An Overview of Oil and Gas Pipelines in Kazakhstan
Karen Krug, Deputy Managing Partner Central Asia Practice, Denton Wilde Sapte
I. Overview of Existing Pipeline Infrastructure
Kazakhstan has vast proven oil and gas reserves. Currently, to assist in marketing the hydrocarbon production there are approximately 10,715 kilometres of oil and gas pipelines within Kazakhstan.
Even though Kazakhstan has large proven reserves of petroleum, the country faces many problems getting its petroleum to both domestic and international markets. Part of the domestic problem is that most of the reserves and production are located in the west while the demand for petroleum (population and industrial centres) comes from the south-east and industrial north. As a leftover from the former Soviet Union system, western petroleum is transported west through Russia to world markets while domestic demands in the east are met by importing from Siberia. Further, most of the pipelines which currently exist date back decades and were designed to aid the former Soviet Union and not Kazakhstan as an independent country. Several projects are in various stages of development to alleviate this situation, the most significant of which is the Caspian Pipeline Consortium («CPC») pipeline.
The majority of the oil pipelines lie in the west, although in the east the Omsk-Pavlodar-Shymkent-Chardzhou pipeline crosses the country from north to south. The existing oil pipelines deliver Kazakhstani crude oil to one of three existing domestic refineries (Atyrau, Shymkent and Pavlodar), to southern Russian or Ukrainian refineries, or to export to world markets. The main international route is through Russia accessed through the crude-oil exporting pipeline from the Caspian. This is the Atyrau-Samara pipeline with a record 13 million tonnes planned to be transported during 2001 (compare to 10.5 million tonnes of oil transported in 1999 and 11.7 million tonnes of oil transported in 2000). A portion of the country’s current oil production, 1.2 million tonnes (planned for 2001), is sent by sea (barge) to Baku to be fed into the Azerbaijani pipeline system (Makhachkala-Tikhoretsk-Novorossiysk pipeline). Another substantial portion is sent to Western Europe by rail.
Most importantly, this year the CPC pipeline, which stretches from Tengiz to Novorossiysk (on the Russian section of the Black Sea) will be operational and loading its first tankers fall of 2001. Initial capacity is expected to be 28 million tonnes per year. This effectively triples Kazakhstani existing export pipeline capacity.
In 2001 the national oil transportation company KazTransOil CJSC («KTO») also developed two new routes for transportation of oil produced in the Aktobe region which allowed the reserves of Zhanazhol and Kenkiyak deposits to be transported via the Bestamak loading dock for further delivery via pipelines transit through Russia to the world markets.
Because Kazakhstan is effectively landlocked, transportation is the key issue for the development of the Kazakhstani petroleum market. Tariff rates, access to pipelines, and available capacity are critical to any petroleum projects. The CPC pipeline is becoming operational and adding export capacity, while the discovery of the Kashagan field offshore Kazakhstan increases demand for capacity.
In light of significant amounts of oil that have been found in the Caspian shelf, President Nazarbaev stated that the CPC project would resolve only part of the total transportation problem and therefore Kazakhstan must join the Baku-Ceyhan project. In June 2001 a Subsidy Agreement between KTO and the U.S. Government (represented by the Commerce Department) was signed. Under the subsidy granted to Kazakhstan to finance its technical support for studying the creation of the Trans Caspian route for export of oil, the governments show great interest in creating conditions for participation of Kazakhstani oil producers in the Baku- Ceyhan project.
In 1992, the governments of Russia, Kazakhstan and Oman signed an agreement to build a 930 mile long pipeline stretching from the Tengiz oil field (operated by Chevron) in north-western Kazakhstan to the Russian port of Novorossiysk on the Black Sea. Since the CPC had formed in 1992, several oil companies in addition to Chevron had arrived in Kazakhstan and were interested in moving their oil from their fields using means other than the existing Russian pipeline and they also joined CPC. Currently the shareholders in the CPC Pipeline are: Caspian Pipeline Ventures, Mobil, Shell, British Petroleum, Oryx, British Gas, Agip, Lukarco BV, Rosneft-Shell, Caspian Ventures, Kazakhstan Pipeline Ventures LLC, Chevron Caspian Pipeline Consortium Company, Mobil Caspian Pipeline Company, Agip International (NA) NV, BG Overseas Holding Limited, Oryx Caspian Pipeline LLC, Rosneft, LUKOil of Russia and Russia, Kazakhstan, and the Sultanate of Oman.
This project is recognised as one of the most important projects for the exportation of Kazakh oil. Expenditures made by the shareholders have already exceeded US $2.5 billion. Initial capacity is expected to be 28 million tonnes a year with a maximum capacity of up to 67 million tonnes a year. On 3 August 2001 CPC shareholders signed an agreement on transportation of oil which is considered to be one of the final steps prior to the actual launch of the Tengiz-Novorossiysk Pipeline. There are significant implications of the moving of Kazakhstani crude away from the Transneft system to the CPC. Transneft has minimum quality requirements for oil entering the system, and as Tengiz and other lighter crude is diverted, it may become difficult to meet these standards with the remaining heavier, more sour crudes.
The CPC Pipeline was approved by the Government of Kazakhstan by decree. The decree allows CPC to set and collect tariffs on oil transported through the pipeline in Kazakhstan. Further, the decree allows CPC to establish and regulate rules determining users’ access to the CPC system in Kazakhstan. A similar decree was obtained in Russia.
Under the CPC General Agreement between the shareholders, the pipeline is constructed to transport shareholder oil only. Transportation of the shareholder’s oil does not necessarily correspond to its portion of the total shareholding. The shareholders are 50% producers and 50% countries (Russia, Kazakhstan and Oman). If a shareholder does not use its allocated share of the pipeline, it first is obligated to offer the excess capacity to the other shareholders, first producer shareholders; and then to country shareholders. If none of the other shareholders reserves the capacity, it then may be available to third parties. Third-party tariffs will be set by a separate agreement.
Currently, the pipeline is loaded with oil from the Tengiz field. CJSC Turgai Petroleum and Russia’s LUKoil also applied for their share in the pipeline’s capacity to transport oil from the North Kumkol field. LUKoil with its share in Tengizchevroil and Rosneft who has not yet been producing oil in Kazakhstan, may also apply for shares of the carrying capacity. The CPC investors have obligations to load the pipeline with crude oil to the full capacity for the project to bring in revenues.
However, Kazakhstani specialists do not believe CPC will reach its 28 million tonne design capacity next year. There are various forecasts regarding this issue, but it is predicted AGIP and British Gas will not complete their connection to CPC oil pipeline from Karachaganak until 2003. Therefore, their share, 6 Million tonnes of oil, will not be transported on CPC until that time. It is unclear how the other participants will fill their quotas.
Most of the gas pipelines, like the oil pipelines, lie in the west. Through several pipelines originating in Turkmenistan and Uzbekistan passing through western Kazakhstan to Russia, the Kazakh cities of Aktyubinsk, Uralsk, Kustanai and Rudny are supplied with Uzbek gas. These main transmission lines, from Turkmenistan in particular, are not fully utilised and therefore are potentially available for access by producers in Kazakhstan to also export gas to Russia or Europe. The majority of the gas shipped in these two transmission pipelines routes are transported into the Russian GazProm system. Consequently, any project requiring export of gas will most probably be negotiating with GazProm for market access until alternative routes are developed.
The domestic gas pipeline infrastructure in Kazakhstan supplies gas only to select regions of the country. These pipelines supply gas from Uzbekistan to southern Kazakhstan (the cities of Shymkent, Taraz, and Almaty). A large swath of Kazakhstan (including Ust-Kamenogorsk, Semipalatinsk, Pavlodar, Astana, Karaganda, and Taldykorgan) remains unconnected to any gas pipelines, and must currently rely on other energy sources for cooking, heating, and power generating needs.
The gas pipelines that are in place are in need of repair. According to KazTransGas, the main gas pipeline «Central Asia Centre» is in need of major reconstruction, which is planned to start in the near future, paid for out of current tariffs receipts and through external financing. «Central Asia Centre» is a main gas pipeline which connects the countries of Central Asia with Russia. The total length of the pipeline is 4,495 kilometres.
Recognising the need for gas supply in the north and in the capital, KazTransGas plans on constructing a pipeline that will tie into the GazProm network to supply gas through Petropavlosk, Kokshetau, Astana, and perhaps to Karaganda and Temirtau. Much additional gas pipeline infrastructure will be required to develop the gas reserves in Kazakhstan.
Gas pipelines are one of the Kazakhstan designated priority sector projects which qualifies for special tax benefits and incentives.
II. The Legal Regime for Pipelines
The legal regime for oil and gas pipelines is evolving. There is no special law in Kazakhstan wholly devoted to pipelines, rather, the legal basis for the regulation of pipelines is found in the Petroleum Law.1 The Petroleum Law was amended in August, 1999 (the «Amendments») to keep up with the rapid developments taking place in the Caspian region within the last few years. More amendments to the Petroleum and Subsoil Laws are currently under consideration by the special working group at the Ministry of Energy and Mineral Resources (the «MEMR»), however, these amendments are not targeted at pipelines. Various other laws also regulate aspects of oil and gas pipelines including the Foreign Investment Law,2 the Licensing Law,3 the Law on Land,4 and the Environmental Protection Law,5 among others. Nevertheless, the legal framework still requires further development.
1 Edict No. 2350 of 28 June 1995, of the President of the Republic of Kazakhstan, Having the Force of Law, «Concerning Petroleum,» as amended by Law No. 467 of 11 August 1999 of the Republic of Kazakhstan «Concerning the Introduction of Amendments and Additions to Certain Legislative Acts of the Republic of Kazakhstan Concerning Issues of Subsurface Use and Conducting of Petroleum Operations in the Republic of Kazakhstan,» (hereinafter «Petroleum Law»).
2 Law of the Republic of Kazakhstan «Concerning Foreign investment,» dated 27 December 1994.
3 Edict of the President of the Republic of Kazakhstan Having the Force of Law, «Concerning Licensing,» dated 17 April 1995.
4 Edict of the President of the Republic of Kazakhstan Having the Force of Law, «Concerning Land,» dated 22 December 1995.
5 Law of the Republic of Kazakhstan, «Concerning Environmental Protection,» dated 15 July 1997. See also «Rules for protection of transmission pipelines» approved by the Ministry of Oil and Gas Industry of the Republic of Kazakhstan on 19 September 1994; Decree No. 732 of the Government of the Republic of Kazakhstan «On Approval of Rules of safety and protection of the environment related to petroleum operations when constructing, laying, maintaining and repairing underwater pipelines and underwater cable lines of electricity transmission and communication» dated 13 June 1996; and Decree No. 772 of the Government of the Republic of Kazakhstan «On Approval of Regulations on the manner and conditions for issue of permits for construction and operation of artificial islands, dams, structures and installations when conducting petroleum operations» dated 24 June 1996.
The Petroleum Law defines «oil and gas pipelines» as:
pipelines which are intended for the transportation of Petroleum, in particular transmission pipelines6, pipelines which operate in the regime of an aggregate collector, as well as equipment and machinery for purification, separation, and liquefying of substances which are transported through the system of pipelines or its individual sections, systems of monitoring and isolation, systems of electrochemical protection, and other equipment intended for servicing such pipelines.7
6 In the Petroleum Law transmission pipelines are defined as «engineering installation consisting of the linear part and associated overland facilities, communications, tele-control and communication facilities intended for transport of petroleum from the place of production (processing) to the place of transfer to other types of transport or the place of processing or utilisation. A pipeline which operates in a regime of a storage collector shall not be referred to as a transmission pipeline.»
7 Petroleum Law, Article 1.
Under the Petroleum Law, pipelines in Kazakhstan can be either private or state-owned, although the management of a transmission pipelines must be carried out by their owners. However, on 28 July 2000 President Nazarbaev signed the Decree «On the List of State Property Not Subject to Privatisation» which makes transmission oil and gas pipelines ineligible for private ownership. The Petroleum Law prohibits local state bodies from interfering with the operational activities of a transmission pipeline, relating pumping, storage and distribution of petroleum.
Kazakhstani legislation generally does not allow monopolistic activities and unfair competition. However, the existence of natural monopolies is allowed in accordance with the law «Concerning Natural Monopolies» dated 9 July 1998. Under this law, a natural monopoly is defined as a condition in a market when the creation of competition to satisfy the demand for a particular type of services (work) is impossible or not economically feasible on account of the technological peculiarities of producing and distributing that type of service (work).
The Natural Monopoly Law further provides that transportation of petroleum and petroleum products, gas and gas condensate by transmission pipelines is considered to be a natural monopoly and is regulated by the authorised state body. However, under Article 2.3 of the law, the law does not apply to legal entities implementing activities falling within the sphere of a natural monopoly (i.e. transportation of crude oil) when such activities are connected with the construction and operation of projects designated exclusively for their own needs.
In summary, whether a project will be considered the subject of a natural monopoly will depend on two factors: (i) the existence of the condition of a natural monopoly; and (ii) whether the pipeline will be constructed for a particular legal entity’s own needs.
However, there are several limitations placed on the ownership and management of pipelines. For example, pipelines must be «open access» on a non-discriminatory basis meaning when there is a reserve in the carrying capacity of a main pipeline, the pipeline owner cannot refuse transportation of other third party’s petroleum. The third party must be given equal rights to transport services at the same tariffs. Further, the Petroleum Law states that the operation of a main pipeline facility must be carried out in accordance with «Rules for Technical Maintenance, Safety and Security of a Main Pipeline,» (the «Rules»). In addition, energy supply enterprises are prohibited from carrying out any measures, which are intended to restrict the established energy consumption limits without the approval of the owner of the main pipeline. Construction and operation of pipelines is also subject to licensing.
Under the Rules, an owner of a transmission pipeline, by agreement with the local state bodies and any other interested entities must engage in joint efforts to provide for the safe operating conditions of the transmission pipeline facility and to prevent possible accidents and emergency situations. The owner of a transmission pipeline is responsible for compliance with the Rules for technical maintenance, safety and security. Regarding security for a transmission pipeline, no work or operation is allowed without the owner’s consent. In addition, building of anything not related to the transmission pipeline is prohibited within a minimum distance established by the construction standards and the Rules for ensuring safety.
Under the law, the tariffs of petroleum pipelines considered to be natural monopolies are set by KTO and are approved by joint resolution of the Agency for the Regulation of Natural Monopolies and Development of Competition and the MEMR. The only exception is the case of the CPC, the Governmental decree approving CPC and specifically allowing CPC to set and collect tariffs on oil transported through the pipeline in Kazakhstan.
KTO increased transportation tariffs for crude in April 2000, in some cases by as much as 60%. The further increase the tariffs last year and currently, the average tariff for transporting oil through the western portion of the system is around US $15 per tonne per thousand kilometres. There was considerable criticism raised because of the non-transparent procedure followed in developing the rates (specifically, no public hearings were held in violation of 1998 regulations) and the basis used to justify the increase. Many argue an independent oil and gas body is needed to regulate the tariffs (not the anti-monopoly committee and KTO). But, the substantial increase in transportation rates directly impacts the economics of projects.
The construction of offshore pipelines is one of several projects currently being evaluated by Kazakhstani decision-makers. However, prior to the Amendments to the Petroleum Law no legislative act in Kazakhstan, including the Petroleum Law, did in fact regulate offshore pipelines. The Amendments attempt to fill in that void.
Rights to construct of offshore oil and gas pipelines may be granted by the State Body through the issuance of a permit. The Competent Body8 correspondingly grants the right to operate offshore oil and gas pipelines. It should be noted that the Petroleum Law is unclear as to what body will function as the State Body. The law defines the Competent Body as the executive body to which the rights directly associated with the conclusion and execution of contracts are delegated. However, it does not identify the State Body.
8 The Competent Body is currently the Ministry of Energy and Mineral Resources.
Once granted, rights for construction and operation of offshore oil and gas pipelines cannot be transferred. Operation in special areas known as marine nature preserves (such as the northern Caspian) requires the exclusive use of pipelines for moving petroleum on-shore9, as do operations in any body of water and coastal zone in Kazakhstan after the initial stages of well testing and field development.10 This means all offshore production must be transported via pipeline onshore for further transport whether domestic or export.
9 Edict of the President having the force of law «On Petroleum»
10 Instructions of the Norms of Ecological Safety During Development and Conducting of Petroleum Operations in Waters and Coastal Zones of the Sea and Internal Bodies of Water from 09.07.99.
Late last year the Government revealed to producers its plans to create the Integrated Routing System («IRS») for the export of Kazakhstani crude oil. This plan, developed within the framework of the memorandum between Russia and Kazakhstan «On Co-operation in the Fuel-Energy Complex,» names KTO as the exclusive transportation agent/broker for producers in Kazakhstan exporting Kazakhstani crude through existing pipeline routes transiting the Russian Federation. Besides negotiating contracts, KTO also is charged with «representing the interests of Kazakhstan petroleum companies.» The Atyrau-Samara, Kenkiak-Orsk and Makhachkala-Tikhoretsk-Novorossisk routes are mentioned specifically in the memorandum.
Prior to the IRS, it was possible for a producer in Kazakhstan to contract directly with Transneft in Russia to transport Kazakhstani crude. After the introduction of the IRS, this has become very difficult to do so. Hydrocarbon contractual provisions guaranteeing free and unimpeded export are of little help, because even if the argument is won in Kazakhstan, Transneft can still refuse to take the crude oil. This leaves little recourse for producers but to use KTO as a broker with Transneft.
The Memorandum appears to be very specific about the above-mentioned three transportation routes but does not name others which suggest other routes are not subject to the KTO burden. Also of interest is the «hiring of Kazakhstani and Russian specialised construction and service organisations for work at the facilities of the oil and gas industry of both states, as well as third states» – as this may be suggesting Russian specialists will have some priority working in Kazakhstan (and visa versa).
III. Future oil Pipeline Plans
There are number of additional oil export routes by pipelines which are currently being reviewed. In addition to CPC, Kazakhstan is exploring the following routes:
Aktau – Baku – Batumi (Trans-Caucasian Corridor). The Baku-Batumi portion of this route already transports about 2 million tonnes of oil per year. Upon further agreement between Kazakhstan, Azerbaijan and Georgia to upgrade the pipeline, it will allow to transport about 10 millions of oil.
Trans-Caspian Route. Utilisation of Trans-Caspian route will allow integration into the Baku-Geyhan pipeline. The cost of the project is about USD 4 billion with transport capacity of 50 to 70 million tonnes of oil. According to the Vice-President of KTO Mr Kabyldin with confirmation of big reserves of hydrocarbons in Kazakhstani sector of the Caspian and certain tax exemptions from the transit countries, the project could be economically viable. The route is supported by the US government and involves significant geopolitical issues.
Kazakhstan-China. China represents an attractive market for Kazakhstan as the demand for oil in the region is growing. The proposed pipeline will involve transportation of western-Kazakhstani oil to western China. The total length of the pipeline will be about 2800 km with minimum transport capacity of 20 million tonnes of oil per year. The feasibility study of the project has been completed11. Issues of tectonic movement in the mountainous areas add additional cost to this project.
11 http://www.kaztransoil.kz/development/projects.html, 7 September 2001
Southern Route. This route provides for the shortest route for transportation of Kazakhstani oil through Turkmenistan and Iran to the terminals of Persian Gulf. The entire length of the project shall be 2137 km and transport capacity should be at least 25 million tonnes per year (to recover the costs). According to KTO, preparations are being made for a feasibility study.12
IV. KazTransOil and KazTransGas
Management of oil pipelines in Kazakhstan is conducted by the Closed Joint Stock Company KazTransOil (KTO), established in 1997 by special Government decree.13 Its main activities include (1) coordination and management of transportation of oil and oil products within Kazakhstan and for export and import, (2) cooperation with oil pipeline companies of other countries with regard to transportation of hydrocarbons in accordance with relevant intergovernmental agreements, (3) coordination of investment activities with respect to the overall development of the system of transmission pipelines, (4) coordination of activities with respect to scientific and technological progress in pipeline transportation of oil and the introduction of new technologies; and (5) the development of foreign economic relations.
13 Decree No. 461 of the Government of the Republic of Kazakhstan «Concerning Reorganization of the Republican State Enterprises «Yuzhnefteprovod» and «Transmission Pipelines of Kazakhstan and Central Asia» dated 2 April 1997.
KTO has the right to organise financing, design, construct and operate transmission pipelines for the transportation of hydrocarbons through the territory of Kazakhstan.14 This means that special permission of the Government will be required if any entity other than KTO is to construct and operate a pipeline or organise financing for a pipeline. It should be noted that there is a conflict of interest with KTO being both the regulator of pipelines and having the rights of a general Contractor in transporting oil or gas by pipelines.
14 Decree No. 1176 of the Government of the Republic of Kazakhstan «Issues of Development of Pipeline Transportation» dated 24 July 1997.
On 5 June 2001 international rating agencies Standard & Poor’s and Fitch awarded credit rating to KTO at the level of the sovereign ceiling. Standard & Poor’s awarded corporate rating for liabilities in foreign and local currency at the «BB» level with a stable forecast.
In June of this year KTO also successfully completed a US $150 million eurobond issuance on international markets. The bonds will mature in 2006. KTO’s bond emission was its first international borrowing.
Recently, 100% of KTO’s shares were transferred to the charter capital of the newly created National Company Transportation of Oil and Gas («TNG»). TNG was created by a government resolution to create a major company fully owned by the state for controlling all of Kazakhstan’s pipeline and other assets. The main activities of TNG are marketing regarding sale and transportation of hydrocarbons and operation of oil and gas pipelines, organising of financing and preparation of feasibility studies, designing and constructing of oil and gas pipelines as well as participation in all domestic and international projects of Kazakhstan for transportation of hydrocarbons.15 In addition to the shares of KTO, as contribution to its charter capital TNG also received the state blocks of seven companies (including airline that runs helicopters and a shipping line) which previously were the assets of KTO. TNG now owns KazTransOil, KazTransGas as well as others.
15 Decree No. 591 of the Government of the Republic of Kazakhstan on creation of closed joint stock company National Company Transportation of Oil and Gas dated 2 May 2001.
Top management of TNG assert that the powers given to TNG over the assets of the major transport and communication companies will increase the efficiency of the oil and gas transport companies. On the other hand, some observers view it as a successful attempt to concentrate power in important sectors of the country.
In August 2000 KTO received its approval of a production development plan for oil for the years 2000-2005. The plan envisages the modernisation and restructuring of the pipeline system in Kazakhstan and the implementation of a number of related development projects.
CJSC KazTransGas was created by the Decree of the Government of Kazakhstan dated 5 February 2000 for systematisation of the work of the oil and gas industry. As mentioned above, 100% of shares in KazTransGas were recently transferred to TNG.
KazTransGas was specifically created to allow the Government to take over the assets of «Tractebel S.A» in the gas transportation and power sectors of Kazakhstan. To finance the purchase of assets KazTransGas received a loan which was secured by the state guarantee of Kazakhstan.
The main activities of KazTransGas include the following: (i) transportation of gas through pipelines, sale of gas on the internal and external markets, development, financing, construction and operation of pipelines in Kazakhstan, including storage and equipment for transportation, and development of feasibility studies of pipelines and projects related to the activities of KazTransGas; and (ii) production, transfer and distribution of electric and thermal energy, designing, production and installation of electric stations, lines of electricity distribution and substations, as well as oil and gas pipelines.
KazTransGas also owns 100% of shares of «Intergas Central Asia», a gas distribution company, and controls the main network of transportation of gas in Kazakhstan.
Kazakhstan, as a landlocked country, needs a well developed oil and gas pipeline system. However, the existing pipeline system cannot meet Kazakhstan’s demands for transportation of its vast hydrocarbon reserves both domestically and internationally in the long term. We hope the recent creation of TNG will result in better management and development of the country’s pipeline system which in turn will lead to the overall development of Kazakhstan’s economy and eventually to the improved well-being of its citizens.
The author expresses thanks to Almas Zhaiylgan and Stephen McHale for the assistance provided during preparation of this article.
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