Logic of Costly Oil Pipelines Knocked

Russia's special envoy to the Caspian, Viktor Kalyuzhny, was in Tehran this week for talks on the legal status of the Caspian Sea and how it should be carved up among the five states surrounding it.

But while arguments about who gets what in the sea, which contains large and possibly colossal reserves of oil, are likely to go on for some time, arguments about how to move this liquid wealth to markets are just as bitter.

Since the emergence of Azerbaijan, Turkmenistan and Kazakhstan as independent oil producers over the past decade, there has been lengthy wrangling over which way to build a main export pipeline from the Caspian.

But analysts increasingly wonder why another big pipeline is needed at all, as cheap export options already exist f an idea likely to have occurred to both Kalyuzhny and his Iranian counterparts since they stand to benefit the most.

The easiest way is by so-called location swaps, analysts say.

Under this system, Caspian oil would be sent to nearby refineries to be processed into products and consumed locally.

The refiner then gives its supplier the same volume of crude elsewhere, to be exported from ports far from the Caspian. Swaps are cheap and avoid the need for new pipelines.

The best routes are through Iran and Russia. Caspian oil can be moved cheaply to three northern Iranian refineries at Tehran, Tabriz and Shiraz, with combined capacity of some 375,000 barrels per day, and suppliers would then get that volume in exchange at Iran's Gulf terminal of Kharg Island.

Caspian oil can also move by barge up the Volga River to the 200,000-barrel-per-day refinery at Volgograd, and then farther to Samara, where three

refineries have a joint capacity of 650,000 barrels per day.

This would allow crude from Western Siberia, the oil heartland of Russia, to be freed up and sent directly abroad, potentially adding a massive 850,000 barrels per day to total exports.

Russian export capacity is limited, but a new pipeline system is now being laid in the northwest of the country linking to a new export terminal being built in the Gulf of Finland.

This will have an eventual capacity of 600,000 barrels per day, enough to move most of the crude that could be swapped along the Volga.

Best of all, swaps can take crude where it is needed.

Most new demand in the coming decades is expected from East Asia, and Iran's Kharg Island is some 15 days' sailing from Singapore.

Exporting through the Gulf of Finland allows Russia the lucrative options of selling either into northwest Europe around Rotterdam in the Netherlands or across the Atlantic into the United States.

By contrast, most pipeline proposals involve taking Caspian crude to the Black Sea or to the neighboring Mediterranean Sea.

A line from Kazakhstan to the Black Sea with eventual capacity of 1 million barrels per day is already being built and will start operating next year.

A line from Baku in Azerbaijan to Ceyhan on the Turkish Mediterranean is being championed by Turkey and the United States, although funding has yet to be found and the economics are seen as questionable at best.

"The logic of that line has always been political, not economic," said James Henderson, head of research at the Renaissance Capital brokerage.

The problem with both those pipeline options is that the Eastern Mediterranean is already oversupplied. Oil comes in from Libya and Algeria, by pipeline from Iraq, Saudi Arabia and Iran, and by sea from Russia. It is awash with oil and a net exporter.

But the economics of exporting from the Mediterranean or Black Sea do not compare with Iran. A large tanker that cannot go through the Suez canal takes roughly 45 days to reach Singapore, obviously far more expensive than from Kharg.

Adding to Russian worries about more crude arriving in the Mediterranean, the value of its own Urals blend crude there has slumped recently on oversupply.

Urals is priced against North Sea Brent, the benchmark for all Atlantic basin crudes.

In recent years, Urals has typically traded at a dollar or two per barrel below Brent, but over the last few days this has widened to $4 to $5.

Russia fears that bringing more crude to the Mediterranean could accentuate this trend.

"It's a question of whether it drives the differential down or if it drives the price down overall, but Russia loses either way. Any crude arriving in the same location as Russian crude is not going to help the price in that area," Henderson said.

Iran has long pushed itself as the obvious export route for Caspian oil, but is not now an option for U.S. producers because of sanctions against the country.

But some non-U.S. producers in Turkmenistan already swap crude out through Iran, and Stephen O'Sullivan, head of research at United Financial Group, sees sanctions easing as the economic fundamentals become clearer.

"Politics has got in the way of the economics. Wherever that happens, obviously the economics win out," he said.

If Russia promoted itself as vigorously as Iran as a swap route, total exports through both countries could reach over 1.2 million barrels per day just by using existing refining capacity in Iran and on the Volga and with no need for expensive new infrastructure.

This is more than the planned capacity of the Baku-Ceyhan line, which has been priced at $2.4 billion but may cost more.

"If there are other locations for the crude to go which already exist, why build a pipeline to Ceyhan?" Henderson said.