Politics of Oil:Caspian Imbroglio

Shebonti Ray Dadwa ,Research Officer,IDSA



In the first week of July 1998, the President of Russia, Boris Yeltsin and the President of Kazakhstan, Nursultan Nazerbaev, signed an agreement, dividing the northern portion of the Caspian Sea. This agreement paved the way for exploiting the vast hydrocarbon reserves in the Kazakh portion of the Caspian from October. However, the agreement comes with the rider that only the sea bed can be drilled. The sea waters, as well as fishing rights, are to be managed jointly by all the states bordering the Caspian—namely, Russia, Iran, Kazakhstan, Azerbaijan and Turkmenistan, while issues like pipelines and telephone cables will have to be negotiated and be the subject of other agreements.1

Though the agreement gives Kazakhstan as well as the other two former Soviet Union (FSU) states—Azerbaijan and Turkmenistan—the chance to develop the hydrocarbon resources lying in their portion of the Caspian, there are a number of other hurdles still to be overcome before these economically-strapped countries can enjoy the benefits of the revenues deriving from the sale of their energy resources. For instance, though this pact may allow the states to develop their oil fields, the problem of transporting oil and gas to the international market still has to be dealt with. Not only does a viable route have to be chosen to carry the oil from this politically unstable region, but other environmentally sensitive issues have to be dealt with as well. Both Russia and Iran oppose the construction of an undersea pipeline, ostensibly for ecological reasons, but in reality because it would bypass their own territories, contributing to a loss of several millions of dollars in transit fees as well as influence in the region.

The agreement which came after months of negotiations gives an indication of the problems involved in developing what is estimated by Western sources as the world's last vast reservoir of energy. For these resources lie beneath the Caspian Sea which is one of the industry's most complicated challenges, both because of disputes over the legal status of the Caspian's continental shelf as well as the innumerable political problems over the routes of pipelines which will carry the region's energy to international markets.

Dispute over the Caspian's Legal Status

For years, the Caspian Sea has been the subject of an intense battle for ownership of its waters. Before the break-up of the Soviet Union, the Caspian was under the joint ownership of the two regional powers, the Soviet Union and Iran, based on two separate treaties in 1921 and 1940. However, at the time, the division was mainly for observing the countries' fishing rights rather than oil, and for preserving the caviar-producing sturgeon found in these waters.

It was only after the break-up of the Soviet Union, and the emergence of three new states, all bordering the Caspian and thereby laying claim to it, and more importantly, to the large oil deposits that lay under its waters, that the issue became the subject of tension. The Caspian is a relatively shallow body of salt water that is the size of Japan—in fact, it is probably the world's largest landlocked body of water, which lies above estimated reserves of about 200 billion barrels of oil (though a more realistic estimate pegs the figure at 27.5 billion barrels of proven reserves with an additional 40-60 billion barrels of estimated reserves).2

Ever since the break-up of the Soviet Union in 1991, the Caspian suddenly became the property of five countries—Russia in the north, Iran in the south, Kazakhstan and Turkmenistan in the east and Azerbaijan in the west.

However, though the Caspian is landlocked, it has for a long time met most of the qualifications of the international Law of Convention on the Law of the Sea, but the Soviet Union and Iran found it convenient to treat it as a lake. Under their 1921 Treaty of Friendship, they made it a freely navigated lake whose resources—mostly sturgeon—were shared by both. But once the three Central Asian states came into being, the issue became far more complicated. For the largest oil and gas fields are believed to be situated within the territorial waters of these three FSU states, with Iran and Russia having comparatively smaller shares.3

If the Caspian were to be given the status of a sea, it would be divided up into territorial zones, with each country bordering it being allowed control over their own portions, as per the 1982 Law of Convention on the Law of the Sea. This would allow the three FSU states, who are said to have the major share of the Caspian's hydrocarbons, to develop their own portions of the sea bed. However, if the Caspian were to be given the status of a lake, as Iran and Russia were claiming it to be, it would be the common property of all the littoral states, which means that any exploitation of its waters as well as navigation rights would have to be subject to agreement by all five. Both Russia and Iran claimed ecological reasons for their objections to laying a sub-sea pipeline, while Russia also declared that since the economies of the FSU states were developed with Russian financial support, it deserved to have "access to the resources of the Commonwealth of Independent States (CIS)."4

However, since April 1998, Russia began to modify its position and President Yeltsin and President Nazerbaev agreed in principle to divide the sea bed and the oil under it into national sectors, though the waters above it would remain international. This meant that all five countries would enjoy common use of the sea itself, with freedom of navigation, fishing rights and environmental protection.5

Analysts say that Moscow decided to abandon its strong insistence that the region is a lake after realising that its own Northern Caspian sector has huge hydrocarbon potential. Also Russia's largest oil company, Lukoil, has benefitted from the dispute as the foreign consortium, the Azerbaijan International Operating Consortium (AIOC),* which is developing Azerbaijan's oil fields, has decided that giving some stake to a Russian company would stop Moscow's objections about the legality of Caspian development as well as other problems created by Moscow.6

However, many Kazakhs fear that the Russians may come up with more hurdles. For instance, Russia has left a number of questions pertaining to infrastructural problems for further negotiations. And given the comments made by Yuri Mirzlyakov, the head of the working group on Caspian issues at Russian's Foreign Ministry, who said that the Caspian was earthquake-prone and might represent an obstacle to further agreement on infrastructure in the Caspian, such as an undersea pipeline, their fear has some justification. Mirzlyakov also declared that though Russia had contemplated building a sub-sea line in the 1980s, it now "considered such a pipeline to be very dangerous" on ecological grounds.7

Iran, too, has objected to a sub-sea line for the same reasons. It says that the Caspian cannot be divided into national sectors and that the oil belongs to all. In May, the Iranian Foreign Minister, Kamal Kharrazi, said that the only way Iran would agree to dividing up the Caspian was if it was sectioned into "equal shares". That would mean that Iran would control 20 per cent of the sea bed, whereas the normal division according to international law would give it less than 10 per cent.

Kharrazi also rejected the Russian idea of dividing the sea bed one way and the waters another. "If there is going to be a division accepted by different countries, I'm sure that one legal regime has to be applied to the sea bed as well as the waters of the Caspian Sea," he said, and declared that any pipeline built under the Caspian Sea would be a disaster to the sturgeon and migrating birds.8

However, Western sources say that Iran's motive was to delay the building of any under-sea pipeline in the hope that the US would drop its opposition to a much shorter, cheaper line across Iran.

This brings us to the other, and much more difficult and complicated problem regarding the region's energy resources—that of pipeline routes.

Pipeline Politics of the Caspian Region

Finding alternative routes for the Caspian's oil and gas is not only commercially imperative but also a strategic necessity. The US government has declared it as a foreign policy priority to transport the region's energy resources through multiple routes, mainly to ensure that the West has access to secure supplies. To do this, however, it has to ensure that the FSU states which possess these hydrocarbons reduce their dependence on Russia. For this, Russia's stranglehold on the region has to be lifted, which is not an easy task given the fact that though Moscow has been accused of never seriously developing the Caspian oil fields—mainly because it did not want to create competition for the oil already flowing from their Siberian wells—Moscow has traditionally viewed the region as its backyard and sphere of influence and controls the access routes for the region's resources. Virtually all of the pipelines and railways which transport the region's oil, gas, metals and cotton pass through Russia. Now in pursuit of what is believed to be the third largest energy deposit in the world after the Persian Gulf and Russia's on-shore deposits in Siberia, in a modern-day version of the old "Great Game", Russia is now pitted against Washington, on the one hand, and the other four littoral states of the Caspian Sea, on the other, for ownership rights, with energy-hungry China hovering in the sidelines, seeking secure additional supplies via overland routes which would lessen its dependence on sea-borne supplies from West Asia. To complicate matters further, Azerbaijan is also locked in a territorial battle with Turkmenistan over ownership rights over the oil that is already flowing out of Azerbaijan.9

Recently, a consortium of mainly US and Western oil companies with the active backing of their governments, has sought to loosen this hegemony by providing transport routes to the south and east, avoiding Russia.10 Though American energy companies joined the rush fairly early, the US government took time to get its act together, despite several of Washington's top power brokers, including former National Security Advisor, Zbigniew Brzezinski, who is now a consultant for Amoco, warning the Administration that it was making a strategic mistake in paying so little attention to the new Central Asian Republics. The CIA finally set up a secret task force to monitor the region's politics and gauge its wealth, and came to the conclusion that working to mould the area's future was "one of the most exciting things that we can do."11

On February 25, Jan Kalicki, Commerce Department Counsellor and Administration Ombudsman for energy and commercial cooperation with the FSU states gave a broad outline of the policy interests and objectives associated with Caspian oil and the construction of pipelines to take it to market. He said: "Our goal is for the investment and revenues generated by the region's energy resources to play a crucial role in furthering economic and political development" in the Caspian and Caucasus region. "We are promoting multiple pipeline routes as the best insurance that oil and gas will continue to flow unimpeded in the future. Building transportation systems for oil and gas will require unprecedented regional cooperation....our approach is to work cooperatively with the key producing transit and consuming countries.12

"Stable and assured energy supplies for the Caspian will reduce our vulnerability to disruptions in world energy supplies. Current world events remind us how sensitive the world economy can be to a preponderance of oil exports through the Strait of Hormuz."13

Though both Russia and the US deny that they are in competition with each other, in 1994, President Clinton declared the Caspian an area of strategic interest to the US. Washington's tacit goals in the region were clear: make sure that Moscow no longer dominates and guarantee that the region's energy resources eventually get safely to Western markets, preferably thanks to the efforts of US oil companies. In fact, soon after the first pipeline carrying initial oil from Azerbaijan to the Russian Black Sea port of Novorossiysk was inaugurated, US Energy Secretary Federico Pena said that Washington will insist that the next pipeline for Azeri oil go west via Georgia and Turkey. He even said that Azeri oil could be exported in "any direction" as long as it was through a non-Russian or non-Iranian pipeline.14

Boris Nemtsov, Russian First Deputy Prime Minister, for his part, insisted that the main pipeline to export Azeri oil would pass through Russia and guaranteed a new spur line that would bypass war-torn Chechnya on its way to Novorossiysk.

By late 1997, the US was pressing hard for the option it favours, a system of energy lines starting through Kazakhstan and Turkmenistan, running under the Caspian Sea to Baku, then through Georgia and Turkey to the Mediterranean coast. However, this pipeline would cost about $4 billion to build and add up to $4/b of oil it carried. Therefore, many company executives prefer to use the easier southern route through Iran or even the northern route through Russia to the Black Sea. But the US does not entirely trust Russia which resents the arrival of foreign influence in what were Soviet republics, while a line through Iran is anathema. "The last thing we need," said a White House aide, "is to rely on the Persian Gulf as the main access for more oil."15

Iran too has been trying hard to convince Western companies and the Central Asian governments that its territory was best for oil export pipelines from the region. Hassan Kashkavi, Iran's Ambassador to Kazakhstan said, "They (the US) cannot ignore Iran in terms of geographic position."16 Though many companies have been deterred by the threat of US sanctions from investing in Iran's petroleum industry, many are recognising the fact that Iran is one of the keys to securing the region's economic independence from Russia.

More importantly, if Iran can make its objections to the building of a sub-sea pipeline stick, it would undermine US plans for a trans-Caspian pipeline scheme to carry oil and gas from Turkmenistan and Kazakhstan to Azerbaijan via an under-sea line and then on to Turkey via Georgia. The main purpose of this line is to link energy exports from friendly countries in such a way as to keep Iran isolated and at the same time find an alternative to using Russian export routes.

However, Tehran says that it is willing to negotiate a new agreement but demands veto rights over any aspect it does not like, and warns that if its interests are not taken into account, it will deal with what it considers illegal activities in the Caspian by using "constructive—and possibly destructive" counter-measures. Tehran's campaign for using the Iranian route strikes a sympathetic chord in oil companies. As a senior Western oil official said, "We'd sign with the Iranians. In this part of the world, they are by far the most trustworthy partners for a pipeline deal. Terrorism? Who's going to blow up their own pipeline?"17

Meanwhile Iran's supreme leader, Ali Khamenei, regards the whole debate as part of a US-inspired plot to impose a military presence on Iran's northern border just as it did on Iran's southern border, the Arabian Gulf. "The US oil companies' presence in the Caspian Sea is aimed at paving the ground for the US military presence in this sensitive oil-rich region," he said recently.18

However, the US has reason to be optimistic as it has the support of some regional leaders like Azeri President Heidar Aliyev, while Kazakhstan's Nazerbaev affirmed in a joint communique with President Clinton that he was leaning toward an East-West oil and gas line under the Caspian Sea as part of the larger system the US is pushing. However, the opinion of the AIOC as well as the Caspian Pipeline Consortium (CPC), which is a group of oil companies operating in Kazakhstan, will have to be taken in the final decision in choosing a route, which is expected to take place some time in October this year. It is expected that given the current low price of oil in the international market, the economics of a project will be the major factor in the decision-making process, when choosing a pipeline route.

In the meantime, many of the oil companies are also looking at eastern routes to get the oil out of the region. Since the Asian market is a far more lucrative one, with energy demand in Asian countries outstripping demand in the Organisation of Economic Cooperation and Development (OECD) countries, proposals for constructing ambitious pipeline projects from the region to multiple destinations like China, Japan and ultimately to the Association of South-East Asian Nations (ASEAN) markets are being drawn up, while still others are looking at pipelines to carry both oil and gas to Pakistan and then on to India. However, all these projects are not only extremely costly because of the distance involved but also cover some very unstable regions (like Afghanistan) as well as Xinjiang province in China. Also, much of the terrain through which these pipelines will be placed is hostile. All these factors will have to be taken into account when deciding on an eastern route.


There are many factors, therefore, that have to be taken into account and various obstacles that have to be overcome before the vast wealth that is known to exist beneath the waters of the Caspian Sea can be accessed and the cash-strapped states that border it can realise their dreams of prosperity. Despite the interest of foreign governments and companies, the Caspian states have yet to see much money from any of the proposed energy projects. Enormous hurdles must be cleared before the oil begins to flow.

First of all, the daunting environmental and legal problems regarding the status of the Caspian Sea have to be overcome before the riches that lie under the sea bed can be exploited. Also the unpredictable but active seismic nature of the basin has to be taken into account, as this introduces an element of risk into what would otherwise be the most obvious means of transport—a pipeline laid on the sea bed.

Secondly, all the FSU states, thanks to their geographic location remain hard to reach and after decades of Soviet rule, face developmental problems. Being landlocked, they depend on the goodwill of their more powerful neighbours like China and Russia and Turkey, on the one hand, and war-torn Afghanistan, on the other, as their resources have to be shipped through their territories before they can reach global markets. As a result, though small quantities of initial oil and gas are being exported, even after years, these grand projects are still in their early stages and it will take more years before their full potential can be realised.

However, the biggest hurdle to transportation of energy from the region is Russia. After the break-up of the Soviet Union, Russia, in an attempt to maintain its influence over these states, offered them security guarantees in return for Russian economic dominance. If they refused, Moscow was suspected of encouraging the separatist movements in these states. For example, in Abkhazia and Nagorno-Karabakh (the Armenian enclave in Azerbaijan), separatists were supplied with arms, when Georgia and Azerbaijan refused to join the CIS. At the same time, those states which agreed to join the CIS were regularly left without power as punishment for unpaid state debts owed by them to Moscow, and came across innumerable problems when negotiating pipeline routes through Russia to market their oil. In other cases, transit was allowed through Russian territory only if they agreed to ship energy resources to poor CIS states and leave cash-paying customers in Europe to Russia's own state-owned firms.19

This was the main reason for the Caspian states turning to foreign partners who could help finance new transit routes. However, this too entailed its own problems. Faced with a financial squeeze, many of the Caspian states settled for minority shares in a number of projects, leading critics to accuse them of trading their dependence on one great power for another. Their problems were exacerbated by the fact that years of Soviet rule had left these states ill-equipped to run their economies, which had been fully state-owned under the Soviet system. As a result, few of the leaders of the newly independent states had any practical knowledge of international finance or trade, which in turn, led to several ill-informed and controversial decisions, including costly and embarrassing repudiation and renegotiation of several contracts for energy projects.20

Finally, the competition for control of the region's energy resources has the potential to spark off developments that will not only make rapid exploitation of its reserves more difficult, but is likely to create a zone of instability and crisis, thereby negating the reason that the Western powers sought alternative sources of energy from the unstable Persian Gulf region.

With all the innumerable hurdles being faced by the various companies with regard to a viable route out of the region to transport the energy resources to the international market, it has been suggested by some experts that for the time being at least, before the full potential of the reserves can be tapped, it is more practical to use a fleet of barges to transport oil and gas from the area. But here again Russia has opposed the barge plan because of fears that it might undermine the attraction of the route across its territory to the Black Sea.21

However, there are some positive signs. The recent signing of the Russian-Kazakh agreement regarding the division of the Caspian could be a forerunner of a settlement between all five states regarding the status of the Caspian. Also, late last year, Azerbaijan began shipping its first oil from Chirag while another pipeline which is owned by the CPC has also opened up, linking Kazakhstan to Novorossiysk. Turkmenistan too opened a small gas pipeline across Iran.

And though the various projects in the region are lagging behind their timetables, and peak oil production and the economic benefits that it promises are unlikely to be realised in the region until 2010, with the current glut in global oil inventories, the markets are not likely to become dependent on Caspian oil in the foreseeable future. Over time, Russia's influence over the region is expected to diminish, with the Caspian states bound to assume more responsibility for their own security needs.

Finally, however, in an energy-hungry world, the final decision will be based on economics. For when it comes to a choice between intervening militarily or writing off debts and investments, the governments of most companies investing in the region are likely to decide that leaving the region is preferable until conditions become more favourable.



1. Financial Times, July 7, 1998.

2. Indian Express, May 1, 1997.

3. Khaleej Times, June 26, 1998.

4. Ibid.

5. Financial Times, June 7, 1998.

6. Petroleum Intelligence Weekly, April 6, 1998

7. Financial Times, July 7, 1998.

8. Ibid.

9. Newsweek, November 24, 1997.

10. Financial Times, September 9, 1997.

11. Time, May 4, 1998.

12. Ibid.

13. US policy on Caspian Oil, USIA Wireless File, February 26, 1998.

14. Newsweek, November 24, 1997.

15. Time, May 4, 1998.

16. Financial Times, May 22, 1998.

17. Ibid.

18. Financial Times, July 7, 1998.

19. Martha Brill Olcott, "The Caspian's False Promise," Foreign Policy, Summer 1998.

20. Ibid.

21. Financial Times, June 17, 1998.