexibility to ameliorate commodity risks Contract flexibility to ameliorate commodity risks Financial exposure commensurate with commercial interests Financial exposure commensurate with commercial interests

Nature of Long-Haul Transport Projects (Equally true for pipelines, LNG, etc.) High capital cost, low return and long payout High capital cost, low return and long payout Long gestation period Long gestation period Require well-defined government role Require well-defined government role Natural gas and crude oil are different in project implementation and impact Natural gas and crude oil are different in project implementation and impact Financing as distributor of project risks – allocate risk/reward Financing as distributor of project risks – allocate risk/reward Diversity costs big bucks (who pays?) Diversity costs big bucks (who pays?) Championed by largest stakeholder(s) Championed by largest stakeholder(s)

Traditional Value Proposition Governments provide political support and regulatory framework Governments provide political support and regulatory framework Producing companies provide long-term ship-or-pay volume guarantees sufficient to amortize financing Producing companies provide long-term ship-or-pay volume guarantees sufficient to amortize financing Consuming companies provide long-term take-or-pay volume guarantees sufficient to amortize financing Consuming companies provide long-term take-or-pay volume guarantees sufficient to amortize financing Credit-worthy shippers provide financial guarantees to lenders or cover cost of capital Credit-worthy shippers provide financial guarantees to lenders or cover cost of capital Transportation of oil and gas is a cost center, not a profit center. Transportation of oil and gas is a cost center, not a profit center.

Transit Interests Complexities increase exponentially with number of transit countries Transit Governments Highest transit feeHighest transit fee Transit Companies Highest tariffHighest tariff Project Promoters Bankable project with manageable financial risks and adequate returnBankable project with manageable financial risks and adequate return Transportation of oil & gas as a profit center, not a cost center

Who is the Commercial Champion? Key indicator of probability for success In market economies: Oil or gas producers who have volumes sufficient to be major shippers, sometimes with their major customers and offtakers Oil or gas producers who have volumes sufficient to be major shippers, sometimes with their major customers and offtakers Merchant pipelines exist only in North America: Merchant pipelines exist only in North America: Deep and liquid marketDeep and liquid market Regulatory rules, including on capacity access and tariff methodology are clear and provenRegulatory rules, including on capacity access and tariff methodology are clear and proven In non-market economies: Governments, parastatals or national champions that set rules of the game and can direct oil and gas flows even by private companies. They measure success differently, e.g., control is more important than financial performance. Governments, parastatals or national champions that set rules of the game and can direct oil and gas flows even by private companies. They measure success differently, e.g., control is more important than financial performance.

Caspian Pipelines U.S. National Interests Political and economic independence of Central Asian and Caucasus countries Political and economic independence of Central Asian and Caucasus countries Incremental supplies of Caspian oil and gas for the world market Incremental supplies of Caspian oil and gas for the world market … American commercial interests American commercial interests … Oil and gas supply diversity for Europe Oil and gas supply diversity for Europe

Producing Country Priorities Kazakhstan Diversity of oil supply routesDiversity of oil supply routesAzerbaijan State control over the pace of natural gas developmentState control over the pace of natural gas developmentTurkmenistan Upstream investment for additional production capacityUpstream investment for additional production capacityUzbekistan Political control?Political control?

Producing Company Priorities Oil Getting the stuff out Getting the stuff outGas Sensible upstream investment Sensible upstream investment Note conspicuous absence of diversity of supply routes as a goal. Diversity comes only with increased volume.

Consuming Country Priorities Old Europe Extend political, economic, and commercial influence without jeopardizing more important relations with Russia Extend political, economic, and commercial influence without jeopardizing more important relations with Russia New Europe Diversity of supply away from Russia Diversity of supply away from RussiaEU Finding a role Finding a role

Consuming Company Priorities Old Europe Maintain competitive advantage in closed home marketsMaintain competitive advantage in closed home markets Claw upstream and midstreamClaw upstream and midstream Maintain long-term relationships with Russian suppliers, while developing new ones in the CaspianMaintain long-term relationships with Russian suppliers, while developing new ones in the Caspian New Europe Maintain lucrative relations with RussiaMaintain lucrative relations with Russia Win in regional industry consolidationWin in regional industry consolidation

Other Interests Transit countries Political weight Political weight Extract economic rent Extract economic rent Transit companies Make money on other people’s oil & gas and credit Make money on other people’s oil & gas and credit Competing routes Block competition by offering better economic terms or speed of execution Block competition by offering better economic terms or speed of execution Russia is the home team

New Asian Factor China seeks land routes to balance current reliance on maritime routes for oil and gas imports China seeks land routes to balance current reliance on maritime routes for oil and gas imports Opportunities for its oil companies to invest and oil service companies to contract work Opportunities for its oil companies to invest and oil service companies to contract work Japan, India, Korea variously seeking own role Japan, India, Korea variously seeking own role

Current State of Play Oil (mainly Kazakhstan) CPC expansion late but finally proceeding CPC expansion late but finally proceeding Much delayed Kashagan Much delayed Kashagan Major increases in trans-Caspian oil shipping depends on resolving issue of control Major increases in trans-Caspian oil shipping depends on resolving issue of control China extending oil pipeline to western Kazakhstan China extending oil pipeline to western Kazakhstan

Current State of Play Gas (mainly Azerbaijan and Turkmenistan) No new production, except for Karachaganak in Kazakhstan No new production, except for Karachaganak in Kazakhstan Russia offering better price on existing route for Caspian gas, but becoming undependable offtaker lately Russia offering better price on existing route for Caspian gas, but becoming undependable offtaker lately No investment decision yet in Azerbaijan for further gas development No investment decision yet in Azerbaijan for further gas development No major upstream investment in Turkmenistan, except from China which is building pipeline No major upstream investment in Turkmenistan, except from China which is building pipeline Azeri-Turkmen relations warming, but major issues still remain Azeri-Turkmen relations warming, but major issues still remain

Transit Making News Nord Stream Nord Stream South Stream South Stream Nabucco Nabucco TGI TGI Blue Stream II Blue Stream II Yamal II Yamal II Odesa-Brody-Plock Odesa-Brody-Plock White Stream White Stream LNG for southeast Europe LNG for southeast Europe Pipeline interconnections in Europe Pipeline interconnections in Europe Success depends on support from major upstream and downstream stakeholders, economic viability and project execution