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Azerbaijan/Turkey: Obstacles Remain In Pipeline Policy

  • Michael Lelyveld

Boston, 20 April 1999 (RFE/RL) -- A protocol last week between Azerbaijan and Turkey on building the Baku-Ceyhan pipeline is both more and less than meets the eye.

While the agreement was hailed by both countries, the preliminary pact known as the Istanbul Protocol is just one of many steps that must be taken before the Caspian Sea oil line to the Mediterranean can proceed beyond the field of dreams.

At its most obvious level, the accord for the U.S.-backed project is little more than an agreement to conclude another agreement, perhaps in three months' time. Officials feared that Sunday's elections for a new Turkish government could delay talks on Baku-Ceyhan by six months without a pact to give negotiations a head start.

For now, Azerbaijan and Turkey have at least averted the criticism that no progress has been made on the plan for a main export pipeline, which many regard as too costly, too risky and too political to succeed. The pipeline policy still has many obstacles to overcome.

The Istanbul Protocol must be accompanied by a host country agreement, an inter-government agreement, a government guarantee agreement and a turnkey agreement before the 1,730-kilometer pipeline to Western markets gets off the drawing boards, industry sources say.

There have already been countless protocols aimed at advancing the oil export plan supported by the administration of U.S. President Bill Clinton, as well as the parallel project for a trans-Caspian gas line.

But what may make the latest agreement different is the growing commitment to the idea that Turkey must provide a guarantee against cost overruns on the Baku-Ceyhan project.

Ankara has argued for more than a year that industry estimates are simply wrong and that the line from Azerbaijan through Georgia and Turkey will cost no more than $2.4 billion. Oil companies are concerned that it will cost $4 billion or more.

A government guarantee would put Turkey's assertions to the test and take the burden of being wrong off the Azerbaijan International Operating Company (AIOC). The U.S. administration has been pressing the solution for the past six months as a way to break the impasse between the governments and the oil companies.

But if the concept of a guarantee is approved, industry officials have at least two major questions. The first is how much will it cover? There is bound to be bargaining over whether Turkey will hold itself accountable for costs only up to $3 billion or $4 billion, or whether it will pay all excess costs, no matter how high they might go.

The question is not trivial in light of AIOC's experience with the early oil line between Baku and the Georgian port of Supsa, which was inaugurated over the weekend. Original project estimates, variously reported as $315 million to $325 million, were grossly exceeded with actual costs reported at between $560 million and $590 million.

Even using the most conservative comparison, the overrun on Baku-Supsa amounted to more than 72 percent. If the same formula were applied to the Baku-Ceyhan project, final costs would total more than $4.1 billion.

The second question is whether Turkey can legally be held liable for overruns in construction costs that do not take place on its own territory. The parties are likely to take great care in dealing with such questions. AIOC and the State Oil Company of the Azerbaijani Republic have argued for months over who should pay for the overruns on the Baku-Supsa line.

But assuming that such problems are eventually settled, the oil companies will have pulled off a remarkable coup. The government cost guarantee would amount to little more than a subsidy to private industry, greatly reducing its risk.

Similarly, the U.S. government's commitment to use financing of the Export-Import Bank and other agencies for Baku-Ceyhan makes the project more attractive, although it undercuts earlier arguments that the line must be commercially viable. While oil companies have stuck to their insistence over the past four years that the pipeline must be a sound investment for them, governments have been gradually drawn in to tip the balance and make the deal work.

When and if a comprehensive deal on cost overruns is signed, the question of commercial viability will largely cease to be a problem for the oil companies. Governments will instead be taking the risk, in exchange for the benefits of being able to direct the flow of oil.

Before such a deal is struck, there may be a renewed debate about the nature and the value of such benefits. The reasons for controlling Caspian export routes may be seen as economic, strategic or simply political.

The questions about the Caspian are the same ones that have been asked since the start of offshore development. But once governments assume business risk by devoting their resources, the public may inquire more closely about the benefits, and it may demand more precise answers this time.

(Lelyveld is Senior Correspondent for the Journal of Commerce. He wrote this analysis for RFE/RL)