Poland agrees to joint development of Ukraine's Odesa-Brody pipeline (01/25/04)

Poland agrees to joint development of Ukraine's Odesa-Brody pipeline

by Roman Woronowycz
Kyiv Press Bureau

KYIV - Poland agreed on January 16 to joint development of the Odesa-Brody oil pipeline from the Ukrainian border to Plotsk, near the Baltic Sea, where the oil would be transported by sea to ports in Western Europe.

The agreement, signed two days after Ukraine's Cabinet of Ministers officially approved the project, is a major step in assuring the pipeline's economic feasibility. It heralded the first concrete step towards development of a single oil transport corridor from the Black Sea to the Baltic Sea, which would make it one of the main oil pipelines from the oil-rich Caspian Sea region to energy-starved Europe

It occurred nearly simultaneously with a renewed impetus to keep the focus of the Ukrainian government on an alternative, reverse usage of the Ukrainian oil transport system, from Brody to Odesa. Extensive mass media reports on January 15 stated that reverse use of Odesa-Brody could bring Ukraine economic benefit, according to a not-yet-released feasibility study. The study, to be released by Energy Solutions LLC, a little-known energy consulting firm, which coincidentally or not also is the name of a widely known and respected Washington-based lobbying firm, was held back after Energy Solutions stated that it needed more time to complete its analysis.

Several energy and oil transport experts in Kyiv who spoke with The Weekly, nonetheless, rejected any possibility of economic benefit from reverse use of the oil pipeline.

The Polish-Ukraine agreement, which Central and Western European leaders and the United States have strongly supported, stipulates the creation of a joint stock company between the two countries, the preparation of a business plan and the development of investors.

UkrTransNafta, the wholly government-owned firm that built and controls the Odesa-Brody pipeline, has said it has developed informal agreements with major international oil companies to pump 14 million tons of high-grade light sweet crude from the Caspian region to Europe annually, beginning with 5 million to 6 million tons next year, should all the details regarding the oil pipeline and the disputes surrounding it be settled.

Andrii Kliuyev, recently appointed vice prime minister of Ukraine's energy sector, who was present at the signing ceremony, which was held in Warsaw, noted afterwards that the agreement was the first tangible step in completing the pipeline from the Ukrainian border town of Brody to Plotsk in the next phase and on to the Polish port city of Gdansk in the final phase of development. Mr. Kliuyev underscored that the project needed to be initiated within the next 30 days so as not to lose momentum, according to Interfax-Ukraine. He identified three phases in the project: preparation and analysis of financing and investment; negotiations with participants; and start-up.

Even with a concrete plan finally on the table in the long-awaited agreement between Poland and Ukraine, controversy which has been the hallmark of the effort to develop the Odesa-Brody pipeline - again emerged a day before the signing ceremony.

On January 15, Energy Solutions, a consulting firm contracted by the Ukrainian government to assess the economic viability of utilizing the still-barren oil pipeline in reverse, stated that the preliminary conclusions drawn from its analysis showed that it was economically expedient to pump oil from Brody to Odesa for a three-year period, during which time Ukraine could develop its Caspian oil route. It stated that Ukraine could make up to $35 million during the life of the contract.

However, Ukraine's Ministry of Fuel and Energy immediately refuted delivery of the report and stated that it had yet to receive any results from the consulting firm. Minister of Fuel and Energy Serhii Yermilov said he was still awaiting the official report and that the firm had a January 19 deadline to present it. He also noted that a decision by President Leonid Kuchma was not expected before February 1. On January 17, the issue surrounding the results of the analysis became more unclear when Energy Solutions asked for more time to present the full feasibility study.

Much of the intrigue that has developed around the Odesa-Brody oil pipeline involves Russia's Tyumenskaya Neftanaya Kompania (TNK) and its recently acquired partner, British Petroleum. The new conglomerate has made a determined effort to convince Ukrainian officials to allow them to pump low-grade Russian Urals crude through Brody to Odesa for a three-year period. In Odesa the Russia crude would be transferred on to tankers and moved through the Black Sea through the Bosporus Sea into the Mediterranean and onto southern Europe.

The main argument TNK-BP has used to convince Ukrainian state leaders to agree to the project is that the pipeline - completed and ready for utilization back in May 2002 - has sat idle since then, while Ukraine has attempted unsuccessfully to lure international oil companies, many from the United States, to commit to using the pipeline to transport Caspian high-quality light sweet crude.

Rejecting TNK-BP assertions, an economic analyst and an executive of UkrTransNafta told The Weekly in separate interviews they see absolutely no benefit for Ukraine in bending to TNK-BP demands and agreeing to a three-year contract. Ukraine would not only have no guarantee that TNK-BP would or could ship the amounts that it has stated it could commit to - about 9 million tons annually - but it would have to expend three dollars more per ton to do so.

While somewhat reticent to explain the political motivations that might lurk behind a decision to absorb losses simply to keep control of the pipeline, the two experts agreed there was no economic benefit to paying three dollars more per ton just to send oil through Odesa-Brody.

"I can tell you right away that there is no economic benefit to reverse, none whatsoever," explained Mykhailo Honchar, director of the Department of Strategy for the Eurasian Transport Corridor for UkrTransNafta, the government-owned corporation that built and controls the Odesa-Brody line.

Mr. Honchar said it was unclear to him why any Russian oil company, not just TNK-BP, would be willing to pay more money to use Odesa-Brody from an economic point of view, when two alternative oil pipelines could be utilized, including the new Prydniprovska pipeline that runs through Ukraine from north to south. He said the recent addition of a new pumping station in Mykolaiv, which would allow the Prydniprovska line to easily absorb the 9 million tons that TNK-BP would like to ship through the Black Sea, combined with a new Russian-Ukrainian state agreement of December 29, 2003, which raised levels of the amount of Russian oil that could be pumped though the line, "should have taken any talk of reversing Odesa-Brody off the table."

The UkrTransNafta executive noted that the oil that would flow in a reversal of Odesa-Brody should TNK-BP obtain the three-year contract it is seeking would not give Ukraine a net revenue gain of $35 million, as the preliminary announcement by Energy Solutions asserted, and could cause economic loss. He explained instead that much of the oil that TNK-BP would ship would not be "new" oil, but crude that would be redirected from Ukrainian rail shipments by which it currently moves from the Russian border to the Black Sea. The specialists note that Ukraine would lose revenue through reduced usage of the more lucrative rail transport system.

"Let's not forget that UkrZaliznytsia (Ukrainian rail) generates revenue from this. Using the pipeline would be cheaper [for TNK-BP] and, therefore, a loss of revenue for Ukraine. [UkrZaliznytsia] has said it could lose as much as $80 million," explained Mr. Honchar.

The logjam of ships waiting to use the Bosporus Sea and Dardanelles presents another major problem for the TNK-BP reverse option. The two experts stated unequivocally, although with a least one note of caution, that the problems with heavy traffic through the only shipping route from the Black Sea to the Mediterranean made the reverse option for Odesa-Brody prohibitive.

"There is indeed a serious problem with getting through the straits around Turkey, explained Volodymyr Saprikin, an energy analyst with the respected Razumkov Center for Economic and Policy Studies.

However, Mr. Saprikin added that there is some questioning by shippers regarding Turkey's motives for limiting traffic through the straits. He surmised that some reserve capacity might exist and that several court actions have been brought because Turkey refuses to open the straits for passage of ships during the night-time hours.

Mr. Saprikin also expressed a slight difference in opinion with Mr. Honchar over the economic viability of the TNK-BP project in the short term. He noted that, at the moment, oil prices are near record levels and as a result the Russian government has raised by 10 percent the level of oil it allows to be extracted from the ground in 2004. With the price for crude oil expected to peak soon and then fall in the second half of the year, Russian oil firms have been looking for ways to get their product out of the country and into market as soon as possible.

As for political motivations in pursuing an Odesa-Brody reverse, when the economics of the matter show it to be only marginally profitable yet very troublesome, Mr. Honchar, expressed two theories.

First, he said, it could simply be that the Russian authorities are using TNK-BP to keep Ukraine from making a concrete step towards integration into European structures by taking Odesa-Brody for itself for three years, the period during which most of the major oil transportation routes for getting Caspian oil to market will be developed. A second theory proposed by Mr. Honchar holds that powerful Ukrainian and Russian business interests with ties to TNK-BP want to exclude powerful Western oil multinationals from access to the Odesa-Brody oil pipeline, while they develop their own interests and plans for shipping the lucrative light sweet Caspian crude to Europe.

"These people see the potential and see that this is a way for them to retain control over the situation," explained Mr. Honchar.

Finally, while the two experts could not unequivocally explain who owned Energy Solutions, the energy consulting firm that had been tasked by the Ukrainian government to produce a feasibility study on the subject, Mr. Saprikin cast doubt on the firm's credentials and the manner in which the tender was awarded. He said he doubted whether the firm had sufficient experience and expertise to be awarded the project if it had been tendered on a competitive and transparent basis.

"I don't think it met the demands of the tender," explained the Razumkov Center energy expert. "It doesn't have the experience that was required and it doesn't have the specialists at the level required, they are not experts on oil and gas transport."

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