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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

(II)

COMMITTEE ON FOREIGN RELATIONS

RICHARD G. LUGAR, Indiana, Chairman

CHUCK HAGEL, Nebraska

LINCOLN CHAFEE, Rhode Island

GEORGE ALLEN, Virginia

NORM COLEMAN, Minnesota

GEORGE V. VOINOVICH, Ohio

LAMAR ALEXANDER, Tennessee

JOHN E. SUNUNU, New Hampshire

LISA MURKOWSKI, Alaska

MEL MARTINEZ, Florida

JOSEPH R. BIDEN, Jr., Delaware

PAUL S. SARBANES, Maryland

CHRISTOPHER J. DODD, Connecticut

JOHN F. KERRY, Massachusetts

RUSSELL D. FEINGOLD, Wisconsin

BARBARA BOXER, California

BILL NELSON, Florida

BARACK OBAMA, Illinois

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

LISA MURKOWSKI, Alaska

MEL MARTINEZ, Florida

GEORGE V. VOINOVICH, Ohio

PAUL S. SARBANES, Maryland

CHRISTOPHER J. DODD, Connecticut

JOHN F. KERRY, Massachusetts

BARACK OBAMA, Illinois

CONTENTS

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, TNKBP, 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

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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.

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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 cliVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
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mates. 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

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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

5

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 governmentto-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.

6

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

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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.

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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 KazakhstanChina 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 deciVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00012 Fmt 6633 Sfmt 6621 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
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sion-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, AzerVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00013 Fmt 6633 Sfmt 6621 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
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baijan, 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

11

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-toindustry 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.

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• 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

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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 postSoviet 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.

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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:]

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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

16

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.

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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

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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 invesVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00022 Fmt 6633 Sfmt 6621 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
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tors 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 imVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6621 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
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porter—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 stateowned 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 KazakhstanBTC (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

21

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

22

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 marVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6602 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
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ket 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?

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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 enVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6601 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
25

ergy 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 selfinterest—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.

26

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

27

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 energysecurity 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 obviVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6601 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
28

ously 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:]

29

1Published 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.

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.

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 stateowned 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

30

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 longterm 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.

31

2 Energy Information Administration. ‘‘Caspian Sea Region: Survey of Key Oil and Gas Statistics and Forecasts,’’ at [http://www.eia.doe.gov/emeu/cabs/caspianbalancesfiles/

sheet001.htm], viewed September 15, 2005.

Table 1.—Estimates of Eurasian Oil and Gas Reserves and Resources

[oil in billions of barrels/gas in trillions of cubic feet]

Region Country

Proven Reserves Possible

Additional

EIA BP 1

(End of 2004)

O & G Journal (1/1/05)

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.

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

32

3 Caspian Sea Region: Survey of Key Oil and Gas Statistics and Forecasts, July 2005.

4 ‘‘Kazakhstan, China Revive Pipeline Deal,’’ Middle East Economic Survey, 19 July 2005.

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 43⁄4 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.

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

33

5Limited 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. 6Linefill 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.

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.

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. Builtin 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.

34

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. 8 At the onset of the prosecution of Khodorkovski, Yukos was ranked by some as the fourth

largest oil company in the world. 9 Ariel Cohen, ‘‘Don’t Punish Latvia,’’ Washington Times, May 5, 2003.

10 ‘‘Japan accuses China in oilfield dispute,’’ FT.com, September 20, 2005, viewed Sept. 22,

2005.

Energy Policy Positions of Relevant Governments 7

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.

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

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

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

35

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.

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

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

36

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?

37

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.

38

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

39

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 followthrough. 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,

40

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. NonU.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

41

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 G8, 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

42

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.

43

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.

44

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 secondguessing 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.

45

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

46

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 largescale 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 41⁄2 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.

47

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

48

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

49

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.

50

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 AsiaPacific 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; 90δrcent 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

4.4δrcent 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

51

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 AsiaPacific 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 counVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00055 Fmt 6633 Sfmt 6601 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
52

tries 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

53

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 MediVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00057 Fmt 6633 Sfmt 6601 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
54

terranean 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:]

55

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,

56

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

57

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 exVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00061 Fmt 6633 Sfmt 6621 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
58

pensively 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,

59

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 cooperationgiven 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 EastWest 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

60

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

61

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-toreach 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

62

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

63

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

64

1 1. U.S. Department of Energy, Energy Information Administration (DoE/EIA), International

Energy Outlook 2005, Table A1.

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

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

65

2 Ibid., Table A4.

3 Ibid., Tables A4 and E1.

4 Ibid., Table R1.

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

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.

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.

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.

66

5 U.S. Department of Energy, Energy Information Administration (DoE/EIA), International

Energy Outlook 2002, Table D1. 6For discussion of this point, see Matthew Simmons, Twilight in the Desert (Hoboken: Wiley,

2005).

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)

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-todevelop 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

67

7For a thorough analysis of this phenomenon, see Terry Lynn Karl, The Paradox of Plenty

(Berkeley: University of California Press, 1997). 8DoE/EIA, ‘‘Russia,’’ Country Analysis Brief, February 2005, electronic doc. Accessed at

www.eia.doe.gov/emeu/cabs/russia.html.

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.

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-toreach 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.

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 bilVerDate 11-MAY-2000 15:23 Apr 24, 2007 Jkt 000000 PO 00000 Frm 00071 Fmt 6633 Sfmt 6621 H:\DOCS\33726.TXT sfrela2 PsN: sfrela2
68

9 ‘‘Sakhalin II Project’s Phase 2 Cost Estimate Rising,’’ Oil and Gas Journal, July 25, 2005,

p.26. 10DoE/EIA, ‘‘Kazakhstan,’’ Country Analysis Brief, July 2005, electronic doc. Accessed at

www.eia.doe.gov/emeu/cabs/kazak.html. 11DoE/EIA, ‘‘Azerbaijan,’’ Country Analysis Brief, June 2005, electronic doc. Accessed at

www.eia.doe.gov/emeu/cabs/azerbjan.html 12World 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. 13DoE/EIA, ‘‘Caspian Sea Region: Environmental Issues,’’ February 2003, electronic doc.

Accessed at www.eia.doe.gov/emeu/cabs/caspenv.html.

lion, 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

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

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

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14See: 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.

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

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,

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sia—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

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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

72

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

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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?

74

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 winwin 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

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tive, 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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