Edward C. Chow Center for Strategic and International Studies

1. The Bush School of Government and Public ServiceTexas A&M UniversityUS-Ukraine Business CouncilPipeline Politics in Eurasia andIts Implications for International SecurityWashington WorkshopSeptember 3, 2009Pipeline 101Alignment of Interests Edward C. Chow Center for Strategic and International Studies

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

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

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

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

6. Traditional Value Proposition • Governments provide political support and regulatory framework • 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 • 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.

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

8. 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 • Merchant pipelines exist only in North America: • Deep and liquid market • Regulatory 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.

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

10. Producing Country Priorities Kazakhstan • Diversity of oil supply routes Azerbaijan • State control over the pace of natural gas development Turkmenistan • Upstream investment for additional production capacity Uzbekistan • Political control?

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

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

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

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

15. New Asian Factor • 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 • Japan, India, Korea variously seeking own role

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

17. Current State of Play Gas (mainly Azerbaijan and Turkmenistan) • No new production, except for Karachaganak in Kazakhstan • 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 major upstream investment in Turkmenistan, except from China which is building pipeline • Azeri-Turkmen relations warming, but major issues still remain

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