Pipelines or pipe dreams?  Lessons from the history of Arab transit pipelines

Paul Stevens
The Middle East Journal, Vol. 54, Issue 2, Spring 2000, pp.224-241.

Abstract:

Stevens outlines a history of transit oil and gas pipelines in the Arab
world over the last 70 years. In particular, he seeks to understand the
causes behind the generally poor performance of the pipelines and tries
to examine the economic basis for this.

Copyright Middle East Institute Spring 2000

Full Text:

The article outlines a history of transit oil and gas pipelines in the
Arab world over the last 70 years. In particular, it seeks to understand
the causes behind the generally poor performance of the pipelines and tries
to examine the economic basis for this. The purpose is to find lessons
and an analytical framework which may inform current discussions of such
pipelines in relation to the development of Caspian hydrocarbons and gas
exports from the Persian Gulf.

In recent years, there has been a renewal of interest in transit oil and
gas pipelines. These are defined as pipelines which must cross another's
territory to get to market.l This interest, arising from Caspian hydrocarbons
and gas exports from the Persian Gulf, has generated analysis which suffers
from two serious failures. It either ignores the poor performance of transit
pipelines in the past or, where problems are analyzed, the concentration
is exclusively on politics. Both ignore the lessons of history. An earlier
study by this author on the experience of such lines in the Middle East
concluded that their operating experience had been abysmal in terms of
interruptions to flow.2 These interruptions had been driven by economic
factors--disputes over transit fees-as much as by political factors.3

This article updates that assessment of the historical experience. In particular,
it includes a later transit line, Transmed, whose experience, in contrast
to the trend, shows an exemplary operating record. The objective of the
article is to extract what historical lessons may be learned and applied
to plans relating to Caspian hydrocarbons and Persian Gulf gas. Much of
the poor performance to be described can be attributed to economic features
of the transit country. These features suggest the probability of a forced
renegotiation of transit fees once the line is operating. They help to
identify "good" transit countries which will not cause disruption and "bad"
transit countries which will. This check-list allows analysts to assess,
in economic terms, some of the routes currently under discussion. This
article hopes to achieve two objectives--the creation of a check-list to
provide a transparent agenda for further analysis and the flagging of the
neglected importance of economic problems for transit. The article concludes
by considering possible solutions to the general problems of transit.

THE RENEWAL OF INTEREST IN TRANSIT PIPELINES

Two recent developments have revived interest in transit pipelines: the
potential of the hydrocarbon resources of the Central Asian Republics of
the former Soviet Union, and the possible export of gas from the Persian
Gulf into the growing energy markets of Asia.4

The hydrocarbon resources of the Central Asian Republics are large, though
exactly how large is debatable. The United States Energy Information Agency
estimated proven oil reserves at 15-29 billion barrels (bb) with possible
reserves of as much as 163 bb.s The same study suggests proven gas reserves
of 236-337 trillion cubic feet (tcf). In a similar vein, the International
Energy Agency suggests proven oil reserves of between 15-40 bb with 70-150
bb as possible.6 To put this in perspective, at the end of 1997, proven
oil reserves in the US were 29.8 bb and in Europe 20.2 bb while proven
gas reserves in the US were 166.5 tcf and in Europe 196.5 tcf.7 There is
significant debate about the legal status of the Caspian Sea (whether it
is to be treated as a sea or lake) around which much of the hydrocarbon
reserves lie.8 Without wishing to enter that debate, it is clear the Caspian
is a lake in the sense that there is no access to the high seas. Exports
of oil or gas in any volume will require transit pipelines and there has
been a proliferation of suggested routes together with discussions of the
various possible problems.9

Transit pipelines are also central to consideration of possible gas exports
from the Persian Gulf which account for 34 percent of global gas reserves
but only seven percent of global gas production.10 Interest has been driven
by several factors. There is the growing hunger for hydrocarbon revenues
following the lower oil prices experienced since 1986.11 The even lower
prices since November 1997, if they recur which is likely, will reinforce
this.12 There is skepticism among many about the viability of liquified
natural gas (LNG) projects because of their size, inflexibility and complexity.13
Despite recent economic problems, there is a growing demand for all forms
of energy in Asia. 14 Finally, the electricity sector in Asia is undergoing
restructuring and deregulation involving private investors. Combined cycle
gas turbine technology is ideal for the private sector with its extremely
short lead times, relatively low capital costs, and quick payback. The
result of all these factors has been a great many negotiations and stated
intentions to develop gas export projects from Iran, Qatar and Oman to
the Asian sub-continent and Europe.15

A SELECTED HISTORY OF TRANSIT PIPELINES IN THE ARAB WORLD]6 Iraq Petroleum
Company (IPC) Line

Prospective exports of Iraqi oil from the Kirkuk field in the 1930s, led
to pressure from the British partners in the Iraq Petroleum Company (IPC)
for a line via British mandated Palestine and from the French for a line
via French mandated Lebanon and Syria. Compromise led to the building of
both, split after Haditha in Western Iraq. A 12-inch line was completed
in 1934 with a capacity of four million tons per year (mty). By 1946, work
started on a 16-inch line to Tripoli and Haifa, in then British mandated
Palestine, parallel to the earlier 12-inch line, constrained by the IPC's
inability to buy larger diameter pipe from the US because of dollar shortages.
After the creation of Israel, the Haifa branch closed. In 1950, work began
on a 30-32 inch, 14 mty line from Kirkuk in Iraq to Banias in Syria which
was completed in 1952. This gave a total capacity to the system of 16 mty.
In 1956, the lines were badly damaged by the Syrian Army during the Arab-Israeli
war in a reprisal for British and French involvement but they were eventually
repaired.17

The 1931 agreement which created the line made IPC free from any transit
fee or taxation except on profit from products sold locally. The only benefit
(the agreement included the signatures of the Lebanese and the Syrian governments)
was a two penny loading fee on every ton loaded at the terminals. Although
the agreement had a 70 year life, the introduction of 50-50 upstream profit
sharing in the early 1950s prompted Syria and Lebanon to seek similar treatment
for the pipelines. In November 1955, the IPC signed a new agreement with
Syria and in 1959 with Lebanon. This provided for a transit fee (one shilling
and four pence per 100 ton-miles); a loading fee of one shilling per ton
and an annual payment of L250,000 for protection and other services. This
was based upon notional profit calculations allowing for a 50-50 profit
split. As with all such calculations there was plenty of scope for further
dispute and interpretation.l8

In August 1966, a new extreme wing of the Bath Party took over the Syrian
government and requested a renegotiation of the transit fee. The claim
was that increasing the line capacity reduced average costs giving a higher
profit base. Negotiations were relatively simple, but the Syrian government
insisted on retroactive payments. The companies, fearful of precedents,
adamantly refused. On 16 November with no agreement in sight, the government
issued a warning setting forth a formula for profit sharing, rejected by
the IPC. Negotiations were broken off on 23 November and Syria unilaterally
raised the transit fee by 46 percent and the loading fee by 92 percent.
In addition, a further three shillings transit fee was levied to compensate
for IPC's "underpayment." This was to be retained until all "accounts are
settled with the company." IPC filled its storage in Banias and ceased
pumping. Shortly afterwards, the Syrian section was also unable to feed
the Lebanese spur line due to alleged pumping problems, which the IPC was
not allowed to investigate. Both sides then proceeded to make claims and
counter claims regarding the way in which the undisputed 50-50 profit sharing
should be interpreted.19

It is unclear whether the dispute was rooted in economics or politics.
Syria's perspective was that this was "an episode in a broader struggle
to free the Arab nation from the domination of Western imperialism and
exploitation by oil monopolists". For the IPC, conceding to Syria would
create a dangerous precedent to haunt its owners in relations with other
Middle East governments. Also, the IPC owners were under pressure from
other governments in the region to expand production. Cutbacks in Iraq
blamed on Syria provided a welcome relief.20

It was growing pressure from Iraq on both Syria and the IPC which reopened
negotiations. Agreement in March 1967 was based upon terms offered earlier
by the IPC. Syria agreed because the loss of Iraqi oil had been easily
managed by the industry and there was a danger of permanent closure which
would deprive Syria of much needed foreign exchange.21

In 1971, as part of the Tehran and Tripoli price agreements, a new transit
agreement emerged between Syria and Tapline (see below) which would double
Syrian revenue at full capacity. Syria therefore approached the IPC to
renegotiate terms, and in July 1971 there was a substantial increase in
fees. In June 1972, Iraq nationalized the IPC, and Syria immediately nationalized
IPC's assets in Syria requiring negotiation of a new agreement. Syria requested
a doubling of transit fees and favorable prices for crude used domestically.
Negotiations faltered and in January 1973, Syria threatened unilateral
action. Iraq's extremely weak bargaining position with strengthening oil
prices forced Iraqi acceptance.22 This left Iraq bitter and determined
to short-circuit Syria's command over Iraq's exports. However, in June
1973 Iraq announced an interest-free loan of $22 million for Syria to expand
the line's capacity. In September 1973, it was announced that Entrepose
of France had been awarded a $44 million contract to expand the line by
200,000 barrels per day (b/d) to 1.4 million b/d (mb/d).23

In 1975, Syria again requested renegotiation of the 1973 terms as was allowed
by the agreement. However, this was with much higher prices following the
"first oil shock." Syria wanted an increase in transit fees while Iraq
wanted a reduction in Syrian domestic offtake or a higher price. In 1975,
Syria's net income from transit fees was $100 million and the price discount
on crude offtake was worth $88 million.24 Iraq now had alternative routes
(see below) and in March 1976 pumping stopped, and the Strategic Pipeline
diverted the oil south. In October 1978, rumors suggested a new Syrian-Iraqi
rapprochement triggered by the Camp David Accords could lead to a resumption
of operations. Pumping resumed in February 1979 at 80,000 b/d at transit
fees which were "a little bit less" than Iraqi dues paid to Turkey and
which involved various offtake arrangements.25

Exports ceased in September 1980 with the Iraqi invasion of Iran although
there was much speculation over the extent of the damage to the Iraqi facilities.
At the beginning of December, it was announced that the Banias line would
re-open at 200,000 b/d which it did in February 1981. In March 1981 an
agreement was also reached to resume pumping through the Lebanese spur
which led to the first loadings in December 1981. Shortly after, plans
were announced to increase the Turkish line capacity (see below) from 700,000/d
to 900,000-1,000,000 b/d by increasing the pumping stations. Meanwhile,
in February 1981, Turkey pressed for a rise in transit fees from 38 cents
per ton to $1.20 per ton reflecting Turkey's view of Iraq's desperation.
By mid 1981, Iraq was exporting 650,000 bld through Turkey and 300,000
b/d through Syria. Syrian throughput was held down by technical problems
and also problems of a "political nature and related to Syria's demands
for higher transit fees." Both lines experienced periodic sabotage attacks
but disruptions were short lived.26

In April 1982, the IPC line was closed as a result of a deal with Iran
to supply Syria with 180,000 b/d. The motive, however, was clearly aimed
at weakening Iraq's war capabilities. Syria initially claimed the closure
was due to disputes over transit fees but later admitted it was a politically
motivated decision. By mid 1985, there were reports that Syria was cannibalizing
the line for its own oil operations. During 1987 there were rumours of
talks to re-open the line but nothing substantive emerged. Again in early
1998 there were rumours of re-opening the line but few took them seriously.27


Overall, the operating record of the IPC line was poor as can be seen from
figure 1. The line was closed for a substantial part of its operating life
and a significant part of this closure was due to economic factors.

Iraq's Alternatives

Iraq, faced with the abysmal performance of the IPC line, took the strategic
decision to break Syria's hold over export routes and decided on a "Strategic
North-South pipeline" from Haditha to Faw at the head of the Gulf. The
line which could pump Rumayla oil to the Mediterranean or Kirkuk oil to
the Gulf would increase Iraq's ability to export via the Gulf. The construction
contract was awarded in May 1970 and the 300-400,000 b/d line was opened
in December 1975 with the eventual potential to run 1 mb/d going North
or 880,000 b/d going South. In September 1973, a $122 million contract
was signed with Brown and Root to develop a deep sea terminal at Khor al-Khafji
(renamed Mina al-Bakr in 1975) 40 kilometres offshore from Faw with an
ultimate capacity of 120 million metric tons per year (mmty). The berths
could handle tankers up to 350,000 dwt.28

Turkey was the other obvious alternative and had been considered by the
IPC as early as 1956 following disruptions during the Suez crisis. In early
1971, serious talks began with Turkey for a gas pipeline from Kirkuk to
south east Turkey which had been under discussion since early 1967.29 A
crude line was also discussed. In October 1972, Iraq announced negotiations
with Snam Progetti for a 500,000 b/d pipeline to a Turkish Mediterranean
port.30

In May 1973 a protocol was signed for a 40-inch 25 mty crude line to exit
at Dortyol. The final agreement was signed on 27 August. The twenty year
agreement paid a transit fee of 35 cents per barrel. The agreement provoked
a hostile Syrian response in terms of Iraq "betraying the masses" and "delivering
the Arabs' oil weapon into the hands of the imperialists and Zionists at
a time when they most need to use it in the battle of destiny." There was
an initial eight month delay in implementation because Turkey had problems
raising finance for its part of the line. However, once the Turkish Parliament
ratified the agreement the line was built in some haste and was inaugurated
in January 1977 with a capacity of 35 mmty.31

The 1973 agreement allowed Turkey to lift 10 mmty for domestic consumption
to be increased to 14 mty after 1983. Disputes over the price of this crude
led to delays in operation and the first crude was only loaded on 25 May
1977 when the 35 cents had been raised to 38 cents to allow for dollar
depreciation.32

While the Turkish and Strategic Lines meant Iraq was no longer dependent
upon Syria for market access, Iraq's transit problems were far from over.
Closure of the IPC line between 1976 and 1979 left Turkey as the sole transit
country although the Strategic North-South Line prevented Turkey from securing
a monopoly position. In November 1977, Iraq suspended deliveries to Turkey
pending payment of $150 million for oil lifted. At this time, market conditions
were such that there was little interest in Iraqi crude from Dortyol. Pumping
resumed in December following payment arrangements but was suspended again
in January 1978 as payment failed to materialize. However, perhaps surprisingly,
this did not stop pumping to the export terminal. Domestic supplies to
Turkey were eventually resumed in September 1978 following a barter agreement.
The line suffered occasional disruption due to sabotage or "accident" but
closure was short lived.33

In mid 1981, the idea was broached for a pipeline across Saudi Arabia.
By March 1982, Saudi Arabia granted rights of way permission and reports
were of a line (Iraq Pipeline Trans Saudi Arabai [IPSA 1]) of 1- 1.6 mb/d.
These plans received a major boost when Syria closed the IPC pipeline in
April. By October 1983, a 630 km tie-in line from Rumaila to the existing
Ghawar-Yanbu Petroline (at the PS3 pumping station) with over 1 mb/d excess
capacity was being considered. Reports also hinted at another line through
Jordan exiting at Aqaba. In May 1984, the Saudi cabinet approved in principle
the agreement to build the tie-in line but problems over how Iraq would
finance the line remained unanswered.34

In July 1984, plans were reported to lay a second parallel Turkish line
to increase the Turkish capacity to 1.5 mb/d. A protocol was signed in
August and final agreement came in April 1985. The line was inaugurated
27 July 1987 at a cost of $485 million with transit fees at 65 cents. In
April 1988, it was reported that Turkey was interested in expanding the
capacity of the second line to 1 mb/d. At this time, Turkey's revenues
from the pipeline were some $350-360 million per year. At the same time,
Iraq announced it was considering building a second North-South strategic
line with a capacity of 900,000 b/d.35

In April 1985, plans were announced for an independent line with a capacity
of 1.6 mb/d through Saudi Arabia (IPSA 2) This would track the East-West
Petroline line but with its own loading terminal at the Saudi port of Yanbu.
The first Iraqi exports from Yanbu via IPSA 1 were in September 1985. In
October 1986, Iraqi exports ceased for two months to allow engineering
work to complete the tie-in and expand capacity. Since this was a time
of strong price competition, it is tempting to conclude that from the Saudi
perspective the temporary loss of Iraqi crude was welcome. This suspicion
was confirmed when for February 1987 it was announced (to Iraq's "bafflement
and frustration") that the Saudi authorities had restricted Iraqi exports
to 250,000 b/d, well below what had been expected. This was when Saudi
Arabia was desperate to persuade markets of the credibility of the $18
per barrel OPEC target agreed to the previous December. IPSA 2 began in
September 1989 at a total project cost of $2 billion, but full operation
was delayed because of incomplete pumping stations. The formal inauguration
took place in January 1990.36 Both IPSA lines were closed following Iraq's
1990 invasion of Kuwait. In January 1991, the Iraqi Revolutionary Command
Council abrogated all agreements with Saudi Arabia including those covering
the IPSA operations.37

In 1991, discussion began between Iraq and the UN about Iraqi oil exports
resuming under a UN humanitarian banner. Turkey immediately announced demands
for a substantial increase in transit fees. These included a one-off lump
sum payment of $264 million regardless of throughput. In the event, Iraq
was not yet interested in resuming exports under UN auspices. Disputes
over fees were compounded by debate over whether to flush the line and
what should happen to the flushed oil. In September 1996 a

Memorandum of Understanding (MOU) was signed between Iraq and Turkey which
covered these issues.38

A pipeline from the Gulf to the Mediterranean was first proposed in 1943
by the US Government to improve US access to Gulf oil thus ensuring a "continuous
supply of cheap oil." Powerful opposition from the US domestic oil industry,
fearing competition, buried the proposal. In July 1945, California Arabian--the
Saudi concession holders-organized the Trans-Arabian Pipeline Company (Tapline)
to build such a line privately. Negotiations over rights of way provided
a foretaste of problems. Transit through Palestine (the first option) was
granted free of charge. Securing rights through Lebanon and Syria, however,
was more complex as both sought to squeeze higher transit fees. Eventually,
in January 1949, agreement was reached. Lebanon and Syria would share annual
pipeline "royalties" based upon the amount of oil carried but with a minimum
guaranteed annual payment. Construction was completed in late 1950 by which
time California Arabian had become the Arabian American Oil Company (Aramco).
The Tapline ownership reflected this new structure. The project was the
world's largest privately financed construction project. The initial capacity
was 320,000 b/d, increased in 1957 to 450,000 b/d with auxiliary pumping
stations between the main stations at Qaisumah, Raffia, Badanah and Turaif
in Saudi Arabia.39

Saudi Oil Minister 'Abdallah Tariqi, in 1960, shortly after his appointment,
criticized the Tapline agreement, arguing for a profit share. The original
agreement gave the Saudi government a "reasonable" transit fee from Tapline
based on a most favoured transit fee basis in the Middle East. Tariqi pointed
out that crude delivered to the Mediterranean was charged at Gulf rather
than Mediterranean posted prices, pocketing the difference which was supposed
to reflect the tanker cost via the long haul route. According to Tariqi,
this shifted Tapline's profits to the Aramco parent companies away from
Aramco thereby avoiding sharing with the Saudi government. The appointment
of Ahmad Zaki Yamani as Oil Minister in 1962 triggered negotiations leading
to an agreement in March 1963 which allowed for retrospective recovery
of readjusted Tapline profits.40

In 1969, Tapline closed for 112 days following sabotage in the Golan Heights
by the Popular Front for the Liberation of Palestine (PFLP). The act attracted
considerable criticism in the Arab world since the main losers would be
Arab governments. MESS estimated the losses at $17.1 million. However,
in November 1969, the PFLP again claimed responsibility for two breaches
in Southern Lebanon. However, in each case the line was repaired within
24 hours. Tapline was again sabotaged twice in September 1971 in Jordan,
but again repairs took less than 48 hours. A further series of sabotage
attacks took place in Jordan, but at no point were loading operations at
Sidon in Lebanon affected. These and other accidental ruptures confirm
the fact that, contrary to popular opinion, providing access to repair
the pipeline is possible, it is extremely difficult to sabotage pipelines
effectively.41

In May 1970, Tapline was ruptured near Dira`a in Jordan by a bulldozer
working on telephone cables. Syria refused to allow repairs without a new
transit agreement. An agreement was reached in January 1971 giving double
transit fees and a lump sum of $9 million to cover other claims. Although
political motives were also at play, it is significant that when the Syrian
government changed (and the political climate with it) the financial demands
remained. Closure came at a very opportune time for Libya negotiating for
higher posted prices. Closure aggravated crude shortages in the Mediterranean
improving Libya's bargaining position. While there is no evidence of collusion,
in 1971 Libya made a substantial aid donation to Syria.42 Lebanon was unhappy
about Syria's stance, since it threatened transit fees and crude availability
for Sidon's Medreco Refinery. Lebanon's disquiet was reinforced by rumors
that Saudi Arabia was considering closing Tapline permanently.43

Following the Syrian agreement, similar terms were offered and accepted
by both Lebanon and Jordan. However, higher transit fees meant that the
Aramco partners viewed Tapline as a marginal means of transport. Falling
European demand was met by reduced Tapline throughput rather than lower
tanker lifting from Ras Tanura. Pumping also stopped occasionally because
storage capacity at Sidon was full reflecting limited offtake needs. However,
financial disputes did not always lead to closure. For example, in 1972,
a dispute over lifting by Jordan for the Zarqa refinery led to a payments
standoff. By this, payments between both sides (Tapline to Jordan for transit
and Jordan to Tapline for offtake) were suspended until agreement could
be reached.44

The collapse in tanker rates following the first oil shock of 1973 had
a significant impact on costs of Gulf loading versus the Mediterranean.
This was reinforced as Aramco expanded its Gulf loading capacity. In September
1974, a new terminal at Ju'ayma with a capacity of 1 mb/d was inaugurated.
Subsequently, Tapline throughput frequently fell to low levels reflecting
cheaper Gulf options. In February 1975, Tapline announced that it would
close, since the November 1974 tax and royalty changes in Saudi Arabia
turned the tax-paid cost of Sidon deliveries into the red. The Saudi government
expressed disquiet over the closure and suggested they would "endeavour
to reopen the pipeline under fair and reasonable terms." As a compromise,
oil was pumped to Jordan's Zarqa refinery and Lebanon's Medreco refinery.
However, disputes over the price of crude and arrears led to periodic shutdowns.
In 1981, Tapline actually agreed to supply Syria with oil to replace the
oil lost because of the outbreak of the Iraq-Iran war. The crude was to
be lifted at Zahrani and shipped to Banias.45

Under the Saudi take-over of Aramco in 1976, ownership of Tapline reverted
to the four US Aramco partners. In June 1982, the Israeli invasion closed
the section in South Lebanon and in December 1983, Tapline's assets in
Syria and Lebanon were abandoned. Supplies to Zarqa continued although
disputes over prices and payments were frequent. In late 1983, Tapline
announced it would also cease its Jordanian operations at the end of 1985,
although intermittent supplies to Zarqa continued after 1985. In 1990,
Tapline's assets in Saudi Arabia became a division of Saudi Aramco, and
deliveries to Jordan ceased. However, the influence of Tapline remained.
The threat of resuming oil flows to Jordan via Tapline, thereby halting
Iraqi exports (the only legitimate Iraqi oil exports under UN sanctions)
persuaded Iraq to accept humanitarian exports under UN Resolution 986.46


As can be seen from figure 2, Tapline's operating record, like the IPC
line, was poor. However, there was a completely different transit line
experience--the Transmed line between Algeria and Italy via Tunisia.

Transmed

Algeria's experience with LNG exports had been unhappy. Projects were horribly
over budget and bedeviled by disputes over prices and delivery terms. In
1970, Bechtel undertook a study of a gas pipeline to Sicily completed in
October 1972. Suggestions for a gas line from Algeria to Europe emerged
in 1971 in an interview with President Houari Boumedienne. although at
that time the Moroccan route was discussed. In October 1973, Sonatrach
and ENI agreed to build a 2,500km line from Hassi R'Mel to La Spezia east
of Genoa for delivery of 11 billion cubic meters per year (bcmy) of gas.
The cost of the line to the Sicilian coast was estimated at $850 million.
However, by September 1977, the cost to the Italian mainland was being
reported at $2.3 billion. In December 1973, an agreement was signed between
Tunisia and ENI to construct the 288 km Tunisian section to be run by ENI,
Sonatrach and the Tunisian government. In 1976, a study was commissioned
by SEGAMO (Sonatrach, Gaz de France and Enagaz of Spain) for a 40 bcmy
gas pipeline between Algeria and Europe. In early 1977, it was reported
that the line had been abandoned by ENI because of "the harsh economic
demands made by Tunisia." In June 1977, the project was "revived" following
a reopening of negotiations between Tunisia and ENI which reached agreement
in the following month 47

In December 1978, Sonatrach borrowed $915 million to build the Algeria
section. In April 1979 a $100 million loan was syndicated for the Tunisian
section, and in February 1980, a loan for the Mediterranean section was
raised. Discussions began to expand the capacity of the line from 12.5
bcmy to 18 bcmy 4$

The line was completed in 1981 and filling began in the Summer but deliveries
were delayed by negotiations over the gas price. The original 1977 agreement
priced the gas at 76.9 percent of the French price for Algerian LNG, indexed
against a basket of fuel oil and gasoil. These computations were overtaken
by the second oil shock. In October 1982, agreement was reached. The negotiations
had ranged between $5.00 per million btu (mbtu) at the Algerian border
from Algeria and $3.80 mbtu from ENI. The final agreement set the price
at $4.41 mbtu, of which $4.01 mbtu would be paid for by ENI and the remainder
by the Italian government as a "political" subsidy. The price was to be
indexed against a basket of crudes rather than products and crude.49

The line was inaugurated on 18 May 1983, and deliveries commenced in June.
In May, the Algerian government announced its intention to double capacity
with a second line. Following the oil price collapse of 1986, gas prices
fell according to the agreed formula. The 4th quarter price for 1986 worked
out at $2.00 per million btu at the Algeria border. In November 1989, an
agreement was reached to add a fourth pipeline to the Transmed system to
increase throughput by some 4-6 bcmy. However, it was later announced that
agreement was delayed because of an inability to agree on price, but in
December 1990 a new supply deal between Sonatrach and Snam was announced.
This was followed in March 1991 by agreement to expand the line. As can
be seen from figure 3, operations have been smooth and uninterrupted by
disputes. Perhaps surprisingly, in view of the political turmoil in Algeria,
the Transmed line has also remained free from sabotage attempts. Only in
November 1997 was the flow disrupted by a fire, described as a "technical
incident." The flow was only disrupted for four days.50

In November 1989, Spain announced a feasibility study for a gas pipeline
from Algeria via Morocco. In April 1991, Spain Algeria and Morocco signed
an agreement for a 1265 km gas line with an annual capacity of 10 bcmy
(of which Morocco would take 2 bcmy at a cost of $1.3 billion. Throughput
began in 1998.51

LESSONS FROM HISTORY THE CHARACTERISTICS OF "GOOD" VERSUS "BAD" TRANSIT
COUNTRIES

>From the historical experience outlined in the previous section, it is
possible to produce a check-list of economic characteristics of any transit
country which indicate whether it will be a "good" or a "bad" transit country.
It must be emphasised that this is not intended as a simple arithmetic
exercise. Countries will exhibit some "good" and some "bad" characteristics.
The characteristics cannot be assumed to have equal weighting. One "good"
characteristic does not necessarily negate one "bad" characteristic. Judgment
is required in each case to weigh their relative importance. However, the
method at least provides a clear basis for debate. Of course judgment on
the transit country should not ignore the politics. These should also be
thrown into the scales prior to any decision.

The Importance To The Economy Of Foreign Investment

The transit territory can abrogate the agreement or demand renegotiation.
However, such actions are not cost free. Unilaterally changing pipeline
agreements to capture higher transit fees means that investors in other
sectors will become wary. Transit countries which are uninterested in or
unable to attract foreign investment will be less constrained by any impact
on their investment reputation. The corollary is that governments desperate
to encourage such investment and which believe they can attract an inflow
will be very reluctant to threaten investment in other sectors by "bad"
behaviour over transit pipelines. However, this must be qualified by the
potential prize for "bad" behaviour in relation to the opportunity cost
of lost investment.

The Importance Of The Prize

The prize to be won from renegotiating a transit agreement has two dimensions-the
absolute amount of the transit fee and its relative importance in terms
of the transit country's access to government revenue and foreign exchange.


In terms of absolute transit fees, the economist's "bygones rule" is crucial.
Assuming profit maximizing-loss minimizing behaviour, a loss making economic
operation will continue, providing that variable costs are covered and
some contribution to fixed costs are made. Closure still incurs fixed costs
while continued operation minimizes losses. Pipelines are especially vulnerable
as their economics are dominated by negligible variable costs.52 The majority
of costs are fixed, associated with securing rights of way and building
the pipeline and pumping stations. Once the line has been built, the transit
agreement is vulnerable to the obsolescing bargain.53 Forced renegotiation
can capture increasing revenue without the risk of closure even if it forces
the pipeline to operate at a loss. Hence, the fruits of renegotiation can
be large. Furthermore, the pipeline operator is also likely to be the producer
of the oil or gas.54 Thus, the transit country can even capture rent associated
with the oil or gas sales. Here, there is an obvious difference between
oil and gas. Oil sales attract considerable rent.55 By contrast, gas sales
have very limited rent and the prize is much less attractive.sb Hence,
gas lines may be regarded as less vulnerable.

The relative importance of transit fees in terms of the government's access
to revenue and foreign exchange is also important. If transit fees represent
a large proportion of revenue and foreign exchange, there is stronger pressure
to push for more. If they are only of limited importance, the potential
damage to other foreign investment may not justify the risk. It might be
argued that high dependence would limit aggressive behaviour by the transit
government for fear of "killing the goose that lays the golden eggs." However,
given the "bygones rule" this should only happen if there is a miscalculation
on how hard to push.

Dependence On Offtake

Dependence on offtake from the transit line for domestic use may inhibit
the transit country from aggressive behaviour for fear of losing supplies
although the "bygones rule" may mute such fears. Again, oil and gas differ.
Denial of oil supplies can usually be offset given the ease of handling
oil and the nature of the international market. Loss of gas supplies however
is far more serious. Transport problems with gas, because of its very low
energy content per unit of volume, mean that alternative supplies are unlikely
to be available without huge expense. Also, once reconnected, to restore
gas supply is far more complex than for oil. Before re-supplying, a gas
engineer must check every burner tip for leaks and for air in the pipes.
Presence of either could result in major explosions. For large individual
users this presents no problem but not for the residential sector. It has
been claimed a British Gas study found it would take three years to reconnect
Birmingham (Britain's second largest city) following a supply cut off.


Fear of supply loss may mute behaviour to increase transit fees. However,
this can be a double edged sword since the transit country can refuse to
pay, but continue to lift. Supplies cannot be halted without cutting off
consumers further downstream. Ukrainian and Russian gas provide a classic
example of such behaviour.

The Availability Of Alternative Routes

The cost of an alternative route places an upper limit on the transit fee
which can be demanded. However, this requires an alternative route with
sufficient capacity to be available and credible. For example, in the case
of Tapline the obvious alternative was always tankers out of the Persian
Gulf. In other cases, pipelines through other countries are required although
this results in more than doubling the cost of getting to market.57 Furthermore,
if such alternatives are to be effective, the routes must compete and not
collude. While there is no explicit evidence of Turkish-Syrian collusion
over Iraq, some degree of coordination over demands for revised fees seems
likely.

In this context, it is interesting to speculate whether the threat of an
alternative route is sufficient without the actual investment. Contestable
market theory suggests that the threat of entry is sufficient to induce
competitive behaviour.58 Actual entry is not required. For transit pipelines
this means, assuming an alternative route is available at low cost, that
actual development may not be needed to force good behaviour on the existing
transit country. The threat of a potential alternative could be sufficient
to ensure "good" behaviour. This argument is particularly relevant to the
Iranian route for Caspian exports which, assuming the removal of US objections,
could be initiated with relatively small investment by linking to the existing
Iranian network.59

Competition For Markets

Finally, if the transit country is a potential competing source of oil
or gas, this could result in "bad" behaviour. Once the transit line is
operating and supplying customers, a marketing infrastructure has obviously
been developed. If the transit country stops the transit flow, it could
then make use of that infrastructure downstream to supplant the original
supplier and develop its own markets. Alternatively, it could also welcome
any transit supply disruption if this led to higher prices on its own exports.
The experience of the IPSA lines outlined earlier provides an example of
such behaviour.

THE TRANSIT PROBLEM AND POSSIBLE SOLUTIONS

An obvious solution to transit problems is to avoid "bad" transit countries
and use only "good" ones. However, this may not always be practical. For
example, applying the criteria outlined above to the Caspian routes referred
to earlier rules many out. Introducing political factors strengthens this
view. Hence, alternative solutions must be considered.

Involving the transit country on a joint venture basis may reduce conflict.
However, even then there is always the temptation to squeeze more rent
by forcing higher transit fees. Another solution is if the transit country
is vulnerable to military or political pressure. An obvious explanation
for Transmed's success may lie in the vulnerability of Tunisia to pressure
from both Algeria and Italy.60 Syria and Turkey, on the other hand were
relatively immune to pressure from Iraq. Yet another solution would be
to neutralize a "bad" transit country by developing an alternative route.
However, as discussed above, this would significantly increase transport
costs and require no collusion between the alternatives.

A new potential solution is suggested by the the recent Energy Charter
Treaty. A significant part of the Treaty addresses transit issues.61 In
particular, it outlines procedures for transit dispute without interrupting
the pipeline's flow, however, problems remain. The Treaty is simply another
piece of paper and, therefore, as vulnerable as any transit agreement,
although abrogation of a multilateral document may involve a higher cost
than a simple bilateral agreement with a neighbor. There is also a widespread
view that the Treaty was hastily written and skates over serious disagreements
between the signatories.62 Hence its meaning, and effectiveness await court
room experience and precedent which may take a long period to emerge.

CONCLUSIONS

This article finds that the record of transit pipelines has generally been
poor. How poor is a function of whether the transit country has the potential
to be "good" or "bad". This in turn is determined by certain characteristics
of the country concerned. Hence Lebanon, Syria, and Turkey proved to be
"bad", Tunisia "good", and Jordan and Saudi Arabia in between. Furthermore,
the problems identified in this article were at least as much the result
of the underlying economics as of the politics. Equally, the perceived
military vulnerability of pipelines is in reality much overstated.

Given these conclusions, it seems that too little attention has been given
by those involved in Caspian oil and gas and Persian Gulf gas projects
to these fundamental problems of transit pipelines. The attitude of those
involved, especially the explorers, has been-"if the hydrocarbons are there
they will get to market".63 However, as this article seeks to show, the
reality is that such pipelines face serious problems to their effective
operation. There are possible solutions but, apart from the Energy Charter
Treaty, which may prove ineffective, they significantly increase the cost
of getting the oil or gas to market. If oil prices, and by association
gas prices, threaten to go low again, these costly solutions present a
serious impediment to many of the projects currently being considered.
Dreams of the Caspian as the next Persian Gulf or of unlimited gas from
the Persian Gulf may well, in the worst sense, prove to be pipe-dreams.

1. This territory has the ability (national or regional) to abrogate unilaterally
international agreements

2. Middle East Economic Consultants, Gulf Oil Transport Prospects, (Beirut:
Middle East Economic Consultants Report No 34, 1982).

3. The term "transit fees" refers to the formal transit fee and the usually
preferential terms under which the transit country can lift oil or gas
from the line for domestic consumption.

4. The original source of interest in such lines periodically re-emerges
as in D. Brito and E. Sheshinski, "Alternatives to the Straits of Hormuz",
The Energy Journal, Cleveland, Vol. 19 No. 2 (1998).

5. Energy Information Administration, Caspian Sea Region (Washington D.C.:
Energy Information Administration, 1997).

6. International Energy Agency, Caspian Oil and Gas (Paris: International
Energy Agency, 1998). For further details see: Middle East Economic Survey
(MEES), (Cyprus), Vol. XLI No.30.

7. British Petroleum, The BP Statistical Review of World Energy (London:
British Petroleum, 1998).

8. The issue of whether the Caspian is treated legally as a sea or a lake
has to do with how its resources are allocated. see: S. Vinogradov, "The
Legal Status of the Caspian Sea and its Hydrocarbon Resources" in G H Blake,
M A Pratt, C H Schofield, and J A Brown (Eds.), Boundaries and Energy:
Problems and Prospects (Den Haag: Kluwer Law International, 1998) and S.
Vinogradov and P. Wouters, "The Caspian Sea: Quest for a New Legal Regime",
Leiden Journal of International Law Vol 9 (1996).

9. S. Akiner, Pipelines from the Caspian, Paper to "The Changing Politics
of International Energy Investment"- IAEE, BIEE, Chatham House and Montreux
Energy 4-5, December 1995; Energy Information Administration, Caspian Sea
Region http://www.eia.doe.gov/emeu/cabs/caspian.html, 1997; The Institute
for International Energy Studies and the Institute for Political and International
Studies, Oil and Gas Prospects in the Caspian Region (Teheran: The Institute
for International Energy Studies and the Institute for Political and International
Studies, 1996); A. Miyamoto, Natural Gas in Central Asia: Industries, Markets
and Export Options of Kazakstan, Turkmenistan and Uzbekistan (London: Royal
Institute of International Affairs, 1997); J. Roberts, Caspian Pipelines.
Former Soviet South Project (London: Royal Institute of International Affairs,
1996); A. Seck, Pipelines from Central Asia and the Transcaucasus: A Maze
of Alternatives Paper to "Boundaries and Energy: Problems and Prospects"-4th
International Conference of the International Boundaries Research Unit.
18-19th July 1996); T. Stauffer, The Iranian Connection: The Geo-Economics
of Exporting Central Asian Energy via Iran (Boulder: International Research
Center for Energy and Economic Development. Occasional Papers: No 29, 1997).


10. British Petroleum, The BP Statistical Review.

11. A. Y. AI-Hamad, Impact of the recent decline in oil revenues on the
Arab economies, Copy of text delivered to the Eighth Oxford Energy Seminar,
1986; W. Khadduri, "Impacts of low oil prices" Oxford Energy Forum, (May
1994); W. Khadduri, Challenges for Gulf Optimization Strategies: Constraints
of the Past. In Gulf Energy and the World: Challenges and Threats (Abu
Dhabi: The Emirates Center for Strategic Studies and Research, 1997).

12. P. Stevens, "Oil Prices: The Start of an Era" Energy Policy Vol. 24
No. 5, (May 1996).

13. T. Stouffer, "Natural Gas and Gulf Oil: Boom or Bane?" in Gulf Energy
and the World: Challenges and Threats (Abu Dhabi: The Emirates Center for
Strategic Studies and Research, 1997).

14. P. Horsnell, Oil in Asia (Oxford: Oxford University Press, 1997).

15. G. Q. Lumsden, The Qatar-Pakistan Pipeline: Politics and Prospects,
Paper to "The Changing Politics of International Energy Investment"-IAEE,
BIEE, Chatham House and Montreux Energy, 4-5 December 1995;1. V. Mitchell
with P. Beck and M. Grubb, The New Geopolitics of Energy (London: The Royal
Institute of International Affairs, 1996); P. Stevens, "A History of Transit
Pipelines in the Middle East: Lessons for the Future" in G. H. Blake, M.
A. Pratt, C. H. Schofield and J. A. Brown (Eds.) Boundaries and Energy:
Problems and Prospects (Den Haag: Kluwer Law International, 1998).

16. To prevent the footnotes of sources in this section from swamping the
text, they are collectively cited in a footnote at the end of each paragraph.
Page numbers are only given where quotations have been used.

17. E. Penrose & E. F. Penrose, Iraq: International Relations and National
Development (Boulder & London: Ernest Benn and Westview Press, 1978).

18. G. W. Stocking, Middle East Oil: A Study in Political and Economic
Controversy (Nashville: Vanderbilt University Press, 1970).

19. Penrose and Penrose, Iraq Stocking, Middle East Oil, p. 274.

20. Stocking, Middle East Oil, p. 282.

21. Stocking, Middle East Oil.

22. For extensive details of the agreement see MEES, VoI.XVI, No. 13. The
actual text is published in MEES, XVI 15.

23. Penrose and Penrose, Iraq MEES, Vol. XV, No. 52; Vol. XVI, Nos. 12,
34.

24. Under the 1973 agreement, Syrian and Lebanon could lift crude at $2.45
per barrel in 1973 rising to $2.75 per barrel by the end of 1975. However,
the first oil shock effectively quadrupled prices. By 1975,

Lebanon and Syria were lifting Iraq crude at $3.05 per barrel compared
to its market price of $11.85. Lebanon could lift up to 1.5 million tons
per year but Syria could lift as much as it needed for domestic consumption.
25. MEES, Vol. XIX, Nos. 19 and 27; Vol. XXII, Nos.2, 6, 8, 13, 20, 21
p. 9.

26. MEES, Vol. XXIII, Nos. 50, 51, 52; Vol. XXIV, Nos.B, 12, 19, 22, 34,
43 p. 2; VoI.XXV, No. 13.

27. MEES, Vol. XXV, Nos.9, 27, 36; Vol. XXIX, No. 7; Vol. XLI, No. I.

28. MEES, Vol. XIII, No. 30.

29. In 1970, Iran was also exploring the possibility of an oil pipeline
through Turkey from Ahwaz to exit at Iskanderum (MEES, Vol. XIII, No. 30).
In March 1968, Bechtel-France was awarded a contract for a feasibility
study for a gas pipeline to Istanbul (MEES, Vol. XI, No. 22).

30. MEES, Vol. XV, No. 51.

31. MEES, Vol. XVI, Nos. 28, 45, 50 p. 2; Vol. XVII, No. 26.

32. Allegedly, the letter demanding renegotiation was delivered 30 minutes
after the inauguration at a desert pumping station as the Iraqi delegation
boarded their jeeps to leave. MEES, Vol. XX, Nos. 14, 24, 32.

33. MEES, Vol. XXI, Nos. 6, 15, 46; Vol. XXII, No. 2; Vol. XXIII, No. 41.


34. MEES, Vol. XXIV, No. 43; Vol. XXV, No. 22; Vol. XXVII, Nos. 2, 32.


35. MEES, Vol. XXVII, No. 42; Vol. XXVIII, No. 28; Vol. XXX, No. 43; Vol.
XXXI, Nos. 28, 31.

36. Considerable detail on the project can be found in MEES, Vol. XXXIII,
No. 15.

37. MEES, Vol. XXVIII, Nos. 29, 52; Vol. XXIX, No. 52; Vol. XXX, No. 16
p. Al; Vol. XXXII, No. 45; Vol. XXXIV, No. 29.

38. MEES, Vol. XXXV, No. 1; Vol. XXXIX, No. 49.

39. I. I. Nawwab, P. C. Speers and P. F. Hoye (Eds.), Saudi Aramco and
its World: Arabia and the Middle East (Dhahran: The Saudi Arabian Oil Company
(Saudi Aramco), 1995). Stocking, Middle East Oil p. 100.

40. Stocking, Middle East Oil, p. 328.

41. In Colombia, the guerillas have generally given up bombing the crude
pipelines since it never affected loading. Instead, they have taken to
leaving notice of their physical presence at points on the line-i.e. "we
could have blown it up if we had wanted to" MEES, Vol. XII, Nos. 32, 33,
47; Vol. XIII, No. 3; Vol. XIV Nos. 46, 47: Vol. XV, No.l.

42. One author claims the move was "in alliance with Libya" A. Al-Sowayegh,
Arab Petro-Politics (London: Croom Helm, 1984). p.105.

43. MEES, Vol. XIII, No. 29; Vol. XIV, Nos. 6, 7, 15; Vol. XIII, Nos. 31,
34.

44. MEES, Vol. XIV, Nos. 17, 24, 27, 41; Vol. XVI, No, 29; Vol. XV, No.22.


45. MEES, Vol. XVII, No. 33; Vol. XVIII, Nos. 18, 26 p. 4, 32; Vol. XXIV,
No. 18.

46. MEES, Vol. XX, No. 42; Vol. XXVII, No. 21; Nawwab et.al., Saudi Aramco.


47. MEES, Vol. XIV, No. 43; Vol. XV, No. 51; Vol. XVII, No. 1; Vol. XVII,
No. 9; Vol. XX, Nos. 11 p.3, 49, 36.

48. MEES, Vol. XXII, Nos. 8, 26; Vol. XXIiI, No. 17.

49. MEES, Vol. XXV, Nos. 18, 23, 51.

50. MEES, Vol. XXVI, No. 33; Vol. XXX> No. 4; Vol. XXXIII, No. 7; Vol.
XXXIV, Nos. 7, 12, 13, 25; Vol. XI, No. 46.

51. A. Aissaoui, "The Maghreb-Europe Gas Pipeline Project" MEES, Vol. XXXVII,
No. 12: I. G. Castiella, The Maghreb-Europe Pipeline: A Case Study Paper
for Workshop - Regulatory Framework for Transborder Pipelines with Reference
to the Caspian - Caspian Oil and Gas Summit, 6th November 1998 MEES, XXXI
6; XXXIV 31.

52. B. McLellan, "Transporting Oil and Gas-The Background to the Economics",
Oil and Gas Finance and Accounting Vol. 7 no 2 (Summer 1992).

53. R. Vernon, Sovereignty at Bay: The Multinational Spread of US Enterprises
(London: Longman, 1971 ).

54. This arises because of the underlying economics of pipelines. High
fixed costs make full capacity operation vital to protect profitability.
Hence, independent pipeline operators are a very rare breed. The best guarantee
for a full pipeline lies in owning both production and line.

55. This can be simply defined as the difference between the cost of production
and the selling price.

56. Stauffer, Natural Gas.

57. It is assumed the cheapest route would be chosen first and so the second
route would be more costly. Also, pipelines are subject to very large economies
of scale (McLellan, Transporting Oil and Gas). Two pipelines built to carry
a total capacity would together incur very much higher average total costs
than one line for the same capacity.

58. W. J. Baumol,1. C. Panzar & R. D. Willig, Contestable Markets and the
Theory of Industry Structure (New York: Harcourt Brace Jovanovich, 1982).


59. N. Ghorban, Iran's Petroleum Links to West and Central Asia: Projects
and Challenges, Paper to IBC Conference-Exploring Oil & Gas Investment
Opportunities in West Asia. (9-11th March 1998); Stauffer, The Iranian
Connection.

60. The Transmed sales agreement was framed so that once the gas crossed
the Algerian frontier it immediately became Italian property. Any transit
fee dispute would technically have been between Tunisia and Italy.

61. J. Carver, "The Energy Charter Treaty and Transit" in T W Waelde and
K M Christie (Eds.) Energy Charter Treaty: Selected Topics. (Dundee: CEPMLP
University of Dundee, 1995); Energy Charter Secretariat, Energy Transit:
The Multilateral Challenge (Brussels: The Energy Charter Secretariat, 1997);
R. Leisen, Transit under the 1994 Energy Charter Treaty CEPMLP Electronic
Library, Dundee http://www.dundee.ac.uk/ petroleumlaw/html/article3-7.html
(1998); M. M. Roggenkamp, "Transit of Network-bound Energy: The European
Experience" in T. W. Waelde (Ed.) The Energy Charter Treaty: An East-West
Gateway for Investment and Trade (London: Kluwer Law International, 1996).


62. C. Bamberger & T.W. Waelde, The Energy Charter Treaty: Entering a New
Phase (Dundee: CEPMLP Working Paper, CEPMLP University of Dundee, 1998);
T. W. Waelde (Ed.), The Energy Charter Treaty: An East-West Gateway far
Investment and Trade. (London: Kluwer Law International, 1996).

63. A view expressed privately to the author on several occasions.

Professor Paul Stevens is the Professor of Petroleum Policy and Economics
at the Centre for Energy, Petroleum and Mineral Law and Policy in the University
of Dundee Scotland.

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