T r a n s i t T r o u b l e s P a u l S t e v e n s Transit Troubles Pipelines as a Source of Conflict A Chatham House Report Paul Stevens Chatham House, 10 St James’s Square, London SW1Y 4LE T: +44 (0)20 7957 5700 E: [email protected] www.chathamhouse.org.uk F: +44 (0)20 7957 5710 www.chathamhouse.org.uk Charity Registration Number: 208223 Transit Troubles Pipelines as a Source of Conflict A Chatham House Report Paul Stevens i www.chathamhouse.org.uk Chatham House has been the home of the Royal Institute of International Affairs for over eight decades. Our mission is to be a world-leading source of independent analysis, informed debate and influential ideas on how to build a prosperous and secure world for all. © Royal Institute of International Affairs, 2009 Chatham House (the Royal Institute of International Affairs) is an independent body which promotes the rigorous study of international questions and does not express opinion of its own. 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The Royal Institute of International Affairs Chatham House 10 St James’s Square London, SW1Y 4LE T: +44 (0) 20 7957 5700 F: +44 (0) 20 7957 5710 www.chathamhouse.org.uk Charity Registration No. 208223 ISBN 978 1 86203 210 1 Designed and typeset by Soapbox Communications Limited www.soapboxcommunications.co.uk Printed and bound in Great Britain by Latimer Trend and Co Ltd ii The material selected for the printing of this report is Elemental Chlorine Free and has been sourced from sustainable forests. It has been manufactured by an ISO 14001 certified mill under EMAS. www.chathamhouse.org.uk Contents About the Author iv Acknowledgments v Executive Summary vi 1 Introduction 1 Defining transit pipelines 1 Why transit pipelines matter and will become more important 2 Future plans for transit pipelines 4 2 A Brief History of Transit Pipelines 8 Tales of disruption 8 Tales of success 10 What makes for ‘good’ and ‘bad’ transit countries? 11 3 Why Transit Pipelines Have Experienced Problems 14 Politics 14 Economics 15 4 Possible Solutions 19 Invasion 19 Globalization and dependence on FDI 19 Making the transit country an offtaker 20 Alternatives to the transit country 20 Finding a common jurisdiction 24 Developing mutual dependence 26 Introducing progressive ‘transit terms’ 27 5 Conclusions 29 References 30 iii www.chathamhouse.org.uk About the Author Professor Paul Stevens is Senior Research Fellow for Energy at Chatham House, Emeritus Professor at Dundee University and Consulting Professor at Stanford University. He was educated as an economist and as a specialist on the Middle East at Cambridge University and the School of Oriental and African Studies, London. He taught at the American University of Beirut in Lebanon (1973–79), interspersed with two years as an oil consultant; at the University of Surrey as lecturer and senior lecturer in economics (1979–93); and as Professor of Petroleum Policy and Economics at the Centre for Energy, Petroleum and Mineral Law and Policy, University of Dundee (1993–2008) – a chair created by BP. Professor Stevens has published extensively on energy economics, the international petroleum industry, economic development issues and the political economy of the Gulf. He also works as a consultant for many companies and governments. iv www.chathamhouse.org.uk Acknowledgments Thanks to John Mitchell, Enno Harks, Jim Jensen, Daniel Litvin and James Nixey for comments on earlier drafts, although all errors are the author’s. Thanks also to Margaret May of Chatham House for her editing skills. Paul Stevens March 2009 v www.chathamhouse.org.uk arching jurisdiction. More transit pipelines will be needed in the future, since oil and gas reserves close to market are being depleted, and there is growing demand for natural gas in the world’s primary energy mix. In recent years, there has been a noticeable fragmentation of legal jurisdictions as the Executive Summary Soviet Union and former Yugoslavia both collapsed. Many of the new transit pipeline projects being discussed are essentially the result of gaming strategies between the various players and will fail to materialize. Chapter 2 starts with a brief history of the many transit pipelines which have been associated with very negative Recent events between Russia and Ukraine at the start of experiences. In the past, they included those operating in 2009 and Russia and Georgia in 2008 have brought transit the Middle East; more recently, attention has been focused pipelines back into the media spotlight. Any reading of the on those in the former Soviet Union. The chapter then history of transit oil and gas pipelines suggests a tendency describes lines which can be viewed either as success to produce conflict and disagreement, often resulting in stories or as having too recent a history for the outcome to the cessation of throughput, sometimes for a short period be determined. This history helps in identifying which and sometimes for longer. It is tempting to attribute this to characteristics make for ‘good’ and ‘bad’ transit countries. bad political relations between neighbours. This is These include: certainly part of the story, but also important is the nature of the ‘transit terms’ – tariffs and offtake terms – whereby the importance of foreign direct investment in the transit countries are rewarded for allowing transit. Put transit country’s development strategy; simply, the trouble with transit pipelines has a significant the importance of the transit fee in the country’s economic basis. macro economy; The report addresses three questions: the dependence upon offtake from the line; the availability of alternative routes; Why will oil and gas transit pipelines become more whether the transit country is also an oil or gas important to global energy markets in the future? exporter in its own right. Why has the history of such pipelines been littered with conflict between the various parties? Chapter 3 seeks explanations for poor performance in What might be done to improve this record in the terms of politics but with the main discussion focusing on future and make transit pipelines less troublesome? the underlying economics which generate conflict. One obvious source of political disputes is a history of bad Chapter 1 defines transit pipelines as lines which cross relations between neighbouring countries. As for the another’s ‘sovereign’ territory to get the oil or gas to market. economics, the key explanation is that there is no reason - Such lines have a number of relevant, common characteris - able, objective basis for determining ‘transit terms’. The tics which tend to generate conflict. Different parties are only sensible reason for the existence of a transit fee is to involved, each with different interests and motivations. This allow the transit country to share in the benefits of the invites disagreement between the parties because of the project. This share will reflect the relative bargaining benefits to be shared and the fact that mechanisms exist to power of the parties to the negotiations. Over time this encourage one or other party to seek a greater share. Even changes and thus there are always pressures to change the though this would apply to any commercial transaction, the transit terms. This trend is greatly encouraged by the vi key difference with transit pipelines is that there is no over - existence of the ‘obsolescing bargain’, the structure of www.chathamhouse.org.uk Executive Summary pipeline costs and the growing volatility of oil and gas The report concludes that there will be an increasing prices. need for and dependence upon oil and gas transit pipelines Chapter 4 considers possible solutions to help reduce but such pipelines are inherently unstable because of conflict and supply disruptions. These include: political disputes and also, of equal importance, as a result of commercial disputes over the transit terms. These a military solution; commercial disputes arise because there is no objective, encouraging the transit country into the global reasonable or fair way of setting the transit terms. economy to make it dependent upon foreign direct Many of the apparent solutions to this problem are, on investment; closer examination, at best ineffective, at least in current making the transit country dependent upon its own circumstances. More generally, history suggests that a gas and oil supplies from the pipeline, although this good experience with transit pipelines requires certain can be a double-edged sword; best- practice conditions to be met. These include: considering alternatives to the transit country not only in terms of geographic routes but (for gas) the a clear definition and acceptance of the rules; actual means of transport including, for example, the projects driven by commercial considerations; use of liquefied natural gas (LNG); credible threats to deter the ‘obsolescing bargain’; encouraging multilateral jurisdictional solutions such mechanisms to create a balance of interest. as the Energy Charter Treaty; developing mutual dependence between the transit However, it is difficult to turn this ‘wish list’ into a practical country and the producer/consumer country. agenda. The only practical, realistic solution in the near term is Finally, the report considers a new solution: basing the to introduce ‘progressive’ transit terms to existing and new ‘transit terms’ on a progressive fiscal arrangement similar agreements.