Pipelines as a source of conflict
THE NEWLY-published report from Chatham House entitled Transit troubles – pipelines as a source of conflict* raises a number of interesting and important issues, and is worth studying in detail, and can be downloaded from the reference below. We are pleased to have the agreement of the report’s author, Professor Paul Stevens, to publish the report’s summary; a brief biography for him appears at the end of this article, from which it will be seen that he is eminently well-placed to be a commentator in this area of the pipeline industry, where engineering and politics either meet or clash, depending on the viewpoint.
RECENT EVENTS between Russia and Ukraine at the start of 2009, and Russia and Georgia in 2008, have brought transit pipelines back into the media spotlight. Any reading of the history of transit oil and gas pipelines suggests a tendency to produce conflict and disagreement, often resulting in the cessation of throughput, sometimes for a short period and sometimes for longer. It is tempting to attribute this to bad political relations between neighbours. This is certainly part of the story, but also important is the nature of the ‘transit terms’ – tariffs and offtake terms – whereby transit countries are rewarded for allowing transit. Put simply, the trouble with transit pipelines has a significant economic basis. The report addresses three questions:
Why will oil and gas transit pipelines become more important to global energy markets in the future?
Why has the history of such pipelines been littered with conflict between the various parties?
What might be done to improve this record in the future and make transit pipelines less troublesome?
Chapter 1 defines transit pipelines as lines which cross another’s ‘sovereign’ territory to get the oil or gas to market. Such lines have a number of relevant, common characteristics which tend to generate conflict. Different parties are involved, each with different interests and motivations. This invites disagreement between the parties because of the benefits to be shared and the fact that mechanisms exist to encourage one or other party to seek a greater share. Even though this would apply to any commercial transaction, the key difference with transit pipelines is that there is no overarching jurisdiction. More transit pipelines will be needed in the future, since oil and gas reserves close to market are being depleted, and there is growing demand for natural gas in the world’s primary energy mix. In recent years, there has been a noticeable fragmentation of legal jurisdictions as the Soviet Union and former Yugoslavia both collapsed. Many of the new transit pipeline projects being discussed are essentially the result of gaming strategies between the various players and will fail to materialize.
Chapter 2 starts with a brief history of the many transit pipelines which have been associated with very negative experiences. In the past, they included those operating in the Middle East; more recently, attention has been focused on those in the former Soviet Union. The chapter then describes lines which can be viewed either as success stories or as having too recent a history for the outcome to be determined. This history helps in identifying which characteristics make for ‘good’ and ‘bad’ transit countries. These include:
the importance of foreign direct investment in the transit country’s development strategy;
the importance of the transit fee in the country’s macro economy;
the dependence upon offtake from the line;
the availability of alternative routes;
whether the transit country is also an oil or gas exporter in its own right.
Chapter 3 seeks explanations for poor performance in terms of politics but with the main discussion focusing on the underlying economics which generate conflict. One obvious source of political disputes is a history of bad relations between neighbouring countries. As for the economics, the key explanation is that there is no reasonable, objective basis for determining ‘transit terms’. The only sensible reason for the existence of a transit fee is to allow the transit country to share in the benefits of the project. This share will reflect the relative bargaining power of the parties to the negotiations. Over time this changes and thus there are always pressures to change the transit terms. This trend is greatly encouraged by the existence of the ‘obsolescing bargain’, the structure of pipeline costs, and the growing volatility of oil and gas prices.
Chapter 4 considers possible solutions to help reduce conflict and supply disruptions. These include:
a military solution;
encouraging the transit country into the global economy to make it dependent upon foreign direct investment;
making the transit country dependent upon its own gas and oil supplies from the pipeline, although this can be a double-edged sword;
considering alternatives to the transit country not only in terms of geographic routes but (for gas) the actual means of transport including, for example, the use of liquefied natural gas (LNG);
encouraging multilateral jurisdictional solutions such as the Energy Charter Treaty;
developing mutual dependence between the transit country and the producer/consumer country.
Finally, the report considers a new solution: basing the ‘transit terms’ on a progressive fiscal arrangement similar to the sort of systems which govern upstream oil agreements. The report concludes that there will be an increasing need for and dependence upon oil and gas transit pipelines but such pipelines are inherently unstable because of political disputes and also, of equal importance, as a result of commercial disputes over the transit terms. These commercial disputes arise because there is no objective, reasonable or fair way of setting the transit terms. Many of the apparent solutions to this problem are, on closer examination, at best ineffective, at least in current circumstances. More generally, history suggests that a good experience with transit pipelines requires certain best-practice conditions to be met. These include:
a clear definition and acceptance of the rules;
projects driven by commercial considerations;
credible threats to deter the ‘obsolescing bargain’;
mechanisms to create a balance of interest.
However, it is difficult to turn this ‘wish list’ into a practical agenda. The only practical, realistic solution in the near term is to introduce ‘progressive’ transit terms to existing and new agreements. However, ultimately both consumers and producers must diversify as far as is economically practical.
Professor Paul Stevens is Senior Research Fellow for Energy at Chatham House, Emeritus Professor at Dundee University and Consulting Professor at Stanford University. He was educated as an economist and as a specialist on the
Middle East at Cambridge University and the School of Oriental and African Studies, London. He taught at the American University of Beirut in Lebanon (1973–79), interspersed with two years as an oil consultant; at the University of Surrey as lecturer and senior lecturer in economics (1979–93); and as Professor of Petroleum Policy and Economics at the Centre for Energy, Petroleum and Mineral Law and Policy, University of Dundee (1993–2008) – a chair created by BP.
*Transit troubles: pipelines as a source of conflict. Prof. Paul Stevens, 2009. A Chatham House Report – see www.chathamhouse.org.uk.
US companies explore putting ethanol pipeline through US Midwest
TWO MAJOR US pipeline companies have announced their plans to assess the feasibility of constructing an ethanol pipeline through the Midwest. If built, the pipeline would the first one totally dedicated to transporting ethanol in the US. Oklahoma-based Magellan Midstream Partners and Pennsylvania-based Buckeye Partners have partnered to explore creating the 2720-km long pipeline to transport ethanol from plants in Illinois, Iowa, Minnesota, and South Dakota to major cities including Pittsburgh, Philadelphia, and New York. The project is estimated to cost more than $3bn.
The American Coalition for Ethanol’s 2007 report lists Illinois as the second largest producer of ethanol in the US, at 317m gall/yr, and corn grown in Illinois is used to produce 40% of the ethanol consumed in the US, according to the Illinois Corn Growers Association (ICGA). Nearly one-third of all gasoline in the US already contains low levels of ethanol – usually between 5.7% and 10%, and the ICGA reports that 95% of the gasoline sold in the Chicago area contains 10% ethanol. However, high levels of ethanol cannot be piped through existing gasoline lines without damaging them. Once ethanol has been transported through existing pipelines, they can’t be shared with other refined products. “In pipelines today, you can ship different materials through in batches, with plugs that separate the shipments. However, ethanol – because it absorbs water, and is a corrosive agent – is really difficult to use in a non-dedicated pipeline,” John Urbanchuk, the director of expert-resources firm LECG, said.
Magellan and Buckeye may be years away from construction, simply because not much is known about transporting ethanol through pipelines. Studies on the technical issues and economic impact of creating an ethanol pipeline are continuing, as highlighted in Dr John Beaver et al.’s paper on pages 29-34; no ethanol pipelines exist in the US, though Brazil is in the process of constructing one and Houston-based Kinder Morgan is understood to have announced plans to test an ethanol pipeline in Florida this year.
Changing the way ethanol is transported may have more of an effect on consumer costs than adopting alternate fuels or even falling oil prices. “If you looked at something in Illinois or maybe Iowa, sending it to the East Coast by freight is anywhere between 16 and 18 cents a gallon. If you take into consideration a refined product travelling the same distance, it would probably be under a nickel. So if you could get ethanol from Illinois to the East Coast for 12 cents a gallon cheaper than you can today, obviously a lot would change in the world, and the interest in ethanol would increase,” Robert White, director of operations for the Omaha, Nebraska-based Ethanol Promotion and Information Council, said. John Urbanchuk agreed, “The cost of shipping ethanol would be about the same as it is to ship gasoline through a pipeline.”
In the US, ethanol is primarily moved by rail and road tankers, which are costly and time-consuming methods of transportation. While a pipeline should help in the cost of distributing ethanol (and presumably in the cost of consuming it), it could also take away jobs from the rail and trucking industry, particularly in the Midwest. Most experts admit there’s something of a chicken-and-the-egg effect as companies consider shipping ethanol. The production of ethanol isn’t high enough today to create a desperate need for pipelines, but without a pipeline infrastructure in place, companies are hesitant to produce more ethanol. One motivator is the Energy Independence and Security Act of 2007, which President Bush signed in December. The law requires that American fuel producers use 36bn gallons of renewable fuels by 2022, with is more than five times what is currently used.
But the biggest challenge to Magellan and Buckeye now may not be moving products through an ethanol pipeline, but moving funding through the federal government pipeline. “They have reached out to Congress and said, ‘Some of this has merit, but we need some support and we need to know how much that support’s going to be, because we need to make business decisions on our end,’” Mr White said. “[This $3-bn project is] a substantial investment that you have to recapitalize somehow.” The companies’ press release repeatedly stresses the importance of government support: “Congressional support and assistance is necessary for a project of this nature given the changing federal policies associated with renewable fuels.” The Energy Act included a provision requiring that the US government undertakes its own feasibility study on ethanol-dedicated pipelines, and this study is due to be released in 2010.