Caspian Oil Has Future

Reports of the Caspian's death have been much exaggerated. The pendulum has swung in recent months from an atmosphere of gold rush to one of disappointment brought about by failed exploration projects and low oil prices. But the truth lies somewhere in between.

"We never believed reserves were as high as some expected, nor as low as some now fear," says Gavin Graham, Shell's vice president for the Caspian region.

Just a year ago the U.S. Department of Energy was floating a figure of over 200 billion barrels of proven and potential reserves in the Caspian basin, placing the region second only to Saudi Arabia as a hydrocarbon-bearing province. But some now believe these figures were politically motivated.

By hyping the potential of Caspian oil, Washington was better able to justify its foreign policy goal of securing pipelines from the region that bypass both Russia and Iran. This would achieve the dual objectives of containing Tehran and ensuring that Moscow did not regain a stranglehold over exports from Central Asia and the Caucasus.

Such hype led to talk of a "New Middle East." As one Western oil executive puts it, "the perception was that all you had to do was to stick a straw in the ground and oil would come gushing out." Yet as one official at the Azeri state oil company SOCAR said, "no one in Azerbaijan ever claimed we were a second Kuwait"

And suddenly this year, the Caspian bubble seemed to burst. The closure of first one Azeri exploration consortium, Cipco, and then a second, Naoc, caused much excitement in the media. Yet it left oil companies in Baku unfazed.

Over a dozen "dry holes" were drilled in the North Sea before oil and gas was found. In the Caspian, it has so far been just six. Besides, geologists had always argued that the blocks explored by Cipco and Naoc, on the outer rim of the South Caspian basin, were unlikely to yield much in the way of oil. "Their failure to find oil there has proved our understanding of the South Caspian geological model rather than disproved it," said Tim Eggar, CEO of Britain's Monument Oil and Gas.

So the Caspian's reserves may not be as large as Washington was trying to portray. But proven reserves of 15 billion to 30 billion barrels of oil are already equal to those of the North Sea. And further exploration will by conservative estimates at least double these over the next decade. "There's every reason to believe that the Caspian will provide a further 'yet to find' of 40 billion barrels, with an upside of perhaps 65 billion barrels," says Monument's Eggar.

As a future oil province equivalent to perhaps two North Seas, the Caspian should start to produce up to 5 million barrels per day over the next decade, or slightly less than the output of Russia or the United States. But unlike those populous countries, almost all of the Caspian's crude oil will be exported, supplying around 5 percent of global demand.

The recent recovery in prices has created a more favorable environment for the development of Caspian oil. But continued volatility on the world oil markets is exacting a heavy toll on upstream plans in the region.

Most companies say the price of benchmark dated Brent Blend crude will need to average around $15 per barrel this year for Caspian ventures to be profitable. But many are also having to factor the present price volatility into their equations and plan for the worst. "We think Brent will trade in a range of $11 per barrel to $16 per barrel," Shell's Graham said. "That means any Caspian project now has to be viable at $11 per barrel."

Azerbaijan's AIOC says it can meet that test and has budgeted those constraints into its next phase of expansion. But the $10 billion AIOC consortium has economies of scale on its side that few others will be able to enjoy.

In a study of a dozen or so projects, Shell concluded that at a price of $18 per barrel, almost all Caspian projects have positive economics. But at $14 some become negative, and at $10 almost all become negative.

Yet there is good reason to believe that costs will fall in the Caspian.

Labor and facilities are already cheap. But drilling and transportation remain sky high. Azerbaijan has only two rigs that can drill in deep water, and competition for these has driven the cost of renting them to among the highest in the world. But more rigs are on the way, promising to ease the drilling drought.

But it is transport that is the highest cost of all. Delivering a barrel of Turkmen oil to market costs some $7 per barrel, compared with $1 per barrel in the North Sea. Even here though, tariffs are being trimmed as the range of transport options increases and routes compete with each other on price.

The Caspian has undoubtedly been the victim of being talked up too much. And it is now clear that there will be failures as well as successes in the bid to exploit its hydrocarbon wealth. Successful development will require solutions to the unique challenges posed by the region's politics and geography. But it would be an error to write-off the Caspian because of this. And beneath the veneer of doom and despondency in recent months, it is clear that world's major oil companies see every reason to stay.

Euan Craik is Moscow bureau chief for Petroleum Argus. He contributed this comment to The Moscow Times.