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. Last Updated: 07/27/2016

Bank Holdup Hits Caspian Oil

When it was announced last week that the opening of the multibillion-dollar Caspian pipeline was postponed, the head of Kazakhstan's state oil company said the delay was due "to uncertainty on the quality, standards and criteria of the Kazakh-Russian oil blend."

Translation: The Caspian Pipeline Consortium needs a way to assess the value of the varying qualities of oil sent through its pipe and reward or punish producers accordingly.

The "oil-quality bank" concept in other parts of the world is as ubiquitous as the oil pipelines that adhere to it. But if the Caspian consortium succeeds in establishing one, it would be the first in the former Soviet Union, setting a precedent that would put pressure on monopoly pipeline operator Transneft to do the same for Russia.

Such a step would swiftly alter the delicate balance between the national crude-oil blend, its price on the world markets and the individual oil companies that make up its components. The establishment of a quality bank would transfer millions of dollars from one company to another, based on a measure of density called "gravity" created by the American Petroleum Institute.

One of the first quality banks was applied to the 1,280-kilometer Trans-Alaskan Pipeline System in the 1970s because not all oil in Alaska was created equal. The pipeline operator realized that companies injecting higher-quality crude saw the value of their contribution decrease because it was mixed in with lower-quality crudes into a certain "blend."

To compensate these companies and penalize those that added lower-quality oil, TAPS created a system that awarded shippers debits or credits depending on their oil quality.

According to its administrative code, the TAPS bank "is an arrangement that makes monetary adjustments among shippers in an attempt to place each in the same economic position it would enjoy if it received the same petroleum that it delivered."

"It's a very commonly used method," said John Dabbar, deputy general manager of operations at the CPC.

The CPC was set up in 1992 by Russia, Kazakhstan and Oman to finance the construction of a $2.5 billion pipeline that now snakes 1,500 kilometers from the Tengiz oil fields in western Kazakhstan to a Russian Black Sea port close to Novorossiisk. The pipeline is designed to pump 1.5 million barrels per day at peak capacity.

The possibility of a CPC oil bank has surfaced periodically since the mid-1990s and most recently last month.

Separately, the State Duma voted for an amendment to the Mineral Resource Tax Law that would introduce an oil- quality bank for Transneft.

If the CPC set up an oil bank, some Kazakhstan producers would most likely send their crude to Samara via Transneft because they would not be penalized for crude quality, experts say. Transneft's tariffs are also substantially lower.

However, the addition of this lower- quality crude — and the absence of the light crude from the Tengiz field, which would be routed through the new pipeline — would lower the overall quality and value of the Russian Urals blend, which already trades at a discount of $1.50 a barrel to the worldwide Brent benchmark.

With annual exports totaling about 900 million barrels, every 10 cent decrease in the price of Urals costs Russia $90 million a year.

It is possible that "heavy" oil from Kazakhstan could make its way into Russia, but it's also possible that Kazakh crude could improve the Urals blend, said Transneft vice president Sergei Grigoryev.

"We already have a plan for Russia's oil-quality bank," Grigoryev said. "We just don't have unanimous consent among the participants. It's up to them to agree to it."

One company against the idea is Tatneft, which along with Bashneft stands to lose the most from its implementation, according to the United Financial Group brokerage. Sibneft and Tyumen Oil Co., who already have deep refining capabilities, would benefit most, while LUKoil and Yukos would be marginally better off. "Tatneft will either have to accept a substantially higher discount or else invest heavily in its processing capacity," UFG said in a research note.

Tatneft officials said the oil-bank initiative is not "prudent."

"For decades, by exporting our high-quality oil, we compensated for the hydrocarbon crude produced in other regions," said Azat Yagafarov, head of Tatneft's Moscow office. "Now, when more than half of our production is oil containing high levels of sulfur and metals, when our major oil fields have already been developed, the introduction of a quality bank will hit us financially."

The possibility of such far-reaching ramifications are keeping CPC officials tight-lipped about their progress.

"It's not top secret or anything," Dabbar said. "It's just business."