On August 5 an explosion in the Turkish section of the Baku-Tbilisi-Ceyhan (BTC) pipeline near Erzincan forced BOTAŞ to close the line. With a pre-explosion flow of approximately 850,000 barrels per day (bd) and throughput capacity of 1 million barrels per day (mbd), the $4 billion, 1,099-mile BTC line was capable of supplying roughly 1 percent of global oil demand via the Mediterranean Sea (see Figure 1). CERA estimates that global spare crude oil production capacity currently stands at approximately 2 mbd (excluding Iraqi and Nigerian “spare” capacity), but much of this is lower quality than the light Azeri crude exported via BTC. Furthermore, the BTC is the only major export route for Caspian oil that does not pass through Russian territory or the crowded Turkish Straits. Thus far, BTC has transported only Azeri oil. However, Kazakhstan is planning to transport oil across the Caspian for export via the BTC. On August 7, two days after the pipeline explosion, the militant Workers’ Party of Kurdistan (PKK) claimed responsibility for the blast. However, Turkish authorities have denied terrorist involvement in the incident, claiming the explosion was caused by a technical flaw in the line.

The BTC pipeline burned from August 5 through August 11. Repair work is expected to take a minimum of two weeks, although one of the project’s major stakeholders, BP, has not committed to a time frame for the reopening of the BTC. Buyers of Azeri crude have been warned to expect a three-week delay to tanker loadings at Ceyhan, and the announcement of lifting dates for September has been delayed because of the damage to the pipeline. Regional producers have responded by slowing or stopping production, putting more oil into storage, and attempting to use alternative export routes. In the wake of the BTC explosion, the members of the Azerbaijan International Operating Company (AIOC) began exporting their production from the Azeri-Chirag-Guneshli (ACG) complex in the South Caspian via alternative routes:

• the Baku-Supsa pipeline through Georgia (150,000 bd nameplate capacity)
• the Baku-Novorossiysk pipeline through Russia (75,000–85,000 bd average flow)
• the Baku-Batumi rail network through Georgia

The capacity of these three alternative routes combined is less than BTC’s 1 mbd of throughput capacity, and the excess capacity in each of these alternative westbound export routes is uncertain. Furthermore, all of these routes bring Azeri crude to the Black Sea rather than to the Mediterranean as BTC did. A rise in Caspian oil exports via the Black Sea would increase tanker traffic through the already congested Turkish Straits and almost certainly cause greater delays and demurrage charges for oil tankers. Exporters of ACG crude have traditionally been reluctant to export via the Baku-Novorossiysk pipeline because they do not wish to mix their high quality crude with the lower quality Russian Urals blend.

Recognizing the limitations of alternative export routes, BP was initially forced to cut ACG production to around 250,000 bd (July production was 905,000 bd). ACG production may decline further given BP’s announcement that the Baku-Supsa pipeline has been closed indefinitely due to the violence in Georgia (see Renewed Hostilities Could Threaten Alternative Export Routes, below). The BP-owned Sangachal oil terminal has just enough storage capacity to accommodate regular commercial needs (maximum storage capacity of 5 million barrels, or three to five days of production at the normal production rate) but does not appear to have sufficient capacity to accommodate major export disruptions.

Before Medvedev’s cease-fire announcement, the conflict over South Ossetia expanded to Georgia ’s other separatist region of Abkhazia. On August 12 Abkhaz separatist authorities announced that their forces had launched an operation to push Georgian troops out of the Kodori Gorge, the only area within Abkhazia’s boundaries to remain under Tbilisi ’s authority. Abkhaz authorities claimed they were undertaking this operation independently without Russian assistance.

Russia now holds the ascendancy and, having removed Georgian forces from South Ossetia and also potentially Abkhazia, is likely in Jane’s view to seek at least a restoration of the preconflict state of de facto independence for both separatist regions, albeit with an increased Russian military presence. This would leave Georgia with reduced control over both separatist regions, severely degraded military capabilities, and greatly reduced prospects for making progress toward membership in NATO. President Saakashvili is likely to face growing challenges domestically, having staked so much on the restoration of Georgian control over its separatist regions.

Long-term geopolitical implications notwithstanding, a resumption of hostilities between Russia and Georgia could have implications for global energy markets. A deteriorating security situation in the South Caucasus could deny regional producers access to the remaining non-Russian export routes. With the BTC temporarily out of commission, companies operating in the South Caspian initially attempted to reroute their crude exports through Georgian ports. At first AIOC officials stated that the fighting between Russia and Georgia did not force the consortium to reduce its exports through the Baku-Supsa pipeline. However, SOCAR officials indicated on August 9 that traffic at major Georgian ports had ceased during the fighting and that the company began ramping up its exports through the Baku-Novorossiysk pipeline to make up for the reduction in westbound export capacity. On August 12 BP announced that the Baku-Supsa line was closed because of ongoing violence in Georgia but denied media reports that Russian forces attacked or damaged the line. In CERA’s view if Georgian ports and pipelines are closed for a prolonged period, regional oil producers would be left with three unattractive options:

• cease production during a period of high oil prices
• attempt to export via the Baku-Novorossiysk pipeline and Russia ’s Transneft system
• attempt to export crude to the Iranian port of Neka and arrange swap agreements for Persian Gulf crude

The last option is highly unlikely for Western companies operating in the Caspian, as transactions with the Iranian state oil companies and their subsidiaries could violate the international economic sanctions on Iran.

If the fighting between Russia and Georgia resumes and leads to widespread instability throughout the South Caucasus, the medium- and long-term implications for Caspian oil and gas exports could be grave. According to CERA’s April 2008 Eurasian Oil Export Outlook, 94 percent of Azeri oil exports flowed through Georgia (via BTC and Georgian ports) in 2007. Overall 36 percent of Caspian (Azeri, Kazakh, and Turkmen) oil exports transited Georgia last year.

The closure of the BTC pipeline and the heightened potential for Caspian oil supply disruptions have not slowed the sharp slide in global oil prices, down approximately $34 during the past month. Crude oil prices are responding more to the economic slowdown, the recent appreciation of the US dollar, and the overall weak outlook for global oil demand than to recent events in the South Caucasus. Many OECD countries are experiencing shrinking oil demand, and now the first signs of declining demand have begun to emerge in developing markets as well. Chinese oil demand has slipped to a seven-month low as year-on-year oil imports in July unexpectedly fell by 7 percent, to about 3.26 mbd. CERA expects the oil market to continue discounting the military situation in Georgia and the Black Sea region unless renewed hostilities lead to direct attacks on oil infrastructure, further reducing oil exports.

If fighting over South Ossetia resumes, the conflict could spill over into Abkhazia and threaten crude transit via Georgia and South Caspian oil production. The decisions of the Russian and the Georgian political leaders and military commanders over the next few days will be critical to determining the future of the conflict and its implications. If key ports and pipelines were to be damaged or destroyed, the consequences for the regional energy industry could be severe.