```

[Senate Hearing 109-866]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 109-866

  ENERGY SUPPLIES IN EURASIA AND IMPLICATIONS FOR U.S. ENERGY SECURITY

=======================================================================

                                HEARING

                               BEFORE THE

    SUBCOMMITTEE ON INTERNATIONAL ECONOMIC POLICY, EXPORT AND TRADE 
                               PROMOTION

                                 OF THE

                     COMMITTEE ON FOREIGN RELATIONS
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                           SEPTEMBER 27, 2005

                               __________

       Printed for the use of the Committee on Foreign Relations

 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 senate

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                     COMMITTEE ON FOREIGN RELATIONS

                  RICHARD G. LUGAR, Indiana, Chairman

CHUCK HAGEL, Nebraska                JOSEPH R. BIDEN, Jr., Delaware
LINCOLN CHAFEE, Rhode Island         PAUL S. SARBANES, Maryland
GEORGE ALLEN, Virginia               CHRISTOPHER J. DODD, Connecticut
NORM COLEMAN, Minnesota              JOHN F. KERRY, Massachusetts
GEORGE V. VOINOVICH, Ohio            RUSSELL D. FEINGOLD, Wisconsin
LAMAR ALEXANDER, Tennessee           BARBARA BOXER, California
JOHN E. SUNUNU, New Hampshire        BILL NELSON, Florida
LISA MURKOWSKI, Alaska               BARACK OBAMA, Illinois
MEL MARTINEZ, Florida
                 Kenneth A. Myers, Jr., Staff Director
              Antony J. Blinken, Democratic Staff Director

                                 ------                                

             SUBCOMMITTEE ON INTERNATIONAL ECONOMIC POLICY,
                       EXPORT AND TRADE PROMOTION

                    CHUCK HAGEL, Nebraska, Chairman

LAMAR ALEXANDER, Tennessee           PAUL S. SARBANES, Maryland
LISA MURKOWSKI, Alaska               CHRISTOPHER J. DODD, Connecticut
MEL MARTINEZ, Florida                JOHN F. KERRY, Massachusetts
GEORGE V. VOINOVICH, Ohio            BARACK OBAMA, Illinois
  

                            C O N T E N T S

                              ----------                              
                                                                   Page
Baran, Zeyno, Director of International Security and Energy 
  Programs, the Nixon Center, Washington, DC.....................    51

    Prepared statement...........................................    55

Ferguson, Alastair, Deputy Executive Director for Gas 
  Development, TNK-BP, Moscow, Russia............................    45

    Prepared statement...........................................    49

Hagel, Hon. Chuck, U.S. Senator From Nebraska....................     1

Harbert, Hon. Karen, Assistant Secretary for Policy and 
  International Affairs, Department of Energy....................     3

    Prepared statement...........................................     6

Klare, Dr. Michael T., Professor of Peace and World Security 
  Studies, Hampshire College, Amherst, Massachusetts.............    60

    Prepared statement...........................................    64

Simons, Paul E., Deputy Assistant Secretary of Energy, Sanctions 
  and Commodities, Bureau of Economic and Business Affairs.......    12

    Prepared statement...........................................    15

    Response to a question from Senator Hagel....................    23

West, J. Robinson Chairman, PFC Energy, Washington, DC...........    37

    Prepared statement...........................................    41

 
  ENERGY SUPPLIES IN EURASIA AND IMPLICATIONS FOR U.S. ENERGY SECURITY

                              ----------                              

                      TUESDAY, SEPTEMBER 27, 2005

                               U.S. Senate,
             Subcommittee on International Economic
                Policy, Export and Trade Promotion,
                            Committee on Foreign Relations,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 2:35 p.m. in 
Room SD-419, Dirksen Senate Office Building, Hon. Chuck Hagel, 
chairman of the subcommittee, presiding.
    Present: Senator Hagel.

             OPENING STATEMENT OF HON. CHUCK HAGEL,
                   U.S. SENATOR FROM NEBRASKA

    Senator Hagel. Good afternoon. Today's meeting of the 
Senate Foreign Relations Subcommittee on International Economic 
Policy, Export, and Trade Promotion will examine oil and 
natural gas energy supplies in Eurasia and U.S. energy security 
policy.
    The recent tightening of world energy markets and damage 
wrought by Hurricanes Katrina and Rita to U.S. oil and natural 
gas production and refining capacity underscored the critical 
balance of America's energy resources. It is important that new 
hydrocarbon reserves are discovered and developed as we devote 
more attention to energy diversification, conservation, and 
development of more renewable and alternative sources of 
energy.
    The Eurasian region--notably Russia, Kazakhstan, the 
Caspian Sea, and Azerbaijan--has become a vitally important 
energy basin and transit corridor. It has more than 10 percent 
of the world's proven oil reserves, and more than 30 percent of 
the world's proven natural gas reserves. The region's producers 
and its European consumers depend heavily on the transit routes 
through and around the Black Sea area, including the narrow 
Bosporus Straits, through which at least three million barrels 
of oil pass per day.
    In the region, Russia is the largest player, holding the 
world's largest proven natural gas reserves and the eighth-
largest proven oil reserves. Russia, today, is the world's 
largest exporter of natural gas and the second-largest oil 
exporter. And, notably, Russia is a key source of Europe's 
energy imports. Russia may also become a major source of energy 
for Asia in coming years. Vast unexplored tracts of Eastern 
Siberia may hold additional significant reserves that could be 
brought by pipeline to China, the Pacific Ocean, or both.
    In May 2005, the Baku-Tblisi-Ceyhan Pipeline was completed, 
marking a milestone in international efforts to bring Caspian 
Sea oil reserves to market. The pipeline is expected to be 
fully operational by December of this year, when the first 
tankers will take delivery of oil from the Ceyhan terminal. By 
the end of 2006, the Baku-Tblisi-Ceyhan Pipeline is projected 
to transport over 500,000 barrels of oil per day. At full 
capacity, this pipeline will be able to deliver approximately 
one million barrels of oil per day to the Ceyhan terminal.
    Some analysts estimate that by 2010 oil production in the 
Caspian Sea could exceed that of South America's largest 
producer, Venezuela. This region's natural gas production may 
eventually eclipse its oil production. The Caspian Sea's proven 
natural gas reserves today are comparable to those of Saudi 
Arabia. On the Caspian Sea, Kazakhstan is a central producer, 
exporting approximately one billion--or one million barrels of 
oil per day. Uzbekistan and Turkmenistan both have large 
reserves of oil and natural gas, but there are significant 
political, region, and commercial challenges that limit their 
development.
    The Black Sea's energy transit infrastructure represents a 
major thoroughfare for the world's oil and gas exports. The 
efforts underway to build additional pipelines in this area are 
significant in light of the continued vulnerability of 
overdependence on the Bosporus and Turkish Straits.
    The energy profiles of our European allies also bear 
consideration. Much of this region's transit infrastructure to 
the west flows through Russia's oil and gas pipeline networks.
    The United States may not become a primary direct consumer 
of the oil and natural gas exports from Eurasia, but developing 
these reserves and bringing them to the world markets is a 
strategic geopolitical, economic, and energy interest for the 
United States. Forecasts of continued global increases in 
energy demand dictate our vital interest in this area. New 
energy supplies expand the worldwide availability of natural 
gas and oil for the benefit of all emerging countries and 
relieves demand pressure in the global energy marketplace.
    Over a decade ago, the United States recognized a similar 
set of interests when the potential of the Caspian Sea was 
first becoming understood. Today, the Eurasian arc of energy 
supplies may represent a similar opportunity.
    Over the past few months, I traveled to Ukraine, Turkey, 
Azerbaijan, Armenia, Georgia, Bulgaria, and Russia, including 
Eastern Siberia, to learn more about this arc of energy supply. 
The Eurasia region, from diversifying the East-West transit 
energy infrastructure to facilitating the development of 
Siberia, presents a more complex opportunity than the Caspian 
Sea did 10 years ago.
    In coming months and years, critical decisions will be made 
as to whether and how these reserves are developed and 
delivered to the market. Some of these projects, such as 
bringing reserves from Eastern Siberia to the Pacific and 
China, present new challenges. International collaboration will 
be needed for Russia to overcome Siberia's inhospitable climate 
and construct thousands of miles of pipeline and successful 
develop East Siberia. Many of these countries are also 
constrained by difficult business and investment climates. The 
United States needs a strategic policy and clear objectives if 
we are to help shape these events, as we did in the Caspian.
    This afternoon, I look forward to the testimony from the 
two panels of highly qualified witnesses who have joined us. I 
thank each for your time and energy to this critical and 
important subject. We are very much appreciative of the 
opportunity to exchange ideas and observations as we delve into 
these energy issues that are so important to the world.
    The witnesses for our first panel are the Honorable Karen 
Harbert, Assistant Secretary of Energy for Policy and 
International Affairs, and Mr. Paul Simons, Deputy Assistant 
Secretary of State for Energy, Sanctions, and Commodities.
    On our second panel are Mr. J. Robinson West, chairman, PFC 
Energy, Mr. Alastair Ferguson, deputy executive director for 
Gas Development of TNK-BP, in Russia, Ms. Zeyno Baran, director 
of International Security and Energy, The Nixon Center, and Dr. 
Michael Klare, professor of Peace and World Security Studies, 
Hampshire College.
    Ladies and gentlemen, we welcome you. We appreciate your 
time. And I would ask, in the order of my introductions, that, 
Secretary Harbert, you begin. Thank you.

           STATEMENT OF HON. KAREN HARBERT, ASSISTANT
        SECRETARY FOR POLICY AND INTERNATIONAL AFFAIRS,
                      DEPARTMENT OF ENERGY

    Dr. Harbert. Thank you, Mr. Chairman.
    And let me congratulate you on holding this hearing and for 
your interest in the region, which as you demonstrated, has a 
very significant contribution to make in enhancing the world's 
energy supply and energy security.
    Also, as you noted, energy is back on the front pages as a 
result of the disastrous hurricanes, Katrina and Rita, and 
President Bush has made it very clear that diversifying our 
energy supply, both in terms of suppliers and fuel mix, is our 
highest priority. And this most recent experience really points 
to how integrated our energy markets are and how a disruption 
in one part of the world can impact the other. So, we welcome 
this opportunity to discuss how this can fit into the overall 
energy picture.
    On the international energy policy front, the U.S. 
Government has been working with governments and the private 
sector around the world to build sustainable economic growth, 
increase energy production, and safeguard the environment. The 
benefit to us is increased supply, greater security of supply 
for global energy markets, and increased commercial 
opportunities for U.S. firms.
    On the Eurasian side, oil and gas producers are key market 
players, and their energy potential is considerable.
    Let me first give a brief overview of some of the resources 
in the region, their production and exports. I will ask that my 
written testimony be included for the record and then tell you 
a little bit about how the Department of Energy is helping to 
achieve the Administration's goals in this region.
    As you noted, Eurasian reserves are approximately 10 
percent of the total proven oil reserves in the world. Let me 
note that this is only an estimate, and that's because many of 
these countries do not actually provide public or reliable 
reserve data. And that's something that we believe should be 
worked on.
    Russia is the largest regional producer, with the 
production of about nine a half million barrels per day, and 
exports about 6.7 million barrels per day. It's second only 
behind Saudi Arabia. The Caspian region is producing about two 
million barrels per day. It also possesses significant gas 
reserves, but it is still dwarfed by Russia, which is the 
world's largest gas producer.
    As a point of reference, in 2004 the U.S. used about 23 
trillion feet of natural gas, and Russia has 1,694 trillion 
cubic feet.
    In short, as you can see, Eurasia production will, and will 
continue to be, a significant contribution to world markets. 
But this begs the question, Where are these Eurasian energy 
resources going? Nearly all of Russia's gas flows to Europe, 
meeting about a third of the demand there. Eighty-seven percent 
of Eurasia's oil is exported to the former Soviet Republic, 
Central and Western Europe, and smaller amounts to China, 
Japan, and then to the United States.
    The most efficient route that would support an increase in 
Russian exports to the U.S. would be via a northern pipeline to 
a deepwater port in the Barents Sea. Transneft is a state 
pipeline monopoly, and they're planning a pipeline that could 
add about a half-billion barrels per day to the world market--
I'm sorry, half a million--but they have not announced a 
timetable for this pipeline construction or for oil exports.
    Historically, to give some context, Russian exports to the 
U.S. have been about 45,000 barrels per day. But in the last 2 
years, we've seen a dramatic increase. In the first months of 
this year alone, U.S. imported an average of 253,000 barrels of 
oil per day from Russia. Russia also plans to expand its gas 
market by targeting the U.S. with liquefied natural gas, which 
is going to be an increasing component of our energy supply mix 
here in the United States.
    In early 2006, Gazprom plans to announce the development 
consortium for its giant Shtokman field. It lies off Russia's 
far north, in the Barents Sea. Shtokman is likely to be the 
world's largest energy project, and Gazprom expects to start 
exporting after 2010. Both ConocoPhillips and Chevron may be 
part of this development consortium. Russia also, through the 
Sakhalin II project, will be exporting gas in about 2008.
    While it's important to consider where future Eurasian 
energy resources will be exported, the highest priority is that 
these resources simply make it to the market. As you noted, 
this is a fungibility of supply. So, the challenges are in 
developing and exporting these resources.
    What are the challenges? Well, the challenges include 
problems with the investment and business climate, 
transparency, corruption, and the rule of law. In Russia's 
case, companies are hindered from energy investment by high 
taxes and undifferentiated fiscal regime that provides no 
incentives for hard-to-produce deposits. Resource development 
has also been hindered there by recentcentralization of the 
energy sector. This centralization, particularly in Russia's 
case, is very problematic. It is fostering an opaque investment 
climate, it's decreasing competition, and it is also decreasing 
opportunities for qualified U.S. companies.
    Another challenge is that many Eurasian reserves are in 
remote or offshore areas that are very technologically 
difficult and expensive to develop.
    A lack of agreement among all of the Caspian littoral 
states remains a challenge for future resource development, as 
well. We also are facing, as I indicated earlier, on the legal 
and regulatory side, some uncertainties in the subsoil laws, 
which are being debated in Russia and in Kazakhstan. Both of 
these countries are trying to determine, What is the definition 
of strategic oil reserves? And I think that that will warrant 
further discussion.
    What are the export challenges? Insufficient export 
capacity is a challenge for this area. It could undermine the 
expansion of Russia's access to global markets. Independent 
pipelines, with the exception of the Caspian pipeline 
consortium are basically nonexistent and independent--i.e., 
open access to Transneft's pipelines still remain problematic.
    In this region, the Administration has consistently 
supported new pipeline development to strengthen not only 
regional cooperation and stability, but to encourage economic 
linkages that can mitigate regional conflicts and secure direct 
access to world markets, via Turkey and the Mediterranean, 
trying to avoid choke points such as the Bosporus Straits.
    Given these obstacles, strengthening energy security in 
cooperation with Eurasia remains a challenge. In Russia, we 
have a Bilateral Energy Working Group. It is carrying out the 
agreements and the challenges set forth between President Bush 
and President Putin since 2002. We also are creating--or we 
have created the Commercial Energy Dialogue. It is a forum for 
joint industry energy discussion by companies, rather than 
governments. This Dialogue is now writing recommendations, due 
to us in November, how to better help and identify 
opportunities for increased energy trade and investment in 
Russia.
    The Department of Energy also maintains dialogues with 
officials from Kazakhstan, Azerbaijan, on market reform and, in 
other Central Asian countries, the legal, fiscal, and 
regulatory policies.
    We have formal energy relationships and partnerships with 
Kazakhstan and Azerbaijan, and, through those dialogues, we 
produce regular reporting.
    In summary, I think there are a couple of things that we 
want to take into account as we move forward with our policy 
and implementing our objectives for this region.
    We need to take a regional approach in addressing Eurasian 
energy topics. They are interrelated regions, interrelated 
countries.
    We need to maintain a robust energy dialogue with these 
countries. They allow us, and them, to resolve issues in a 
government-to-government manner. And we need to take into 
account the private-sector concerns as they affect our 
policies.
    We need to encourage more Eurasian energy exports. The U.S. 
has been a strong supporter of oil and gas development in the 
region, and we have facilitated relationships between U.S. and 
regional companies and financial institutions in this area.
    We need to encourage multiple pipelines and Eurasian 
infrastructure expansion. We should maintain a focus on the 
construction of the northern pipeline in Russia.
    Maybe most importantly, we need to encourage a more open 
and transparent investment climate for the region's energy 
sector.
    The governments of the region must create the environment 
that will attract capital for oil, gas, and pipeline projects. 
Capital is a coward; it will go where it is most comfortable.
    The private sector is really the only vehicle that can 
bring forth the capital and the technology and the management 
expertise needed to grow these economies and their energy 
sectors, particularly in those areas where these resources are 
so far flung and hard to get to.
    In conclusion, U.S. energy security is strengthened when 
Eurasian countries are stable, are secure, and are strong 
energy producers and exporters with the capacity to diversify 
their economies. The U.S. and Eurasia will benefit when the 
region is maximizing its energy output. This means that leaders 
must be committed to market-oriented policies that stimulate 
this badly needed investment.
    From the U.S. perspective, we have to diversify our energy 
supply. We have to diversify our energy mix. We know that we're 
going to be in need of increased liquefied natural gas. We 
understand LNG is not without challenges in our own country. We 
are seeking to address those. And the most recently passed 
energy legislation provides a path forward here in our own 
country.
    As Russia steps forward on the world stage in leading the 
G-8 next year, we hope that they will take full advantages of 
opportunity to future address energy security from their 
perspective and from our perspective and, most importantly, 
from a world energy market perspective.
    Thank you.

    [The prepared statement of Dr. Harbert follows:]
   Prepared Statement of Hon. Karen Harbert, Assistant Secretary for 
         Policy and International Affairs, Department of Energy
    Thank you Mr. Chairman. I am pleased to have the opportunity to 
appear before you to discuss Eurasian energy supplies, the implications 
for U.S. energy security, and the Department of Energy's role 
facilitating the Administration's goals in the region.
    To help ensure U.S. energy security, the U.S. Government 
consistently has called for supply diversity. The Eurasian oil and gas 
producers are key market players and their energy potential is 
considerable. The energy relationships between the United States and 
Eurasian countries are designed to strengthen the overall relationships 
between our countries and to enhance global energy security, 
international strategic stability, and regional cooperation.
    First I would like to provide an overview of reserves, resources, 
and exports. Then I will address the challenges in this region and tell 
you about the Department's activities and relationships with Eurasian 
countries.
                  oil and gas production and resources
    Russia and the countries in Central Asia and the Caspian are key 
contributors to the global oil and gas market. Russia produces about 
9.5 million barrels per day of oil and exports about 6.5 million 
barrels per day to its export markets. Most of Russia's oil is exported 
to former Soviet countries and to Central and Western Europe, with 
small amounts to China and Japan. It is the world's second largest 
producer and exporter of oil just behind Saudi Arabia. In the 1990s, 
Russia experienced a dramatic downturn in production, but since the 
beginning of this decade the growth rate rebounded averaging 8 percent 
per year. Recently, however, we are seeing a slowdown in the growth 
rate and the Russians are predicting production to grow by only 1 to 2 
percent in the near term. There are a number of factors contributing to 
this decrease--the demise of Yukos, high taxes, the focus on increasing 
government control over the energy sector, and less investment. Some 
estimates predict that Russia could produce about 11 million barrels 
per day by 2015; however, this will depend on its ability to change the 
factors affecting investment in exploration and development. Russia is 
the world's largest gas producer, and although its gas production has 
been relatively flat, it is expected to continue on its current growth 
path if there is sufficient investment in new fields. Russia is 
currently producing about 57 billion cubic feet per day--most of which 
is exported to Europe.
    The Caspian region continues its upward trend and is now producing 
about 2 million barrels per day with production predicted to reach more 
than 5 million barrels per day by 2015. Its natural gas production is 
about 13.5 billion cubic feet per day. Turkmenistan is the region's 
largest gas exporter, with its primary markets in Ukraine and Iran. 
Industry observers speculate that its production could double in the 
next 5 years with most of it going to Russia. Azerbaijan may produce 
about 2 to 2.4 billion cubic feet per day by 2015 with the Shah Deniz 
field coming on line. Projections for Kazakhstan production are still 
uncertain given the lack of export capacity.
    Russia has vast oil and gas reserves, but since reserve data are 
not made public, it is difficult to know with certainty what Russia 
really has. Its proven oil reserves are conservatively estimated at 
about 60 billion barrels as reported by the Oil and Gas Journal. 
However, Russian companies have estimated that oil reserves could be 
around 100 billion barrels. Also, many areas have yet to be explored 
and are in difficult and remote regions. Russia, followed by Iran, has 
the world's largest natural gas reserves of about 1680 trillion cubic 
feet.
    Resource estimates for the Central Asia-Caspian region vary widely 
because many areas of the region have not been fully explored. EIA 
indicates that proven oil reserves are somewhere between 17 and 44 
billion barrels. Companies have estimated that resources (not proven 
reserves) are in excess of 100 billion barrels. EIA estimates the 
region's proven natural gas reserves at 232 trillion cubic feet. Again, 
natural gas reserves are not fully explored and could be considerably 
greater. Whatever the numbers, it is clear that the Caspian region is a 
significant source of oil and gas reserves that can become an important 
source of supply for the global market. The challenges are in 
developing and exporting these resources.
                           export challenges
    One of the major difficulties faced by Russia and the Caspian 
states as they attempt to develop and export their energy resources is 
the lack of export transportation infrastructure. During the Soviet 
era, all of the oil and natural gas pipelines in the Caspian Sea region 
(aside from limited capacity in northern Iran) were routed through 
Russia. Prior to 1997, exporters of Caspian region oil had only one 
major pipeline option available to them, a 240,000-barrel-per-day 
pipeline from Kazakhstan to Russia. Since independence, several new oil 
export pipelines have been built. However, the relative lack of oil and 
gas export options continues to limit exports to markets outside the 
former Soviet Union.
    The Administration has consistently supported the development of 
new pipeline projects, especially an East-West transport corridor that 
would stretch from Kazakhstan through Azerbaijan, Georgia, and Turkey 
to the Mediterranean. The Baku-Tbilisi-Ceyhan (BTC) oil pipeline, the 
first project in this East-West transport corridor, is in the final 
stage of construction, and we expect the first oil to be loaded on 
tankers at the port in Ceyhan later this year contingent upon the 
resolution of several pending minor construction delays. It is expected 
to ship between 1 and 1.5 million barrels per day by 2009 and operate 
for 40 years. Negotiations are underway to include Kazakhstan in this 
pipeline project. We encourage Kazakhstan to reach agreement with 
Azerbaijan on an Inter-Government Agreement to define the terms under 
which Kazakhstan oil will enter BTC. This step would constitute a 
strong statement of the Kazakhstan Government's commitment to expanding 
its energy cooperation with its Western neighbors.
    By extending its reach across the Caspian Sea, an Aktau-Baku-
Tbilisi-Ceyhan (ABTC) project would strengthen regional cooperation and 
stability, encourage economic linkages that can mitigate regional 
conflicts, and help Kazakhstan secure direct access to world markets 
via Turkey and the Mediterranean, without subjecting its exports to the 
uncertainties of geographic chokepoints such as the Turkish Straits.
    In Russia's case, the export capacity situation is improving with 
increased capacity from Baltic ports and via rail shipments. If 
Russia's midterm oil production increases as it recovers from a lack of 
investment following the Yukos case, Russia must expand its oil 
infrastructure. However, Russia seems to be relying on geopolitical 
factors rather than market forces to determine which pipelines to build 
and this could undermine the expansion of Russia's access to global 
markets. In short, Transneft has selected favored projects, such as the 
Baltic Pipeline System expansion and the Far East pipeline, at the 
expense of industry-preferred projects such as the Caspian Pipeline 
Consortium expansion and construction of a Northern pipeline. 
Independent pipelines, with the exception of the Caspian Pipeline 
Consortium, are non-existent, and independent (open) access to 
Transneft's pipelines remains problematic.
    In 2001, the Caspian Pipeline Consortium, Russia 's first and only 
private pipeline, was completed and now ships almost 700,000 barrels 
per day of Kazakh and Russian crude to the port of Novorossysk. It is 
expected to ship 1.3 million barrels per day once its expansion plans 
are approved. This pipeline is a unique project involving more than 
eight companies and the governments of Russia, Kazakhstan, and Oman. 
Negotiations among these governments and companies have been 
challenging. We are hopeful that the final obstacles to approve the 
expansion are soon resolved.
    The most efficient route that would support an increase in Russian 
oil exports to the U.S. would be via a pipeline from Russia's Far North 
to a deepwater port in the Barents Sea. Companies and government 
officials have been discussing this proposal since 2002, and currently, 
Transneft is planning a 290-mile pipeline that could add 500,000 
barrels per day to the world market, but has not announced a timetable 
for pipeline construction or first oil exports. Historically, Russian 
exports to the U.S. have been only around 45,000 barrels per day, but 
the last 2 years have seen an increase. In the first 6 months of 2005, 
the U.S. imported an average of 253,000 barrels of oil per day from 
Russia.
    Russian oil exports to Asia are projected to increase in coming 
years. The Russian government continues to make strategic alliances 
with Asian countries that promise more oil deliveries. The recently 
approved construction of the Far East pipeline will be key for 
increased oil exports to Asia. It is expected to cost more than $15 
billion, cross some 2700 miles, and transport 1 to 1.5 million barrels 
per day at full capacity. The first phase of development will reach 
China; a pipeline extension likely will later reach Russia's Pacific 
Coast to serve Japan and other markets, including the U.S. west coast. 
Questions remain on whether there is enough regional oil to supply this 
pipeline. Eastern Siberia is an undeveloped area with an unknown 
resource base. Reliable reserve figures are not available for this 
region, and it will take time before new production comes to market. 
Some anticipate the need to divert Western Siberian resources to fill 
the pipeline, but Russian company and government officials maintain 
that the Eastern Siberia resource base is sufficient to fill the Far 
East pipeline. Caspian oil exports to Asia will increase with the new 
Kazakhstan-China oil pipeline. China is financing construction of this 
600-mile, $850 million pipeline, capable of moving 400,000 barrels of 
crude a day. The second section of the three-part pipeline is due to 
come on line in December 2005.
    In discussing export routes for this region, we must recognize the 
importance of Turkey. Its strategic location makes it a natural energy 
bridge for transporting Russian and Caspian oil and gas. Under optimal 
conditions, approximately 6 million barrels per day of oil could 
transit Turkey in a given year. That number includes 3 million barrels 
per day shipped through the Bosporus and Dardanelles Straits (hereafter 
referred to as the Bosporus), 1.5 million barrels per day of Iraqi oil 
via pipeline, and 1.5 million barrels per day through the BTC pipeline. 
The actual amount of crude presently transiting Turkey is much lower, 
about 3 million barrels per day, due to repeated attacks on Iraq's oil 
infrastructure and the fact that it will be some time before BTC is at 
full flow.
    Since it will take time to secure Iraq's pipeline and get BTC to 
full flow, the importance of the Bosporus Straits, which connect the 
Black Sea to the Mediterranean Sea, becomes increasingly important. 
Turkey has raised concerns about the ability of the Bosporus Straits, 
already a chokepoint for oil tankers, to handle the current tanker 
traffic load. The Turks see crude transports through the Bosporus as an 
accident waiting to happen, and they hope to reduce tanker traffic. As 
a result, a number of options are under consideration for oil 
transiting the Black Sea to bypass the Bosporus Straits. We are 
encouraging countries in this region to develop alternative routes to 
the Bosporus Straits.
    In support of the Administration's commitment to multiple 
pipelines, the U.S. Trade and Development Agency has funded feasibility 
studies of several Bosporus Bypass pipeline projects. These studies are 
an important contribution to the decision-making process on the 
addition of pipelines to connect Central Asia to Western oil markets.
    In regard to gas exports, the gas pipelines built during the Soviet 
era continue to serve as the conduit for Russian and Central Asia gas 
exports. Russia sends most of its gas to Europe, meeting about a third 
of Europe's demand. Russia has been a reliable gas supplier to Europe 
and will help meet Europe's increasing gas demand. In 2002, Gazprom 
added to its export capacity by building the Blue Stream pipeline under 
the Black Sea to Turkey. It can deliver about 16 billion cubic meters 
per year, but much of it is unused due to insufficient demand and 
Turkish claims that the gas is of poor quality. Gazprom also is 
considering an expansion of its Yamal pipeline to Europe, building a 
pipeline all the way to Great Britain, and constructing a system in the 
Far East that would bring Kovyka gas to South Asian markets.
    Russia does plan to expand its gas markets by developing its LNG 
capability. It views the U.S. as the No. 1 market. On September 2, a 
Gazprom delegation traveled to Cove Point, Maryland to celebrate the 
arrival of Gazprom's first LNG shipment to the U.S. Gazprom is not 
currently producing LNG, but the company arranged a swap to begin its 
participation in the North American market. Russia's potential for gas 
exports to the U.S.--as LNG--are significant. Having announced a short 
list of five companies with which it will cooperate, in early 2006 
Gazprom plans to announce a development consortium for its giant 
Shtokman gas field, which lies offshore Russia's far north in the 
Barents Sea. LNG from this field would be targeted to the United 
States. The size and scale of this project cannot be overstated. 
Shtokman is likely to be the world's largest energy project with 
reserves of 113 trillion cubic feet of gas and 31 million tons of gas 
condensate. Gazprom expects to start Shtokman LNG exports of 15 million 
tons per year after 2010, and ConocoPhillips and Chevron are on the 
short list to take part in the development consortium.
    Although Gazprom is focused on Shtokman to target North American 
markets, Russian LNG is also likely to reach the U.S. from the 
Sakhalin-2 project on Russia's Pacific coast. Shell, the Sakhalin-2 
operator, and the other project consortium members--including Gazprom--
are building the world's largest LNG plant. The facility is expected to 
come on stream in 2008 and produce 9.6 million tons a year of LNG to 
supply Japan, South Korea, China and the United States. Initial 
contracts call for Shell to export 1.6 million tons of LNG a year to a 
planned LNG facility on the West coast. Russian LNG also could be 
developed from its Yamal Peninsula, and a U.S.-Russian partnership is 
considering a major project in that region.
    Caspian gas is produced primarily by Uzbekistan and Turkmenistan, 
and in smaller volumes by Kazakhstan and Azerbaijan. These countries 
rely on Soviet-era pipelines, owned by Gazprom, to get their gas to 
Russian and European markets. The South Caucasus gas pipeline now under 
construction from Baku, Azerbaijan, through Georgia to Turkey, will 
significantly increase the opportunity to move gas from the south 
Caspian Sea to Western markets. Extending this pipeline on the East 
from Turkmenistan to Baku and, on the west, from Turkey to Southern 
Europe, and the increased investment in gas reserve development to 
support the pipeline, would provide a major opportunity to improve the 
supply of gas to world markets. Building a consensus among the 
countries involved in such a project, negotiating the necessary 
agreements and encouraging the flow of capital to the region are 
obviously major challenges, but we believe a regional East-West gas 
pipeline is an important goal toward which we will continue to work. 
Asian markets are too distant from Caspian reserves to be financially 
viable, and until new infrastructure is created, North American 
consumers are unlikely to use any Central Asian gas.
    It is clear that our interests are aligned with those of the 
Eurasian countries. We seek increased supplies from diverse sources and 
Eurasian countries seek to maximize output and exports. The U.S. and 
Eurasian countries acknowledge that increased commercial cooperation 
and energy trade are shared goals. But although our interests are 
aligned, numerous challenges present obstacles to expanding energy 
trade between the U.S. and Eurasia.
                    resource development challenges
    One of the most significant issues for Eurasian countries is 
increasing resource development and production. Many of the reserves 
are in remote or offshore areas or will otherwise be technologically 
difficult and expensive to develop. The Caspian Sea is 700 miles long 
and contains six separate hydrocarbon basins, most of which have not 
been developed or even fully explored.
    The most significant problem with the Caspian Sea's oil and natural 
gas resources is the lack of an agreement among the five littoral 
states. Although Russia, Azerbaijan, and Kazakhstan have each signed 
bilateral agreements with each other, Iran and Turkmenistan have not. 
Iran's position is that each country be given 20 percent of the Sea's 
resources. In other words, each country ought to receive 20 percent of 
all production revenues from the entire Caspian Sea regardless of 
investment.
    Russia relies on its own and foreign firms to develop hard-to-reach 
assets. But companies are hindered from investment by high taxes and an 
undifferentiated fiscal regime that provides no incentives for hard-to-
produce deposits. In recent weeks, the government has begun serious 
discussions about tax differentiation to provide incentive for 
greenfield development and brownfield renovation. Energy producers in 
Russia are hopeful that energy tax differentiation will be implemented.
    Other significant challenges in both Russia and Central Asia 
include problems with the investment and business climate, corruption, 
rule of law, and transparency. Each country faces its own challenges in 
improving the environment for more energy investment and business. In 
Russia, one potential barrier to investment is worth noting: the 
subsoil law. A new law on subsoil development and amendments to the 
current law are still being considered by the Russian parliament, the 
Duma. While the terms are not finalized, it is likely that legislation 
will place restrictions on companies deemed foreign and limit foreign 
investors from developing ``strategic'' oil and gas or mineral 
deposits. At this time, the Russian government has not specified what 
type of ownership structure constitutes a foreign firm or which assets 
will be considered strategic. However, we continue to seek 
clarification from Russian officials on these issues.
    Challenges in Kazakhstan's investment environment concern a growing 
feeling in Kazakhstan that past agreements with foreign investors were 
too generous. The investment climate has been affected by such things 
as changes in laws relating to domestic content and government policy 
on visas for expatriate workers. A dispute over provisions of the 
production sharing agreement (PSA) with Tengizchevroil, while resolved, 
led to a government statement that future PSAs would have less 
favorable provisions for foreign investors, and, indeed, Kazakhstan's 
law has been changed to require that the government-owned oil and gas 
company KazMunaiGaz now own at least half of any PSA project and act as 
contractor in all new offshore PSAs. When a new series of blocks is 
offered for lease, the direction of the government with respect to 
investment terms should become clear.
    Turkmenistan is host to one of the largest gas reserves in the 
world. However, the legal and regulatory framework in that country 
lacks the credibility necessary to attack significant investment to 
develop an energy transportation infrastructure. We hope that this 
situation will change, and we look for opportunities to engage 
Turkmenistan on this issue.
    Eurasian resource development also has been hindered by 
centralization of control in the energy sector. Russia in particular 
has consolidated Kremlin control over energy companies. The Russian 
government is nearing completion of its acquisition of the 10.7 percent 
stake needed to have a controlling 50 percent plus stake in Gazprom. 
Rosneft and Gazprom are competing to acquire the Russian oil company 
Sibneft, which at this time is still free of any government ownership. 
Rosneft acquired Yukos assets and is seeking to acquire even more. This 
centralization is obviously problematic: it decreases competition and 
the opportunities for U.S. firms. And in cases throughout the world, we 
have seen decreases in efficiency when national oil companies assume 
control of assets that were operated by private oil companies.
                       energy security challenges
    Given the obstacles discussed above, strengthening energy security 
in cooperation with Eurasia remains a challenge.
    We maintain that the best way to strengthen energy security and 
meet Eurasian and U.S. goals is to expand commercial energy 
cooperation, which I will discuss further in a minute.
    On a government-to-government level, we are working with many 
Eurasian countries to strengthen the overall relationship between our 
countries and enhance global energy security, international strategic 
stability, and regional cooperation.
                         department activities
    With Russia, our bilateral energy dialog focuses on meeting the 
objectives established by President Bush and President Putin in their 
2002 and February 2005 joint statements. They tasked us to carry out 
the governmental aspects of the energy relationship, and in 2002 the 
Secretary of Energy and the Russian Minister of Energy established the 
Energy Working Group (EWG).
    The EWG has proven to be an excellent mechanism for regularly and 
candidly discussing our mutual successes and the remaining obstacles to 
promoting energy trade and investment. We believe the dialog has 
correctly become more finely focused over time and that in the future 
it will focus on promising areas for cooperation such as LNG, pipeline 
infrastructure, and energy legislative and regulatory experiences.
    It is important to also note that, beyond the EWG, a slightly less 
formal but no less frequent and important process exists in which 
senior officials of both governments meet to discuss current and future 
issues that require resolution, a sharing of views, or government 
action. I note that among the first foreign dignitaries that Secretary 
Bodman met in his capacity as Secretary of Energy were Alexey Miller of 
Gazprom, Anatoly Chubais of Unified Energy Systems, Minister of 
Industry and Energy Khristenko, Minister of Economic Development and 
Trade Gref, Minister of Foreign Affairs Lavrov, Prime Minister Fradkov, 
and Ambassador Yusufov. That is an impressive demonstration of 
commitment to the energy relationship in such a short and busy period. 
I should add that Secretary Bodman visited Russia, Ukraine, and 
Azerbaijan within his first 4 months on the job. While in Azerbaijan, 
Secretary Bodman participated in ceremonies commemorating the loading 
of first oil into the BTC pipeline.
    The other key component to the U.S.-Russia Energy Dialogue is the 
industry-to-industry cooperation through the Commercial Energy Dialogue 
and commercial partnerships. In December 2002, the two governments 
sponsored the creation of the Commercial Energy Dialogue (CED), 
designed to be a forum for organized, joint, pan-industry energy 
discussion by the companies rather than by the governments. The goal 
was to make recommendations to both governments to remove obstacles to, 
and identify opportunities for, increased energy trade and investment. 
The American Chamber of Commerce in Russia and the Russian Union of 
Industrialists and Entrepreneurs agreed to co-chair the CED, and 
numerous companies on both sides joined. The CED submitted their 
initial recommendations to the two governments in September 2003 at the 
second U.S.-Russia Commercial Energy Summit, and the recommendations 
were incorporated into our bilateral dialog. These recommendations 
remain one of the finest-ever encapsulations of the industry's view of 
critical steps needed and opportunities yet to be fulfilled. The CED 
members are now updating their recommendations and will submit them in 
a November report to President Bush and President Putin and their 
respective Departments of Energy and Commerce. The governments will 
then review the report and make every effort to respond to the energy 
industry community's recommendations.
    With commercial partnerships, the number and dollar value of U.S.-
Russian business partnerships in the energy sector are below their 
potential and the level needed to support necessary growth of oil and 
gas production and exports. There have been notable successes, but too 
few. The Caspian Pipeline Consortium shipped its first crude, 
culminating several years of cooperation in construction and management 
between U.S., Russian, and other companies. The Sakhalin-1 project has 
become the largest U.S. investment in Russia and will mark its first 
oil production on October 1st. Lukoil expanded its gasoline retail 
network on the U.S. east coast. ConocoPhillips and Lukoil struck a 
major deal involving upstream, downstream, and third-country 
cooperation. Marathon purchased a medium-sized oil producer in Russia. 
Amerada Hess, a medium-sized U.S. oil company, entered the Russian 
sector for the first time. Gazprom made a strategic decision to enter 
the global LNG market, with a major focus on the North American market.
    The Department of Energy also maintains active dialogs with energy 
officials from Kazakhstan and Azerbaijan on market reform in the energy 
sector and the development by these and other Central Asian countries 
of sound legal, fiscal, and regulatory policies to support economic 
growth, including energy development. In December 2001, we established 
a U.S.-Kazakhstan Energy Partnership. In July 1997, we established the 
U.S.-Azerbaijan Energy Partnership. Under the Partnership, the 
Department is committed to cooperation across the entire range of 
energy policies and technologies. Departmental officials meet regularly 
with representatives of the Azerbaijan and Kazakhstan governments.
                                summary
    To sum up, I would like to leave you with what we believe are 
important actions to increase energy security with U.S. and Eurasian 
cooperation.

     Take a regional approach when addressing Eurasian energy topics.
     Maintain energy dialogs with the Eurasian countries. They allow 
U.S. and Eurasian countries to discuss and resolve issues. The energy 
dialogs also can facilitate opportunities for U.S. and Eurasian 
companies to work together on future investments in each other's energy 
industries and in other parts of the world.
     Encourage more Eurasian energy exports. The U.S. has been a 
strong supporter of oil and gas development in the region and has 
facilitated relationships between U.S. and regional companies and 
financial institutions in Eurasian energy exploration and development. 
With Russian oil exports, we welcome additional crude volumes, and 
according to the companies that operate the Louisiana Offshore Oil 
Port, we can receive about 1 million barrels per day or more of Russian 
oil.
     Encourage multiple pipelines and Eurasian infrastructure 
expansion. We should maintain focus on the construction of a Northern 
Pipeline in Russia. This project is commercially sensible and could 
deliver Russian crude to the U.S. even more quickly than Persian Gulf 
exports can reach the U.S. We strongly support a Trade and Development 
Agency feasibility study that would analyze the U.S. market's 
receptivity to Russian crude. Such a study could put to rest the 
misinformation that exists in the Russian energy sector that the U.S. 
can only accept limited amounts and quality types of Russian crude.
     Encourage a more open and transparent investment climate for the 
region's energy sector. The governments of the region must create the 
environment that will attract the capital for oil, gas and pipeline 
projects. The private sector is the best way to bring forth the 
capital, technology, and management expertise needed to grow these 
economies and their energy sectors. No Eurasian government has the 
financial or other wherewithal to build the oil and gas fields, 
pipelines, refineries, ships, and distribution networks, or even the 
hydrogen filling stations one day, of the future. Our job in the 
government is to encourage the adoption of the best environment for 
commercial actors to do business.
                               conclusion
    U.S. energy security is strengthened when Eurasian countries are 
stable and secure energy producers and exporters, with the capacity to 
diversify their economies. The U.S. and Eurasia benefit when the region 
is maximizing its energy output to support global, and its own economic 
growth. This means that leaders must be committed to market-oriented 
policies that stimulate needed investment.
    U.S. energy security is strengthened by diversifying our supply of 
energy by increasing our imports of Eurasian gas, especially of 
liquefied natural gas. We understand that LNG is not without challenges 
in this country--but we are steadfast in our support of natural gas as 
a cleanburning fuel that can be imported safely, and increasingly more 
cheaply, regasified, and distributed through our existing gas 
pipelines. American natural gas demand is projected to grow by nearly 
40 percent over the next two decades, while our imports of natural gas 
will more than double from 4 trillion cubic feet annually to 9.5 
trillion cubic feet. LNG will supply virtually all of that increase.
    Finally, U.S. energy security can be strengthened by other 
countries agreeing on what the priorities are for energy security. To 
this end, we look forward to the opportunity afforded to Russia as the 
President of the G-8 in 2006. Russia has selected energy security as 
its theme, and we continue to work with our Russian colleagues on just 
what energy security means--for them, for us, and for the world.
    Thank you.

    Senator Hagel. Secretary Harbert, thank you. And your full 
statement will be included in the committee.

  STATEMENT OF PAUL E. SIMONS, DEPUTY ASSISTANT SECRETARY OF 
   ENERGY, SANCTIONS AND COMMODITIES, BUREAU OF ECONOMIC AND 
                        BUSINESS AFFAIRS

    Mr. Simons. Thank you, Mr. Chairman.
    Let me also extend my thanks to you for your initiative in 
calling this hearing. We certainly appreciate your personal 
interest in this topic, which is very timely in this era of 
tightened energy security. We also agree with you that Russia 
and Central Asia are very much central to global energy 
security and will become increasingly important in the next 
several decades.
    Russia, as you noted, has already become one of the world's 
leading oil and gas suppliers, and yet it still has many 
interesting opportunities to pursue. Production in Azerbaijan 
is ramping up as new transit opportunities come online. And 
Kazakhstan is very well positioned to become an important 
global energy supplier in the current decades.
    I'd like to make two points up front. Number one, the U.S. 
Government very much speaks with one voice on Russia and 
Caspian energy issues. You'll note that the text of my 
testimony very much dovetails with Assistant Secretary 
Harbert's, so I won't duplicate that in my oral statement.
    And, secondly, energy is very much an important and growing 
issue in our bilateral relationship, in our bilateral 
diplomatic relationship, with the countries of Russia, as well 
as Central Asia. Mr. Chairman, it should be noted that during 
your visit, Ambassador Burns, who was in communication with me 
today, wanted me to extend his regards, and to let you know 
that he appreciates your interest in this issue. And, certainly 
from the President down to the Secretary to the Assistant 
Secretary level to our ambassadors, we're very much concerned 
with energy, and we consider it an important issue in all our 
bilateral relationships.
    Russia is very much the predominant energy player in the 
post-Soviet sphere. Russia now accounts for about 20 percent 
non-OPEC oil product, and, despite some leveling off of 
production that we've seen this year, is still--has been the 
fastest growing among the non-OPEC producers in recent years.
    As you know, Mr. Chairman, U.S. energy companies have 
participated actively in the Russian energy market since about 
1992. The potential does remain promising. But, as you pointed 
out, and as Assistant Secretary Harbert pointed out, while the 
U.S. companies are poised to make additional investments in 
Russia, the rules of engagement are shifting and do remain in 
question. Russian industry has been consolidating in recent 
years, and the Government's role has been centralizing and 
expanding. Likewise, Russian operators have made great strides 
to control certain key aspects, the upstream and downstream 
activities, from exploration to transport. And this has been 
somewhat troubling.
    In our view, Russia's primary challenge in the coming years 
will be to continue to meet its role as a burgeoning oil and 
gas producer, but to strive to accommodate these nationalistic 
pressures, these centralization pressures, while also reaching 
out to capital and technology from foreign investments to 
develop new projects.
    So, we continue to remind the Russians that U.S. companies 
seek a stable and predictable commercial environment. They're 
calling for clearer, sounder operating rules, clarification of 
laws on the subsoil, on state secrets, and a review of 
licensing procedures and tax policies that discourage 
investment.
    Assistant Secretary Harbert mentioned four key areas we're 
working on with Russia. Clearly, the export infrastructure is 
important. LNG cooperation is important. Expansion of the 
Caspian pipeline consortium is important. And the more general 
attitude towards foreign investment-- in particular, in the 
upstream--and I think this is where your trip to Eastern 
Siberia was very valuable, because, as you noted in your 
opening statement, very harsh climate, the lack of 
infrastructure, remote locations, and complex geology really 
cries out for the type of project management expertise that 
foreign investment can bring.
    So, as more attention is focused on Eastern Siberia, we 
will be encouraging Russia to work with international partners, 
to be transparent with data, to reach out to foreign 
investment, to adopt new technologies, to safeguard the 
environment as it explores and develops this very interesting 
resource.
    Initial signs are that Russia may be limiting the level of 
foreign participation in certain auctions for blocks in Eastern 
Siberia. We will press the Russian Government to reverse this 
approach, noting that substantial investments will be needed to 
develop these very remote fields.
    A couple of words on Kazakhstan before we move on to the 
questions. Kazakhstan and the entire north Caspian region also 
have tremendous resources. U.S. energy companies were involved, 
at the very start, in opening up this region. They were among 
the first non-CIS foreign investors in Kazakhstan, and we 
certainly expect American companies to be very active in 
Kazakhstan for many years to come.
    In that regard, we note that we have strongly encouraged 
the Government of Kazakhstan to act constructively and 
responsibly in bilateral efforts with Azerbaijan to link its 
Caspian ports up by tanker to the very important BTC pipeline. 
We certainly believe that this effort, which would provide an 
export platform for future production--in particular, at 
Kazakhstan's Kashagan field-- must be held to the same very 
high standards that were upheld several years ago in the BTC 
intergovernmental agreement. And this is an area that we're 
working on very actively with the Government of Kazakhstan.
    Finally, just in conclusion, Russia and the Caspian 
continue to represent very promising opportunities for upstream 
oil and gas investments needed to meet glowing global demand 
over the next couple of decades. We certainly recognize 
Russia's leadership role in global energy markets. This is 
something we will be focusing on in the G-8 Summit next year. 
And we underscore the contributions that--very, very valuable 
contributions that Russia has made over the past decade to 
supply expanding world oil demand. And I would note that most 
of those contributions were made by the Russian private sector, 
which developed substantially over this period.
    We'll continue to work with U.S. energy companies--and the 
Russian and Kazakh Governments, in particular--to encourage 
production increases to meet expanding global demand, as well 
as the expansion of the transport infrastructure, particularly, 
as I mentioned, by expanding the Caspian pipeline consortium, 
as well as the BTC pipeline.
    We'll emphasize to these countries the need to advance 
corporate governance and transparency issues--I know this was 
the topic of our hearing last year on Africa--including the 
application of revenues from oil and gas activity, adherence to 
the rule of law, strengthening of regional stability, 
broadening stakeholder participation, safeguarding the 
environment, and improving the investment climate.
    Thank you, Mr. Chairman.

    [The prepared statement of Mr. Simons follows:]
  Prepared Statement of Paul E. Simons, Deputy Assistant Secretary of 
 State for Energy, Sanctions and Commodities, U.S. Department of State
    Mr. Chairman, distinguished members of the Sub-Committee, I am 
pleased to be here today to discuss trends in oil and gas exploration, 
development and transportation in Russia and other regions of the 
former Soviet Union. I am also looking forward to addressing the 
greater region's rich potential to uncover additional reserves and 
expand production in coming years, with the participation of U.S. 
energy companies. Clearly, our approach to engaging Russia and 
resource-rich surrounding areas on energy cooperation is pertinent 
today, as the world confronts tight oil markets and as we consider ways 
to deepen energy security, nationally and globally.
    The U.S. Energy Information Administration forecasts that the world 
is likely to consume about 120 million barrels of oil per day in 2025. 
That is a significant increase from current global consumption of about 
85 million barrels per day. Moreover, as part of our national effort to 
shift to cleaner burning fuels, U.S. demand for natural gas, 
particularly imports of liquefied natural gas, is set to expand. U.S. 
demand may reach 32 trillion cubic feet--a 35-40 percent increase over 
current levels--by 2025. Meeting this expected demand will be 
challenging, as production from many traditional oil and gas fields, 
from West Texas to the North Sea, has plateaued or declined, while new 
fields present a series of political, technical and economic challenges 
to develop. Thus, to avoid shortfalls, we must press every lever in our 
energy security arsenal. This includes, as detailed in our national 
energy policy, promoting conservation and improving energy efficiency 
by adopting new technologies and applying market-based incentives, and 
diversifying energy supplies, especially in terms of greater imports of 
liquefied natural gas. We need to support the development of 
alternative fuels, and work with our allies to modernize and protect 
energy infrastructure worldwide.
    It also means expanding oil and gas production at home, including 
our work to advance the development of Alaska's vast oil and natural 
gas reserves, and to bring greater diversity to world energy production 
in environmentally friendly ways. Through energy diplomacy abroad, in 
partnership with our G-8 counterparts, we are pressing oil-producing 
countries for policy reforms, including the removal of barriers to 
trade and investment in energy production, transportation and refining. 
We are also emphasizing the need for transparency, reliability and 
availability of oil and gas market data.
    The former-Soviet region that is the subject of this hearing will 
make important contributions to global energy security in the coming 
decades. Russia has already become one of the world's leading oil and 
gas suppliers, yet has more resources to exploit; production in 
Azerbaijan is ramping up as new transit options come on line; 
Kazakhstan is well positioned to become an elite energy supplier in 
coming decades; energy companies of all sizes from all over the world 
are expressing interest in deepwater Black Sea exploration.
    The challenge in this vast region is for governments and private 
producers to continue to build on resources and momentum, to work 
together to realize the greater region's full potential. With local 
resources and U.S. capital and technology, Russia and the rest of the 
region could increase output dramatically--much to the benefit of local 
governments and populations as well as the global energy market. But 
the region cannot fully recognize this potential unless local 
governments provide a predictable and reliable investment regime, 
streamlined and backed by investor-friendly legislation. Judicial 
systems must be independent and strong, adhering to rule of law, being 
transparent and recognizing the sanctity of contracts. Moreover, local 
governments must pursue a flexible, responsible approach to expanding 
new and existing pipeline capacity or other transport options--one that 
is based on economics, rather than politics. Local and national 
governments in the region should also establish procedures to involve 
communities in development, to increase public awareness, explain 
public benefits and allay concerns about detrimental environmental and 
health consequences.
    All the while, it will be important to keep in mind that high oil 
prices can reduce incentives for governments in major oil exporting 
nations to pursue economic reforms and liberal investment regimes that 
promote the efficient development and distribution of natural 
resources. We must remind energy producers of the need to avoid 
backtracking on reforms and reinforce the crucial, central role of 
private investment, which fosters efficiency, promotes transparency and 
increases benefits to the general population.
            russia: the largest non-opec producer, exporter
    Russia is the predominant energy player in the post-Soviet sphere, 
producing about 9.5 million barrels of oil per day and over 22 trillion 
cubic feet of natural gas per year. Russia's unrivaled growth in crude 
oil output--fields in Western Siberia expanded production by 14 percent 
per year 1999-2004--are supplying extremely tight world markets with 
incremental oil production. Russia now accounts for 20 percent of non-
OPEC oil production, and, despite a leveling off of production this 
year, still has been the fastest growing among non-OPEC producers in 
recent years.
    U.S. energy companies have participated in the Russian market since 
1992. Sakhalin I is an excellent example of U.S.-Russia joint 
investment projects. The Caspian Pipeline Consortium's Tengiz-
Novorossiysk pipeline is another example of significant investment in 
the region. The Russian market's potential remains attractive. But 
while U.S. companies are poised to make additional investments in 
Russia, the rules of engagement are shifting and remain in question. 
Russian industry has consolidated in recent years, and the government's 
role is centralizing and expanding. The forced sale last year of the 
principal operating asset of Yukos, in the eyes of foreign investors, 
had negative repercussions on Russia's outlook to the investment 
community. In the post-Yukos environment, which is still developing, 
two government-owned entities, GazProm and Rosneft, increasingly 
control energy assets; another state-owned entity, Transneft, maintains 
its domination of the oil transport sector.
    Russian operators have made great strides to control many key 
aspects of upstream and downstream activities, from exploration to 
transport mechanisms and related infrastructure. Subsequently, Russia's 
neighbors, particularly the Baltic States, Poland, Ukraine and Georgia, 
have expressed concerns that Moscow uses its strong position as energy 
provider as a foreign policy lever, e.g., by manipulating quantities 
exported or prices. Meanwhile, Russia increasingly sees the market for 
its oil and gas exports shifting over time from Europe, where growth is 
slow, to Asia and the United States, which is keen to receive its 
supplies of crude oil and liquefied natural gas.
    Russia's primary challenge in coming years, in our view, will be to 
continue to meet its role as burgeoning oil and gas producer, striving 
to accommodate nationalistic pressures to centralize, while also 
seeking capital and technology from foreign investors to develop new 
projects. We remind the Russians that U.S. companies continue to seek a 
stable, predictable commercial environment, and call for clearer, 
sounder operating rules, e.g., clarification of laws on subsoil and 
state secrets and a review of licensing procedures and tax policies 
that discourage investment. In recent years, we have seen two large 
Russian firms enter into partnerships with Western companies. TNK has 
partnered with BP and Lukoil has joined ranks with ConocoPhillips. We 
see these partnerships as strong statements of shared interests and 
excellent examples of cooperation between former rivals and 
adversaries. We encourage this type of cooperation, and would like to 
see it expanded.
    U.S. strategic goals, in terms of energy security, have not changed 
vis-a-vis Russia. As iterated in the Joint Statement by President Bush 
and President Putin on U.S.-Russia Energy Cooperation, signed February 
24, 2005, in Bratislava, Slovakia, our nations should concentrate on 
ways to enhance energy security, diversify energy supplies, improve the 
transparency of the business and investment environment, reduce 
obstacles to increase commercial energy partnerships, and develop 
resources in an environmentally safe manner. We know that Russia values 
an official U.S.-Russia energy dialog, particularly the Energy Working 
Group and the Commercial Energy Dialogue. We also expect Russia to 
focus on energy security during its G-8 Presidency next year. With 
these notions in mind, we will continue to work with our Russian 
counterparts to boost energy supplies to world markets and seek 
commercial opportunities for American energy firms.
                        russia's resources . . .
    Analysts report that Russia has proven oil reserves of over 60 
billion barrels, most of which are located in Western Siberia, between 
the Ural Mountains and the Central Siberian Plateau. Approximately 14 
billion barrels of oil resources exist on Sakhalin Island, in the far 
eastern region of the country, just north of Japan. Eastern Siberia, 
much of which is unexplored, is thought to contain additional reserves 
of oil and gas. The Sea of Azov, in the South, may also be energy rich. 
Last year, Russia produced over nine million barrels of oil per day, 
and exported about 6.7 million b/d of oil and oil products. Only Saudi 
Arabia produced and exported more. During the period 2000-2004, Russia 
increased oil production by 8.5 percent per year; exports rose 14 
percent annually. This year, however, the pace has slackened.
    Russia holds the world's largest natural gas reserves, with 1,680 
trillion cubic feet already proven. Much remains unexplored, 
particularly in extreme northern and eastern regions, so actual 
reserves could be much greater. In 2004, Russia was the world's largest 
natural gas producer, as well as the world's largest exporter. GazProm, 
a state-owned entity, essentially holds a monopoly position on gas 
production and distribution in Russia, producing 90 percent of Russia's 
gas. It is, however, inefficient as an operator. GazProm's largest 
fields are in decline and production has been stagnant for more than a 
decade. In recent years, GazProm has had to rely on Turkmenistan, which 
is dependent on GazProm's pipelines for transit, to meet export 
obligations in the former Soviet Union and Europe. Kazakhstan and 
Uzbekistan also export gas to Russia, partially to supply regions of 
Siberia.
                . . . and its weak export infrastructure
    Russia's export infrastructure is badly in need of an upgrade. 
Transneft's aging pipelines can carry over two-thirds of Russia's crude 
exports to Western markets. Remaining exports must be shipped by rail 
or barge, which tend to be expensive and inefficient. Major oil export 
points now are Primorsk, on the Baltic Sea near St. Petersburg; the 
Druzhba system, which runs through Belarus and Ukraine, and on to 
Poland and Southeastern Europe; and Novorossiysk and Tuapse on the 
Black Sea. Russia also exports crude oil through Ukrainian ports at or 
near Odesa, on the Black Sea. Oil arrives through the Pridniprosky 
pipeline and Odesa-Brody, which was reversed in 2004.
    In recent years, Transneft has considered two large projects to 
increase export capacity. Lukoil has proposed a Barents Sea oil 
terminal at Murmansk, a year-around ice-free port, to deliver crude 
from the Western Siberia and Timan-Pechora basins. Transneft has 
suggested an alternative site in the High North near Indiga; this port, 
however, freezes in winter. The U.S. Government supports projects that 
could expand export capacity to the global market. In our view, a 
northern export route could provide up to two million barrels of oil 
per day for potential export to the United States.
    Meanwhile, Russia is embarking on efforts to expand exports to 
Japan and China, which now receive minimal volumes of Russian crude by 
rail. For 2 years, Transneft studied proposals to construct a massive 
eastern pipeline, roughly from Lake Baikal, in Central Siberia, to the 
Pacific port of Nakhodka, near Vladivostok. Russia has also considered 
building a pipeline to Daqing, China. The latest plans are divided into 
two stages. Beginning December, Transneft will construct a Siberian 
pipeline from Taishet, in Irkutsk Oblast, to Skovorodino, near the 
Russian-Chinese border, with an extension to be built to China. 
Simultaneously, Russia will construct an oil terminal at Nakhodka. In 
the second stage, Transneft will extend the pipeline from Skovorodino 
to the Pacific Coast. The pipeline's capacity will be 1.6 million 
barrels per day, 600,000 b/d of which would be delivered to China. The 
balance would be shipped to Nakhodka, initially by rail, for export to 
Japan or Korea. The economics of the plan, as well as the environmental 
implications, are uncertain.
    GazProm's pipeline network largely runs from east to west, passing 
through Ukraine and Belarus on the way to European markets; Ukraine 
currently transports 80-85 percent of Russia's natural gas exports to 
Europe. Russia and Ukraine tentatively agreed some years ago to create 
an International Gas Transit Consortium to upgrade the existing 
pipeline network and expand gas exports to Europe. Bickering over 
prices, volumes, partners, illegal taps and operator rights has delayed 
the project. GazProm, meanwhile, is considering alternatives. Blue 
Stream, a pipeline running under the Black Sea to Turkey, was completed 
in 2002. This year, Russia partnered with Germany to announce a $10 
billion project to construct a pipeline under the Baltic Sea--a route 
that would circumvent Ukraine, Poland and the Baltic States. GazProm is 
also negotiating with Poland to construct Yamal-II, which would link 
Belarus to Slovakia and points west without traveling through Ukraine.
                       sakhalin and the far east
    Sakhalin Island, lying north of Japan, holds reserves of 14 billion 
barrels of oil and 96 trillion cubic feet of natural gas. The Russian 
Government partitioned the onshore and offshore territories of Sakhalin 
for exploration and development purposes; Sakhalin-I is progressing; 
Sakhalin-II is already producing oil; Sakhalin III, initially with U.S. 
participation, will be retendered. A consortium led by ExxonMobil will 
celebrate ``first oil'' at Sakhalin-I, a $12 billion project, on 
October 1. The partners hope to produce 250,000 barrels of oil per day 
and one billion cubic feet of natural gas in the initial stage. Royal 
Dutch Shell, with Russian and Japanese partners, is engaged in 
developing Sakhalin-II, which will include Russia's first liquefied 
natural gas (LNG) facility. Shell recently announced that costs of the 
second phase have doubled--from $10 billion to $20 billion. LNG 
exports, beginning 2008, will reach the United States via Mexico, where 
Shell is constructing two re-gasification plants. The project also 
plans to supply oil and natural gas to Japan and, perhaps, other Asian 
markets.
               shtokman: offshore lng in the barents sea
    We are very much encouraging LNG--liquefied natural gas--
cooperation with Russia, particularly at the massive Shtokman field in 
the Arctic. Russia is prepared to work with international partners on 
the project, which contains reserves of 112 trillion cubic feet of 
natural gas. On September 16, Russia released a ``short list'' of 
project partners, which included Chevron and ConocoPhillips; the 
Norwegian firms Statoil and Norsk Hydro and France's Total were also 
named. The Russian Duma has already approved a production sharing 
agreement in support of the project, though it is unclear when a final 
decision on project participants will be made. First phase plans call 
for 770 billion cubic feet of gas extraction per year, which will be 
converted into 14 million tons of LNG to be exported to the United 
States. After 2011, production could be ramped up to 2.5-3.1 trillion 
cubic feet of gas per year.
           high hopes for the high north and eastern siberia
    With production declining in Russia's Soviet era oil and gas fields 
in Western Siberia--currently the source of 60-70 percent of Russia's 
oil production--energy analysts are increasingly looking north and 
east, to the Yamal Peninsula and the largely unexplored region of 
Eastern Siberia. In the East, Krasnayarsk, Irkutsk and Yakutia oblasts 
may be rich in oil and gas resources; some observers refer to the area 
as the ``next Caspian.'' A harsh climate and utter lack of 
infrastructure, as well as remote locations and complex geology, 
present formidable challenges to prospects for development. Alexander's 
Oil and Gas Connection reckons that only 8 percent of Eastern Siberia 
has been explored geologically. According to the Petroleum Economist, 
the Russian Ministry of Natural Resources is offering 38 blocks in 
Eastern Siberia and the Far East for exploration this year. Higher 
global energy prices will bolster interest in these remote regions, 
though very high estimates for costs of exploration, development and 
transport--with few options--may dampen any excitement.
    Earlier, TNK-BP tentatively announced plans to construct a 2,000-
2,500-mile gas pipeline from Kovykta, Irkutsk Oblast, across China and 
the Yellow Sea to South Korea, but the Russian Government has not 
approved either the pipeline or gas exports. Total reserves of up to 70 
trillion cubic feet of gas may be at stake. Rosneft, meanwhile, is 
exploring northern Krasnayarsk Oblast, where oil production could 
exceed 300,000 barrels per day by 2012. GazProm, focused on Yamal 
Peninsula and its 52 trillion cubic feet of gas reserves, may explore 
opportunities for LNG facilities in the High North, with the 
possibility of exporting to Mexico or the U.S. West Coast. TNK-BP is 
also weighing a 5-year, $4 billion investment in Irkutsk's 
Verkhnechonskoye oil field, which could start producing in 3 years.
    As more attention is focused on Eastern Siberia, we will encourage 
the Russians to work with international partners, be transparent with 
emerging data, attract foreign investment, adopt new technologies and 
safeguard the environment as it explores and develops its resources. 
Initial signs are that Russia may be limiting the level of foreign 
participation in certain auctions for blocks in Eastern Siberia. We 
will press the Russian Government to reverse this approach, noting that 
$35 billion or more in investment will be needed to develop these 
remote fields.
              the promise of production, the lure of china
    Some observers have raised concerns over the possibility that 
Russia may export incremental oil and gas produced in Eastern Siberia 
to China, Korea and Japan, rather than Europe or the United States. 
Such developments, however, should not pose a threat to U.S. energy 
security. In a global context, additional Russian exports to China and 
other points in Asia would free up supplies elsewhere, from other 
producers, to meet market demand in the U.S. and other growth markets.
                    kazakhstan and the north caspian
    Kazakhstan and the entire North Caspian region also have tremendous 
resources. At Tengiz, Kashagan and other fields, over 25 billion 
barrels of reserves are proven; there is potential for up to 110 
billion barrels. Natural gas reserves range from 65-70 trillion cubic 
feet. We strongly support the work of U.S. energy companies and their 
international partners, who are now focused on ramping up production, 
improving transportation to markets, and heightening energy security in 
the North Caspian region. U.S. energy companies were among the first 
non-CIS foreign investors in Kazakhstan; we expect American companies 
to be active in the region for many years to come.
    Kazakhstan, a huge country, remotely located, for many years held 
valuable resources but lacked export routes to global markets. After 
the breakup of the Soviet Union, Kazakhstan had to rely on Russia's 
Transneft to carry its crude oil exports. That situation changed in 
2001, when the Caspian Pipeline Consortium, or CPC, completed 
construction of a nearly 1,000-mile pipeline from the North Caspian to 
Novorossiysk, Russia, on the Black Sea. CPC, a joint venture between 
the governments of Russia, Kazakhstan and Oman, with private partners 
that include U.S. energy companies, now transports over 500,000 barrels 
per day, mostly from the Tengiz field. The partners have drawn up plans 
to expand CPC capacity to 1.34 million barrels per day by 2009. Those 
plans have been delayed, however, as Russia expresses concerns over 
tariffs, corporate governance and management control. We have strongly 
encouraged the Russian Government to work constructively with CPC 
partners to resolve these issues and move forward with expansion, 
particularly as production in Kazakhstan is set to increase.
    Overall, Kazakhstan produced about 1.2 million barrels of oil per 
day in 2004, and exported, through CPC and other routes, about one 
million b/d. The Kazakh Government hopes to increase production to 
about 3.5 million b/d by 2015, especially as the huge Kashagan field 
comes into production. Moreover, Kazakhstan has expanded production of 
natural gas in recent years, and expects to reach 570 billion cubic 
feet this year. A lack of export infrastructure--plus a focus on oil--
has limited gas production in Kazakhstan; previously, gas had been 
flared or re-injected into oil wells to maintain production pressure. 
The Government of Kazakhstan is now studying options for increasing gas 
production and distributing it to global markets. As Kazakhstan aims to 
expand oil and gas production, it will require additional investment. 
We will encourage Kazakhstan to be transparent and give all capable 
companies fair access in any new tender process, whether for new 
acreage or for subcontracts on existing projects.
    Recognizing strong demand for crude in the East, Kazakhstan and 
China have begun constructing a 600-mile crude oil pipeline from Atasu 
to Alashankou, Xinjiang, China. The three-part pipeline, scheduled for 
completion in 2011, will extend from Atyrau in the north Caspian region 
to western China and will ultimately have the capacity to carry 400,000 
b/d. The initial stages of the project are scheduled for completion in 
December 2005. The proposed sale of PetroKazakhstan, a Canadian 
venture, to the China National Petroleum Corporation, is also 
indicative of Kazakhstan's focus on new markets. Clearly, demand for 
oil in East Asia, as well as in South Asia, is expanding rapidly. 
Kazakhstan, given its location, is well suited to meet a portion of 
that demand.
    At the same time, we expect Kazakhstan to continue exporting to the 
West, particularly from the Tengiz and Kashagan fields.
    Given the scope of the energy supply and demand challenges we face 
today and in years ahead, Kazakhstan has the potential to be a critical 
element in addressing the world's energy needs. As with Russia, we need 
to work with Kazakhstan to promote transparency and private investment, 
and to encourage leaders to expand cooperation with U.S. energy 
companies. Moreover, we must work with Kazakhstan and other countries 
of Central Asia and the Caucasus to encourage them to build out and 
expand infrastructure, and, in particular, to increase transport 
options.
                    azerbaijan and the south caspian
    The promise of expanding incremental, non-OPEC energy production in 
the Caspian region--and transporting it to the global market--has 
already begun to play out in Azerbaijan, where offshore resources have 
been the focus of international energy companies for many decades. In 
the past, remote locations, political tensions, regional conflicts and 
undetermined maritime boundaries marred production and transport 
efforts. Those issues, as well as environmental sensitivities and 
proximity to Iran, continue to resonate today. However, multinational 
efforts to overcome these hurdles are showing results in the South 
Caspian.
    Azerbaijan produced nearly 320,000 barrels of oil per day in 2004, 
about half of which came from the offshore Azeri-Chirag-Gunashli (ACG) 
fields. Total oil production could increase to one million barrels per 
day by 2010. Analysts estimate offshore proven reserves at 7-13 billion 
barrels of oil; Azerbaijan's state-owned oil company claims over 17 
billion barrels. In recent years, ExxonMobil and Russia's Lukoil have 
failed to find additional commercially viable reserves at offshore 
sites, raising questions about Azerbaijan's ability to increase 
production substantially in coming years. Analysts report that 
Azerbaijan has proven natural gas reserves of 30 trillion cubic feet--
and the potential for much more. Currently, Azerbaijan is a net gas 
importer--mostly from Russia. That is set to change, however, 
particularly as the giant Shah Deniz field, with at least 14 trillion 
cubic feet of reserves, comes on line, beginning 2006.
    The crowning achievement of regional political leaders and 
international energy companies in the South Caspian is the Baku-
Tbilisi-Ceyhan (BTC) pipeline. Traditionally, export routes for Azeri 
oil were limited to cross-Caucasus or Russian pipeline and rail links, 
which led to Black Sea ports. These routes, however, proved risky, as 
they passed through unstable areas like Chechnya. Moreover, in modern 
times, the Bosporus Straits, which lead from the Black Sea to the 
Mediterranean, became increasingly congested and subject to shipping 
delays.
    A consortium of international oil trading and construction 
companies and state-owned oil companies in Azerbaijan and Turkey, 
encouraged by strong U.S. Government support, created the Azerbaijan 
International Operating Company in the early-1990s to stimulate 
offshore production at ACG fields. A production sharing agreement was 
signed in 1994 and became effective in 1997. Overcoming strong 
political, engineering and environmental barriers, a similar group 
broke ground in 2002 on a 1,000-mile pipeline, connecting Azerbaijan's 
offshore oil fields to the Mediterranean port of Ceyhan, Turkey, via 
Georgia. The pipeline is slated to be completed in December 2005; oil 
has already begun to flow from Baku. Initial capacity is 200,000-
300,000 barrels per day, increasing to 500,000 barrels per day in 2006 
and eventually to one million barrels per day. Parallel to the BTC 
pipeline, partners are constructing a South Caucasus Pipeline to carry 
Azeri gas from Shah Deniz to Turkey. Initial volumes should reach 245 
billion cubic feet per year. The BTC, a success by any measure, serves 
as an example of political cooperation, engineering accomplishment and 
environmental protection worldwide.
                             expanding btc
    We strongly encourage the Government of Kazakhstan to act 
constructively and responsibly in bilateral efforts with Azerbaijan to 
link the Port of Aktau or Kuryk by tanker with the Baku-Tbilisi-Ceyhan 
pipeline. We believe that this latter effort, which would provide an 
export platform for future production at Kazakhstan's Kashagan field, 
must be held to very high standards--the same high standards that were 
upheld some years ago at the signing of the BTC inter-governmental 
agreement.
    The BTC partners, including U.S. energy companies, insist that a 
Kazakhstan-BTC (KBTC) IGA must have appropriate commercial, legal, and 
environment protections. The partners want the IGA explicitly to limit 
the investors' present and future tax liabilities to those taxes that 
are agreed upon in the subsequent Host Government Agreements (HGA). 
Moreover, they want the IGA to be ratified by parliament and signed by 
the President, in order to give it a superior legal status (as an 
international treaty) to any future parliamentary amendments to the tax 
code.
    The opening of the BTC pipeline, which transports Caspian crude 
from Azerbaijan to the Mediterranean port at Ceyhan, dramatically 
increased the value of Azerbaijan's oil reserves, namely, by bringing 
them closer to world markets. A successful agreement to link North 
Caspian production into the BTC by tanker to Baku would do the same for 
Kazakhstan's reserves. Moreover, it would greatly improve Kazakhstan's 
position in terms of investment potential and attractiveness--and 
return on investment.
                    black sea deepwater exploration
    BP is leading international efforts to explore the Black Sea. With 
Turkish partners, BP has launched efforts to drill an exploratory well, 
nearly 10,000 feet deep in waters that are about 4,000 feet deep, off 
the coast of Turkey. Efforts could expand to Georgia's coastal waters, 
where an American company has exploratory rights. U.S. energy companies 
are also interested in exploring deepwater areas off the coast of 
Ukraine, surrounding the Crimean Peninsula. Currently, local companies 
are producing oil and gas from shallow water regions of the Black Sea, 
mostly in Russia, Ukraine and Romania.
               additional efforts to bypass the bosporus
    Expanding Russian production in recent years has led to increasing 
bottlenecks at the Bosporus Straits, controlled by Turkey. In the 
winter of 2003-2004, a tanker backlog of 30 days or longer developed, 
cutting into profits of oil producers and transporters. Expanded 
production in Russia, the Caspian and the Black Sea could further 
aggravate the situation. Russian and Turkish entities, as well as 
international energy companies, have begun exploring options for 
Bosporus bypasses, mainly in the form of pipelines. Various parties 
have put six or more options on the table at various times. Proposals 
include a pipeline from Burgas, Bulgaria, to Alexandropolous, Greece, 
supported by Russia's TNK-BP; a pipeline from Samsun to Ceyhan, Turkey, 
supported by the Government of Turkey; and at least two options for 
building pipelines across the Balkans. The Odesa-Brody pipeline, built 
by the Government of Ukraine, has not fulfilled its original purpose as 
a Bosporus bypass. The pipeline was reversed in 2004 to carry Russian 
Urals crude to the Black Sea for export through the Bosporus; that 
decision may be revoked in 2006.
    The U.S. Government, aware of shipping delays and the 
environmentally sensitive nature of the Bosporus, generally supports 
efforts to build out infrastructure and improve transport efficiency in 
the region. However, weighing the commercial viability of the various 
proposals, in our opinion, is the responsibility of the private sector, 
which will ultimately finance and construct any pipelines that may move 
forward. Meanwhile, the U.S. Government will work with the Government 
of Turkey to improve operational efficiency in managing traffic flow in 
the Bosporus and to protect the environment from a catastrophic spill.
                               conclusion
    Russia and the Caspian continue to represent promising 
opportunities for upstream oil and gas investments needed to meet 
growing global demand over the next two decades. We recognize Russian's 
leadership in global energy markets, and underscore the contributions 
that Russia has made to supply expanding world oil demand, especially 
over the past 5 years. We will continue to work with U.S. energy 
companies and the Russian and Kazakh governments, in particular, to 
encourage further production increases and an expansion of transport 
infrastructure, particularly by expanding the Caspian Pipeline 
Consortium and the Baku-Tbilisi-Ceyhan pipeline. We will emphasize to 
them the need to advance corporate governance and transparency, 
including applications of revenues from oil and gas activity, adhere to 
rule of law, strengthen regional stability, broaden stakeholder 
participation, safeguard the environment and improve the investment 
climate. We will work with others in the region, from Turkmenistan to 
Turkey, Georgia to Ukraine, to cooperate internationally in exploring 
new fields and maximize efficiency of transit routes. All the while, we 
will promote partnerships between U.S. and local entities, with the 
objective of expanding production to meet rising global demand.

    Senator Hagel. Mr. Simons, thank you. And your full 
statement will be included in the record, as well.
    Let me ask each of you--and, again, I appreciate your 
comprehensive statements--you mentioned--each mentioned, in 
reference--in your testimony--our ambassadors in these 
countries and in this region, their focus, priorities. How do 
we coordinate our policies in the region with our ambassadors? 
And I guess that might begin with a statement from each of you 
about the coordination of your two departments on these kinds 
of issues, and then maybe work it down to the ambassadorial 
level in the region. Are there regional conferences? Are there 
departmental conferences?
    Secretary Harbert, we'll begin with you. Thank you.
    Dr. Harbert. It may be shocking to find out that we work 
quite well together, but we do. As Deputy Assistant Secretary 
Simons noted, this is an area where we have constant contact 
with each other at headquarters over here in Washington. The 
ambassadors and many officers go through the Foreign Service 
Institute and a variety of seminars before they go out to post. 
And we participate in the actual preparing of ambassadors and 
economic counselors and commercial counselors before they go 
out to post, and apprise them of how important energy is in the 
formulation of our foreign policy and how important it is in 
our commercial policy abroad. So, we begin here in Washington.
    You may be surprised to find out that in Russia, that is 
the largest Department of Energy office that we have around the 
world. We have 17 people there. They're housed within the 
embassy, and they report to the ambassador. So, we coordinate 
quite well at the ground level, as well as back here. And we 
hold, obviously, a great deal of meetings between ourselves, 
with the National Security Council, on coordinating our policy, 
which--this Administration believes, in that region, energy 
plays a very, very important part of it. And, for that, we are 
each charged with making sure that we are doing is 
complementary.
    Senator Hagel. Thank you.
    Mr. Simons?
    Mr. Simons. Thank you. I would agree that we're very 
closely knitted up. I think there are several layers of 
coordination. First--and I would, again, make reference to the 
Energy Department-led effort--we're very linked into these 
energy dialogues with individual key countries--specifically, 
Russia and Kazakhstan. And those really do, to some extent, 
provide an overarching policy framework for how we handle 
energy issues.
    We're also very tightly linked up with the private sector, 
both here in Washington, as well as abroad and through our 
embassies. And sometimes the private-sector connections are 
what provide the glue, also, to keep the policy oriented, in 
particular, on those concerns that are most immediate--of most 
immediate interest to our companies.
    And, finally, in particular, in Russia, we have the 
presidential interest, we have the involvement of the National 
Security Council that provides another overarching chapeau to 
our efforts.
    Senator Hagel. Thank you. You mentioned Kazakhstan and 
Russia in your statements, as well as your answer to the first 
question. If you could enlarge upon the region--specifically, 
Turkmenistan, where we have some reason to believe there are 
rather considerable natural gas deposits--take it a little 
further, to Uzbekistan and some of the countries in this area--
what kind of progress are we making? Where are our greatest 
challenges? And any reflection on this particular area--
specifically, Turkmenistan, Uzbekistan? And then we'll get into 
some other questions.
    Dr. Harbert?
    Dr. Harbert. Thank you. As I mentioned earlier, capital is 
a coward. And, in particular on Turkmenistan, I think there is 
tremendous opportunity there for foreign investment. There's 
tremendous opportunity, in terms of realizing them as a 
valuable energy exporter. We would hope to see that there is a 
government there that we could work with in a much more open 
and transparent and--way. And we certainly have great 
expectations for their ability to play in the regional market 
there. They are an important--they have an important 
relationship with Russia and what they do with their resources.
    I would like to say, for the region as a whole, I think one 
of the things that we need to keep in mind as we look at each 
country by country is that these are very interrelated issues. 
And whether they be linked by common economic interests or 
integrated energy infrastructure, there is an integrated energy 
infrastructure, both pipeline and otherwise, that has existed 
for a number of years, and that is a baseline from which they 
begin to look at new investments and how they can move their 
product around. And that is something that is a backdrop of how 
they take their things to market and what new investments are 
needed that they keep in their minds.
    On other countries in the region that we are hoping to see 
progress in, we'll be anxiously, obviously, looking at what 
happens in the Ukraine with the new government. We're looking--
with Kazakhstan, there is a great deal of potential, 
particularly if they are able to realize the intergovernmental 
agreement for the BTC pipeline. That affords them new 
opportunities to diversify the way that they can get their 
product to market.
    It's in their interest--it's in these countries' interests 
to find ways to get their product to market, to diversify the 
way that they get their products to market. And that's 
something, from a policy perspective, we continue to look for 
ways to support.
    Senator Hagel. Thank you.
    Mr. Simons?
    Mr. Simons. Thank you. I would pretty much agree with that 
assessment. Certainly, Turkmenistan has very interesting gas 
reserve potential. We've known about it for a long time. There 
have been discussions underway for many years, for instance, to 
route some of that gas through Afghanistan to South Asia. In 
theory, it sounds very promising. But, again, you have 
political-risk issues and investment-climate issues that, up to 
now, have not been able to bring the private sector along. So, 
we continue to be in close contact with the government there. 
We're analyzing the situation. We're in contact with the 
private sector. But, up to now, the situations haven't been 
really ripe to get to the investment stage.
    Similar situation in Uzbekistan. It has substantial gas 
reserves, but most of them serve the local market, and we 
haven't had an investment-climate situation that's been 
propitious to launch anything more comprehensive. But we 
continue to keep a close eye on those countries, and we'd like 
to see those reserves more--integrated more broadly into the 
global energy picture.
    Senator Hagel. Thank you.
    Mr. Simons, how is the U.S. working, and under what 
process, to encourage a resolution of the boundary disputes in 
the Caspian--specifically between Azerbaijan, Iran, 
Turkmenistan? Are we engaged in any formal dialogue or 
processes to help resolve this boundary dispute in the Caspian?
    Mr. Simons. I'll have to get back to you on that. I don't 
have anything firm. My understanding is that an arrangement has 
been worked out, a practical arrangement, between the three 
countries that have, currently, substantial offshore resources 
that are being developed--i.e., Azerbaijan, Russia, and 
Kazakhstan. It is sturdy enough that it's been able to bring 
the private sector in, and bring along the quality and quantity 
investment that we've seen. I don't believe that there is any 
diplomacy underway to resolve the final issues with the 
Iranians and the Turkmen, but I'll have to get back to you on a 
more firm answer on that.

    [Mr. Simons' response to the question follows:]
      Response by Paul E. Simons to a Question from Senator Hagel
    Question 1. What, if anything, is the U.S. Department of State 
doing to resolve the dispute over Caspian Sea delimitation between the 
littoral states?
    Response. The United States is not party to any boundary 
discussions between any of the Caspian States and thus we hold to our 
long-standing policy not to make judgments on the merits of the 
boundary positions of any of these coastal States. We encourage the 
boundaries to be resolved amicably among and between the affected 
Caspian parties on the basis of international legal principles in order 
to achieve an equitable solution.
    The United States is encouraged that Russia, Kazakhstan and 
Azerbaijan have reached agreements on the division of the seabed in the 
northern part of the Caspian. Iran and Turkmenistan have not yet signed 
on to the approach of using the equidistant method used by the north 
Caspian States.
    In order to help resolve the impasse in the Central Caspian, the 
United States has sent experts to Azerbaijan and Turkmenistan and has 
briefed the Presidents of those countries on the technical and legal 
aspects of delimitation. We stand ready to renew our assistance at any 
time at the request of either country.

    Senator Hagel. Thank you.
    Secretary Harbert, would you care to add anything to that?
    Dr. Harbert. It may be merely just a statement of fact, 
but, in terms--the northern percent of the Caspian Sea--Russia, 
Azerbaijan, and Kazakhstan--when they divided it, in May 2003, 
I'll just note that Kazakhstan received 27 percent; Russia, 19; 
and Azerbaijan, 18 of the Caspian Sea. I'm not talking about 
boundary disputes, but that was what was agreed to back in May 
of 2003.
    Senator Hagel. Thank you. You mentioned the northern 
pipeline in Russia. Are there U.S. companies playing roles in 
that, at this point?
    Dr. Harbert. We have been very supportive of the Russians 
being supportive of the northern pipeline. At one point, they 
were looking at a route that would have been including 
Murmansk, which is a pipeline up in the same area. And we 
understand that they have chosen to pursue other parts of their 
infrastructure, at the moment, that do not include being very 
serious, at the moment, about the northern pipeline. And we 
feel that that's not in their interest. And we do believe that 
there is commercial interest in that area, and we will 
continue--as part of our Energy Working Group, we have gotten 
very specific with the Russians about the opportunities we 
think this will afford them to export product. And if it's a 
commercially viable product, the investment will be there. And 
I know there are companies that have discussed this in quite 
tangible terms with the government.
    Senator Hagel. Mr. Simons, would you care to add anything?
    Mr. Simons. I agree with Karen. I think clearly there could 
be commercial interests, but the overarching question is, To 
what degree is Russia going to open up any parts of its 
pipeline system to involvement by non-Russian players. And I 
think that's the hub of the issue.
    Senator Hagel. Which would lead me to another question 
regarding the Russian centralization of the energy sector. What 
do you believe is the objective? Is there a specific policy 
behind that, aside from having complete Russian ownership, 
downstream/upstream pipeline ownership? Is your analysis in any 
way swayed by presidential elections coming up in a few years? 
However you would, each of you, care to respond to that 
question, I would appreciate it.
    Dr. Harbert. Certainly. I think there are a number of 
things that are very clear and a number of things that are very 
opaque. Certainly, the decision-making about what is happening 
in the energy sector is certainly becoming more centralized 
within the presidential administration. There is--another thing 
that is very clear is that Gazprom, which now a state-owned 
entity, as well as the other state-owned entities in the 
transport sector, are on an asset buying spree at the moment, 
and the resources that they have are not being used to develop 
more resources; they're being used to purchase additional 
assets and resources around the region.
    What is not clear to us, and certainly to potential and 
current investors, is where the energy policy is going. As many 
investors have said, it would be nice just to know, and then we 
could make some decisions.
    The clarity and the sanctity of contracts is of preeminent 
importance to investors, and that is something that they want 
to be clear. What is the subsoil law going to be? What is the 
fiscal regime going to be? What type of royalties am I facing? 
What are--what are the definitions, according to the Russians, 
of ``strategic reserves''? Where am I going to be able to 
invest? If they would actually be able to just put a policy out 
there that were able to be relied upon, then, I think, foreign 
investors, including U.S. companies, would have a lot more 
surety of where they're going to be putting their capital in 
Russia. Nobody is willing to stand by and wait by the 
sidelines, but we're hopeful that the--in their enlightened 
self-interest--that the Russians will come forward and 
elucidate us with what their energy policy is. It is clear, 
from where we stand, that there is ample opportunity for 
foreign investment, that there is ample time right now to make 
those investments so that product will come onto the market in 
a timely way. But the longer that the process of putting out 
their policy to the--to the foreign investment community, 
you'll find that investment may go elsewhere. And that's not in 
their interest, and it's not in the world, you know, energy 
outlook, to their benefit.
    Senator Hagel. Mr. Simons?
    Mr. Simons. Thank you. I think it's useful to note that, in 
the process of Russian energy privatization over the eighties 
and the nineties, a lot of the upstream resources were 
privatized. Most of them. And this led to the very rapid 
expansion and recovery of Russia oil production--pretty much 
everything that we've seen, which did a great deal to satisfy 
global energy security requirements in the late nineties and 
early 2000s. That was provided by the Russian private sector, 
with a lot of involvement by Russian technology.
    On the other hand, the pipelines were not privatized at 
that time. The pipelines remained in state hands, and the 
pipeline capacity did not grow commensurately. So, you have a 
situation now where you've had large increase, private-sector-
driven, in the productive capacity, but the pipeline structure 
remains constrained.
    So, I think this is really the argument to go back to the 
Russians with and basically point out that when they did open 
up, they were able to expand production substantially, but now 
they're relying on railcars and other second-best 
opportunities, which is actually reducing income to the Russian 
State, because it's a lot more expensive to export via railcar.
    So, I think it's a win-win, to take a look at opening up 
this pipeline segment to private investment, both local, as 
well as foreign.
    Dr. Harbert. If I might add just a factoid to bring this 
into a fine point. In the beginning of this decade, Russian oil 
production was rising at a rate of about 14 percent per year. 
Now we have it at about 1 to 2 percent per year.
    Senator Hagel. Thank you.
    In some of these countries we're talking about, corruption 
has been an inhibiting factor, and you have generally both 
referenced it--in foreign investment, in moving forward in the 
development, production capabilities. If left generally 
unaddressed, how much of a factor is that going to be in the 
future for development of these resources?
    Dr. Harbert. Senator, I think that might be hard to 
quantify, but it would certainly be a factor for companies to 
look to other places to put their resources. Corruption, if you 
look at the--over time, it has been a way for states to enrich 
themselves and not to their medium or long-term benefit. The 
short-term benefit certainly does not, then, lead to long-term 
gain on the economic grounds.
    One would argue that the energy sector, which is going to 
be a predominant force in this region's economy from here to 
forward, that they should get it right from the beginning, and 
they attract quality investment, and not quantity investment, 
that they will then--and their citizens of the region--will 
benefit more broadly. To have the benefit of the few and not 
the benefit of the many, we've seen, in many states around the 
world, that then there is a popular rejection of using those 
resources, because they want to see more of the revenue from 
those resources accrue, and the benefits to accrue, to their 
people. So, corruption is really a tax on the people of that 
region.
    Senator Hagel. Thank you.
    Mr. Simons?
    Mr. Simons. I would agree with that. And I would just note 
that many of the oil-producing countries themselves, not at our 
initiative, but at their own initiative, are trying to get a 
grip on the situation. Within the last couple of months, 
Kazakhstan has joined the EITI initiative, the British 
Transparency Initiative. And Azerbaijan is taking a very close 
look at options, with our assistance, in terms of how they can 
handle oil windfalls in a way that benefits their citizens. So, 
a number of the countries, particularly in the Caspian area, 
are beginning to focus on this themselves.
    Senator Hagel. Thank you.
    How do we engage our Asian partners--or do we--on energy 
issues matters? For example, we have spoken of China. Take the 
North Asia region--China, Japan, South Korea--do we have any 
coordinated effort with our friends and our allies in that area 
regarding energy policy?
    Secretary Harbert?
    Dr. Harbert. First, on China, we have established, as we 
have with Russian and Kazakhstan, Azerbaijan, a formal energy 
dialogue that we engage in. The State Department participates, 
the Commerce Department participates, and a variety of other 
agencies around town participate. And we had a meeting of that 
group several months ago, here in town. From that, we've 
identified specific areas that we should be pursuing, in terms 
of enhancing our mutual interests. Foremost among those is 
energy efficiency. As China becomes an increasingly bigger 
consumer of energy, it is in their interest to become a more 
efficient user. It's in our interest that they become a more 
efficient user. And we're helping them to become a more 
efficient user, looking at their regulatory environment and 
other ways that they may become a more efficient user.
    And Japan. We have had a very long and rich history on 
cooperation with Japan, from a science and technology 
perspective. They have been a partner of ours for over 25 
years, and exchanging personnel in our laboratories, in our 
laboratory complex around the country, to help their scientists 
improve their understanding of the very hard technological 
issues that we both face. They are active partners with us in 
expanding our understanding of hydrogen and using hydrogen as a 
long-term solution to our energy supply. They are participating 
in the EDR project and looking at ways that we can actually 
design the next best class of nuclear technology, which we 
believe is in our interest to use as a solution to our energy 
mix, as well. They are participants. How do we sequester 
carbon? And how do we address climate change? And I know that 
that's a big area of interest of yours. And we have been strong 
partners, outside of the rubric of Kyoto, on exploring ways to 
improve the capture and sequestration of carbon. So, we have a 
very strong, robust relationship with Japan, and in an 
interesting new path forward with China.
    Senator Hagel. Thank you.
    Mr. Simons?
    Mr. Simons. Thank you. In addition to the DOE-led China 
dialogue, which I think is very promising, Deputy Secretary 
Zoellick also leads an economic dialogue with China that 
focuses on investment policy and energy policy, in particular. 
He went out, in early August, and had his first discussions 
with the Chinese, and I think this is likely to be a very 
promising opportunity to discuss investment and energy policies 
with the Chinese.
    We also have a very vibrant working group within APEC, the 
Asia-Pacific Economic Cooperation group, on energy. And this 
brings together, of course, all the major Asia-Pacific 
partners. We talk about data transparency issues, establishment 
of strategic reserves, some of the same energy-efficiency and 
conservation issues, and, of course, it brings developed and 
developing countries together.
    And then, finally, with the OECD countries, with the 
industrialized countries, we have a very active dialogue in the 
International Energy Agency covering a lot of the same broad 
energy-security issues.
    Senator Hagel. The OECD countries would obviously include 
whatever relationship we would have with EU and EU-member 
countries. Is that correct? Same kind of basis.
    Mr. Simons. Yes.
    Senator Hagel. Secretary Harbert, you noted in your 
testimony that you--Department of Energy strongly supported a 
Trade and Development Agency feasibility study that would 
analyze the U.S. market's receptivity to Russian crude. Could 
you develop that in a little more detail?
    Dr. Harbert. Certainly. This is an opportunity that's 
actually focused around liquefied natural gas. And the Russian 
market obviously is an untapped gem for liquefied natural gas, 
from a U.S. market perspective. What their hesitation has been 
is that, Is there the receiving capability here in the United 
States? We certainly have the demonstrated appetite, but do we 
actually have the market capability to absorb what they might 
potentially be able to export? Before they invest in the 
infrastructure, they want to be assured of a market.
    And so, the Trade and Development Agency here has put 
forward the option of doing a market feasibility of our own 
market to demonstrate to the Russians that, actually, yes, we 
can receive this. The Russians are reviewing the specifications 
and the scope of work that the TDA has put forward to them, and 
we expect that they would move forward in short order.
    I will note that, in furtherance of that, Mr. Khristenko, 
who is Secretary Brodman's counterpart in Russia, will be 
coming to the United States this coming month, in October, to 
actually look at this very issue. We'll be holding discussions, 
and we plan on taking--we were going to be taking him down to 
Louisiana to look at the loop facility. And, unfortunately, 
that doesn't seem to be what would be most fruitful at the 
time, given the hurricanes. We will be taking him to some other 
liquified natural gas facilities that already exist and giving 
him extensive briefings on what are our capabilities here and 
what are our capabilities here.
    We gave a similar seminar to a variety of decision-makers 
in Russia about the LNG market, what the new energy bill does, 
what projects are on the pipeline, what the permitting process 
is like, so that they can be assured, if they're going to be 
furthering their infrastructure investments in this area, that 
there actually is going to be a market to receive those--that 
LNG.
    Senator Hagel. As well as terminals, especially on the West 
Coast. I would assume that they'd want to have some assurance 
of that, as well.
    Dr. Harbert. When Minister Khristenko comes, we're going to 
be taking him to facilities here on the East Coast, just simply 
because that's where he's going to be. Certainly, there are 
opportunities for liquified natural gas terminals to be 
realized on the West Coast. The Administration's been strongly 
supporting the expansion of LNG terminal capacity, working with 
State and local officials to make that happen, and working on 
streamlining the permitting process so that these projects can 
come online in a reasonable amount of time. And, again, I think 
the energy bill that the Congress passed this year helps us get 
there a lot faster.
    Mr. Simons. No, thank you.
    Senator Hagel. Well, you both have been generous with your 
time and your comments. I would leave the record open for a 
day, in the event some of my colleagues who were not here would 
want to present some questions to be responded to. And I know, 
Mr. Simons, you'll be back to me on one of the issues that we 
talked about.

    [The information previously referred to follows:]
                               Memorandum
    (This memorandum is largely drawn upon information provided by Mr. 
Bernard A. Gelb, specialist in Industry Economics, Resources, Science 
and Industry Division, Congressional Research Service (CRS).)

                               background
Russian Oil and Gas Reserves and Export Challenges
    The Russian Federation is a major player in world energy markets. 
With one fourth of the world total, it has more proven natural gas 
reserves than any other country (Table 1), and has about the eighth 
largest proven oil reserves.\1\ Russia also is the world's largest 
exporter of natural gas, the second largest oil exporter, and the third 
largest energy consumer.
---------------------------------------------------------------------------
    \1\ Published estimates of proven oil and/or gas reserves by 
country can differ widely. Thus, Russia's ranking of natural gas 
reserve holdings differs among organizations that compile such data, 
depending partly on whether certain types of resources are included.
---------------------------------------------------------------------------
    Energy exports have been a major driver of Russia's economic growth 
over the last 5 years, as Russian oil production has risen strongly and 
world oil prices have been relatively high. This type of growth has 
made the Russian economy very dependent on oil and natural gas exports, 
and especially vulnerable to fluctuations in world oil prices. The U.S. 
Energy Information Administration estimates that, on average, a $1 per 
barrel change in oil prices results in a $1.4 billion change in Russian 
revenues in the same direction.
    Most of Russia's proven oil reserves are located in Western 
Siberia, between the Ural Mountains and the Central Siberian Plateau. 
The Western Siberia region made the Soviet Union a major world oil 
producer in the 1980s, reaching production of 12.5 million barrels per 
day (bbl/d) in 1988.
    Oil production fell steeply after the Soviet Union dissolved in 
1991, to less than six million bbl/d in 1997 and 1998. State-mandated 
production surges had accelerated depletion of the country's largest 
fields and the Soviet central planning system collapsed. Russian oil 
output started to recover in 1999. Many analysts attribute this to the 
privatization of the industry, which clarified incentives and increased 
less expensive production. Increases in world oil prices, application 
of technology that was standard practice in the West, and rejuvenation 
of old oil fields helped boost output. After-effects of the 1998 
financial crisis and subsequent devaluation of the ruble may well have 
contributed. However, after reaching slightly over nine million bbl/d 
in 2004, Russian crude oil production has leveled off.
    Roughly 25 percent of Russia's oil reserves and 6 percent of its 
gas reserves are on Sakhalin Island in the far eastern region of the 
country, just north of Japan. Several consortia are in different phases 
of exploring and developing oil and gas production and export 
facilities, including export plans to the United States via liquefied 
natural gas (LNG) terminals and export pipelines to the mainland. 
However, except in two cases, there has been little progress.
    Almost three fourths of Russian crude oil production is exported, 
with the rest refined in the country. About two-thirds of Russia's 6.7 
million bbl/d of liquids exports in 2004 went to Belarus, Ukraine, 
Germany, Poland, and other destinations in Central and Eastern Europe. 
All these destinations are points along Russia's major export pipeline, 
Druzhba, and its multiple branches. The remaining one-third of crude 
oil exports were sent to maritime ports and sold in world markets. 
Because of recent higher world oil prices, almost 40 percent of 
Russia's oil exports are exported via railroad and river barge. Most of 
Russia's exports of refined petroleum products are fuel oil and diesel 
fuel used for heating in European countries.
    Russia's capacity to export oil faces difficulties. One stems from 
the fact that crude oil exports via pipeline are under the exclusive 
jurisdiction of Russia's state-owned pipeline monopoly, Transneft. 
Bottlenecks in the Transneft system make the company's export capacity 
unable to meet oil producers' export ambitions. Only about four million 
bbl/d can be transported in major trunk pipelines; the rest must be 
shipped by rail and river routes. Most of what is transported via 
alternative transport modes is refined petroleum, which helps to reduce 
the crude oil export capacity deficit. These modes are much more costly 
than shipment via pipeline and could become less viable if world oil 
prices fall. The Russian government and Transneft have taken steps 
toward developing a new export infrastructure.
    Unless significant investment flows into improving the Russian oil 
pipeline system, non-pipeline transported exports probably will grow. 
For example, without a dedicated pipeline, rail routes presently are 
the only way to transport Russian crude oil to East Asia. Russia is 
exporting about 200,000 bbl/d via rail to the northeast cities of 
Harbin and Daqing and to central China via Mongolia. The Russian 
government's treatment of Yukos might have affected rail exports to 
China since Yukos is the leading exporter of oil to China. However, 
Lukoil has taken over the role of rail supplier.
    Transportation of oil in the Black Sea region may be in flux. A 
large portion of Russia's oil presently is shipped via tankers from the 
Black Sea to the Mediterranean and to Asia, mostly from the port of 
Novorossiysk. The expected late 2005 opening of the Baku-Tbilisi-Ceyhan 
(BTC) pipeline that will transport mostly, if not entirely, oil 
produced by Azerbaijan and Kazakhstan poses increased competition to 
Russian oil. If Azerbaijan diverts all of its oil shipments via BTC, 
exports from Novorossiysk will decrease. There are reports of a 
proposal to reverse the flow of the Baku-Novorossiysk line, allowing 
for 250,000 bbl/d more crude oil exports to be sent from Russia to Baku 
and then along the BTC route. If BTC proves less advantageous than 
hoped, shipments via Novorossiysk (along with Batumi, Supsa, and 
Odessa) may not decrease. The appendix to this memorandum contains 
descriptions of proposals to expand Russia's network of oil and natural 
gas pipelines.
    With about 1,700 trillion cubic feet (tcf), Russia has the world's 
largest natural gas reserves (Table 1). In 2004, it was the world's 
largest natural gas producer and the world's largest exporter. Its 
natural gas industry has been less successful than its oil industry, 
with natural gas production and consumption largely unchanged since the 
breakup of the Soviet Union. Moreover, Russia's energy strategy calls 
for only modest natural gas production growth (about 1.3 percent per 
year) by 2010 even under its most optimistic scenario. Growth of 
Russia's natural gas sector has been impaired by ageing fields, 
monopolistic control over the industry, state regulation, and 
insufficient export pipelines. For example, three large fields in 
Western Siberia (Urengoy, Yamburg, and Medvezh'ye), that together 
account for about 70 percent of the total natural gas production, are 
in decline. The government projects sharp drops in natural gas output 
between 2004 and 2020.
    Gazprom, Russia's state-run natural gas monopoly, holds nearly one-
third of the world's natural gas reserves, produces nearly 90 percent 
of Russia's natural gas, and operates the country's natural gas 
pipeline network. Gazprom is Russia's largest earner of hard currency, 
and the company's tax payments account for around 25 percent of Federal 
tax revenues. Gazprom is heavily regulated, however. By law, Gazprom 
must supply the natural gas used to heat and power Russia's domestic 
market at government-regulated below-market prices. Thus, about two-
thirds of the company's revenue comes from its export sales to Europe, 
where natural gas is sold at monopolistic prices. Because Russian gas 
provides about 25 percent of the natural gas consumed in Europe, 
Gazprom is considered by some observers to be one of Moscow's main 
foreign policy tools.
    Issues have arisen with the growth of Gazprom's sales to European 
gas consumers. European trade representatives have criticized Gazprom's 
dominant market position and two-tiered pricing system, and linked the 
pricing issue to Russia's accession to the World Trade Organization 
(WTO). Russia agreed to grant independent natural gas producers access 
to Gazprom's pipelines. Also, in response to calls for fair pricing, 
the Russian government doubled prices to Russian industrial consumers. 
But the new price level is far less than half of the prices charged at 
the German and Ukrainian borders.
    Historically, most of Russia's natural gas exports went to Eastern 
Europe, and Russia continues to export significant amounts of natural 
gas to customers in the Commonwealth of Independent States. But, in the 
mid-1980s, Russia, as part of the Soviet Union, began trying to 
diversify its export options. By now, Gazprom has shifted much of its 
exports to meet the rising demand of EU countries, as well as that of 
Turkey, Japan, and other Asian countries. If Gazprom is to attain its 
long-term goal of increasing its European sales, it will have to boost 
its production, as well as secure more reliable export routes to the 
region. Several proposed new gas export pipelines would serve European 
markets if constructed.

                       Table 1.--Estimates of Eurasian Oil and Gas Reserves and Resources
                           [oil in billions of barrels/gas in trillions of cubic feet]
----------------------------------------------------------------------------------------------------------------
                                                                   Proven Reserves
                                                       ---------------------------------------      Possible
            Region                      Country                             O & G Journal (1/    Additional EIA
                                                         BP (End of 2004)         1/05)               \1\
----------------------------------------------------------------------------------------------------------------
Russia                          ......................  72/1,694            60/1,680           n.a./n.a.
----------------------------------------------------------------------------------------------------------------
Caspian Sea Region              Azerbaijan              7.0 (oil)/48 (gas)  7 (oil)/30 (gas)   32/35
                               ---------------------------------------------------------------------------------
                                Iran \2\                \3\ 0.1/0           n.a./n.a.          15/11
                               ---------------------------------------------------------------------------------
                                Kazakhstan              9.7/106             9/65               92/88
----------------------------------------------------------------------------------------------------------------
                                Turkmenistan            0.5/102             0.5/71             38/159
                               ---------------------------------------------------------------------------------
                                Uzbekistan              0.6/66              0.6/66             2/35
                               =================================================================================
                                Total                   17.9/322            17.1/232           184/293
----------------------------------------------------------------------------------------------------------------
Reference Areas                 United States           29/187              22/189             \4\ 47/271
                               ---------------------------------------------------------------------------------
                                North Sea \5\           n.a./n.a.           15/170             n.a.
                               ---------------------------------------------------------------------------------
                                Saudi Arabia            263/238             259/2              n.a.
                               ---------------------------------------------------------------------------------
                                WORLD                   1,189/6,337         1,278/6,040        n.a.
----------------------------------------------------------------------------------------------------------------
 \1\ Excludes proven reserves. Data from various sources compiled by EIA in Survey cited below.
 \2\ Only regions near the Caspian Sea are included.
 \3\ Data from EIA.
 \4\ Undiscovered conventional oil and gas.
 \5\ Includes Denmark, Germany, Netherlands, Norway, and United Kingdom.
Sources: BP. BP Statistical Review of World Energy 2005. June 2005; Penwell Publishing Company. Oil & Gas
  Journal. December 20, 2004; Department of Energy, EIA. Caspian Sea Region: Survey of Key Oil and Gas
  Statistics and Forecasts, December 2004; EIA. U.S. Geological Survey. ``National Oil & Gas Assessment,'' at
  [http://www.energy.cr.usgs.gov/oilgas/noga/2004update.htm], viewed March 1, 2005.
EIA--Energy Information Administration.
n.a.--Not available from sources listed below.

           caspian oil and gas reserves and export challenges
    The Caspian Sea region historically has been an oil and natural gas 
producer, but many believe that the region contains large resources of 
oil and gas capable of much greater production than at present. The 
Caspian region presently is a significant, but not major, supplier of 
crude oil to world markets, according to estimates by BP and the Energy 
Information Administration (EIA), U.S. Department of Energy. The 
Caspian Sea region produced roughly 2 million barrels per day (bbls/
day) including natural gas liquids in 2004, or about 2.5 percent of 
total world output).\2\ More than a dozen non-Caspian countries each 
produce more than 1.5 million bbls/day. Caspian region production has 
been higher, but suffered during the collapse of the Soviet Union and 
the years following. Kazakhstan accounts for about 65 percent and 
Azerbaijan for about 20 percent of current regional crude oil output.
---------------------------------------------------------------------------
    \2\ Energy Information Administration. ``Caspian Sea Region: Survey 
of Key Oil and Gas Statistics and Forecasts,'' at [http://
www.eia.doe.gov/emeu/cabs/caspian_balances_files/sheet001.htm], viewed 
September 15, 2005.
---------------------------------------------------------------------------
    Depending upon the estimator, the Caspian Sea region has proven 
(economically recoverable) reserves of 17-18 billion bbls of crude oil 
(Table 1). This is equal to about 1.5 percent of total world proven 
reserves, and less than U.S. reserves (22 billion or 29 billion bbls, 
depending upon the estimator). Estimates of much larger ``possible'' 
reserves suggest a potential for much greater production. However, as 
indicated by analysis later in this memorandum, there are obstacles to 
increases in output and exports now and in the future.
    Unlike oil, the region's proven reserves of natural gas are a 
higher proportion of the world total than is its natural gas 
production. In some important instances, exploration efforts hoping to 
find oil have found almost entirely gas instead. Estimates of proven 
reserves of natural gas in the Caspian Sea region by BP and the Oil and 
Gas Journal range as widely as those for oil--232 tcf and 322 tcf, 
respectively (Table 1), or 3.8 percent to 5.0 percent of the world 
total. Increases in the Caspian region gas production face obstacles 
somewhat similar to those that challenge further oil development and 
production.
    The Caspian Sea region's relative contribution to world production 
of natural gas is larger than that for oil. With gas output of 4\3/4\ 
trillion cubic feet per year (tcf/y) in 2004, it accounted for 5 
percent of world production. As with oil, gas production has been 
higher, but suffered during the collapse of the Soviet Union and the 
following years. Turkmenistan and Uzbekistan are the heavily 
predominant producers; each had production of about 1.9 tcf/yr in 2004, 
or about 40 percent of the region's gas output.
    There is a likelihood of much greater additional reserves of crude 
oil and natural gas being found in the Caspian Sea region. This is 
reflected in the number of oil companies that have large stakes there. 
Much of the known reserves have not been developed yet, and development 
usually leads to the discovery that prospects are larger than 
originally estimated. Moreover, many areas remain unexplored. The EIA 
estimates that an additional 186 billion barrels of crude oil reserves 
are possible,\3\ which would raise the total to 10 times its present 
level. This level of proven reserves would equal about 75 percent of 
the amount now held by Saudi Arabia (Table 1) and could come to roughly 
15 percent of total world reserves.
---------------------------------------------------------------------------
    \3\ Caspian Sea Region: Survey of Key Oil and Gas Statistics and 
Forecasts, July 2005.
---------------------------------------------------------------------------
    The prospective increase in natural gas proven reserves appears to 
be much smaller in relative terms than for oil, but still very large. 
It is estimated that there are nearly 300 tcf in additional natural gas 
reserves in the region. Should this be the case, total Caspian region 
proven reserves in 2010 would put the region's proven gas reserve total 
at very roughly twice its present level and far exceed present Saudi 
Arabian natural gas reserves.
    Any comparison of Caspian Sea region oil and natural gas reserve 
volumes versus those of Saudi Arabia should be tempered by 
acknowledgment of the considerable advantage of Saudi oil and gas in 
terms of much lower costs of production and much easier market access. 
Also, whatever the quantities and the production costs of their energy 
resources, Caspian countries' ability to develop and bring them to 
market could depend to some extent on the ability to establish and 
maintain relationships with international energy companies.
    In view of the above, Caspian region countries potentially are 
large exporters of oil and gas. Caspian Sea region oil and gas have 
several markets now and a wider variety of potential markets. These 
include nations trying to meet their economies' demand for energy and 
those that also wish to reduce their dependence on Persian Gulf energy.
    Now, nearly all Caspian crude oil goes north and/or west. 
Reflecting the Soviet era dictates and infrastructure, it travels 
largely via pipeline to and/or through Russia to European markets, with 
refineries as part of the network. Some also goes by tanker through the 
Bosporus straits to Western European markets via the Mediterranean. 
Natural gas transportation, even more than oil, is tied to pipelines 
going mainly north and/or west through Russia and its monopoly 
pipeline--Transneft. This, together with the fact that Russia itself 
produces oil and gas, provides Russia with the market power to collect 
transit fees on Caspian energy shipped through its transportation 
network, and to determine in some cases how much it is willing to 
transport. Also, because energy competes on a delivered-cost basis, 
reflecting transit fees, Caspian wellhead prices suffer. Caspian region 
countries thus have incentives to develop alternatives to routes 
through Russia--possibly consortia of routes that avoid long transits 
through Russia in reaching European and other markets and provide 
leverage in negotiating transit fees on shipments that do go through 
Russia.
    Caspian energy sources are attractive to Turkey: they are close and 
offer Turkey an opportunity to offset part of its energy import bill 
through transit fees for shipments across its territory. Turkey's 
energy use is growing much faster than its output, making it a rapidly 
growing importer of both oil and gas; it already is a large market for 
Russian gas. Also, Turkey has very good relations with Caspian and 
Central Asian countries. However, some observers believe that Turkey 
has been optimistic in its expectations of natural gas consumption, and 
overcommitted itself to future imports of gas.
    East Asian countries also are potentially attractive markets. Japan 
already imports a significant quantity of gas; and energy consumption 
in India and Pakistan is growing rapidly. Perhaps most significant, 
China's proven oil and gas reserves are small compared with the current 
and potential size of its economy and recent steep increases in its oil 
consumption. This has led to Kazakhstan and China to agree to build a 
pipeline between the countries.\4\
---------------------------------------------------------------------------
    \4\ ``Kazakhstan, China Revive Pipeline Deal,'' Middle East 
Economic Survey, 19 July 2005.
---------------------------------------------------------------------------
    The prospects of Caspian energy exports to the regions identified 
above may be limited by newly expanding or developing non-Caspian 
energy exports to those regions. These developments include expansion 
of North Africa's gas export capacity, discovery of a large natural gas 
province in and near Egypt, development of a large gas field in 
Pakistan, and growing liquefied natural gas export capacity of Persian 
Gulf nations.
    There are, however, inter-related geographical, political, 
economic, technological, legal, and psychological obstacles to the 
further exploration for and development of Caspian Sea region energy 
resources. Because the Caspian Sea is landlocked and the region's 
nations are distant from the largest energy markets, transportation 
must at least begin by pipeline, followed in many cases by tanker 
through the shallow and congested Bosporus straits.\5\ Pipelines from 
the Caspian region completed before 1997, except those in northern 
Iran, were routed to Russia and designed to link the former Soviet 
Union internally. The several pipelines now operating have sufficient 
capacity to handle present production, but little more. Completion of 
the CPC pipeline from Kazakhstan's Tengiz oilfield to Novorossiisk 
(Russia) on the Black Sea in 2001 and its planned expansion is notable, 
but the effective capacity of the CPC line, and that of others, may be 
constrained by limits on tanker passage through the Bosporus. When the 
Baku-Tbilisi-Ceyhan pipeline becomes operational in late 2005,\6\ its 
capacity plus that of presently operating pipelines will total 2.1 
million bbls/day. New pipelines to serve East Asian markets have 
economic potential but could be lengthy, and entail transit through 
Afghanistan, Iran, and/or Pakistan. Routes to East Asian markets via 
Iran would include shipping through the Persian Gulf.
---------------------------------------------------------------------------
    \5\ Limited depth, heavy traffic, and environmental considerations 
have resulted in restrictions on travel through the Bosporus straits 
imposed by Turkish authorities. Supporters of the Baku to Ceyhan 
pipeline assert that Ceyhan, a Turkish Mediterranean Sea port, can 
handle very large carriers, while the Supsa and Novorossisk ports are 
restricted to smaller tankers that can transit the Bosporus. Also, 
Ceyhan can remain open all year, whereas Novorossiisk is closed up to 2 
months per year.
    \6\ Linefill of the BTC pipeline began in May 2005; it is expected 
that the first tanker will be loaded in the fourth quarter of 2005. 
``BTC Inaugurated,'' FSU Oil & Gas Monitor, 25 May 2005, p. 10.
---------------------------------------------------------------------------
    These issues are complicated by the fact that pipeline routes face 
potential disruption by regional conflicts. These include longstanding 
tension between India and Pakistan, continuing unsettled conditions in 
Afghanistan, the Armenia-Azerbaijan dispute over Nagorno-Karabakh, 
separatist efforts in Georgia, and military activity in Chechnya.
    On the purely economic side, the longer the pipeline route, the 
less attractive it is to producers, other things being equal, inasmuch 
as energy competes on a delivered-cost basis and transit fees (based 
upon distance) effectively lower the wellhead price received by 
producers. Because transit fees are a source of revenue to governments, 
politics as well as economics come into play in pipeline route 
selection. Built-in precautions to minimize environmental impacts, 
particularly in and around the Sea, add to pipeline costs. In addition, 
much of Caspian energy resources are offshore, requiring special large 
drilling rigs. Very limited rig production capacity in the relatively 
isolated region makes the acquisition of rigs expensive and 
logistically difficult, hampering development of Caspian energy 
resources. This situation is easing a little as one new rig was added 
to the fleet in the past year and another is in the production 
pipeline.
    Full realization of the energy potential of the region also is 
impeded by the unresolved legal status of the Caspian Sea. Despite a 
number of efforts, so far only Azerbaijan, Kazakhstan, and Russia among 
the littoral states have reached agreement on delineating ownership of 
the Sea's resources or their rights of development. Potential wealth 
from development heightens the stakes and intensifies the claims by 
each country.
    Investment enthusiasm slackened after the surge of production-
sharing agreements during the early and mid-1990s. Some recent 
exploration efforts have had disappointing results, particularly with 
respect to oil. Somewhat reduced activity, from less investment, has 
reduced the rate of discovery, with a further psychological effect. On 
the other hand, the March 2003 acquisition by China of a large stake in 
the North Caspian Sea Project suggests some confidence in the prospects 
of a least one large venture.
    Despite the obstacles discussed above, energy development in the 
Caspian Sea region is proceeding and is likely to proceed further given 
the widely perceived prospect of very large energy resources in the 
Caspian Sea region. The pace of development, however, may be less rapid 
than might be the case with fewer hurdles.
Energy Policy Positions of Relevant Governments \7\
---------------------------------------------------------------------------
    \7\ Nearly all of the discussion of other nations' energy policy in 
this section is taken from the following CRS documents: CRS Report 
RL33093, China and the CNOOC Bid for Unocal: Issues for Congress, by 
several authors; CRS Issue Brief IB92089, Russia, by Stuart D. Goldman; 
CRS Report RL32087, Russian Oil and Gas Companies and Central and 
Eastern Europe, by Steven Woehrel; and CRS Report RL32466, Rising 
Energy Competition and Energy Security in Northeast Asia: Issues for 
U.S. Policy, by Emma Chanlett-Avery.
---------------------------------------------------------------------------
    Each in its own way, other major countries in the energy arena have 
taken aggressive stands with respect to energy supplies. Internally, 
Russia has moved to take control of its own energy supplies. It may be 
argued that this was partially the motivation behind the Russian 
government's prosecution of Mikhail Khodorkovsky, CEO of Yukos. 
Khodorkovsky, who acquired state-owned assets during the privatization 
process, adopted open and ``transparent'' business practices while 
transforming Yukos into a major global energy company.\8\ Yukos is 
being broken up and its principal assets sold off to satisfy alleged 
tax debts. At a state-run auction, Yukos' main oil production 
subsidiary was sold to Baikalfinansgrup, the sole bidder, for about 
half of its market value, according to western industry specialists. 
The previously unheard-of Baikalfinansgrup reportedly is a group of 
Kremlin insiders headed by a close associate of President Putin. Then, 
Baikalfinansgrup was purchased by Rosneft, a wholly state-owned Russian 
oil company. This and other Russian government actions have clouded 
prospects for private investment, including that by U.S. and other 
foreign companies.
---------------------------------------------------------------------------
    \8\ At the onset of the prosecution of Khodorkovski, Yukos was 
ranked by some as the fourth largest oil company in the world.
---------------------------------------------------------------------------
    In Central Europe, Russian firms with close links to the Russian 
government have used leverage to buy up energy companies to gain 
control over energy supply. For example, Yukos obtained majority 
control of a Lithuanian refinery by slowing oil supply to it, and 
buying it at a reduced price. In Latvia, the Transneft pipeline cutoff 
all oil shipments to the port of Ventspils (diverting the flow to the 
Russian port of Primorsk). Many see Transneft's move as a tactic to 
obtain a controlling share of the firm that operates the Ventspils 
terminal.\9\
---------------------------------------------------------------------------
    \9\ Ariel Cohen, ``Don't Punish Latvia,'' Washington Times, May 5, 
2003.
---------------------------------------------------------------------------
    Central Asian countries have extensive energy ties to Russia 
stemming from the numerous transportation routes that are Moscow 
oriented. Russia initially opposed western investment in Caspian Sea 
energy projects, insisted that oil from the region be transported 
through Russian territory to Black Sea ports, and argued for equal 
sharing of Caspian Sea oil and gas. But it has become more agreeable, 
and even cooperative with, western projects, and it has signed an 
agreement with Azerbaijan and Kazakhstan on Caspian seabed borders 
essentially based upon shore mileage.
    In East Asia, the largely undeveloped energy resources of 
neighboring Siberia have become the objective of a scramble by Japan, 
South Korea, and China to meet their increasing energy needs 
(particularly with respect to China) while reducing dependence on the 
Middle East. China and Japan appear to be engaged in a bidding war over 
Russian projects and in a contest over access to Russian oil via a 
pipeline. China, Japan, and South Korea have been moving aggressively 
to shore up partnerships with existing suppliers, pursue new energy 
investments overseas, and pursue alternatives to petroleum. A 
relatively minor skirmish has erupted between Japan and China in which 
Japan has accused China of producing oil or gas from a field in waters 
close to the median line between the countries in the East China Sea. 
Japan asserts that China's actions risk extracting oil or gas from 
shared deposits. China has countered that, bey virtue of its shallow 
continental shelf, its economic zone extends further than the median 
line.\10\
---------------------------------------------------------------------------
    \10\ ``Japan accuses China in oilfield dispute,'' FT.com, September 
20, 2005, viewed Sept. 22, 2005.
---------------------------------------------------------------------------
    China has become increasingly concerned about its growing energy 
needs. The government's Tenth Fiscal Five-Year Plan for 2001-2005 
included a new plan to establish a strategic stockpile for its energy 
sector. Beijing has also sought to establish supply sources outside of 
the volatile Middle East, including buying a stake in a Spanish firm to 
become the largest offshore producer of oil in Indonesia; signing a 25-
year contract to buy liquefied gas from Australia; pledging to 
construct a 1200 kilometer-long oil pipeline from Kazakhstan; and 
signing deals with over 20 countries, many of them outside the Middle 
East, to buy into foreign oilfields. In the past 2 years alone, Chinese 
companies have acquired assets in Ecuador, Australia, Kazakhstan, 
Azerbaijan, Algeria, and Oman, among others.
    Chinese industry and officials have made particular inroads in the 
Caspian region. Most prominent was an accord between China and 
Kazakhstan, giving the PRC's state-owned oil company Chinese National 
Petroleum Company (CNPC) a 60 percent stake in the Kazakh state firm 
Aktobemunaigaz. The two companies may develop a pipeline between Atyrau 
and the western province of Xinjiang. Acquisitions in Azerbaijan and 
preferential rights to develop natural gas in Turkmenistan also have 
boosted Beijing's presence in the region. China also has worked to 
strengthen the Shanghai Cooperation Organization, a regional security 
organization that includes China, Russia, Kazakhstan, Uzbekistan, 
Tajikistan, and Kyrgyzstan.
    Other major Chinese initiatives include expanding the natural gas 
infrastructure and developing gas-fired power plants that will use 
liquefied natural gas instead of oil. The China National Offshore Oil 
Corp (CNOOC) announced plans to build a third LNG terminal by 2009. 
Natural gas is an attractive alternative in that it is plentiful 
outside the Middle East and relatively environmentally friendly. In the 
short-term, however, the cost of gas infrastructure and the 
availability of large amounts of inexpensive coal will preclude 
extensive use of natural gas.
                                 ______
                                 
                                Appendix
       selected major proposed russian oil export pipelines \11\
---------------------------------------------------------------------------
    \11\ Nearly all of the discussion of Russian oil and pipelines is 
taken from the Russia Country Analysis Brief of February 2005, prepared 
by the Energy Information Administration.
---------------------------------------------------------------------------
    There are several proposals to expand Russian oil pipelines. The 
largest of Russia's export pipelines to Europe, the 2,500-mile Druzhba 
line has a capacity of 1.2-1.4 million bbl/d. It begins in southern 
Russia, near Kazakhstan, where it collects oil from West Siberia, the 
Urals, and the Caspian Sea. From Belarus to where the pipeline splits 
in two at Mozyr, the system is only approximately 50 percent utilized. 
After Mozyr, both branches are fully utilized, one running through 
Belarus, Poland and Germany; and the other section running through 
Belarus, Ukraine, Slovakia, the Czech Republic, and Hungary. Work has 
begun to increase the pipelines' capacity between Belarus and Poland. A 
proposal to extend the pipeline into Germany (specifically to 
Wilhelmshaven) would reduce tanker traffic in the Baltic Sea, and would 
allow for exports of Russian crude oil to the United States via 
Germany.
    The Baltic Pipeline System (BPS) went on line in December 2001 
carrying crude oil from Russia's West Siberian and Timan-Pechora oil 
provinces westward to the newly completed port of Primorsk in the 
Russian Gulf of Finland. Throughput capacity at Primorsk has been 
steadily increased to around one million bbl/d by December 2004. The 
BPS gives Russia a direct outlet to northern European markets, allowing 
the country to reduce its dependence on transit routes through Estonia, 
Latvia, and Lithuania. The growth of the BPS has come at considerable 
cost to the Baltic countries, as Russian crude has been re-routed 
through the BPS. Russian authorities have stated that when allocating 
the country's exports, precedence will be given to sea ports in which 
Russia has a stake over foreign ones. Pending government approval, the 
pipeline will be expanded to 1.2 million bbl/d.
    A proposed pipeline would carry crude oil from Russia's West 
Siberian Basin and Timan-Pechora basin westward to a deepwater tanker 
terminal at Murmansk on the Barents Sea. This would allow for between 
1.6 and 2.4 million bbl/d of Russian oil exports to reach the United 
States via tankers within only 9 days, much faster than shipping from 
the Middle East or Africa. LNG facilities at Murmansk and Arkhangelsk 
(to the southeast) also have been suggested, possibly allowing for gas 
exports to American markets. Despite support for the Murmansk proposal 
from Russian oil companies, American oil companies, and the U.S. 
Government, Transneft (and thereby the Russian government) has 
approached the project with trepidation. Transneft was considering a 
shorter western route with a terminus at Indiga instead of Murmansk, 
and Transneft's CEO said the Murmansk project was no longer 
economically feasible. The Indiga pipeline would be closer to the 
Timan-Pechora oil fields than the Murmansk pipeline, but, in contrast 
to Murmansk, the port of Indiga is iced over during the winter. Since 
the Russian government has given priority to the construction of the 
Taishet-Nakhodka pipeline (see below), Transneft is reluctant to take 
on two large pipeline projects at the same time.
    The Adria pipeline runs between Croatia's port of Omisalj on the 
Adriatic Sea and Hungary. Originally designed to load Middle Eastern 
oil at Omisalj and pipe it northward to Yugoslavia and then to Hungary, 
the pipeline's operators and transit states have been considering 
reversing the flow--a relatively simple step--giving Russia a new 
export outlet on the Adriatic Sea. Connecting the pipeline to Russia's 
Southern Druzhba system requires the agreement of Russia, Belarus, 
Ukraine, Slovakia, Hungary, and Croatia. These countries signed a 
preliminary agreement on the project in December 2002; however, 
negotiations over the project's details (including tariffs and 
environmental issues) have been slow. Some analysts expect that the 
Adria pipeline could transport about 100,000 bbl/d of Russian crude in 
the first year of reversal, with an ultimate capacity of about 300,000 
bbl/d.
    The prospective large Chinese market for oil has led to serious 
consideration of building a pipeline from the Russian city of Angarsk 
to Nakhodka (near the Sea of Japan) or to Daqing, China. The situation 
is fluid, and no definitive decision as to choice has been made.
    The route to Nakhodka is longer, passes close to Lake Baikal (a 
site with environmental-related obstacles), and consequently is more 
expensive than the Daqing route. It will provide a new Pacific port 
from which Russian oil could be shipped by tanker to other Asian 
markets and possibly North America. The Daqing option is favored by 
China, although China could obtain exports via the Nakhodka route. 
Russian officials and Transneft executives have reported that the 
Nakhodka route would include a pipeline spur from Skovorodino (located 
about 30 miles from China), which could provide China with Russian oil.
Selected Major Actual and Proposed Russian Gas Export Facilities
    The 750-mile Blue Stream natural gas pipeline connects the Russian 
system to Turkey, 246 miles of which extends underneath the Black Sea. 
Natural gas began flowing through the pipeline in December 2002 at a 
rate of 71 billion cubic feet per year (bcf/y), which was to increase 
by 71 bcf/y. Estimates put 2004 transport levels at approximately 565 
bcf/y. However, in March 2003, Turkey halted deliveries through Blue 
Stream, invoking a clause in the contract allowing either party to stop 
deliveries for 6 months. After filing suit in Stockholm's International 
Arbitration court, the two sides came to an agreement in November 2003 
and the supply of natural gas to Turkey resumed in December 2003.
    Under one proposal, the Yamal-Europe I pipeline (1 tcf per year), 
which carries natural gas from Russia to Poland and Germany via 
Belarus, would be expanded another 1 tcf per year. However, Gazprom and 
Poland disagree on the exact route of the second branch as it travels 
through Poland. Gazprom is seeking a route via southeastern Poland to 
Slovakia and on to Central Europe, while Poland wants the branch to 
travel through its own country and then to Germany.
    The idea of a North Trans-Gas pipeline (or North European Gas 
Pipeline), extending over 2,000 miles from Russia to Finland and the 
United Kingdom via the Baltic Sea, was proposed in June 2003 by Russia 
and the UK. About 700 miles of the pipeline will pass under the Baltic 
Sea. In January 2004, the Russian government issued an official decree 
in support of the pipeline's construction and several European oil and 
natural gas concerns have reportedly shown interest in the project. 
However, there presently is no definite consortium developing the 
pipeline. Gazprom's CEO announced in February 2005 that the pipeline 
would be delayed from its 2007 start date to 2010. The project is 
expected to cost $5.7 billion and to transport approximately 0.7-1.0 
tcf of natural gas beginning in 2010. The main advantage of this 
pipeline to Russia is that it no longer will have to negotiate transit 
fees with nearly half a dozen countries or pay them in natural gas. A 
possible spur to Sweden also has been considered. Although both 
countries are enthusiastic about the project, unresolved conflicts 
between the EU's liberalized natural gas market and Russia's state 
regulated system could be a hindrance.
    Rusiya Petroleum (a consortium led by TNK-BP), South Korea's state-
owned Korea Gas Corporation (Kogas), and the Chinese National Petroleum 
Company (CNPC) have announced plans to construct a pipeline connecting 
Russia's Kovykta field to China's northeastern provinces and across the 
Yellow Sea to South Korea. The plan calls for a 1.2 billion cubic feet-
per-year pipeline that would deliver roughly two-thirds of its natural 
gas annually to China, delivering the rest to South Korea and (in 
smaller quantities) to the domestic market en route. The partners 
expect that the pipeline could come online in 2008.
    There have been proposals for LNG export facilities at Murmansk, 
Yamal, and Shtokman near the Barents Sea. These terminals could provide 
U.S. East Coast LNG terminals with natural gas in the future. The 
economic success of Norway's nearby Snovit project, already further 
along the way to completion, will be a barometer for the success of 
other Barents Sea LNG terminals. To serve the Western United States and 
Asia, the developers of Sakhalin II have begun construction on the 
south end of Sakhalin Island.
Maps
http://www.eia.doe.gov/emeu/cabs/Caspian/Maps.html
                                 ______
                                 
    Senator Hagel. In conclusion, do either want of you want to 
add anything?
    Dr. Harbert. I would only add that this is a region of 
tremendous opportunity, and that, as Paul mentioned, this is a 
win-win, and that for these governments to take advantage of 
their natural resources for the benefit of their own economies 
requires the right investment climate and the right type of 
investment that multinational corporations offer.
    Senator Hagel. Thank you.
    Mr. Simons?
    Mr. Simons. No, thank you.
    Senator Hagel. Well, good to have you both back with us. 
And we are always appreciative of your efforts. Give our 
regards and thanks to your colleagues.
    Thank you.
    As the first panel is leaving, and as Bertie is setting up 
a new set of name plates, the second panel can move up to the 
table.
    [Pause.]
    Senator Hagel. Bertie, thank you. You always take good care 
of our guests. We are grateful. He usually gives each of you a 
glass of ethanol in the afternoon, just to make sure you're 
awake.
    Thank you, again. We are most grateful for each of you 
coming forward. And I think all of you, almost all of you, have 
been here a number of times and have testified before a number 
of committees. So, we're, again, appreciative of your efforts 
to come forward and share with us some of your thoughts on the 
issue that we're examining today.
    In the area of energy, which is vast, as you all know, we 
look forward to your testimony, and I'll have some questions at 
the end. Take the time that you need. And, as I introduced you, 
that's how we will begin.
    Mr. West, welcome back.

            STATEMENT OF J. ROBINSON WEST, CHAIRMAN,
                   PFC ENERGY, WASHINGTON, DC

    Mr. West. Thank you, Senator.
    I have my written testimony, and I'd like to a couple of 
points make, some of which were covered, in part, before.
    One, I think that the timing of this hearing is very 
important, because Russia takes over the leadership of the G-8 
in January. And I think this is an opportunity for both Russia 
and the G-8 which should not be lost. This is very timely.
    Russia is the only member of the G-8 which is not only a 
significant producer--the United States is also a significant 
producer--but it's also a significant exporter, so it really 
has a special role to play in the G-8. It has substantial oil 
reserves, but when it comes to gas, it is the Saudi Arabia of 
gas. It can play an already significant role, and it can play a 
tremendously important role.
    But it also lacks certain critical factors. It has the 
resources, but it lacks other things. Energy production 
requires massive long-term investment, capably managed. Russia 
has a long and distinguished history in oil and gas, but the 
current Russian oil and gas sector was created out of the chaos 
of the last 15 years, and it lacks the stability and 
organizational skills necessary to mount a giant multi-phased 
energy program, which is what's going to be required for Russia 
and for the world economy.
    President Putin has grand designs for the Russian energy 
industry. As the Russian military has fallen away, energy has 
become the keystone and capstone of--it is their foreign policy 
calling card, and it is their calling card to have a place at 
the high table of the world economy and geopolitics. President 
Putin believes the state should play a dominant role in certain 
strategic industries, particularly in oil and gas. He is well 
within his rights to promote this policy, but the sector must 
be managed efficiently. And right now, frankly, it isn't.
    We need management accountability and transparency, which 
remain serious problems, in each organization, along with the 
capital structure, management systems, and strategic outlook 
needed to organize and execute multi billion-dollar projects, 
taking 10 or 15 years to realize. This--just having a big 
bureaucracy managing things isn't good enough; it's got to be a 
competent bureaucracy, and there is very little demonstrated 
ability to manage a big portfolio of world-class projects.
    One of the points, also, that we believe is that my firm, 
PFC Energy Estimates, indicate that Russian oil production, 
which is now at about 9.2 million barrels per day, will peak at 
just over 10 million barrels per day in 2008, and then begin to 
plateau and decline unless there is a huge infusion of capital, 
technology, and management for further exploration and 
development. More importantly, the end of Russia's oil 
renaissance spells the end of recent growth in non-OPEC energy 
supplies. If you look at global oil markets, virtually all the 
surge in non-OPEC oil production has come from Russia.
    There is one slight misunderstanding that I think is 
important to correct. In the previous panel, the point was made 
that production had risen rapidly at the end of the nineties 
and the beginning of the new millennium. But the fact of the 
matter is, Russian production had collapsed earlier, and is now 
just getting back up to its former levels. So, this was really 
a brownfield renaissance. These were discovered fields. And so, 
I think it's important to put that in perspective.
    I think there are three areas that should be focused on. 
One is oil exploration, the second is liquefied natural gas, 
and the third is infrastructure. And the previous panel talked 
about it, and I know there will be discussion on gas.
    Without further exploration in other prospective regions--
notably, Eastern Siberia and the Arctic--we believe Russian 
production will begin to fall by the end of the decade. 
However, without a stable legal and operating environment and a 
tax policy that encourages investment in exploration, Russia 
simply will not meet its energy potential.
    Secondly, Russia is unique; its oil resources are vast 
distances from the border in export markets. As was pointed out 
in the earlier panel, the government, through Transneft, 
controls the oil and, through Gazprom, controls the gas. And 
there's going to be massive investment required in state 
companies. And finding a vehicle to do this is not 
uncomplicated.
    And another point is LNG--is liquefied natural gas. And 
many of the future megafields are located predominantly 
offshore, which require technology and expertise, especially in 
liquefied natural gas. And Gazprom, which insists on 
controlling many of these, simply has no experience in this 
area.
    And it's going to be LNG which is going to be the real 
energy bridge, if there is one, between the United States and 
Russia. And I think both Presidents, at Bratislava and other 
points, have made this. And unless the northern gas--Siberian 
gas is--develop LNG exports fairly quickly, however, other 
competing projects in Africa and the Middle East will beat them 
in the race to U.S. markets. There is a window. And if Russia 
doesn't get in this--in the queue, there are other places in 
West Africa and North Africa and the Middle East, and possibly 
even Latin America, that'll beat it out.
    As I mentioned earlier, there has been a brownfield 
renaissance, but, you know, exploration is going to be very 
important, and the private sector and international companies 
can really be critical in helping to support that.
    Again, Russia's energy sector power has been reconcentrated 
in state companies, or companies which are loyal to state 
interests. This is simply a fact. It's clear how committed--or, 
it is not clear how committed or able the state companies are 
to manage the sector efficiently. The challenges and needs are 
daunting. To put it in perspective, Gazprom--to give you an 
idea of the inefficiency of Gazprom, Gazprom consumes more gas 
to extract, process, and transport its gas per year than the 
entire country of France consumes in a year. So, instead of 
dwelling on the loss of Yukos--and there's been a lot of 
politics around here--I think it's very important that people 
focus on substantively getting Russia--helping Russia to 
optimize its portfolio. And the Government should look for ways 
to resurrect the U.S. energy dialogue in ways that promote 
efficiency, the participation of international oil companies in 
key projects, and the development of new resources within the 
context of the Kremlin's emerging energy doctrine. It's their 
oil and their gas--they're going to run it the way they want. 
But they have to understand it has to be run competently. And I 
think we've got to help them.
    But to get critical projects moving, international partners 
are going to be absolutely essential to assure high operating 
standards and the necessary capital requirements are available. 
Also that the U.S. dialogue must focus on real deals, not vague 
memorandum of understanding often signed by Russian companies, 
with no follow-through. The focus should also shift to more 
achievable and tangible discussions, such as technical 
solutions for pipeline bottlenecks, technology to increase 
energy efficiency of infrastructure, these kinds of--how to 
make the system work as well as it can.
    One of the things that I think is also important is that 
the dialogue and the U.S. Government should encourage the 
development of highly accountable, agile, and risk-taking 
independent oil and gas companies in Russia. This can become 
very, very important to moving projects forward. If you rely 
just on big state companies, I don't think we're going to get 
where we want to go. The oil and gas sector should not be left 
to state enterprises alone.
    In turning to Kazakhstan, I think it's important to 
recognize that Kazakhstan is arguably one of the most important 
new upstream investment frontiers since the opening of the 
North Sea in the 1970s, their huge--three supergiant fields--
Tengiz, Karachaganak, which is one of the world's largest gas 
condensate fields, and Kashagan, which is the largest single 
discovery in the last 25 years, and which is being developed by 
a consortium of companies, including Exxon and ConocoPhillips. 
But, ultimately, for Kazakhstan to realize its production 
potential, it'll have to decide what additional pipeline routes 
are used--to use or to build beyond the existing Soviet-era 
Transneft and CPC pipelines. Kazakhstan's output can continue 
to grow only if it gets access to more pipeline capacity before 
2010.
    Just as the world's energy security benefits from the 
diversity of supply, the regional energy security of Eurasia is 
enhanced by the diversity of export routes. Choke points in 
Russia, the Caucasus or the Bosporus can be mitigated through 
multiple export options. China is going to play a critical role 
in this. China borders Kazakhstan in the east, and it's also 
competing for access to Kazakhstan's reserves, introducing a 
noncommercial element to the competition for Kazakh resources. 
For example, it broke ground in 2004 to build its first-ever 
oil pipeline to connect foreign reserves to China before it 
struck its $4 billion acquisition, last month, of 
PetroKazakhstan. CNPC will become the second largest producer 
in Kazakhstan, after Kazakhstan's national oil company. 
However, China's involvement with the Kazakh energy sector 
should be seen as positive and natural evolution. We should not 
see it as competing. This is something I don't think we should 
discourage. And, for the global energy markets, as well, it 
provides additional diversity and should provide more diversity 
of export groups.
    One thing that is confusing to foreign oil company 
producers in Kazakhstan is the ultimate U.S. strategy with 
regard to multiple exit routes. Pipelines are projects with 
long lives, and politics and geopolitics can determine whether 
they operate or shut down. However, over the long life of a 
pipeline, political and geopolitical circumstances can change, 
especially in Russia, in regions such as the Caspian. I'd 
remind you that at the end of the Carter administration, the 
beginning of the Reagan administration, there was adamant 
opposition to the big gas lines from Russian going to western 
Europe. This turned out to be a mistake. Russia has turned out 
to be a very reliable supplier to western Europe, and it's an 
important link, and it's tended to stabilize Russia and build 
links with the West.
    The BTC pipeline is a perfect case, also. It was conceived 
in the early 1990s, with the desire to bypass Russia. Yet 
before the pipeline was even commissioned, BP, its operator and 
largest investor, is now the largest foreign investor in 
Russia, owning 50 percent of TNK-BP, as represented in this 
panel, which is now the second largest oil producer in Russia.
    Given the size and scale of the Kashagan project, which is 
a world-class project--this is a supergiant field; this is an 
elephant--the consortium partners are looking for export routes 
to reach markets. Pressure to build a pipeline via Iran is 
likely to grow. Non-U.S. foreign oil company producers may 
decide to stop second guessing U.S. policies and opt for 
commercial imperatives.
    In the end, whatever U.S. policy is, this is a business, 
and people have to recognize this. And if certain policy steps 
are taken to deny logical commercial investments, there will be 
a cost. It's certainly within the purview of Congress and the 
Administration to set whatever policy, but it's got to 
recognize that certain policies may lead to costs which could 
hurt the U.S. consumer and make life more difficult in the oil 
markets.
    In conclusion, both Russia and Kazakhstan, the timing for 
construction and the direction of new export routes will 
influence the pace of development of the energy sector in both 
countries. High oil prices have empowered both countries to 
pursue more resource, nationalist policies, and promote their 
respective national energy companies and project management 
skills, to explore and develop more technically complex 
projects in the Eurasian frontier.
    So, in conclusion, I would say, whatever policies are 
undertaken by the U.S. Government and recommended by Congress, 
I think it's very important to recognize that they must be made 
within a rational commercial context, or they can be self-
defeating.
    Thank you.

    [The prepared statement of Mr. West follows:]
      Prepared Statement of J. Robinson West, Chairman, PFC Energy
    Good afternoon. Senator Hagel and distinguished members of this 
Subcommittee, it is a pleasure to come before you today to address such 
an important topic. My name is Robin West and I am the Chairman of PFC 
Energy. PFC Energy is a strategic advisory firm, based in Washington, 
DC. We work with most of the companies in the global petroleum industry 
on various aspects of their international oil and gas investments and 
market strategies.
                 russia as the only g-8 energy exporter
    The timing of today's hearing is fortuitous as it occurs in the 
lead up to Russia assuming the 6-month leadership of the G-8 in January 
2006. President Putin has announced that the theme of his presidency 
will be energy security. Given recent events, this would be a good idea 
now no matter which country was leading the G-8, but makes particularly 
good sense under Russian leadership.
    Of all the G-8 members, Russia is the only nation with massive 
production and large reserves of oil and gas. It produces 9.2 million 
barrels of crude oil per day (bpd) and 22 trillion cubic feet (tcf) of 
natural gas. The U.S., the only other large producer in the G-8, 
generates 5.4 million barrels of crude oil per day and 19 tcf of gas. 
But Russia exports 4.85 million barrels of crude oil per day (bpd) and 
7.7 tcf of gas, whereas the U.S. imports about 12.1 million bpd of 
crude oil and products and 4.1 tcf of gas. Russia supplies world 
markets now and can do even more in the future. Given high prices and 
maturing production elsewhere, such as the North Sea and North America, 
Russia has a critical role to play with its large estimated reserves of 
oil, over 72 billion barrels and 1694 trillion cubic feet of gas. 
Russia is the Saudi Arabia of natural gas.
    Russia has the reserves to play this leading role on the world 
energy stage, but it lacks other critical factors. Energy production 
requires massive long-term investment capably managed. Russia has a 
long and distinguished history in oil and gas. The current Russia oil 
and gas sector however created out of the chaos of the last 15 years 
lacks the stability and organizational skills necessary to mount a 
giant multi-phase energy program.
  strong state oil and gas firms to dominate the russian hydrocarbon 
                                 sector
    President Putin has grand designs for the Russian energy industry. 
He believes the state should play a dominate role in certain strategic 
industries, particularly in oil and gas. He is well within his rights 
to promote this policy but the sector must be managed efficiently. 
State enterprises, notably Gazprom, Rosneft--Russia's national gas and 
oil companies, respectively and Transeft, Russia's oil pipeline 
company, have large assets and some very capable people. However, 
management accountability and transparency remain serious problems in 
each organization along with the capital structure, management systems, 
and strategic outlook needed to organize and execute multi-billion 
dollar projects taking 10 or 15 years to realize.
    One only has to read to the business headlines to be familiar with 
the on-again, off-again merger of Gazprom and Rosneft or have followed 
the completely bungled destruction of Yukos to realize that the current 
policies will not permit Russia to meet its energy potential. Gazprom's 
imminent bid for Sibneft, Russia's No. 5 oil producer and one of the 
most efficiently managed energy companies in Russia, combined with 
Rosneft's poaching of Yuganskneftegaz, Yukos' crown jewel production 
subsidiary, risks reversing the tremendous efficiency gains the Russian 
sector made in the 1990s--gains that were primarily the result of the 
adoption of Western technology and management know-how. The impact 
could be enormous, both for Russia and world's energy markets, as the 
world needs every barrel of Russian oil and molecule of Russian gas.
    Russia is the largest world's largest gas producer and now the No. 
2 oil producer, but its production growth has faltered in the past 
year. PFC Energy estimates indicate that Russian oil production, now at 
9.2 million barrels per day, will peak at just over 10 million barrels 
a day in 2008, and then begin to plateau and decline unless there is a 
huge infusion of capital, technology and management for further 
exploration and development. More importantly, the end of Russia's oil 
renaissance spells the end of recent growth in non-OPEC energy 
supplies. But with growing Chinese and Indian demand plus the 
insatiable appetite of the U.S., markets will be tight and even more 
reliant on the Middle East.
         bringing russian reserves to the international market
    The Russian energy sector needs international investment in several 
critical areas--oil exploration, liquefied natural gas, and 
infrastructure.
    There may be large energy reserves in Russia, probably the largest 
outside of the Middle East. But without massive investment and 
management skills, it will not flow. Billions will be needed as well to 
expand its export capacity. Extensive exploration has taken place in 
Western Siberia, where most of the oil production now occurs. Without 
further exploration in other prospective regions, notably Eastern 
Siberia and the Arctic, Russian production will begin to fall by the 
end of the decade. However, without a stable legal and operating 
environment and a tax policy that encourages investment in exploration, 
Russia will not meet its energy potential.
    Russia is unique in that oil resources are vast distances form the 
border and export markets. A large network of petroleum pipelines, 
managed by Transneft, requires critical upkeep and expansion costing 
billions. Pipelines linking Russia to China and Japan need to be built. 
Likewise, Transneft should commit not to hamper the operation and 
expansion of pipelines crossing Russia, notably from the Caspian 
region.
    Russia with its immense gas reserves is the largest supplier of 
natural gas to Western Europe. This gas moves through pipes built in 
the early-1980s over the strenuous objection of the Carter and Reagan 
administrations. In retrospect, this opposition was mistaken, since 
Russia has been a consistent, reliable supplier to the West. However, 
Gazprom faces production challenges within Russia and is still reliant 
on Soviet-era production facilities in Central Asia, primarily in 
Turkmenistan, to meet its supply contracts in Western Europe. With the 
exception of the Zapolyarnoye field, which was discovered in the 1960s 
but not opened in 2001, Gazprom has not commissioned a major field 
since the dissolution of the Soviet Union nearly 15 years ago.
    Future mega-fields in Russia are located predominately off-shore, 
which require technology and expertise, especially in the Liquefied 
Natural Gas (LNG) sphere, that Gazprom lacks. Progress is slowly being 
made with Sakhalin projects, and most recently with Chevron and 
ConocoPhillips named among six IOCs short-listed for the giant Shtokman 
LNG project. LNG is a different business than pipeline gas. It involves 
super cooling natural gas to a liquid, loading it on large specialized 
tankers, and shipping it long distances to terminals near concentrated 
markets, primarily in Western Europe, North America, and Asia. LNG 
projects involve a chain of massive investments tied by complex 
commercial arrangements competing against other LNG projects.
    Russia has virtually no experience in LNG, and yet LNG represents a 
critical opportunity for Russia. More importantly, LNG is the means by 
which a true energy bridge can be built between Russia and the U.S., a 
goal of both Presidents Putin and Bush. Unless the northern Siberian 
gas is developed into LNG exports quickly however, other competing 
projects in Africa and the Middle East will beat them in the race to 
the U.S. markets.
    However, negotiations undertaken by international companies in 
Russia are an ordeal. State enterprises are often slow and unfocused, 
negotiating with many companies for the same projects. The bureaucracy 
is opaque and sometimes corrupt. Russian oil and gas laws can be 
unworkable, titles to reserves contradictory, and in some cases, tax 
laws effectively confiscatory.
              resurrecting the u.s.-russia energy dialogue
    The U.S. has focused on Russia for an energy partnership because of 
its impressive oil production increases. No other country had made such 
production gains--growing from 6.8 million barrels a day to 9.2 million 
barrels a day in 2004. As mentioned previously, this growth was fueled 
by the so-called ``brownfield renaissance'' where Gazprom and the 
Russian oil companies continued to exploit existing big fields, and 
avoided the daunting task of developing large new greenfield oil and 
gas projects. The U.S. Government sought to define a closer 
partnership, whereby U.S. oil companies would participate in the 
development of the expensive new fields and pipelines that drive future 
production increases. Just as the U.S.-Russia energy relationship 
appeared to be heading toward a clearer definition in 2003, the arrest 
of Khodorkovsky and manner in which Yukos was destroyed effectively put 
the U.S.-Russia energy dialog on hold as the Kremlin grappled with how 
it wants to manage its energy sector, a debate which persists to this 
day.
    It is clear that Russia's energy sector will be dominated by state 
companies, or companies ``loyal'' to the state's interests. That is a 
fact. It is less clear how committed--or able--the state companies are 
to managing the sector efficiently. The challenges and needs are 
daunting--to put it in perspective, Gazprom consumes more gas to 
extract, process and transport its gas per year than the entire country 
of France consumes in a year.
    Instead of dwelling on the loss of Yukos from Russian energy scene, 
the U.S. government should look for opportunities to resurrect the 
U.S.-Russia energy dialog in ways that promote efficiency, 
participation of IOCs in key projects and the development of new 
resources within the context of the Kremlin's emerging energy doctrine. 
To get critical projects moving quickly, international partners are 
needed to ensure that high operating standards and the necessary 
capital requirements are available.
    However, to be effective, the U.S.-Russia energy dialog must focus 
on real deals, not vague memorandum of understanding often signed by 
Russian companies with no follow through. The focus should also shift 
to more achievable and tangible discussions, such as technical 
solutions for pipeline bottlenecks, technology to increase energy 
efficiency of infrastructure, etc. Too often the dialog has focused on 
overly ambitious, Soviet-style mega-projects that have ended in failure 
due to a lack of political will or commerciality, or both.
    Likewise, steps should be taken to encourage the development of 
highly accountable, agile, and risk-taking independent oil and gas 
companies in Russia. The oil and gas sector should not be left to state 
enterprises alone.
       caspian sea development to be determined by export access
    The location of the Caspian Sea region, between Russia and Iran, 
has determined the focus of U.S. interests toward this region. In part 
to promote the sovereignty of the newly independent countries of 
Central Asia, as well as to maintain the isolation of Iran, the U.S. 
government dedicated the majority of its regional efforts in the 1990s 
to energy policy. The most visible result of this effort is $3.6 
billion, 1,100-mile Baku-Tbilisi-Ceyhan pipeline which is scheduled to 
deliver first oil this year.
    Despite the initial flurry of activity focused on Azerbaijan, due 
in a large part to its strategic location bordering Iran, Kazakhstan is 
arguably one of the most important new upstream investment frontiers 
since the opening of the North Sea in the 1970s. IOC participation to 
date has focused on three key mega-projects: Tengiz--one of the world's 
giant oil fields, operated by Chevron with ExxonMobil and Kazmunaigaz, 
Kazakhstan's national oil company, holding minority stakes; 
Karachaganak--the world's largest gas condensate field, operated by ENI 
and BG with Chevron holding a minority position; and Kashagan--the 
largest single discovery in the past 25 years which is currently 
underdevelopment by a consortium led by ENI with ExxonMobil and 
ConocoPhillips among the project partners. Collectively, all three 
projects have the potential to propel Kazakhstan into the elite company 
of the world's largest energy producers. Kazakhstan's exports currently 
average 800,000 barrels per day, with the potential to increase upwards 
of 1.6 million barrels per day by 2010, and by 2020 nearly 3.6 million 
barrels per day.
    Additional significant investment by Western companies in 
Kazakhstan's offshore, which is technically complex given its unique 
characteristics, is predicated on the Kazakhs offering attractive and 
transparent fiscal terms. However, as highlighted by the Kazakhs' 
recent use of a controversial pre-emption right to buy into the 
Kashagan project consortium or the less than favorable new Production 
Sharing Agreement (PSA) law, the Kazakh government's intent is clearly 
to create a much more robust national oil champion in the coming years 
with a greater volume of production directly under its control.
    Ultimately, for Kazakhstan to realize its production potential, it 
will have to decide what additional pipeline routes to use or build 
beyond the existing Soviet-era Transneft and Caspian Pipeline 
Consortium (CPC) pipelines. Kazakhstan's output can continue to grow 
only if it gets access to more pipeline capacity beyond 2010. The 
expansion of the CPC pipeline, which crosses Russia to the Black Sea, 
has been cast into doubt as Russia, which owns a stake in the pipeline, 
has sought renegotiate the terms of the project. Meanwhile, and perhaps 
not coincidentally, Russia is simultaneously promoting the upgrading of 
the Atyrau-Samara route, which links into its Transneft system. 
Kazakhstan is also considering accessing the BTC pipeline, which would 
require the upgrading of port facilities to ship crude by tanker across 
the Caspian Sea before offloading into the BTC pipeline.
    Just as the world's energy security benefits from the diversity of 
supply, the regional energy security of Eurasia is enhanced by the 
diversity of export routes. Choke points in Russia, the Caucasus, or 
the Bosporus can be mitigated through multiple export options. Unlike 
the Chinese, IOC-led pipeline consortiums, including BTC, must make 
their investment decisions on a commercial basis, including the timing 
of alternative available export options and adequate supply over the 
life of the pipeline. Still, experience in the region has shown that 
politics can play an important role in pipeline commitments, but 
politics is difficult for companies to predict.
    China, which borders Kazakhstan to the east, is also competing for 
access to Kazakhstan's reserves, introducing a non-commercial element 
to the competition of Kazakh resources. It broke ground in 2004 to 
build its first-ever oil pipeline to connect foreign reserves to China 
before it struck its $4 billion acquisition deal last month of 
PetroKazakhstan, a Canadian based oil company with operations 
exclusively in Kazakhstan, which will supply the pipeline. With this 
transaction, CNPC will become the second largest producer in 
Kazakhstan, after Kazakhstan's national oil company. However, China's 
involvement in the Kazakh energy sector should be seen as a positive 
and natural evolution for the region, and for the global energy markets 
as well, as it provides additional diversity of export routes as well 
incremental supply to the world markets.
    One thing that is confusing to foreign oil company producers in 
Kazakhstan is the ultimate U.S. strategy with regard to multiple exit 
routes. Pipelines are projects with long lives and, yes, politics and 
geopolitics can determine whether they operate or shut down. However, 
over the long life of a pipeline, political and geopolitical 
circumstances can change--especially in Russia and regions such as the 
Caspian. The BTC pipeline is a perfect case in point. It was conceived 
in the early 1990s with the desire to bypass Russia. Yet before the 
pipeline is even commissioned, BP--its operator and largest investor--
is now the largest foreign investor in Russia, owning 50 percent of 
TNK-BP, which is now the second largest oil producer in Russia.
    Given the size and scale of the Kashagan project, the consortium 
partners are looking for export outlets to reach markets. Pressure to 
build a pipeline via Iran is likely to grow. Non-U.S. foreign oil 
company producers may decide to stop second-guessing U.S. policies and 
opt for commercial imperatives.
                               conclusion
    In both Russia and Kazakhstan, the timing for construction and the 
direction of new export routes will influence the pace of development 
of the energy sector in both countries. High oil prices have empowered 
both countries to pursue more resource nationalist policies and promote 
their respective national energy companies as the dominate player in 
the sector.
    However, IOC participation will still be required to bring their 
technology and project management skills to explore and develop more 
technically complex projects in Eurasia' frontier regions. For too 
long, energy has been used policymakers as a proxy for geopolitical 
influence in the region, instead of seeing the resources as the basis 
for economic independence and interdependence as the countries of 
Eurasia become integrated in the world energy markets.
    From a policy perspective, these regional issues of production and 
transportation are interwoven with U.S. strategy for global energy 
security. U.S. policy can and should promote increased oil and gas 
trade with Russian and the Caspian Sea region, which will contribute to 
the diversity of supply and to the future economic growth and security 
of these countries--a result that will have considerable consequences 
for U.S. energy and foreign policy objectives.

    Senator Hagel. Mr. West, thank you.
    Mr. Ferguson, welcome.

 STATEMENT OF ALASTAIR FERGUSON, DEPUTY EXECUTIVE DIRECTOR FOR 
                GAS DEVELOPMENT, TNK-BP, MOSCOW,
                             RUSSIA

    Mr. Ferguson. Thank you.
    Mr. Chairman, I appreciate your invitation to address this 
hearing entitled ``Energy Supplies in Eurasia and implications 
for U.S. Energy Security.'' And, as the deputy executive 
director for gas development at TNK-BP, based in Moscow, I 
spend a considerable amount of my time working on East Siberian 
developments.
    For the record, TNK-BP is a company jointly owned by both 
BP and Alfa-Access-Renova, and, at more than $10 billion, 
represents the largest single foreign investment in Russian 
history. We're currently the second-largest producer of oil in 
Russia, roughly the same worldwide level as Chevron, and larger 
than ConocoPhillips.
    In addition to presenting my oral testimony, I ask 
permission to submit a slide presentation on unlocking of East 
Siberian resources into the record.
    Senator Hagel. It will be included in the record. Please 
proceed. Thank you.
    Mr. Ferguson. My testimony today will center on the 
hydrocarbon-rich region of East Siberia and the role that it 
can specifically play in helping to meet global energy demands 
over the coming decades, including the United States, to ensure 
that liquefied natural gas will be available for both the West 
Coast, for both Middle East and Asia-Pacific suppliers.
    Before starting, let me state clearly that I'm here 
representing a Russian company, and that, while the main focus 
of our activities is inside Russia, we appreciate the 
importance of engaging with key external audiences to 
understand the significant role of Russia in global affairs. 
And that clearly includes this committee.
    As part of Russia's upcoming chairmanship of the G-8 next 
year, energy will be very high on that agenda, and my comments 
here today are in support of these efforts. What I'm about to 
say, I and my senior colleagues have said inside Russia many 
times.
    In today's tight energy markets, every energy producer is 
important to global supply. Russia, specifically, is one of the 
most important members of that club. The country has the 
world's largest proven resources of natural gas, the second-
largest coal reserves, and the eighth-largest proven oil 
reserves. Yet there are significant challenges.
    While Russia remains the largest non-OPEC producer of oil, 
production rates have been largely stagnant for the past 12 
months, and industry analysts expect that trend to continue. 
Therefore, increasing Russian production will be critical to 
meeting future global oil demand.
    As for natural gas, Russia holds nearly twice the reserves 
of the next-largest country, Iran. In 2004, Russia was the 
world's largest natural gas producer, as well as the world's 
largest exporter.
    According to the U.S. Department of Energy, however, 
Russia's natural gas industry has not been as successful as its 
oil industry at increasing production. The DOE notes that 
Russia's energy strategy calls for only modest natural gas 
production growth, about 1.3 percent, by 2010. In addition, and 
significantly, Gazprom's big three major fields in West 
Siberia, which comprise more than 70 percent of Gazprom's total 
natural gas production, are now in decline.
    Interestingly, Russia's gas pipeline exports only flow 
west, to Europe, not east, to the growing--fast-growing Asia-
Pacific markets. But Russia has successfully built a sizeable 
European business, supplying about 25--between 27 to 30 
percent, depending on the calculations, of current European 
market demand.
    Now, Asia has become a principal driver in world energy 
markets, largely due to China's remarkable consumption growth 
in recent years. The continuing surge in China's oil demand, 
which increased by 15 percent, or almost one million barrels 
per day in 2003 alone, has emerged as a major factor in 
influencing prices.
    As the gap between consumption and production levels in 
Asia expands, the regional economic powers appear to be 
concerned that tight supplies and consequent high prices may 
constrain economic and industrial growth. As China, Taiwan, 
South Korea, Japan, and even the U.S. West Coast scramble to 
meet their growing energy needs, the largely undeveloped 
resources of East Siberia have become viewed as a potentially 
important supply option.
    The Russian energy strategy to 2020, as outlined in the 
middle of 2003, set specific targets to deliver Russian gas and 
Russian pipeline gas into key Asia-Pacific markets and open up 
a new export corridor to the East from 2010. The real question 
is how best to meet this demand.
    As mentioned earlier by other speakers, Russia has 
significant proven energy reserves, but many of its untapped 
resources are geographically well-positioned to supply the 
growing Asia-Pacific markets, including the U.S. Perhaps the 
most significant undeveloped hydrocarbon region is East 
Siberia, an area analogous, in terms of its energy riches, with 
the Caspian Sea 15 years ago. The parallels are actually quite 
striking. Significant undeveloped resource space, both oil and 
gas, a need for technology and large-scale financial investment 
to establish both new export corridors and infrastructure, and 
a need for key strategic geopolitical decisions from the 
respective governments.
    A cursory look at the region indicates that it could, in 
fact, be much bigger. First, its size. As you can see from the 
first chart--the first enlarged chart, over here--East Siberia 
is a massive geographical area, 90 percent of the size of the 
continental U.S. As Senator Hagel knows, Nebraska fits into 
this region 36 times.
    As for its hydrocarbon resource potential, Russian and 
Western geologists have found that the vast majority of the 
province has the potential to contain oil and gas in truly 
world-scale quantities.
    As you can see from the second chart, so far only about 
4\1/2\ percent of the oil producing areas have been explored, 
and about 7 percent of the gas areas. But this has already 
resulted in proven gas reserves of just under 200 trillion 
cubic feet, exceeding those of both the United States and the 
Gulf of Guinea. The resource base in one field alone, Kovykta, 
is more than the whole of China's gas resource space.
    As for oil, at the bottom of this chart, seven billion 
barrels have been proven, but there is the potential for this 
figure to reach a level equal to all of U.S. and Caspian proven 
reserves combined.
    Having spent more than 26 years in the oil and gas 
industry, and seeing how the advances of technology have taken 
us to the extremes of our planet in search of resources, I can 
safety tell you that this is one of the largest remaining 
undeveloped hydrocarbon basins in the world today.
    I believe the next key question, therefore, is how to 
develop these resources and get them to market. The Russian 
Government is currently considering options for construction of 
an oil pipeline to China, and the country's eastern coastline 
to serve regional energy markets, including Japan and the U.S. 
West Coast. A proposed gas pipeline, however, is more 
problematic.
    Some critics argue that Russian should develop either the 
Sakhalin gas fields offshore in eastern Russian or the East 
Siberian gas fields. They maintain that the current market does 
not justify development of both. We feel strongly otherwise. 
And let me explain.
    While current U.S. West Coast uncontracted LNG demand is 
relatively small, the amount of expected demand by 2020 is 
significant--by our calculations, more than 20 billion cubic 
meters per annum, and nearly three-quarters of that expected 
supply has yet to be identified.
    China, on the other hand, is expected to consume nearly 200 
billion cubic meters annual by 2020, and nearly 40 percent of 
that figure, or five times as much as U.S. West Coast demand, 
will need to be imported and has yet to be contracted.
    If one adds in the other Asia-Pacific countries, the 
region, as a whole, will require 200 to 250 billion cubic 
meters per annum of gas imports by 2020, to be contracted over 
the next 15 years. This is double the current level of LNG 
imports to the region today, and will result in intense 
competition for resources.
    As far as reserves are concerned, the amount of gas 
reserves and resources in Sakhalin is smaller than Kovykta in 
East Siberia, and this is especially important, when 
considering that those who favor a Sakhalin or East Siberia 
approach see this gas supplying Chinese, Japanese, and U.S. 
West Coast markets, amongst others.
    Secondly, the gas from Sakhalin is associated gas, meaning 
that its production rates track that of the oil reserves where 
it is situated. This means that it rises and falls with oil 
production and is difficult to guarantee a steady supply of gas 
to those markets.
    Clearly, Sakhalin cannot provide all of--for all of these 
demands alone, nor can one field like Kovykta and East Siberia. 
But together they can make a major contribution to growing 
regional energy consumption, and can significantly alter the 
Asia-Pacific region gas balance. In fact, the Asia-Pacific 
market is so significant that it justifies fuel-field 
development and construction of a 4,800 kilometer pipeline from 
East Siberia to China and on to South Korea, one that would 
stretch from this committee hearing room in Washington to 
Anchorage, Alaska, at a cost of up to 18 billion U.S. dollars.
    Without Kovykta and East Siberia, however, the picture is 
very different. The fast-growing economies of East Asia are 
likely to sink, pulling in a significant amount of gas 
production from other regional producers, including the Middle 
East, Indonesia, and Australia, and this will result in the 
U.S. West Coast being severely limited in its supply options. 
And, second, it will drive global prices for natural gas 
higher, because the massive gas fuels in East Siberia, 
including Kovykta will remain stranded.
    Timing is another key issue here. China, Taiwan, South 
Korea, and Japan all understand these dynamics extremely well. 
They're not only looking to the future, but are also planning 
for it. China, for example, is studying the options to 
construct as many as 11 LNG regasification facilities along its 
east and northeastern coast to take Middle East, Indonesian, 
and Australian liquefied natural gas in the event that East 
Siberian gas fields transporting Russian pipeline gas to China 
are not developed. So, even with the development of East 
Siberia, China will need some additional LNG, but, without, it 
will need to focus clearly on LNG from other markets.
    At TNK-BP, we've spent the last 2 years studying these 
issues in detail. And over the previous 5 to 8 years, the 
companies--the legacy companies have spent $300 million in this 
process. We have analyzed the various transportation options 
and project costs. We've engaged in extensive research and 
negotiations in market demand. And we have assessed the impact 
of developing Kovykta and Sakhalin gas at the same time.
    We feel that we understand these issues well, and it is our 
view that both projects can, and should, be developed at the 
same time. There is significant market demand in China, Taiwan, 
South Korea, Japan, and the United States to develop Sakhalin 
and, at the same time, utilize the natural gas from East 
Siberia--in Kovykta, specifically.
    Let me add that Kovykta needs to be viewed as the anchor 
project around which East Siberian gas resources can be 
developed. East Siberian pipeline gas can supply Asia markets 
and indirectly free supplies of LNG to be exported to U.S. West 
Coast markets.
    In summary, this is about getting the right gas to the 
right markets at the right time. Furthermore, we believe that 
the East Siberian energy can be developed in a way that fosters 
regional cooperation and energy security while maximizing 
market economic principles by providing China, the U.S., and 
others the energy needed to meet future demand.
    East Siberian pipeline gas to Asia is also the most cost-
effective way to export Russian gas while providing for 
important regional development in Russia. This would, in turn, 
maximize the revenues to Russia.
    In short, and as mentioned by the previous speakers, this 
is a true win-win scenario that will fundamentally change the 
energy relationship between Russia, China, and South Korea, 
and, at the same time, provide greater energy security to the 
Asia-Pacific region.
    In summary, I'd like to reiterate what I said at the start 
of my comments. I was invited here as the representative of a 
Russian company that understands the importance of engaging 
with key external audiences. And, as part of Russia's upcoming 
chairmanship of the G-8 next year, energy security will be very 
high on the agenda. And my comments here today are in support 
of these efforts.
    While East Siberia is a relatively unknown hydrocarbon 
region today, I hope that I've demonstrated just how important 
it will be over the coming years and decades to be an important 
support of supply to world markets if developed in a timely and 
efficient way.
    Thank you.

    [The prepared statement of Mr. Ferguson follows:]
Prepared Statement of Alastair Ferguson, Deputy Executive Director for 
                        Gas Development, TNK-BP
    Mr. Chairman, members of the Committee, I appreciate your 
invitation to address this hearing entitled ``Energy Supplies in 
Eurasia and Implications for U.S. Energy Security.'' My name is 
Alastair Ferguson and I am the Deputy Executive Director for Gas 
Development at TNK-BP. TNK-BP is a company jointly owned by BP and 
Alfa-Access-Renova, and at more than $10 billion represents the largest 
single foreign investment in Russian history. We are currently the 
second largest producer of oil in Russia; roughly the same worldwide 
level as Chevron and larger than ConocoPhillips.
    My testimony today will center on the hydrocarbon rich region of 
East Siberia and the role that it can play in helping to meet global 
energy demands over the coming decades--including, for the United 
States, to ensure that liquefied natural gas will be available for the 
West Coast from both Middle East and Asian-Pacific suppliers.
    Before starting, let me state clearly that I am here representing a 
Russian company and that while the main focus of our activities is 
inside Russia, we also appreciate the importance of engaging with key 
external audiences that understand the significant role of Russia in 
global affairs--and that clearly includes this Committee. As part of 
Russia's upcoming chairmanship of the G-8 next year, energy will be 
high on the agenda. My comments here today are in support of these 
efforts. What I am about to say I, and my senior colleagues, have said 
many times inside Russia.
                         russia's resource base
    In today's tight energy markets, every energy producer is important 
to global supply. Russia specifically is one of the most important 
members of that club. The country has the world's largest proven 
resources of natural gas, the second largest coal reserves and the 
eighth largest proven oil reserves.
    Yet there are challenges. While Russia remains the largest non-OPEC 
producer of oil, production rates have been largely stagnant for the 
past 12 months--and industry analysts expect that trend to continue. 
Therefore, increasing Russian production will be critical to meeting 
future global oil demand.
    As for natural gas, Russia holds nearly twice the reserves (1694 
tcf, 48 tcm) of the next largest country, Iran. In 2004, Russia was the 
world's largest natural gas producer (57 bcfd, 589 bcma) as well as the 
world's largest exporter (14.2 bcfd, 148 bcma).
    According to the U.S. Department of Energy, however, Russia's 
natural gas industry has not been as successful as its oil industry at 
increasing production. The DoE notes that ``Russia's energy strategy 
calls for only modest natural gas production growth (about 1.3 percent) 
by 2010.'' In addition, Gazprom's Big Three major fields in Western 
Siberia which comprise more than 70 percent of Gazprom's total natural 
gas production are now in decline. Interestingly, Russian gas pipeline 
exports only flow west to Europe--not east to growing Asian markets. 
Russia has successfully built a sizable European business supplying 
(150 bcma) about 27 percent of current European market demand.
                         growing demand in asia
    Asia has become a principal driver in world energy markets, largely 
due to China's remarkable consumption growth in recent years. The 
continuing surge in China's oil demand, which increased by 15 percent, 
or almost 1 million barrels per day in 2003 alone, has emerged as a 
major factor in influencing world oil prices.
    As the gap between consumption and production levels in Asia 
expands, the region's economic powers appear to be concerned that tight 
supplies and consequent high prices may constrain economic growth. As 
China, Taiwan, South Korea, Japan and even the U.S. West Coast scramble 
to meet their growing energy needs the largely undeveloped resources of 
East Siberia have become viewed as a potential important supply option. 
The Russian Energy Strategy to 2020 as outlined in 2003 set specific 
targets to deliver (10 bcfd, 106 bcma) Russian gas into key Asia 
Pacific markets and open up a new export corridor to the east. The real 
question is how best to meet this demand.
                        east siberian resources
    As discussed above, Russia has significant, proven, energy 
reserves. Many of its untapped resources are geographically well 
positioned to supply the growing Asia-Pacific markets--including the 
United States. Perhaps the most significant undeveloped hydrocarbon 
region is East Siberia; an area analogous in terms of its energy riches 
with the Caspian Sea 15 years ago.
    The parallels are striking--significant undeveloped resource base 
(both oil and gas), a need for technology and large-scale financial 
investment to establish new export corridors, and a need for key 
strategic/geopolitical decisions from respective governments. A cursory 
look at the region indicates that it could, in fact, be much bigger.
    First, its size. As you can see from this chart, East Siberia is a 
massive geographical area; 90Sec. rcent of the size of the continental 
United States. As Senator Hagel knows, Nebraska fits into this region 
36 times.
    As for its hydrocarbon resource potential, Russian and western 
geologists have found that the vast majority of the province has the 
potential to contain oil and gas in truly world-scale quantities. As 
you can see from this second chart, so far only 4.4Sec. rcent of oil 
producing zones have been explored and only 7 percent of the gas 
zones--but this has resulted in proven gas reserves of 198 tcf, (5,6 
tcm) exceeding those of both the United States and the Gulf of Guinea. 
The resource base in one field alone, Kovykta (2 tcm) is more than the 
whole of China's gas resource base. As for oil at the bottom of this 
chart, 7 billion barrels have been proved but there is the potential 
for this figure to reach a level (75 billion barrels) equal to all U.S. 
and Caspian proved reserves combined.
    Having spent more than 26 years in the oil and gas industry--and 
seeing how the advances of technology have taken us to the extremes of 
our planet in search of resources--I can safely tell you that this is 
one of the largest remaining undeveloped hydrocarbon basins in the 
world.
                           access to markets
    I believe the next key question, therefore, is how to develop these 
resources and get them to market.
    The Russian government is currently considering options for 
construction of an oil pipeline to perhaps China and the country's 
eastern coastline to serve regional energy markets including Japan and 
the U.S. West Coast.
    A proposed gas pipeline, however, is more problematic. Some critics 
argue that Russia should develop either the Sakhalin gas fields 
offshore eastern Russia or the East Siberian gas fields, including the 
massive Kovykta reserves. They maintain that the current market does 
not justify development of both fields. We feel strongly otherwise. Let 
me explain.
    While current U.S. West Coast un-contracted LNG demand is 
relatively small, the amount of expected demand by 2020 is significant 
(more than 20 billion cubic meters annually), and nearly \3/4\ of that 
expected supply has yet to be identified. China, on the other hand, is 
expected to consume nearly 200 billion cubic meters annually by 2020, 
and nearly 40 percent of that figure--or 5 times as much as U.S. West 
Coast demand--will need to be imported and has yet to be contracted.
    If one adds in the other Asia-Pacific countries, the region as a 
whole will require 200-250 bcma of gas imports by 2020 to be contracted 
over the next 15 years. This is double the current level of LNG imports 
to the region today and will result in intense competition for 
resources.
    As far as reserves are concerned, the amount of gas reserves in 
Sakhalin are smaller than Kovykta--and this is especially important 
when considering that those who favor a Sakhalin or Kovykta approach 
see this gas supplying Chinese, Japanese and U.S. West Coast markets. 
Second, the gas from Sakhalin is ``associated gas'' meaning that its 
production rates track that of the oil reserves where it is situated. 
This means that it rises and falls with oil production and is difficult 
to guarantee a steady supply of gas to markets.
    Clearly, Sakhalin cannot provide for all of these demands alone--
nor can Kovykta--but together they can make a major contribution to 
growing regional energy consumption and can significantly alter the 
Asia Pacific Region gas balance. In fact, the Asia-Pacific market is so 
significant that it justifies full-field development and construction 
of a 4,800 kilometer pipeline from East Siberia to China and onto South 
Korea--one that would stretch from this Committee hearing room in 
Washington to Anchorage, Alaska--at a cost of $18 billion dollars.
    Without Kovykta, however, the picture is very different. The fast 
growing economies of East Asia will act as a sink, pulling in a 
significant amount of gas production from the other regional producers 
including the Middle East, Indonesia and Australia. This will result in 
the U.S. West Coast being severely limited in its supply options--and 
second, it will drive global prices for natural gas higher because the 
massive gas fields East Siberia, including Kovykta, will remain 
stranded.
    Timing is another key issue here. China, Taiwan, South Korea and 
Japan all understand these dynamics extremely well. They are not only 
looking to the future, but also planning for it. China, for example, is 
studying options to construct as many as 11 LNG re-gasification 
facilities along its east and northeastern coasts to take Middle East, 
Indonesian and Australian liquefied natural gas in the event that the 
East Siberian gas fields transporting pipeline gas to China are not 
developed. Even with development of East Siberia, China will need some 
additional LNG, but without they will need to focus clearly on LNG from 
other markets.
    At TNK-BP, we have spent the last 2 years studying these issues in 
detail and spending $300 million in the process. We have analyzed the 
various transport options and project costs. We have engaged in 
extensive research and negotiations on market demand and we have 
assessed the impact of developing Kovykta and Sakhalin gas at the same 
time. We feel that we understand these issues well and it is our view 
that both projects can and should be developed at the same time. There 
is sufficient market demand in China, Taiwan, South Korea, Japan and 
the United States to develop Sakhalin and at the same time utilize the 
natural gas from Kovykta and East Siberia. Let me also add that Kovykta 
should be viewed as the anchor project around which East Siberia's gas 
resources can be developed. East Siberian pipeline gas can supply Asian 
markets and indirectly free supplies of LNG to be exported to American 
markets.
    In summary this is about getting the right gas, to the right 
markets, at the right time.
    Furthermore, we believe that East Siberian energy can be developed 
in a way that fosters regional cooperation and energy security while 
maximizing market economic principles by providing China, the U.S. and 
others, with the energy needed to meet future demand. East Siberian 
pipeline gas to Asia is also the most cost effective way to export 
Russian gas--while also providing for important regional development in 
Russia--and would in turn maximize revenues to Russia. In short, this 
is a true win-win scenario that will fundamentally change the energy 
relationship between Russia, China and South Korea, and provide greater 
energy security to the Asia-Pacific region.
                               conclusion
    Senator, in summary I would like to reiterate what I said at the 
start of my comments. I was invited here as the representative of a 
Russian company that understands the importance of engaging with key 
external audiences. As part of Russia's upcoming chairmanship of the G-
8 next year, energy security will be high on the agenda and my comments 
here today are in support of these efforts. While East Siberia is a 
relatively unknown hydrocarbon region, I hope that I have demonstrated 
today how it has the potential over the coming years and decades to be 
an important source of supply to world markets if developed in a timely 
and efficient way.
    Thank you for your time and attention.

    Senator Hagel. Mr. Ferguson, thank you.
    Ms. Baran, welcome.

 STATEMENT OF ZEYNO BARAN, DIRECTOR OF INTERNATIONAL SECURITY 
     AND ENERGY PROGRAMS, THE NIXON CENTER, WASHINGTON, DC

    Ms. Baran. Thank you, Mr. Chairman, for the opportunity to 
appear before you today.
    With your permission, I would like to submit my full 
statement and briefly highlight some of the key points.
    Senator Hagel. It will be included in the record. Please 
continue.
    Ms. Baran. Thank you.
    The Eurasian region is strategically important for the U.S. 
in diversifying energy supplies away from reliance on Saudi 
Arabian and Persian Gulf energy resources. While the U.S. needs 
to ensure that these hydrocarbons are developed and that they 
reach world markets cheaply and safely, it also needs to make 
sure the countries in the region will reform internally. 
Otherwise, as we try to diversify away from dependence on 
Middle Eastern oil and gas, we will be creating a second Middle 
East.
    Senator Hagel, as you well know, the U.S./Caspian Sea 
multiple pipeline strategy that was developed in the 1990s was 
fairly effective. Given changes across Eurasia, it is important 
to come up with a new framework for the broader Eurasian 
region.
    Today, the biggest policy challenge for the U.S. is Russia. 
As other speakers mentioned, Russia is the world's largest gas 
exporter, and the second-largest oil exporter after Saudi 
Arabia. A Department of Energy report describes the Russian gas 
monopoly Gazprom as ``one of Moscow's main foreign policy 
tools.'' Russia's use of energy as a foreign policy tool is the 
key point on which I would like to focus in my testimony.
    Over the past several years, we have seen Putin dismantle 
Yukos, once the largest Russian oil company. Through state-
owned Rosneft, the Kremlin has gradually consolidated the 
assets of Yukos under its control. Gazprom is also planning to 
buy the privately held Sibneft, Russia's fifth-largest oil 
producer, and enter the oil sector as well. Soon, Putin will be 
in direct control of the world's largest integrated oil and gas 
enterprise.
    Adding to the strength of its monopolistic base at home has 
been the increase in oil prices. I believe as long as oil 
prices remain high, there is little incentive for the Russian 
Government to improve the investment climate and attract the 
billions of dollars of capital necessary to increase oil and 
gas production. But it is in America's and world energy 
security's interests for Russia to produce more oil and gas, 
and as we heard, it is important to act fast.
    Early oil is running out, and huge investment and new 
technologies are needed to exploit the more remote and 
difficult fields, such as those in the West and East Siberia. 
Therefore, now is a good time to discuss a set of new 
initiatives and conditions, especially as Russia prepares to 
assume the presidency of the G-8. Russia has already stated 
that energy security will be its major theme. The U.S. needs to 
have its own energy security strategy as well.
    The U.S. needs to engage with Russia on energy and ensure 
that it can purchase Russian oil and gas, including LNG, on a 
commercial basis. In order for this to occur, the U.S. and 
Russia need to work together to channel Gazprom and other oil 
and gas industry operators toward market-based and to mitigate 
monopolistic power.
    The U.S. and the EU share similar interests in this area. 
In fact, their common position should be to try to break up the 
monopolies that control the oil, natural gas, and electricity 
industries across Europe and Eurasia. Not only are monopolies 
clearly bad for consumers, charging higher prices than would 
firms in a more competitive situation, but they also offer 
geostrategists in the Russian government an irresistible 
temptation to use energy supplies as leverage over Russia's 
neighbors.
    Russia will need a lot of investment in new infrastructure 
in order to develop its major oil and gas fields. The U.S., 
together with the EU, could put together a large package with 
the involvement of international financial and lending 
institutions, as well as the Western and Russian private 
sector. But this package should be made conditional on Russia 
improving the investment climate by promoting the rule of law 
and bringing transparency to governance. These forms will be 
required to make the major investments happen.
    The U.S. needs to hold a transatlantic discussion to urge 
the Europeans not to cut any further long-term deals with 
Russian monopoly companies without any pressure to change; 
otherwise, Europeans will be hurting Russian energy development 
as well as their own long-term security.
    Last December, the International Energy Agency expressed 
concern that the EU as a whole was becoming too reliant on 
Gazprom, which could use its power as a monopoly supplier to 
push up gas prices.
    Despite its might, Gazprom is vulnerable. It is burdened 
with its obligation to supply Russian consumers with gas at 
below market prices. Gazprom needs to undertake significant 
corporate restructuring and reinvest in technology to increase 
its domestic production. Otherwise, in order to meet its supply 
commitments it will continue to acquire as much cheap gas in 
Central Asia as possible and sell that gas more expensively to 
Western markets.
    Essentially, Gazprom's diplomacy is to press the countries 
around the Black Sea and the Caspian Sea region to agree to gas 
supply and transit agreements that satisfy the company's goals; 
specifically, keeping Central Asian gas prices at below world 
market rates, channeling such Central Asian gas to low-paying 
Russian consumers, and protecting its lucrative European 
markets by freezing out Central Asian suppliers. In short, 
Gazprom is trying to strengthen its monopoly power, which, in 
turn, will strengthen its leverage and that of the Russian 
Government over European gas consumers. Given the long-term 
implications of such a development, I strongly support the 
creation of a transatlantic initiative on Eurasian gas.
    Mr. Chairman, the second key issue I would like to focus on 
is the Bosporus choke point and a new corporation possibility. 
As you, yourself, noted, the bulk of the Russian oil is 
transported to the Black Sea, and, from there via tankers to 
world markets. The increasing amount of oil being transported 
to the Black Sea has caused the dangerously narrow and 
overcrowded Bosporus to become a real choke point, stalling 
traffic in and out of this closed body of water. In severe 
weather conditions, delays can be up to 30 days, which is 
hugely costly for the oil companies. Once Russian and Kazakh 
oil is produced at full capacity and transported to the Black 
Sea, traffic through the straits will simply become paralyzed.
    BTC will take some of this oil, but at least one more 
bypass pipeline is needed. Given the importance of 
uninterrupted oil exports to its economy, Russian is now 
actively looking for a second Bosporus bypass pipeline.
    A win-win project on which the U.S. can work with Russia 
and Turkey is to encourage Turkey to provide incentives for 
companies to construct a new oil pipeline across Turkey to 
Ceyhan. With a capacity of one million barrels per day, such a 
pipeline would also increase Russian government tax revenues by 
five to six billion dollars per year. The U.S. could then focus 
oil exports into the Mediterranean at Ceyhan, thereby creating 
a sort of oil supermarket where traders buy Iraqi, Azeri, and 
Urals crude.
    A third issue I would like to discuss is the implication of 
the Russian/Chinese energy partnership in light of the 
developments in and around Central Asia over the last several 
years.
    While it is difficult to think of a long-lasting Russian/
Chinese strategic partnership, at least for now both seem to 
have decided to cooperate to reduce the U.S. influence and 
presence in Central Asia through the framework of the Shanghai 
Cooperation Organization, or SCO. Last month, Russia and China 
held joint military exercises. Russia and India will hold their 
first-ever joint army drill next month. In 2006, all of the SCO 
members and observers are expected to participate in such 
military exercises.
    While Russia, China, and India have expressed interest in, 
``maintaining stability in Central Asia and ensuring the 
stability of oil supplies,'' it makes one wonder if an anti-
American alliance is in the making. Given the participation of 
Iran in the SCO, and its new president's preparedness for a 
confrontation with the U.S., it would be prudent for the U.S. 
to pay close attention to these developments in Central Asia.
    Moreover, Russia, China, Iran, and India have also been 
increasing their energy cooperation. Given that all have state-
owned monopoly companies, their business practices are 
different than those of Western companies. They are also able 
to offer government backing and non-transparent incentives 
Western companies are unable to offer. These developments are 
clearly not in the interests of the United States of America or 
of American companies.
    Finally, a realistic approach to the region's hydrocarbon-
rich, but democracy-poor countries such as Turkmenistan and 
Uzbekistan is needed in order for the West to make full use of 
alternative sources and transport routes in the region. We need 
to recognize that the U.S. democracy and freedom agenda is in 
direct opposition to that which the major SCO countries are 
preaching today. Therefore, the United States needs to develop 
new policies that better address the new challenges so that 
U.S. energy security can be strengthened and influenced, 
maintained, and deepened across Eurasia.
    In this context, I would like to conclude by expressing my 
strong disagreement with the State Department's reported 
decision to move Central Asia out of the European Bureau and 
into the South Asian Bureau. The U.S. has been able to help the 
Caspian Sea region's energy projects and internal reform 
process by offering the region an East-West perspective. If the 
Central Asian countries are placed together with Afghanistan, 
Pakistan, and India, the chances of them coming under the SCO's 
influence will be significantly increased. Most importantly, 
Kazakhstan, which has long made clear its long-term vision to 
be closely engaged with Euroatlantic institutions, will be left 
with little option but to increase cooperation with its giant 
neighbors--Russia, Iran, and China. And such cooperation may 
come at the expense of energy cooperation with the U.S.
    Therefore, I would like to conclude my presentation by 
urging you, Mr. Chairman, to carefully consider this pending 
reorganization of the U.S. Government as you deliberate on ways 
to increase U.S. energy security.

    [The prepared statement of Ms. Baran follows:]
Prepared Statement of Zeyno Baran, Director, International Security and 
                   Energy Programs, the Nixon Center
    Thank you, Mr. Chairman and Members of the Committee, for the 
opportunity to appear before you to share with you my views on Eurasian 
energy dynamics and implications for U.S. energy security. I have 
closely followed Eurasian energy developments and U.S. policy toward 
the Caspian Sea Basin since the mid-1990s, and I am delighted to be 
part of this hearing today.
    With its significant oil and gas reserves, especially in Russia and 
Kazakhstan, the Eurasian region is vitally important to the U.S. 
strategic effort to diversify energy supplies away from sources in the 
Middle East. The U.S. has a clear need to ensure that these supplies 
reach world markets cheaply and safely; however, it has an equal need 
to ensure internal reforms in the countries of the region. If it fails 
to do so, its effort to end its energy dependence on oil and gas from 
Saudi Arabia and the Persian Gulf will only result in the creation of a 
``second Middle East,'' with equally damaging consequences for U.S. 
interests.
                a review of u.s. caspian energy strategy
    In the 1990s, the U.S. developed a multiple pipeline policy to the 
oil and gas reserves of the Caspian Sea. The intention of this policy 
was to allow the production of the region's newly independent countries 
to reach Western markets without having to rely solely on Russia's 
transportation infrastructure. The U.S. strategy was founded on four 
major objectives. The first was to strengthen the independence and 
prosperity of the Caspian states through the revenues obtained from 
energy production. The second was to bolster the security of worldwide 
energy markets by ensuring the free flow of supplies unfettered by the 
policies of regional competitors and by geographic chokepoints such as 
the Bosporus. Third was to reestablish close economic linkages among 
the new states of the region in order to prevent or mitigate regional 
conflicts, while the final goal was to enhance overall business 
opportunities.
    The U.S. extended its support to five major pipeline projects 
intended to achieve the above-mentioned goals. The most significant 
projects backed by the United States were the two pipelines along the 
so-called East-West Energy Corridor. First was the Baku-Tbilisi-Ceyhan 
(BTC) oil pipeline, which later this year will begin transporting 
Azerbaijani (and, in the future, Kazakhstani) oil through Georgia to 
Turkey's Mediterranean port of Ceyhan, and second was the South Caspian 
Gas Pipeline, which after its completion next year will transport 
Azerbaijani gas via Georgia into Turkey and onward to Western Europe.
    U.S. support for these two projects did not reflect any anti-
Russian agenda; it was instead intended to break the Russian monopoly 
on economic and political relations with Azerbaijan and Georgia so that 
these newly emerging states could freely develop their economic and 
foreign policies without fear of reprisal. The breaking of the Russian 
monopoly over the region's transportation system also helped Western 
companies operating in Azerbaijan and Kazakhstan. Once they were able 
to use the east-west pipelines and railroads to get their oil to 
markets, the companies were in a much stronger negotiating position 
vis-a-vis Russian corporations, who had become accustomed to charging 
high transport tariffs and gave preferential treatment to Russian 
companies. The availability of alternative routes provided security for 
Western companies operating in this region.
    Despite the strong support of the U.S. Government, the east-west 
pipelines would never have materialized were it not for their 
commercial attractiveness. American involvement was certainly important 
to the oil companies and other investors, as it substantially reduced 
the political risk of these projects. However, U.S. support was not 
sufficient by itself to make the projects a reality; the international 
consortium responsible for the development of Azerbaijani oil and gas 
did not make the final decision on either pipeline until each state 
signed the internationally-binding agreements offering the investors 
the right incentives and the necessary legal protection.
    Ultimately, U.S. Caspian policy envisioned these pipeline projects 
acting as engines of economic growth, providing an impetus for 
political and economic reform in both the producing and transit states. 
Indeed, to avoid the so-called ``resource curse'' experienced by many 
energy-rich countries in the developing world, Azerbaijan and 
Kazakhstan have created Oil Funds that are transparently managed and 
monitored by international financial institutions and NGOs. While the 
governments have used part of the money to improve the living 
conditions of the countries' poorest citizens, the bulk of the energy 
revenues have been set aside in investments for the future. Although 
the implementation of democratic and political reforms have been slow, 
both countries are heading toward critically important elections this 
fall, and both leaderships seem committed to conducting elections that 
would meet international standards.
                putin as the ceo of russian oil and gas
    The U.S. vision in its Caspian energy strategy was the correct one, 
and many of its policy goals are still valid objectives. However, 
important developments require a new framework for the broader Eurasian 
region. Today the biggest policy challenge for the U.S. is Russia, 
which may well become a second Saudi Arabia in more than one sense. 
Indeed, Russia is already the world's largest gas exporter, and is the 
second-largest oil producer after Saudi Arabia. According to the 
Department of Energy, Russia has more than twice the gas reserves of 
the next country on the list--Iran. The report further states that the 
Russian gas monopoly Gazprom ``holds nearly one-third of the world's 
natural gas reserves, produces nearly 90 percent of Russia's natural 
gas, and operates the country's natural gas pipeline network . . . 
Because exported Russian natural gas accounts for approximately 25 
percent of Europe's demand for natural gas, Gazprom is also one of 
Moscow's main foreign policy tools.'' This is the key point I would 
like to focus on in the remainder of my testimony.
    As you know, Presidents Bush and Putin concluded a Strategic Energy 
Partnership in 2002. While it is not clear at all what the U.S. and 
American companies got out of this partnership, it has been a rather 
lucrative one for the Russians. With little interference from the 
United States, Russia has constructed monopolistic oil and gas networks 
that now threaten the energy security of the entire region. Over the 
past several years we have seen Putin dismantle Yukos, once the largest 
Russian oil company, and through the state firm Rosneft gradually 
consolidate its assets under the Kremlin's control. Yuganskneftegas, 
the main production unit of Yukos, was effectively nationalized in 
December 2004; through the acquisition of other assets, Rosneft plans 
to overtake Lukoil as Russia's leading oil company by 2008. Gazprom is 
also planning to enter the oil sector and will soon by the privately 
held Sibneft, Russia's fifth-largest oil producer. Soon Putin will be 
in direct control of the world's largest integrated oil and gas 
enterprise.
    It is not as if their intention to do so had been kept secret; in 
September 2003, Anatoly Chubais declared that ``Russian business ought 
to be allowed to expand . . . with the aim of creating a liberal 
empire'' in the former Soviet sphere. This sentiment was echoed at the 
highest levels of government; in 2004, then-energy minister (and later 
prime minister) Viktor Khristenko declared that Russia would act ``more 
confident in pursuing its interests, while relying on [the] common 
resources'' of the former Soviet states.
    Adding to the strength of its monopolistic base at home and in its 
``near abroad'' has been the increase in world oil prices. As I 
mentioned earlier, Russia is the world's second largest oil exporter 
after Saudi Arabia, and earned $34 billion from oil exports in the 
first half of 2005--almost 50 percent more than the same time last 
year. Over the last 5 years, Russian economic growth has been primarily 
fueled by energy exports, and the economy has become dangerously 
dependent on the energy sector. And as long as oil prices remain high, 
there is little incentive for the Russian government to improve the 
investment climate and attract the billions of dollars worth capital 
necessary to increase oil and gas production.
    Instead, Russia can afford to focus on its long-term interests in 
the energy sector: strengthening Gazprom, both as a gas monopoly and 
soon as an oil giant; building up Rosneft through former Yukos assets; 
and maintaining the monopoly power of the state-owned pipeline operator 
Transneft. All these long-term goals dovetail perfectly with Russia's 
long-term geopolitical interests.
    But it is in America's and world energy security's interest for 
Russia to produce more oil and gas, and it is important to act fast. 
Easy oil is running out and huge investment and new technologies are 
needed to exploit the more remote and difficult fields such as those in 
the West and East Siberia. Therefore now is a good time to discuss a 
set of new initiatives and conditions, especially as Russia moves to 
head the G-8. Russia has already stated that energy security will be 
its major theme; the U.S. needs to have its own energy security 
strategy as well.
    Given that Russia wants to accede to the World Trade Organization 
(WTO) by end of the year, the U.S. has some leverage over Russia, but 
it is limited, especially given that there are other pressing issues in 
the bilateral agenda ranging from North Korea to Iran. Moreover, the 
U.S. needs to engage with Russia on energy and ensure that it can 
purchase Russian oil and gas, including liquidified natural gas (LNG) 
on a commercial basis. For the purchase to be on a commercial basis, 
the U.S. and Russia need to work together to channel Gazprom and other 
oil and gas industry operators toward operations on commercial basis 
and mitigate monopolistic power. The U.S. and the EU share similar 
interests in this area, and in fact, their common position should be to 
try to break up the monopolies that control the oil, natural gas and 
electricity industries across Europe and Eurasia as monopolies are 
clearly bad for consumers, because they charge higher prices than in a 
more competitive situation, while offering geostrategists in the 
Russian Government an irresistible temptation to use energy supplies as 
leverage over Russia's neighbors.
    Russia will need a lot of investment to develop new infrastructure 
needed to develop its major oil and gas fields. The U.S., together with 
the EU, could put together a large package--with the involvement of 
international financial and lending institutions, as well as the 
private sector (Western and Russian)--but make it conditional to Russia 
improving the investment climate--such as rule of law, transparency and 
governance, which will be required to make the major investment to 
happen.
    The Russians have responded to competition, especially from the 
Caspian, and the U.S. therefore needs to maintain its focus on the 
Caspian. The monopoly control of Transneft over the oil pipelines is 
one of the major hindrances on Russian oil export. Transneft is 
creating massive bottleneck as it keeps pipelines under its control and 
does not let any other company develop pipelines. Russians provided 
good terms for the early oil pipeline from Baku to Novorrossisyk, 
mainly after the companies built another early oil pipeline from Baku 
to Supsa, the Georgian port on the Black Sea--concerned about the 
competition, the Russians then gave good terms to the companies for 
their route. Similarly, only after the Baku-Tbilisi-Ceyhan oil pipeline 
from the Caspian Sea to Turkish Mediterranean port of Ceyhan became 
real, the Russians became more constructive on the Caspian Pipeline 
Consortium to transport oil from Kazakhstan to Russian Black Sea port 
of Novorrossisyk. And now we have seen once Kazakhstan and China began 
work on their oil pipeline, Russia announced it would be building East 
Siberia with a spur to the Pacific.
         transatlantic initiative needed on gas diversification
    The main leverage the U.S. would have is by working with the 
Europeans, and when they are talking about expanding Russian energy 
partnership, having them understand that increasing oil and gas 
supplies from Russia does not necessarily increase their energy 
security. What the Europeans need to do, given that they are the major 
market for Russian gas, is to say to Russia they will continue to 
purchase their gas only after Russia signs on to the Energy Charter 
Treaty, conducts competitive business, and offers the Central Asian oil 
and gas transiting Russian infrastructure the same terms.
    The U.S. therefore needs to hold a transatlantic discussion to urge 
the Europeans not to cut any long term deals with Russian monopoly 
companies without any pressure to change--otherwise, they will be 
hurting Russian energy development and Europe's own long-term security. 
For example having Gazprom grow without any checks is not good for 
Europe's long term security; and in this context, the pipeline 
agreement between Russia and Germany that would cut out Poland and 
Ukraine is not a positive development as these two transit countries 
would not be able to pressure Gazprom to behave in a commercial manner.
    Western and Central European countries are dependent on the Russian 
gas monopoly Gazprom as their sole or primary supplier of natural gas. 
Consequently, European energy utilities have vested commercial 
interests in maintaining cordial relations with Gazprom. For example, 
Germany's Ruhrgas is a major investor in Gazprom. Such relationships 
create a disincentive for European countries to take a firm line with 
Russia, even as Russia's policies undercut democracy at home and 
undermine the sovereignty and independence of its neighbors.
    Gazprom has over the last years systematically increased its 
leverage over European energy markets by bolstering its monopolistic 
control of regional pipelines. Last December the International Energy 
Agency already expressed concern that the EU as a whole was becoming 
too reliant on Gazprom, which could use its power as a monopoly 
supplier to push up gas prices. Russia in the past withheld oil and gas 
supplies to pressure the Baltic States and has done the same in the 
South Caucasus. The fact that Russia has in the past been a reliable 
gas supplier to Western Europe is meaningless; Russia has never had the 
kind of power it has recently acquired and we simply have no precedent 
to help us determine how it will use this power.
    Gazprom is not without vulnerability. It is burdened with its 
obligation to supply Russian consumers with gas at below-market prices. 
Gazprom needs to undertake significant corporate restructuring and 
reinvest into technology to increase its domestic production. 
Otherwise, to meet its supply demand, it will continue to try to 
acquire as much cheap gas in Central Asia as possible, and sell that 
gas more expensively to Western markets. In other words, Gazprom will 
need to rely on its monopoly control of regional pipelines to compel 
Turkmenistan, Uzbekistan, and Kazakhstan to continue to sell their gas 
at below-world prices. This has already made gas into a major 
geopolitical issue.
    Gazprom's diplomacy is to press the countries around the Black and 
Caspian Seas to agree to gas supply and transit arrangements which 
satisfy the company's goals, specifically: keeping Central Asian gas 
prices at below-world-market rates; channeling such Central Asian gas 
to low-paying Russian customers; and protecting its lucrative European 
markets by freezing out Central Asian suppliers. In short, Gazprom is 
trying to strengthen its monopoly power, which in turn will strengthen 
its leverage (and that of the Russian government) over European gas 
consumers.
    The Central Asian states must therefore settle for barter deals 
with lower-paying Russian customers, as Gazprom reserves for itself 
more lucrative deals with Western European consumers. And the West's 
challenge then is to prevent Gazprom from further strengthening its 
leverage over European markets by reducing its monopoly power and 
channeling it toward more market-based behavior.
        the bosporus chokepoint and new cooperation possibility
    The bulk of Russian oil is transported to the Black Sea and from 
there via tankers to world markets. The increasing amount of oil being 
transported to the Black Sea has caused the dangerously narrow and 
overcrowded Bosporus to become a chokepoint, stalling traffic in and 
out of this closed body of water. In severe weather conditions, delays 
can be up to 30 days, which is hugely costly for the oil companies. 
Once Russian oil companies reach their production targets, and once the 
Caspian Pipeline Consortium (CPC) begins to transport oil from 
Kazakhstan to the Black Sea at full capacity, traffic through the 
Straits will simply become paralyzed. Any incident that caused delays 
above and beyond those caused by traffic and weather would shut down 
the passageway for a considerable period, with devastating effects for 
all countries in the region, which rely on the Bosporus for 
transportation of imported goods and exported commodities.
    The occurrence of such an incident, whether it is a major oil spill 
or a terrorist attack, is a serious possibility; the consequences of 
the latter are nearly unimaginable. If an LGP tanker is attacked while 
traversing the narrow Bosporus through a city of 14 million, over a 
million people could be killed. After all, Istanbul was already hit 
twice by terrorists in November 2003 and is a front-line state in the 
war against terror.
    One way to make the Straits safer is to divert some of the oil 
traffic to bypass pipelines. Once the BTC pipeline opens later in the 
year, the bulk of Azerbaijani oil will reach world markets via Ceyhan. 
Other Caspian countries could also use this pipeline, but there still 
will be significant amount of Russian oil transported via tankers. 
Given the importance of uninterrupted oil exports to its economy, 
Russians are now actively looking for a second Bosporus bypass 
pipeline.
    A win-win project the U.S. can work on with Russia and Turkey is to 
encourage Turkey to provide incentives for companies to construct of a 
new oil pipeline across Turkey to Ceyhan with capacity of 1 million 
barrels per day, which would also increase Russian government tax 
revenues by $5bn to $6bn a year. The U.S. could then focus oil exports 
into Mediterranean at Ceyhan, and thereby create a sort of oil 
``supermarket'' where traders buy Iraq, Azeri or Urals oil.
           implications of russian-chinese energy partnership
    Ending months of speculation, Putin has confirmed earlier this 
month that Russia will build a multi-billion dollar oil pipeline across 
Siberia to first go to China's Daqing oil terminal and then be extended 
to Nahodka, the Pacific port from which oil can be shipped to Japan and 
to the U.S. In addition, Gazprom is in talks with CNPC to lay two 
pipelines to China. One would carry Russian gas west to join China's 
internal West-East pipeline and the other would head to the country's 
northwest direction; for each pipeline, the figures are 20-30 bcm per 
year.
    The Russian-Chinese energy cooperation is extremely significant in 
light of the developments in and around Central Asia over the last 
several years. While it is difficult to fathom a long-lasting Russian-
Chinese strategic partnership, at least for now both seem to have 
decided to cooperate to reduce the U.S. influence and presence in 
Central Asia. Benefiting from the growing concern over perceived U.S. 
support for the revolutions in Georgia, Ukraine and Kyrgyzstan, Russia 
and China used the July summit of the Shanghai Cooperation Organization 
(SCO) to make the first declaration against the presence of the U.S. 
military bases in the region. The SCO has been a weak regional alliance 
consisting of co-chairs Russia and China, and the Central Asian 
countries of Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan, with 
Mongolia as the observer. In July, India, Iran and Pakistan joined as 
observers as well.
    Last month Russia and China held a joint military exercise, Russia 
and India will hold their first ever joint army drill next month, and 
in 2006 all of the SCO members and observers are expected to 
participate in such military exercises. While Russia, China and India 
have expressed interest in ``maintaining stability in Central Asia and 
ensuring the stability of oil supplies'' it makes one wonder if an 
anti-American alliance is in the making. Given the participation of 
Iran, and its new president's preparedness for confrontation with the 
U.S., it would be prudent for the U.S. to play close attention to these 
developments in Central Asia.
    Moreover, a realist approach to the region's hydrocarbon-rich but 
democracy-poor countries, such as Turkmenistan and Uzbekistan, is 
needed in order for the West to make full use of the alternative 
sources and transport routes in the region. The United States needs to 
develop new policies that better address the new challenges, so that 
U.S. energy security can be strengthened and influence maintained and 
deepened across Eurasia.
                    conclusions and recommendations
    I hope I was able to draw a picture in which the Kremlin knows that 
control over the Eurasian energy infrastructure, especially its gas 
pipelines, is its most effective foreign policy tool today. Given that 
Gazprom will for the foreseeable future be the leading gas supply 
provider to the EU, the U.S. needs to urge the European gas consumers, 
as well as transit states, to form a transparent, market-based, 
commercial relationship with Gazprom. Forging such a relationship 
requires all these states to strive for increased competition in gas 
supply and transit arrangements, and to circumscribe Gazprom's monopoly 
power.
    The U.S. can also work with the countries of the former Soviet 
Union for them to pay upfront for the gas they take from Gazprom and 
charge Russia for transit services, thus bringing full transparency to 
the gas relationship. They also need to make sure to not collect any 
further debt to Russian companies that could force them to reach debt-
for-equity deals. The South Caucasus countries can already work with 
the EU and the Energy Charter to adopt European standards in these 
dealings; Russia needs to join the Energy Charter as well.
    The U.S. needs to recognize that there is a new alliance taking 
place that brings countries of the SCO closer in cooperating on 
political, military and economic areas. Russia, China, Iran and India 
have also been increasing their energy cooperation-given that all have 
state-owned and monopoly companies, their business practices are 
different than those of the West. Moreover, they are able to offer 
government backing and non-transparent incentives Western companies are 
not able to offer. These developments are neither in the interest of 
American companies nor in line with U.S. stated Caspian Sea region 
policies I discussed earlier.
    Moreover, U.S. democracy and freedom agenda is in direct opposition 
to what the major SCO countries are preaching today. While the U.S. may 
be limited in its ability to influence the region's developments, it 
nonetheless needs to be consistent in its promotion of internal reform 
and democratic change. While criticizing Uzbekistan or Turkmenistan for 
their democratic short-falls, the U.S. and the EU cannot turn a blind 
eye to developments in Russia in the name of ``energy security''. At 
the same time, it is important to be realistic about the implications 
of pushing the freedom and democracy agenda in a region where other 
major powers are vying for influence by promising stability instead.
    In this context, I would like to express my strong disagreement 
with the State Department's reported decision to move Central Asia out 
of the European Bureau and into the South Asian Bureau. The U.S. has 
been able to help the Caspian Sea region's energy projects and internal 
reform process by offering the region an East-West perspective. If the 
Central Asian countries are put together with Afghanistan, Pakistan and 
India, the chances of them coming under the SCO's influence will be 
significantly increased.
    If this decision is not reversible, then it would be important to 
assess the signals the U.S. would be sending to the leaderships and the 
people of Central Asia. Such major reorganization would also require a 
new Eurasian energy strategy, as the strategy of the 1990s looking 
East-West would effectively come to an end. A new Central Asian energy 
strategy would then be devised to integrate the infrastructures of 
Central Asia and countries like Afghanistan, Pakistan and India. For 
example the U.S. would then need to strongly support the proposal to 
get Central Asian gas to India to block Iranian gas. On the negative 
side, Kazakhstan, which has long made clear its long-term vision to be 
closely engaged with Euro-Atlantic institutions, will be left with 
little option but to increase cooperation with its giant neighbors 
Russia and China, and such cooperation may come at the expense of 
energy cooperation with the U.S. I therefore would like to conclude my 
presentation by urging you Mr. Chairman and Members of the Committee to 
carefully consider this pending reorganization of the U.S. Government 
as you deliberate on ways to increase U.S. energy security.

    Senator Hagel. Thank you, Ms. Baran, very much for your 
comments.
    We will get back to each of you, after we hear from Dr. 
Klare, with some question. So, thank you, again.
    Dr. Klare, welcome.

STATEMENT OF DR. MICHAEL T. KLARE, PROFESSOR OF PEACE AND WORLD 
                  SECURITY STUDIES, HAMPSHIRE
                      COLLEGE, AMHERST, MA

    Dr. Klare. Thank you very much, Senator. And I want to 
thank you for giving me this opportunity to appear before you 
today and also to commend you for holding hearings on such an 
important and, I would say, not well understood topic.
    I will read from my comments. I hope they could be included 
in the record.
    The United States stands today at a critical juncture in 
its energy policy, particularly with respect to petroleum and 
natural gas. The demand for energy in this country has been 
rising steadily over the past few years, because of economic 
growth and the vital role of energy and transportation. At the 
same time, many other countries, both developed and developing, 
have also experienced an increased need for energy.
    Satisfying these huge increases in energy demand will place 
enormous pressure on the global energy industry to satisfy 
these needs. Fortunately, the industry has, until now, 
succeeded in satisfying the world's ever-increasing thirst for 
petroleum products. But now there is reason to doubt whether 
the steady growth in petroleum output can be sustained in the 
decades to come, calling into question many assumptions about 
national energy policy.
    Experts in the field have long been aware of this worry, 
but the devastation wrought by Hurricanes Katrina and Rita have 
brought this into public consciousness. Katrina was significant 
for two reasons. First, because it demonstrated just how tight 
worldwide supplies of oil have become, and secondly because it 
exposed the vulnerability of drilling operations in the deep 
waters of the Gulf of Mexico, the only oil-producing area of 
the United States to experience an increase in output over the 
past few years. While we can expect the full recovery of most 
onshore energy operations and near-shore operations in these 
affected areas, it's not yet evident that we could expect the 
full recovery of deep offshore operations in the Gulf of 
Mexico, and this could entail a significant increase in U.S. 
reliance on imports in the years ahead. And, of course, U.S. 
reliance on imports have been growing steadily, passing the 50 
percent mark in 1998, now up to about 55 percent, and expected 
to reach 66 percent by 2020.
    Where will this additional imported oil come from? It would 
be nice to think that all of it could come from friendly, 
stable countries in North America, but this is not likely to 
prove the case. As America's dependence on imports grows, more 
and more of this oil will have to come from the developing 
world and transitional states of the former Soviet Union, many 
of them prey to chronic instability.
    Exactly which of these countries will prove to be our major 
suppliers at any given moment of time cannot be pre-determined, 
but we can expect growing reliance on supplies from the Middle 
East, the former Soviet Union, the Caspian, West Africa, and 
Latin America. It's the stated goal of the Bush Administration 
to try to maximize America's access to these foreign suppliers, 
and this is the principal objective of the National Energy 
Policy (in its foreign policy implications) adopted in 2001.
    But, despite the efforts of the Administration to increase 
access to foreign oil, and the evident desire of many of these 
producers to expand their output, numerous obstacles have 
arisen to frustrate plans to boost their production. These 
range from internal unrest and ethnic violence to endemic 
corruption, managerial incompetence, political wrangling among 
competing power brokers, terrorism, insufficient investment 
funds, the faster-than-expected depletion of some older fields, 
and disappointing drilling results in some newly developed 
areas.
    It's possible, of course, to attribute these problems to 
unexpected, but temporary, impediments that will disappear in 
the course of time, allowing for increased production in the 
future, but a prudent policymaker would have to conclude that 
something deeper and more systemic is at work precluding large-
scale gains in the future.
    What is this systemic situation we face? In my testimony, 
I'll briefly address two problems.
    First, a gradual slowdown in the growth of worldwide 
petroleum output as large, easy to develop fields in more 
accessible areas go into decline and a bigger share of global 
output is derived from smaller, deeper, more scattered fields 
in less accessible areas.
    And, second, the natural propensity for oil production in 
the developing and transitional countries to invite internal 
unrest and conflict over the allocation of petroleum revenues.
    Let me speak briefly about each of these.
    First, the growing reliance on less productive, less 
accessible fields. This is the predictable trajectory of any 
resource extraction process, in that entrepreneurs will always 
seek to develop the largest and most accessible sources of 
supply first, and leave the less attractive sources for later. 
Needless to say, extraction in these more remote and 
unattractive areas entails far more demanding and costly 
technologies than extracting from near-to-hand sites. It also 
exposes drilling and delivery operations to more extreme 
challenges of climate and weather, a troubling reality that we 
now see with greater clarity as a result of Hurricanes Katrina 
and Rita.
    The problems raised by our growing reliance on remote, 
hard-to-reach reservoirs will persist whether or not we have 
reached the point of peak worldwide production, as claimed by 
some. I know that everyone in this room is familiar with the 
discussion about peak oil, and I won't elaborate on it here. 
But, while we cannot determine with any certainty that we are 
at or near the moment of peak petroleum production, I do think 
we can state with some assurance that the world's remaining 
oil, however great its extent, exists in fields that lie deeper 
underground, farther off shore, dispersed in smaller pockets, 
and located in more extreme climates than many of the fields 
now in production. We can still get at this oil and bring it to 
market, but the costs of doing so will rise, and the net output 
will not be as great as from earlier fields.
    And the development of these remote fields also raise 
significant environmental concerns, particularly when they 
entail the construction of long pipelines through 
environmentally sensitive areas.
    The second factor I'll mention briefly is the propensity 
for oil production in developing countries or transitional 
societies to invite internal conflict over the allocation of 
petroleum revenues.
    This danger arises most frequently in countries where there 
are few other significant sources of wealth and where the state 
owns the rights to underground oil and mineral resource 
reserves. When these conditions prevail, there is a powerful 
incentive for avaricious cliques and individuals to gain 
control of the national government and its resources assets, 
and, once in power, to retain control for as long as possible, 
through any means necessary. The natural result is a persistent 
tendency towards corruption, cronyism, and authoritarianism in 
all such ``petro states,'' as they have been called. And 
because the potentates who rule these states are generally 
reluctant to risk their continued tenure and oil wealth through 
holding fair elections, the sole option for those who seek a 
change in government is often through assassination, coup 
d'etat, terrorism, or armed rebellion. And it's these sort of 
upheavals that periodically result in the disruption of oil 
deliveries from key producing areas.
    Now, both of these points apply, I believe, with particular 
vigor to the situation in Eurasia. Eurasia was, of course, one 
of the main early sites of oil production. Baku was once one of 
the world's leading centers of oil production. And, in the 
Soviet era, West Siberia became a major source of energy. But 
today the onshore fields around Baku are largely depleted, and 
many of the older fields in Western Siberia are in decline. Any 
hope of boosting production in Russian and the newly 
independent republics of the Caspian Sea will, therefore, 
require the development of harder-to-reach fields in Eastern 
Siberia and offshore areas. This is an inherently demanding 
endeavor requiring utilization of advanced technology in the 
construction of new drilling rigs, pumping stations, and 
pipelines.
    A similar picture holds for the development of natural gas. 
As Mr. Ferguson indicated, the gas fields in West Siberia are 
now in decline and we increasingly will have to rely on 
offshore fields off of Sakhalin and in the Caspian.
    Given the difficulties involved in tapping into this oil 
and gas, it's not surprising that many of these projects have 
run into substantial difficulties. The estimated cost of the 
Sakhalin II natural gas project, for example, has doubled over 
the past few years, from $10 to $20 billion, causing a delay in 
the startup of export. Development of the giant Kashagan field, 
which we also heard about, has also run into difficulty, 
driving up costs and delaying the start of operations.
    I won't go into the problems arising from the distribution 
of these fields through the construction of long pipelines, 
because this has been addressed, but I do want to point out 
that these pipelines often go through areas of ethnic unrest, 
of sites of terrorist activity, and protecting them will become 
a continuous struggle in the years ahead, and could entail the 
United States more deeply in military affairs in those parts of 
the world, which I think we should look at with great caution.
    In addition, many of these remote and offshore projects 
entail significant environmental dangers. For example, 
scientists have concluded that construction of the Sakhalin II 
project poses a significant risk to the survival of the western 
North Pacific gray whale, a highly endangered species. Much 
concern has also been voiced about the environmental impact of 
offshore oil and gas production in the Caspian Sea, the habitat 
of 400 unique species.
    Turning now to the second factor I discussed, the 
propensity towards authoritarianism and political disorder, we 
can see signs of this in Eurasia, as well. In Russia, the 
central government, headed by President Putin, has moved 
aggressively to extend state control over the nation's energy 
industry, as we heard from the last speaker. These moves have 
been accompanied by the arrest of top leaders of Yukos and in 
other maneuvers that appear to be of dubious legality, giving a 
greater concentration of power over energy in the President's 
hands. These moves, even if not strictly illegal, have been 
widely viewed as part of a larger trend towards the 
concentration of economic and political power in the 
President's hands, reversing progress towards democratization 
in Russia.
    Kazakhstan and Azerbaijan have also witnessed the 
concentration of power in the hands of their presidents, Ilham 
Aliyev and Nursultan Nazarbaev, respectively. While both have 
staged elections to convey a veil of legitimacy over their 
continued rule, neither has permitted a free press, free 
speech, or the unimpeded existence of opposition parties. Human 
rights observors in both countries have reported repeated 
jailings and persecution of independent journalists and 
opposition political figures. Corruption is also said to be 
widespread, with friends and relatives of the ruling elite 
favored with government contracts, while much of the population 
lives in poverty.
    For the present, leaders of both Azerbaijan and Kazakhstan 
appear to be in firm control of their countries. But just 
because there are no public expressions of dissent does not 
mean that there are not reservoirs, deep reservoirs, of 
discontent in these countries. As recent developments in 
Kyrgyzstan and Uzbekistan show, powerful anti-government 
currents can be found just below the surface of allowable 
public discourse. And what's particularly worrisome about this 
situation is that many of those who oppose the authoritarian 
rule in these countries are losing faith in the promise of 
democracy and turning, instead, to radical Islamic movements 
for inspiration and leadership.
    Let me conclude, then, with just a few observations on the 
policy implications of this.
    First, I believe that we have passed the point at which it 
is possible to assume that, even with increased effort and 
investment, the global energy industry will be able to continue 
expanding petroleum output in tandem with the ever-growing 
demand expected from the world's developed and developing 
countries. Total oil output may rise for some years to come, 
but it will never fully satisfy the world's thirst for more 
petroleum. This means, I believe, that energy prices will 
remain high, by historical standards, and that we will be at 
constant risk of energy shortages and price hikes from major 
storms and political upheavals in the oil-producing countries.
    There simply is no supply-side solution in sight that can 
save us from this predicament. Only by curbing our demand can 
we ease the pressure on oil supplies. Therefore, energy 
conservation and the development of alternative fuels must 
constitute the principal thrust of any new national energy 
policy.
    And, finally, I think it would be a terrible mistake for 
the United States Government to play a conspicuous and 
insertive role in promoting extensive involvement of American 
companies in the extraction of Eurasia's oil and natural gas. 
It's one thing for these private firms to employ the normal 
channels of international commerce to gain access to Eurasian 
supplies, but another thing altogether for the U.S. Government 
to be seen as spearheading such efforts, particularly when this 
entails the establishment of close ties with powerful elite who 
control these countries, especially the Caspian countries. 
Whatever our actual intent, these efforts will be viewed by 
dissidents in those countries as conferring American approval 
on the regimes in power, thereby making us, the United States, 
targets of the dissidents' wrath.
    None of the Caspian region's regimes is entirely stable, 
and, when and if they are swept away by opposition forces, we 
do not want to be viewed as their evil twins, and so be made 
persona non grata, as occurred in Iran after the overthrow of 
the shah in 1980. We could certainly encourage U.S. energy 
firms to do what they are good at, which is seeking out and 
producing energy, but we should do nothing to fan suspicions 
that they are essentially tools of the American government.
    I hope that you find my observations useful. Thank you for 
allowing me to testify.

    [The prepared statement of Dr. Klare follows:]
  Prepared Statement of Dr. Michael T. Klare, Professor of Peace and 
         World Security Studies, Hampshire College, Amherst, MA
    Distinguished Members of the Subcommittee:
    Thank you for inviting me to address the question of energy 
supplies in Eurasia and their implications for U.S. energy security. It 
is a great honor to appear before this distinguished body. Senator 
Hagel has performed a valuable national service by focusing attention 
on the vital issue of energy security, and I hope that my remarks will 
shed some light on this important topic.
    The United States now stands at a critical juncture in the 
evolution of its energy policy, particularly with respect to petroleum 
consumption. The demand for energy in this country has been rising 
steadily over the past years as a result of continued economic growth 
and the vital role of air, ground, and sea transportation in all 
aspects of economic activity. According to the U.S. Department of 
Energy (DoE), total energy use in the United States grew by 16 percent 
between 1990 and 2002, and is projected to grow by another 35 percent 
between 2002 and 2025. At the same time, many other countries, both 
developed and developing, have also experienced an increased need for 
energy, pushing total world energy use from 348 quadrillion BTUs in 
1990 to a projected 645 quadrillion BTUs in 2025, an increase of 85 
percent.\1\
---------------------------------------------------------------------------
    \1\ 1. U.S. Department of Energy, Energy Information Administration 
(DoE/EIA), International Energy Outlook 2005, Table A1.
---------------------------------------------------------------------------
    The growing worldwide need for primary energy has been translated 
into increased demand for every conceivable source of energy. This is 
especially true for petroleum, the world's leading source of primary 
energy, and for natural gas, the fastest growing source of energy. 
According to the DoE, global consumption of petroleum is projected to 
rise by 41 percent between 2002 and 2025, from 78.2 to 119.2 million 
barrel per day (mbd), while consumption of natural gas will rise by 69 
percent between 2002 and 2025, from 92.2 to 156.2 trillion cubic feet. 
Petroleum consumption in the United States--the world's leading 
consumer of oil--is projected to rise by comparable percentages, from 
17.0 mbd in 2002 to 27.3 mbd in 2025.\2\
---------------------------------------------------------------------------
    \2\ Ibid., Table A4.
---------------------------------------------------------------------------
    Satisfying these huge increases in demand will place enormous 
pressure on the global energy industry. Fortunately for all of us, this 
industry has, until now, succeeded in satisfying the world's ever-
increasing thirst for petroleum products. While there have been some 
notable bumps along the way--most notably in 1973-74, during the Arab 
oil embargo, and again in 1979-80, following the Islamic Revolution in 
Iran--global oil production has generally kept pace with rising 
worldwide demand. This has been made possible by the development of new 
fields in such areas as the North Slope of Alaska, the North Sea, the 
coastal waters of Africa, and the former Soviet Union, as well as 
through the more efficient exploitation of existing fields. But now 
there is reason to doubt whether this steady growth in petroleum output 
can be sustained in the decades to come, calling into question many 
assumptions about national energy policy.
    Experts in the field have been aware of this concern for some time, 
but the devastation wrought by Hurricane Katrina has brought this into 
the public consciousness. Katrina was significant for two reasons: 
first, because it demonstrated just how tight world supplies of 
petroleum have become in recent years and how little room for maneuver 
we have in times of crisis; and second, because it exposed the 
vulnerability of drilling operations in the deep waters of the Gulf of 
Mexico, the only major oil-producing area of the territorial United 
States to experience an increase in output over the past few years. 
While we can expect the full recovery of most onshore energy operations 
in the affected areas, it is not yet evident that we can expect the 
full recovery of deep offshore operations, at least not in the 
immediate future. This could entail a significant reduction in domestic 
crude production, with an accompanying increase in reliance on imports. 
Hence the importance and timeliness of this hearing.
    As the Members of the Subcommittee are well aware, there has been a 
steady increase in U.S. dependence on imported petroleum over the past 
few decades. As recently as 1985, we produced over 70 percent of the 
oil we consumed. But demand has increased while domestic production has 
declined, and so the extent of our reliance on imports has steadily 
grown. We crossed the 50 percent threshold of import dependence in 
1998, and, before Hurricane Katrina, were projected to reach 56 percent 
in 2010 and 66 percent in 2020.\3\ How Katrina will affect these 
projections cannot be determined at this time, but we should expect a 
more rapid increase in the dependency rate.
---------------------------------------------------------------------------
    \3\ Ibid., Tables A4 and E1.
---------------------------------------------------------------------------
    Where will this additional petroleum come from? It would be 
comforting to think that it will all be derived from Canada, Mexico, 
and other nearby, friendly suppliers, but this is not likely to prove 
the case. As America's dependence on imports rises, more and more of 
this foreign oil will have to be obtained from distant producers in the 
developing world, many of them prey to chronic instability. Exactly 
which of these countries will prove to be our major suppliers at any 
given moment in time cannot, of course, be determined in advance, but 
the DoE does give us a good idea of what the options will look like: 
according to its most recent projections, 32 percent of world petroleum 
output in 2025 will be accounted for by the Persian Gulf producers, 
another 13 percent by African producers, 14 percent by producers in 
Latin America, and 14 percent by the nations of the former Soviet 
Union.\4\ Whatever the relative share of U.S. supplies provided by 
these countries at any given moment, all are likely to figure 
prominently in U.S. foreign energy policy.
---------------------------------------------------------------------------
    \4\ Ibid., Table R1.
---------------------------------------------------------------------------
    It is the stated goal of the Bush administration to diversify the 
foreign sources of American petroleum supplies and, to the degree 
possible, to enhance America's access to all of these potential 
suppliers. These are among the major objectives of the ``National 
Energy Policy'' (NEP) adopted by the administration in the spring of 
2001 and announced by the President on May 17, 2001. I need not 
summarize these proposals in detail, but suffice to say that the NEP 
called on senior government officials to do everything in their power 
to encourage and assist the leaders of the major foreign oil producers 
both to increase their country's output and to make this added energy 
available to consumers in the United States. And, to the degree that 
they have been able to do so, these officials have endeavored to 
achieve these objectives.
    But despite these efforts, and the evident desire of many foreign 
oil producers to expand their output, numerous obstacles have arisen to 
frustrate plans their efforts to boost production. These range from 
internal unrest and ethic violence to endemic corruption and managerial 
incompetence, political wrangling among competing power brokers, 
terrorist strikes, insufficient investment funds, the faster-than-
expected depletion of some older fields, and disappointing drilling 
results in some newly developed fields.
    To lend some specificity to this observation, consider the 
following. In its 2002 projections of future oil output, the Department 
of Energy predicted that the combined output of Indonesia, Iraq, 
Nigeria, Saudi Arabia, and Venezuela would total 24.1 million barrels 
per day in 2005.\5\ However, according to the most recent DoE ``country 
analysis briefs'' on these countries, their combined output during the 
past year or so has averaged only about 18.9 mbd, a shortfall of over 5 
mbd. This discrepancy is not due to faulty assumptions on the part of 
the DoE, but rather to the fact that oil officials in those countries 
have encountered unexpected impediments to their efforts to boost 
production. These have included the bitter insurgency in Iraq, 
political upheaval in Venezuela, ethnic violence in Nigeria, 
organizational limitations in Indonesia, and what appears to be faster-
than expected depletion of large fields in Saudi Arabia. (I say 
``appears to be'' because Saudi officials have not released field-by-
field data on the output of their major reservoirs, frustrating efforts 
by outside observers such as Matthew Simmons of Simmons & Co. 
International to gauge the country's long-term production capacity.\6\)
---------------------------------------------------------------------------
    \5\ U.S. Department of Energy, Energy Information Administration 
(DoE/EIA), International Energy Outlook 2002, Table D1.
    \6\ For discussion of this point, see Matthew Simmons, Twilight in 
the Desert (Hoboken: Wiley, 2005).
---------------------------------------------------------------------------
    It is possible, of course, to attribute these shortfalls to 
unexpected but temporary impediments that will disappear in the course 
of time, allowing for greatly increased production rates in the years 
ahead. But a prudent policymaker would have to conclude that something 
deeper and more systemic is at work, precluding large-scale gains in 
the future. This assessment, I contend, is the only sensible way to 
proceed.
    What, then, is the systemic situation we face? It is too early to 
answer this question with any degree of certainty, but I think we can 
attribute these problems to a number of critical factors. I will 
address two of these in my testimony: first, a gradual slowdown in the 
growth of worldwide petroleum output as large, easy-to-develop fields 
in more accessible areas go into decline and a bigger share of global 
output is derived from smaller, deeper, more scattered fields in less 
accessible areas; and second, the natural propensity for oil production 
in developing countries to invite internal conflict over the allocation 
of petroleum revenues. I will discuss each of these briefly.
    First, growing reliance on less productive, less accessible fields. 
This is the predictable trajectory of any resource-extraction process, 
in that entrepreneurs will always seek to develop the largest and most 
accessible sources of supply first and leave the less attractive 
sources for later. This trajectory is plainly evident in the case of 
petroleum. For example, in the United States, the first fields to be 
developed were in readily accessible, onshore areas of Pennsylvania, 
Texas, and Oklahoma; only later, as these onshore fields in the Lower-
48 went into decline, did the oil companies invest in the extraction of 
oil from more remote, difficult-to-reach fields in Alaska and the deep 
waters of the Gulf of Mexico. Needless to say, extraction in these 
remote areas entails far more demanding and costly technologies than 
extraction from onshore sites; it also exposes drilling and delivery 
operations to more extreme challenges of climate and weather--a 
troubling reality that we now see with greater clarity in the Gulf as a 
result of Hurricanes Ivan, Katrina, and Rita.
    The problems raised by our growing reliance on remote, hard-to-
reach reservoirs will persist whether or not we have reached the point 
of ``peak'' worldwide petroleum output, as claimed by some. I know that 
all in this room are familiar with this discussion, and so it need not 
be elaborated upon here. In any case, there is no way to predict the 
moment of peak production in advance--we will only know of its 
occurrence after world output has begun a long-term decline. But while 
we cannot determine with any certainty that we are at or near the 
moment of peak production, I do think that we can state with some 
assurance that the world's remaining oil--however great its extent--
exists in fields that lie deeper underground, farther offshore, 
dispersed in smaller pockets, and located in more extreme climates than 
many of the major fields now in production. We can still get at this 
oil and bring it to market, but the costs of doing so will rise and the 
net output from any given reservoir is likely to be less than that 
obtained from the large, prolific fields that have satisfied our 
petroleum needs in the past. Development of these remote fields will 
also raise significant environmental concerns, particularly when they 
entail the construction of long pipelines through environmentally 
sensitive areas, such as Arctic regions or tropical forests.
    The second factor that deserves attention is the propensity for oil 
production in developing world or transitional societies to invite 
internal conflict over the allocation of petroleum revenues. This 
danger arises most frequently in countries where there are no other 
significant sources of wealth and where the state (rather than private 
landowners) owns the rights to underground oil and mineral resources. 
When these conditions prevail, there is a powerful incentive for 
avaricious cliques and individuals to gain control of the national 
government--thereby gaining control over the oil sector and all the 
revenues this entails--and, once in power, to retain control for as 
long as possible through any means necessary. The natural result is a 
persistent tendency toward corruption, cronyism, and authoritarianism 
in all such ``petro-states,'' as they have been called.\7\ Because the 
potentates who rule these states are generally reluctant to risk their 
continued tenure by allowing generally fair elections, the sole option 
for those who seek to remove the prevailing regime or to install 
themselves in its place is through assassination, coup d'etat, or armed 
rebellion. It is these sorts of upheavals that periodically result in 
the disruption of oil deliveries from key producing states, adding to 
the pressure on global supplies.
---------------------------------------------------------------------------
    \7\ For a thorough analysis of this phenomenon, see Terry Lynn 
Karl, The Paradox of Plenty (Berkeley: University of California Press, 
1997).
---------------------------------------------------------------------------
                        the situation in eurasia
    Both of these factors--our growing reliance on hard-to-get-to oil 
and the propensity of petro-states to invite internal political 
disorder--apply with particular vigor to Eurasia.
    Eurasia was, of course, one of the first areas of the world to 
harbor large-scale petroleum extraction. During the Czarist era, the 
area around Baku, in what is now Azerbaijan, was one of the world's 
major centers of production, supplying much of Europe in the years 
leading up to the First World War. Later, during the Soviet era, large 
fields were developed in Western Siberia, between the Ural Mountains 
and the Central Siberian Plateau, and in western Kazakhstan. In the 
1980s, production in these areas made the Soviet Union a major world 
oil producer, pushing its total output to a record of 12.8 mbd in 1988. 
All of these onshore fields were connected to an elaborate system of 
pipelines, permitting the delivery of crude oil to refineries and 
markets throughout the Soviet space and to friendly clients in Eastern 
Europe. Soviet energy officials were aware that additional petroleum 
reserves were located in Eastern Siberia and in offshore areas of the 
Caspian Sea and Sakhalin Island, but lacked the inclination and know-
how to develop these hard-to-reach reserves, and so concentrated on the 
intensive exploitation of the more accessible, onshore fields.
    Today, the onshore fields around Baku are largely depleted and many 
older fields in Western Siberia are in decline. Any hope of boosting 
net production in Russia and the newly independent republics of the 
Caspian Sea basin will, therefore, require the development of Eastern 
Siberian and offshore fields. This is an inherently demanding endeavor, 
requiring the utilization of advanced technology and the construction 
of new drilling rigs, pumping stations, and pipelines. Even with 
massive involvement and investment by Western firms, the exploitation 
of these fields will prove costly and arduous.
    A similar picture holds for natural gas production in the region. 
Russia harbors the world's largest reserves of natural gas, and the 
Central Asian republics of Turkmenistan and Uzbekistan also possess 
substantial supplies. But the core of Russian gas production is 
concentrated in three giant fields in Western Siberia--Urengoy, 
Yamburg, and Medvezh'ye--and these fields are now in decline and 
Gazprom, the state gas monopoly, predicts steep declines in natural gas 
output between 2005 and 2020.\8\ Once again, significant supplies are 
known to lie in offshore fields in the Caspian and off Sakhalin. But 
obtaining this gas presents similar challenges to the production of 
offshore oil in these areas.
---------------------------------------------------------------------------
    \8\ DoE/EIA, ``Russia,'' Country Analysis Brief, February 2005, 
electronic doc. Accessed at www.eia.doe.gov/emeu/cabs/russia.html.
---------------------------------------------------------------------------
    Given the difficulties involved in tapping into these hard-to-get-
at supplies, it should not be surprising that the large consortia 
established to accomplish this feat have run into substantial 
difficulties. The estimated cost of the Sakhalin II natural gas 
project, for example, has doubled over the past few years, from $10 to 
$20 billion, causing a delay in the initial startup of export 
operations.\9\ Development of the giant Kashagan oil and gas field in 
Kazakhstan's sector of the Caspian Sea has also run into difficulty, 
driving costs up and delaying the start of operations. According to the 
DoE, ``Kashagan contains a high proportion of natural gas under very 
high pressure, the oil contains large quantities of sulphur, and the 
offshore platforms require construction that can withstand the extreme 
weather fluctuations of the northern Caspian Sea area.'' These 
difficulties have discouraged some of the project's initial investors, 
forcing a restructuring of the operating consortium and delaying the 
field's expected online date beyond 2008.\10\ Problems have also 
emerged in Azerbaijan's sector of the Caspian Sea. Although some 
offshore projects have proved successful, notably the Azeri, Chirag, 
Deepwater Gunashli (ACG) structure, others have proved less so. 
``Besides the ACG project,'' the DoE noted recently, ``many of 
Azerbaijan's offshore prospects have been relatively disappointing on 
contrast to the high expectations for the Caspian Sea region in the 
1990s.'' \11\
---------------------------------------------------------------------------
    \9\ ``Sakhalin II Project's Phase 2 Cost Estimate Rising,'' Oil and 
Gas Journal, July 25, 2005, p.26.
    \10\ DoE/EIA, ``Kazakhstan,'' Country Analysis Brief, July 2005, 
electronic doc. Accessed at www.eia.doe.gov/emeu/cabs/kazak.html.
    \11\ DoE/EIA, ``Azerbaijan,'' Country Analysis Brief, June 2005, 
electronic doc. Accessed at www.eia.doe.gov/emeu/cabs/azerbjan.html
---------------------------------------------------------------------------
    I will not use this occasion to discuss the problems arising from 
the transportation of oil and gas from the landlocked Caspian to 
markets around the world, as I believe these problems are well 
understood. Nonetheless, it is important to indicate that the 
construction of these pipelines--and their protection from terrorist 
and insurgent attack--remains a significant challenge to the global 
energy industry and participating nations. Even if new oil and gas 
projects in the Caspian region come on line, it should not be assumed 
that the resulting output can be safely and economically delivered to 
markets around the world.
    In addition, many of these remote and offshore projects entail 
significant environmental dangers. For example, a scientific panel 
convened by the World Conservation Union concluded that the Sakhalin II 
project poses a significant risk to the survival of the Western North 
Pacific Gray Whale, a highly endangered species. ``It is particularly 
unfortunate that the only known foraging grounds for the [surviving 
Gray Whale population] lie along the northeastern coast of Sakhalin 
Island, where existing and planned large-scale offshore oil and gas 
activities pose potentially catastrophic threats to the population.'' 
\12\ Much concern has also been voiced over the environmental impact of 
offshore oil and gas production in the Caspian Sea, the habitat of over 
400 species unique to the region. Likewise, environmentalists in 
Georgia have expressed concern that possible leaks from the Baku-
Tbilisi-Ceyhan (BRC) pipeline could endanger the famed mineral waters 
of the Borjomi Valley.\13\
---------------------------------------------------------------------------
    \12\ World Conservation Union, Impacts of Sakhalin II Phase 2 on 
Western North Pacific Gray Whales and Related Biodiversity, Report of 
the Independent Scientific Panel, n.d.
    \13\ DoE/EIA, ``Caspian Sea Region: Environmental Issues,'' 
February 2003, electronic doc. Accessed at www.eia.doe.gov/emeu/cabs/
caspenv.html.
---------------------------------------------------------------------------
    Turning now to the second factor I discussed earlier--the 
propensity toward authoritarianism and political disorder in oil-
producing states of the developing world--we can also detect signs of 
this in the former Soviet space. This is not the place for a detailed 
analysis of political conditions in Russia and the Caspian republics, 
but I believe that the corrosive effects of petroleum politics have 
taken root there.
    In Russia, the central government, headed by President Vladimir 
Putin, has moved aggressively to extend state control over the nation's 
energy industry, using questionable legal tactics in the process. Most 
notable, of course, is the use of tax laws to assert state control over 
OAO Yukos, once the nation's top oil producer. These moves have been 
accompanied by the arrest of CEO Mikhail Khodorkovsky and other top 
Yukos officers on charges of fraud and tax evasion. Putin has also 
presided over the merger of state-owned Rosneft and the natural gas 
giant Gazprom, producing a state-controlled energy behemoth with 
substantial interests in oil, natural gas, and nuclear power. These 
moves, while not strictly illegal, have been widely viewed as part of a 
larger trend toward the concentration of economic and political power 
in Putin's hands, reversing progress toward democratization in Russia.
    Kazakhstan and Azerbaijan have also witnessed the concentration of 
power in the hands of their presidents, Ilham Aliyev and Nursultan 
Nazarbaev, respectively. Though both have staged elections to convey a 
veil of legitimacy over their continued rule, neither has permitted a 
free press or the unimpeded existence of opposition parties. The 
election that brought Ilham Aliyev to power in October 2003 (succeeding 
his father, Heyday Aliyev) was reportedly tainted by widespread fraud 
and the use of violence, and the 1999 re-election of Nazarbaev has been 
stained by similar tactics. As in Azerbaijan, a ruling dynasty of sorts 
is being established, with Dariga Nazarbaev, the president's daughter, 
the heir apparent. Human rights observers in both countries have 
reported repeated jailings and persecution of independent journalists 
and opposition political figures. Corruption is also said to be 
widespread, with friends and relatives of the ruling elite being 
favored with government contracts while much of the population lives in 
dire poverty.
    For the present, the leaders of both Azerbaijan and Kazakhstan 
appear to be in firm control of their countries. But just because there 
are no public expressions of dissent--those who attempt to voice public 
disagreement are likely to be jailed or worse--does not mean that there 
are no reservoirs of discontent. As recent developments in Kyrgyzstan 
and Uzbekistan demonstrate, powerful anti-government currents can be 
found just below the surface of allowable public discourse. What is 
particularly worrisome about this situation is that many of those who 
oppose their authoritarian rulers are losing faith in the promise of 
democracy and are turning to radical Islamic movements for inspiration 
and leadership. We cannot be sure if this was a factor in the armed 
insurrection in Andizhan in Uzbekistan on May 12-13, but there is 
reason to suspect the growing influence in that country of Hizb-ut 
Tahrir and other radical fundamentalist organizations.\14\
---------------------------------------------------------------------------
    \14\ See: Stephen Blank, ``U.S. Strategic Dilemmas in Uzbekistan 
and Turkmenistan,'' Briefing at the Center for Strategic and 
International Studies, Washington, D.C., July 27, 2005.
---------------------------------------------------------------------------
                        implications for policy
    There is much to consider in all of this that bears on U.S. energy 
security and American foreign policy. I recognize that the actual 
making of policy is the prerogative of our elected leaders, but I would 
like to make a few comments for the record.
    Just as I see two primary factors that underlie the strained energy 
situation we now find ourselves in, there are two principal policy-
related conclusions I would derive from this analysis:

    First, I believe that we have passed the point at which it is 
possible to assume that, with increased effort and investment, the 
global energy industry will be able to continue expanding petroleum 
output in tandem with the ever growing demand expected from the world's 
developed and developing countries. Total oil output may continue to 
rise for some years to come, but it will never fully satisfy the 
world's thirst for more petroleum. This means, I believe, that energy 
prices will remain high by historical standards, and may climb higher 
still. It also means that we will be at constant risk of energy 
shortages and price spikes from major storms and political upheavals in 
the oil-producing countries. There is no supply side solution in sight 
that can save us from this predicament; only by curbing demand can we 
ease the pressure on oil supplies. Energy conservation must, therefore, 
constitute the principal thrust of any new national energy policy.
    Second, I think it would be a terrible mistake for the U.S. 
government to play an active, conspicuous role in promoting extensive 
involvement of American firms in the extraction of Eurasia's oil and 
natural gas. It is one thing for such firms to employ the normal 
channels of international commerce to gain access to Eurasian supplies, 
and another thing altogether for the U.S. Government to be seen as 
spearheading such efforts--particularly when this entails the 
establishment of close ties with the potentates who control many of 
these countries. Whatever our actual intent, such efforts will be 
viewed by dissidents as conferring American approval on these regimes, 
thereby making us targets of the dissidents' wrath. None of these 
regimes is entirely stable, and when (and if) they are swept away by 
opposition forces, we do not want to be viewed as their evil twin and 
so made persona non grata, as occurred in Iran after the overthrow of 
the Shah in 1980. We can certainly encourage U.S. energy firms to do 
what they are good at, which is seeking out and producing major sources 
of energy, but we should do nothing to fan suspicions that they are 
nothing but tools of the American government.

    I hope that you find my observations to be useful. Thank you for 
allowing me to address this august body.

    Senator Hagel. Dr. Klare, thank you.
    And, again, to each of you, I am grateful for your 
testimony, and if I could capture you for another few minutes, 
I would like to ask a couple of questions.
    Throughout most of the testimony that we heard this 
afternoon, business climate in Russia, environment, the 
importance of Russia--obviously, Dr. Klare has a little 
different approach to some of these issues--but, generally, it 
has been recognized in at least three of your testimonies 
today, as well as representatives from State and Energy, that 
Russia will play a very important role here in the future of 
energy development, affecting the United States in many ways.
    I'm going to ask you, Mr. Ferguson, to begin with 
addressing this question, because you represent a company doing 
business actually on the ground in Russia, so you are beyond 
theory and policy. But I'm going to ask each of you to respond 
to this.
    What needs yet to be done, in your opinion, Mr. Ferguson, 
for Russia to start to arrive at the potential and have the 
impact that most of you believe it will have at some point in 
the reality of doing business in the climate that you are doing 
business in? And I will ask each of you to comment on that. 
What are your thoughts about how we, the United States, become 
more engaged? Again, Dr. Klare will have a different opinion of 
this. He's expressed it. But I want to hear all of your 
opinions. And especially in light of one of the comments that 
was made in the testimony of Ms. Baran, in talking about the 
Shanghai Cooperation Organization and the implications of that, 
that she brings out.
    So, if I could start with you on that very general open 
question, Mr. Ferguson, then I would go to Mr. West and go down 
the line. Thank you.
    Mr. Ferguson. Thank you. I think, in some ways, the best 
way to answer this, Senator, is that we believe that TNK-BP has 
actually found a formula for sustainable success in Russia. And 
it's maybe--there's some lessons there, I think, for maybe how 
we need to engage in--both now and in the future. And this 
formula is a combination of, you know, increased, but very 
efficient, you know, commercial investment, new technology, 
together with improved transparency and better governance. 
Those four elements kind of combine into not only continuing to 
yield good returns for the company, but also create real 
benefits in Russia. In some ways, the best thing that companies 
like TNK-BP and individuals like myself can do is promote these 
large-scale strategic developments that can benefit both Russia 
and--regionally and federally--but actually contribute to 
Russian GDP targets. There is more to be said for these 
strategic projects, both oil and gas, going ahead than probably 
anything else. It makes the biggest single difference. 
Likewise, we don't see, as a Russian--as a Russian private 
entity, we don't see any shortage of opportunities in Russia.
    So, I think it's a combination of applying--and it's the 
right combination of things, I feel--of both transparency, 
governance, new technology, and efficient investment. And I 
think that we know, through our discussions, and discussions of 
a very senior level with the Russian Government, that that's 
something that they genuinely appreciate and use as a model for 
some of their--some of the other companies that are there.
    Senator Hagel. Let me, before I go to Mr. West, ask the 
part two of the question. This is regarding Ms. Baran's 
thoughts concerning the Shanghai Cooperation Organization and 
the implications that she suggested could be the case, and the 
geopolitical representations made in her observations. You were 
there on the ground in Russia. Do you see that possibility 
occurring, that this organization, the SCO, could be organized 
to shut the United States out of this area, geopolitically, 
strategically, militarily, energy-wise, and that being maybe 
one of the purposes of it? What are your general reactions to 
her point?
    Mr. Ferguson. I can only only comment on what I see, from 
an East Siberian standpoint in taking Russian pipeline gas into 
China and Korea. But I would say we see it slightly 
differently, you know, on the ground. We think it is essential 
for the U.S. and Russia to maintain a very strong bilateral 
dialogue. Both the relationship and the dialogue are critical.
    I wouldn't say we have the same concerns as expressed by 
Ms. Baran.
    Senator Hagel. Thank you.
    Mr. West?
    Mr. West. Mr. Chairman, a couple of points which I think 
are important to keep in mind. The first is that this is 
Russia's oil and gas, and I think we should be very cautious 
about telling Russians what to do with their oil and gas. And 
they're very, very sensitive on this, so I think we have to 
have a light touch.
    Secondly, I don't disagree that there is not massive 
corruption, and, frankly, incompetence in certain parts of the 
Russian Government. I think it took a long time to happen, and 
it's going to take a long time to clean up. And I think it 
would be very difficult for us to do so, particularly in a 
high-price environment.
    Instead, I would argue that, in terms of--there are really 
a couple of levels of this--one is, in terms of getting more 
Russian oil and gas into the world market--and I'm an oil and 
gas guy, and I see that as the first task--I think the best way 
to do that is to have a number of transactions which are 
serious deals, which are enforceable deals, which are 
commercial deals, which are properly executed, and that there's 
only one way that can be done, and that is if President Putin 
invests his authority and the Duma ratifies that, so that 
people have protection and--the previous panel, the 
representative of State or Energy were talking about rule of 
law, that people have enforceable contracts that these be good 
commercial deals. I think that--I think that, frankly, that's 
the way--I'm, frankly, rather skeptical of policy dialogues. I 
think there was a lot of talk between Russian and the United 
States that accomplished virtually nothing, and I think what's 
going to get things done are serious deals. And I think the G-8 
Summit is an excellent opportunity for President Putin to drive 
those deals and to be able to have signings with 
representatives of a lot of companies from all over the world.
    On the question of--by the way, I agree, Mr. Ferguson, on 
transparency, on good governance and efficient investment, but, 
again, I think a lot of these things are going to take a long 
time. And, with all due respect, I expect to be retired before 
there's much movement on some of this.
    On the Shanghai question, I think one of the things that's 
very important to remember, that it is--two things--one, it is 
in, I believe, the U.S. economic interest to have as much 
investment in Russia as possible, and to have as many stable 
projects go in Russia as possible. And if Indian or Chinese 
companies participate in that, fine, if it brings more new oil 
and gas to the market. I think it would be a very serious 
mistake for the Russians to try and preclude Americans or 
others, and, likewise, I think it would be a mistake for us to 
try and preclude the Chinese or Indians and others.
    One of the things it's important to point out, as I 
mentioned in my comments opening, is about the big gas 
pipelines to the West, which the United States opposed at the 
time, which I think was a mistake, in retrospect. Pipelines 
hardwire relationships. Pipelines are different than simple 
commercial arrangements. There is massive multi billion-dollar 
investments at both ends, on the production end, and often 
whole industries, cities, can grow up around the other end of 
the pipelines. So, I would argue that that energy can be a way 
to stabilize relationships, not destabilize relationships.
    I guess the last point is, is that there may be 
opportunities, particularly for the Chinese, to come in--the 
only way the United States can do things, really, on any scale, 
is through private-sector investment--the Chinese--there may be 
ways for Chinese Government funding, which is--could be a much 
lower interest cost to fund certain projects which otherwise 
might not get done but which, in turn, could bring more energy 
to the market.
    Senator Hagel. Mr. West, thank you.
    Ms. Baran?
    Ms. Baran. Thank you. As I believe I mentioned, in my 
testimony, so long as oil prices remain so high, I just do not 
see what kind of leverage or influence the U.S. would have on 
Russia. I think some of the things that we have said have also 
been said before, and I am sure people are hearing it in 
Russia, but it is just not, at this point, in the Kremlin's 
interest to change the way it is acting. And because of that, I 
have suggested that we work with European and other allies so 
that there could be a united effort and a common approach. We 
have seen, for example, how BTC affected Russia's behavior vis-
a-vis the CPC. Competition works well. When Russians are forced 
to deal with a competitive environment, they adjust and 
actually behave in a much more market-friendly manner.
    And I agree with Rob--there has been wonderful dialogue 
between the U.S. and Russia--but I am not sure how the 
Americans have benefited from it. I can tell you what the 
Russians have gotten out of it, but I think it is time to 
perhaps consider what the U.S. wants to get out of it.
    Regarding Shanghai, clearly the more oil and gas in the 
market, the better. My concerns were about some of the 
developments since July, when for the first time, this 
organization essentially asked the United States to leave the 
region, and, since then, Uzbekistan has asked the U.S. to close 
its military base. It's most likely that Kyrgyzston is going to 
do the same. The organization initially began as something not 
anti-American--which is what still the Chinese and the Russians 
and others are saying--but some of the declarations and some of 
the actions require one to think and at least be aware of what 
is happening there.
    And, of course, companies from China, Russia, India promise 
support for governments without and not necessarily pressing 
for democracy, and human rights. Several of these presidents--
of Kazakhstan, Uzbekistan, and Turkmenistan--have been hosted 
in Beijing and Moscow and offered a billion dollars of 
investment without any conditions. And I think again that the 
U.S. has very limited leverage, given that there are different 
types of incentives now offered to Eurasian leaders. And we 
just need to be aware of this.
    Senator Hagel. Thank you.
    Dr. Klare?
    Dr. Klare. I'd like to just speak for a few minutes about 
the Shanghai Cooperation Organization, because it has been 
brought into this. And I agree with Ms. Baran that the Russians 
and Chinese see this as a pushback to the United States. But I 
think this needs to be put into perspective and we need to 
recognize that, from the perspective of Moscow and Beijing, the 
United States--and here I mean the government, not the oil 
companies--has been an interloper in this region in a very 
aggressive and conspicuous manner. It was President Clinton who 
began this process, when he pushed the BTC pipeline and 
established military ties with Georgia and Kazakhstan. This was 
viewed, at the time, by Russian leaders very explicitly as a 
challenge, as an intrusion by a foreign power into their own 
historical region, and they responded with military moves of 
their own.
    Now, with the Bush administration, there has been an 
increased American military presence in the region. I'm not 
being critical of this; I'm saying we need to see how it's 
perceived in Moscow and Beijing as an intrusive move. So, from 
their perspective, I think the Shanghai Cooperation 
Organization is a response--not an initiative of theirs, but a 
response to what they see as a heavy-handed, excessive 
American, and military American, presence in this area.
    So, it's not that they're asking the United States to 
leave. It's the military presence that they are objecting to, 
and particularly the U.S. bases in Central Asia. So, I think we 
should understand that our behavior does prompt this response. 
And it's why I suggested, in my testimony, that we should 
separate commercial activities, which could go on separate from 
all of this, from diplomacy and military activities that I 
think are making this situation more tense and are arousing 
anti-American hostility in the region.
    Thank you.
    Senator Hagel. Thank you.
    Let me ask each of you to respond, in any way you want, to 
an open question, because it is getting late, and we are now 
about two hours and 15 minutes into this hearing, and I know 
you each have other obligations.
    And it is this. In any last comments that each of you would 
like to make, based on what you've heard from other panelists 
that you want to amplify, on a point that you made in your 
statement, or any additional comments that you would like, this 
is the opportunity to do it.
    And we'll begin with you, Mr. West.
    Mr. West. I'll spare you, Mr. Chairman.
    Senator Hagel. Thank you. That's why you get invited back 
so often, Mr. West, because you're very clear and concise, and 
brief.
    [Laughter.]
    Senator Hagel. Mr. Ferguson?
    Mr. Ferguson. I'll take the advantage, Mr. Chairman. It's 
my first visit here.
    Senator Hagel. You can have his time, as well.
    [Laughter.]
    Mr. Ferguson. Just to make some closing remarks.
    Senator Hagel. Yes.
    Mr. Ferguson. I think there's an important word to use: 
leadership. I think an example is your own leadership in 
holding these hearings and a recent visit to the East Siberian 
region is a very important part of what's needed for the 
future.
    I would close by saying there are four areas where I think 
the U.S. agencies and groups need to think about--and this 
committee needs to think about--how it works, going forward, in 
terms of opening up these new export corridors and resource 
base in Russia.
    First, I mentioned previously the importance of the U.S./
Russian dialogue. I understand the comments made by others, but 
I think it's an important ingredient in creating a platform, 
right, for others to operate on. Right? It's always listened 
to. It isn't always understood. But I think the most important 
thing is identifying the common areas--the common areas where 
each--where there is genuinely a win-win solution for the 
different players. And recent evidence on the hard focus on 
both price stability and energy security are going to be 
absolutely key, going forward over the next several years. So, 
that would be number one.
    Number two, recognizing and broadening--broadening and 
deepening the understanding of both--Russia's resource base, 
the role that it will play in this. I think it's-- it was said 
by several of the panelists, and several of the earlier panel, 
it's actually little understood just what impact I think it 
could have. And I think we need to broaden and deepen that 
understanding in the Administration.
    Third, an adjunct to that, the role--the specific role that 
East Siberia can play. I think we've got to highlight it a bit 
more clearly.
    And, last, and probably most significantly, is 
understanding that the development of something like East 
Siberia is a genuine win-win for the different stakeholders and 
countries in the region. It's one of those few things I think 
would be a good example for--and I've said this to our Russian 
colleagues--that is--and the Russian Government--it's a good 
example of where every single participant in it, including the 
U.S., can actually benefit, at the same time as Russia is 
picking up the presidency of the G-8 with a strong focus on 
energy security.
    So, I think there's a bit of a framework there, in maybe 
those four points, as to how we need to look, going forward.
    Thank you.
    Senator Hagel. Thank you, Mr. Ferguson.
    Ms. Baran?
    Ms. Baran. Very quickly, I would like to stress one more 
time, the importance of this pending decision to move Central 
Asia to South Asia at the State Department. I understand it is 
mainly a decision by the State Department. The NSC and Pentagon 
are not changing. And it is unclear to me at this point what 
the implications would be, but, having recently traveled to 
Kazakhstan--and I know that you follow Kazakhstan very 
closely--if they at least perceive that they are left behind 
without an East-West perspective, and considered in a different 
regional context, as opposed to a European context, it would be 
very damaging, and I think we will lose a lot of the progress 
on reforms that has already been made. And you probably know, 
Senator Hagel, that, most likely President Nazarbaev is going 
to hold elections in December that will be meeting 
international standards. This is because we have been engaging 
with Kazakhstan and offering it an East-West perspective.
    Senator Hagel. Ms. Baran, thank you. I have noted your 
comments and your testimony. And, in fact, I will be asking the 
State Department for some clarification, because I think you 
make some good points. And I appreciate very much you pointing 
this out to the committee. And if you have any additional 
thoughts on this, please let us know. Thank you.
    Dr. Klare?
    Dr. Klare. First, I just want to congratulate you, again, 
Senator, for holding these hearings. As professor of 
international relations, I know how important this region is, 
and the testimony you've elicited has been some of the best 
I've read in academic journals and elsewhere. So, 
congratulations. And I hope it's disseminated as widely as 
possible.
    Just two very brief points. A number of the prior witnesses 
have talked about the possibility of a geopolitical contest 
arising in Central Asia between the U.S., Russia, and China. 
And I think there is a perception in many places that this is 
underway. And I fear that it has a self-sustaining character, 
that each side will view the other with suspicion and respond 
that way. And I think it would be deeply, deeply dangerous for 
that to occur. I think the U.S., Russia, and China should 
cooperate as much as they possibly can in the economic and 
energy areas. It's the best thing for all of us.
    Also, I've spoken, in my statement, but not at length, 
about the environmental dimensions of all that we've discussed 
today. The areas--as I said, the areas where these activities 
are taking place--the Arctic, Siberia, the Caspian Sea, the 
Bosporus, the Black Sea--are all very much environmentally 
threatened areas. And oil drilling and pipelines pose an 
increased threat to the survival of endangered species. And I 
know that civil society in that part of the world is becoming 
increasingly aware of this and will have its voice heard. So, 
we really have to pay attention to the environmental 
dimensions.
    Senator Hagel. Dr. Klare, thank you.
    To each of you, thank you, again, for your testimony and 
your insights. And we will be calling upon you again.

    [Whereupon, at 4:45 p.m., the hearing was adjourned.]
  

                                  
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