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. Last Updated: 07/27/2016

Caspian Deal's Dark Future

The signing this week of a multi-billion dollar Caspian Sea oil-mining deal between Azerbaijan and a consortium of eight foreign companies is indeed a milestone, but the biggest problems are probably still ahead.

With the largest proven oil reserves in the world, the former Soviet Union should be going through an oil boom. Time and again, however, the internal political problems of the Russian oil industry and Russia's ambitions to maintain economic control over the whole region have prevented this oil from getting out of the ground.

Last week's $7 billion Caspian shelf deal is highly reminiscent of the $20 billion deal struck in 1992 between the Central Asian republic of Kazakhstan and U.S. oil company Chevron for the Tenghiz oil field.

Back in 1992, it looked like Chevron and Kazakhstan were onto a sure thing. The Tenghiz field had proven reserves and the two sides quickly came to an amicable agreement on division of the costs and profits from the deal.

Chevron invested about half a billion dollars in the project before a possibly fatal flaw became apparent. No pipelines existed to pump large volumes of oil out of Kazakhstan. Chevron would have to construct a pipeline of its own, either through Russia to the Black Sea port of Novorossiisk, or through the political pariah state of Iran.

The former Soviet republic of Turkmenistan recently signed a deal to build a natural gas pipeline across Iranian territory to Turkey, but it will be some time before a U.S. company will do the same.

This leaves the Russian route, but this has proved just as risky. Chevron has failed to reach an agreement with Russia on building a pipeline across its soil. Russia has demanded maximum control for the least investment and requested a share in the Tenghiz oil field, basically a renegotiation of the whole deal.

The foreign oil companies who have just committed to spending all that money in Azerbaijan are obviously hoping the Chevron story will not be repeated in their case. But the potential problems in the Caspian are if anything even muddier than they were in Kazakhstan.

The Azerbaijan consortium has one big advantage in that it will get support from a very powerful Russian partner, Lukoil -- Russia's biggest privatized oil company -- which has been given a share in the project.

But the issue of constructing a pipeline to export oil from Azerbaijan is just as vexed as it was in the case of Kazakhstan, and other even more thorny problems look set to arise.

There are three possible pipeline routes out of Azerbaijan, either across a sliver of land held by Armenia to Turkey, across Iran to Turkey, or else across Russia to a Black Sea port. Each has serious problems.

The direct route to Turkey via or near Armenia is the most obvious but faces serious political risk. Armenia and Azerbaijan have been fighting an undeclared but very bloody war over the disputed territory of Nagorno-Karabakh for the past five years. There have been some signs of peace breaking out in the last couple of months, but no oil company is going to start building a pipeline through the region until that peace has proven it can last.

Going across Iran is once again a no-no. That means that the companies may have to deal with Russia.

Russia however says that the whole $7 billion deal is illegal. In a string of diplomatic notes, Russia has argued that the Caspian Sea should have the legal status of a common economic zone and that Russia has a veto on the use of its resources.

Even if Russia did accept Azerbaijan's right to sign the deal, agreeing on the terms for the construction of a new pipeline through Russia would be no easy matter. Russia will quite justifiably want a high price for any pipeline across its territory.

But perhaps the most bizarre twist of events will come if Russia decides, for reasons of politics or finance, that it does want the pipeline across its territory and wants to convince Western oil companies not to use the more direct route near Armenia.

Western oil executives must be having nightmares at the not-inconceivable possibility that with a little help from Russia, the situation in Nagorno-Karabakh will deteriorate and Armenia will return to open war with Azerbaijan. Hopefully, not even Russian oil politics are that Machiavellian.