[Senate Hearing 108-116]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-116

                         U.S. ENERGY SECURITY:
                         RUSSIA AND THE CASPIAN

=======================================================================

                                HEARING


                               BEFORE THE


                 SUBCOMMITTEE ON INTERNATIONAL ECONOMIC
                   POLICY, EXPORT AND TRADE PROMOTION


                                 OF THE


                     COMMITTEE ON FOREIGN RELATIONS
                          UNITED STATES SENATE


                      ONE HUNDRED EIGHTH CONGRESS


                             FIRST SESSION

                               __________

                             APRIL 30, 2003

                               __________


       Printed for the use of the Committee on Foreign Relations


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
                                 senate



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                     COMMITTEE ON FOREIGN RELATIONS

                  RICHARD G. LUGAR, Indiana, Chairman

CHUCK HAGEL, Nebraska                JOSEPH R. BIDEN, Jr., Delaware
LINCOLN CHAFEE, Rhode Island         PAUL S. SARBANES, Maryland
GEORGE ALLEN, Virginia               CHRISTOPHER J. DODD, Connecticut
SAM BROWNBACK, Kansas                JOHN F. KERRY, Massachusetts
MICHAEL B. ENZI, Wyoming             RUSSELL D. FEINGOLD, Wisconsin
GEORGE V. VOINOVICH, Ohio            BARBARA BOXER, California
LAMAR ALEXANDER, Tennessee           BILL NELSON, Florida
NORM COLEMAN, Minnesota              JOHN D. ROCKEFELLER IV, West 
JOHN E. SUNUNU, New Hampshire            Virginia
                                     JON S. CORZINE, New Jersey

                 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

LINCOLN CHAFEE, Rhode Island         PAUL S. SARBANES, Maryland
MICHAEL B. ENZI, Wyoming             JOHN D. ROCKEFELLER IV, West 
LAMAR ALEXANDER, Tennessee               Virginia
NORM COLEMAN, Minnesota              JON S. CORZINE, New Jersey
                                     CHRISTOPHER J. DODD, Connecticut

                                  (ii)




                            C O N T E N T S

                              ----------                              
                                                                   Page

Borg, Ms. Anna, Deputy Assistant Secretary for Energy, Sanctions 
  and Commodities, Bureau of Economic and Business Affairs, 
  Department of State............................................     2
    Prepared statement...........................................     5
Chow, Mr. Edward, visiting fellow, Carnegie Endowment for 
  International Peace............................................    44
    Prepared statement...........................................    48
Coburn, Mr. Leonard L., director, Office of Russian and Eurasian 
  Affairs, Department of Energy..................................     9
    Prepared statement...........................................    14
Hagel, Hon. Chuck, U.S. Senator from Nebraska, Opening Statement.     1
Nanay, Ms. Julia, senior director, PFC Energy....................    28
    Prepared statement...........................................    32
Somers, Andrew, president, American Chamber of Commerce in Russia    38
    Prepared statement...........................................    42

 
                         U.S. ENERGY SECURITY:
                         RUSSIA AND THE CASPIAN

                              ----------                              


                       Wednesday, April 30, 2003

                               U.S. Senate,
                    Committee on Foreign Relations,
 Subcommittee on International Economic Policy, Export and 
                                           Trade Promotion,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 2:33 p.m., in 
Room SD-419, Dirksen Senate Office Building, the 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. Earlier this month I 
chaired a hearing on global energy security. At that hearing, 
the administration and expert witnesses gave an overview of the 
state of global energy as it relates to U.S. national security. 
As witnesses testified at the last hearing, America's national 
security cannot be separated from our interest in a stable 
global energy market. America is the world's leading consumer 
of crude oil with almost 60 percent of our economy dependent on 
imported oil.
    Our dependence on imported crude oil creates potential 
vulnerabilities to our economy with implications for America's 
national security. Because energy independence is not 
achievable in the near term, America needs a comprehensive 
energy policy that recognizes the realities of our inter-
connected world. Today we will examine how development of 
energy resources in Russia and the Caspian Sea region and the 
availability of those resources might affect U.S. national 
energy security strategy.
    Russia has the world's eighth largest share of oil reserves 
and the largest natural gas reserves in the world. Russia holds 
great promise as a global energy supplier. The U.S.-Russian 
relationship will continue to be a high priority for all 
aspects of America's national security policy.
    From 1997 through 2000, I held a series of hearings in this 
committee on the development of oil and gas pipelines in the 
Caspian Sea region. While not a simple answer for reducing U.S. 
dependence on Middle Eastern oil, the Caspian region holds 
significant potential for energy development. The two primary 
oil producers in the Caspian, Kazakhstan and Azerbaijan, 
current produce 1 million and 300,000 barrels of oil per day 
respectively. That production has the potential to double over 
the next decade.
    As we consider how best to realize the Caspian's potential, 
we must focus on more than just production and reserves, 
pipelines and infrastructure. We must take into account the 
political and geopolitical realities in the region. The future 
of both Iran and the U.S.-Iranian relationship will also 
influence the Caspian region's energy development.
    Encouraging, financing, and building export pipeline routes 
can contribute to regional economic integration and stability. 
But the Caspian countries must complement their economic 
development with progress toward political reform, rule of law, 
and human rights.
    Here to help lend clarity to these important issues this 
afternoon are two distinguished panels of experts. First we 
will hear from Deputy Assistant Secretary of State for Energy, 
Sanctions and Commodities Anna Borg. Ms. Borg will be followed 
by Leonard Coburn, who is the Department of Energy's Director 
of the Office of Newly Independent States, Russian and Middle 
Eastern Affairs.
    The second panel includes witnesses representing a variety 
of perspectives. Andrew Somers is president of the American 
Chamber of Commerce in Russia, based in Moscow. He was recently 
appointed by Commerce Secretary Evans to chair the commercial 
energy dialogue with Russia.
    Next we will hear from Julia Nanay, senior director at PFC 
Energy here in Washington. Ms. Nanay has worked in the oil 
industry in various capacities since 1976 and specializes in 
analyzing oil and gas sector risks in Russia and the Caspian 
region.
    And finally, we will receive testimony from Edward Chow. 
Mr. Chow is a visiting scholar in the Russian and Eurasia 
Program at the Carnegie Endowment for International Peace. Mr. 
Chow has over 20 years of experience working on oil issues in 
Russia and Asia, as well as the Middle East, Africa, South 
America, and Europe.
    To all of our witnesses, thank you very much for taking the 
time to come before this committee today. I should say before 
we start the ranking Democratic member of this committee, 
Senator Sarbanes from Maryland, is recuperating after surgery. 
He will be back, I understand, next week but regrets that he 
will miss this hearing, sends his regards. And I am sure he 
will hang on every word of testimony that you will give today, 
as he reviews the transcript.
    Again, thank you very, very much for coming. And we will 
begin with you, Mr. Coburn--or, I am sorry, Ms. Borg is first.
    Ms. Borg, please forgive me. And if you would proceed with 
your testimony, thank you very much.

  STATEMENT OF MS. ANNA BORG, DEPUTY ASSISTANT SECRETARY FOR 
   ENERGY, SANCTIONS AND COMMODITIES, BUREAU OF ECONOMIC AND 
             BUSINESS AFFAIRS, DEPARTMENT OF STATE

    Ms. Borg. Mr. Chairman, thank you very much for this 
opportunity. I have a longer written testimony, which I will 
leave and just summarize the basic arguments in an oral 
statement.
    Senator Hagel.  It will be included in the record, as well 
as all the witnesses' complete statements. Thank you.
    Ms. Borg. I am very pleased to be here today with the 
Department of Energy to discuss energy issues in Russia and the 
Caspian and the relationship to U.S. energy security and 
commercial opportunities. We are particularly pleased that the 
subcommittee has chosen this dynamic region to focus on first 
in its follow-up to the earlier April hearing on international 
aspects of U.S. energy security.
    The President's national energy policy noted the importance 
of Russia and the Caspian to global energy production and made 
a number of recommendations to the Secretaries of State, 
Commerce, and Energy on commercial conditions in the investment 
climate. We are working with our colleagues at those 
departments on implementing these recommendations. We have both 
successes to report and areas for still further progress.
    Russia, as you noted, is important to world energy markets 
because it is the world's largest exporter of natural gas, the 
second largest oil exporter, and the third largest energy 
consumer. Russian oil production has rebounded from the lows of 
the mid-1990s, thanks largely to capital investment by Russian 
oil firms and the increasing use of Western oilfields service 
companies.
    Production in February 2003 was already about 8 million 
barrels a day. And with sustained firm oil prices, it is 
possible that production over the next 6 years could go to as 
high as 11 million barrels a day. While estimates vary over the 
size of Russian's proven oil reserves, going from about 50 
billion to 60 billion barrels, Russia also has the world's 
highest reserves of natural gas, about 1,700 trillion cubic 
feet.
    The Caspian, the non-Russian Caspian region is also rich in 
these resources with oil production expected to increase from 
the current level of about 1.5 million barrels a day to about 4 
million barrels a day by 2010, possibly reaching as high as 5 
million barrels a day in that time frame.
    However, despite the impressive production rise since 1998, 
there remain some challenges to sustaining Russia's rapid 
growth rate over the long term. Huge investments will be 
necessary to improve the aging infrastructure and the 
transportation networks and to extend those networks to the 
very remote areas where many of Russia's greatest undeveloped 
fields lie.
    The pace and scope of actual investments are, however, in 
question. The key factors affecting the outcome are the 
questions of limited export pipeline capacity, as well as the 
investment climate. We have encouraged the Russian Government 
to involve the private sector increasingly in pipeline 
development. And so, while much has been achieved in Russia, we 
continue to see room for improvement in the investment climate 
and have concerns about the content and pace of reforms.
    We continue to support passage of beneficial production 
sharing agreement amendments to the Russian tax code. We also 
look forward to the development of new subsoil legislation for 
projects that do not need to be developed on PSA terms. We 
promote these steps in our high-level contacts with Russia, in 
addition to within the context of the U.S.-Russia energy 
working group, the U.S.-Russia commercial energy dialogue, and 
through the work of our Ambassador in Moscow, his staff, and 
those of us from the State Department as we have a chance to 
visit there or meet visitors here.
    In the first wave of international focus on developing 
Caspian resources in the mid-1990s, the key challenge was to 
transport these vast reserves from a landlocked sea to world 
markets in a manner that diversified pipelines as part of our 
energy security policy while observing at the same time our 
policy of discouraging investments in Iran's oil sector. The 
transportation challenge has largely been overcome. Thanks in 
large part to efforts by successive U.S. administrations, with 
solid bi-partisan backing in Congress, we are succeeding in our 
policy of developing an east-west energy corridor involving 
multiple export pipelines.
    Our focus will continue to be on both encouraging 
improvements in the investment climate and on how these 
countries use their revenue. In working on the investment 
climate, we will continue to promote strengthening the rule of 
law, stabilizing tax and fiscal requirements, combating 
corruption, promoting respect for contract sanctity and 
improving transparency.
    Our engagement with Russia and the Caspian countries is 
consistent with the key terms of our international energy 
security policy, as outlined in the President's national energy 
policy. Energy security, of course, is improved by all 
increased and diversified production of energy that enters the 
global marketplace.
    Developments in Russia and the Caspian are having a 
profound effect on global supply and diversification. The 
Caspian, as you noted, is positioned to be the largest source 
of non-OPEC supply growth globally in the coming years. Russia 
already is an energy superpower. And their new energy 
production, even if the rate of growth decelerates, will 
enhance U.S. and global energy security and contribute 
significantly to a well-balanced global supply mix. That said, 
of course, it is important to remember that neither Russia nor 
the Caspian region can replace Saudi Arabia as swing producers, 
nor can they change the fact that two-thirds of proven world 
oil reserves are in the Middle East.
    As for natural gas, exports from Russia to Western Europe 
contribute significantly to our allies' economic stability and 
vitality. Russia supplies Europe with approximately 25 percent 
of its natural gas. And with North Sea gas and oil production 
slated to decline in the coming decade, Russia's gas exports 
will bolster its contribution to global energy diversification.
    Our relationship with Russia on energy issues is a key part 
of our bilateral relationship, a piece of a broader matrix, of 
course, of interaction on a range of issues both political and 
economic. Our cooperation on energy was revitalized with 
President Bush and President Putin's joint statement on energy 
in May 2002 and continues with regular meetings of an 
intergovernmental dialogue within the framework of the U.S.-
Russia energy working group. That process is supplemented by a 
business-to-business dialogue called the Commercial Energy 
Dialogue, which grew out of last October's highly successful 
U.S.-Russia Commercial Energy Summit in Houston.
    U.S. exploration and production companies are keenly 
interested in Russia's potential, though they remain concerned 
about the need for continued improvements in the investment 
climate, further progress towards a liberalized energy market, 
and increased export capacity. We are pleased with the very 
energetic participation by a broad range of American firms in 
the U.S.-Russia commercial energy dialogue and their 
cooperation with their Russian private sector colleagues in 
jointly developing draft recommendations to both of our 
governments on ways to facilitate increased commercial 
cooperation and investment in Russia. Those recommendations 
will be presented at the next U.S.-Russia commercial energy 
summit in September 2003. As of June a year ago, total U.S. 
private investment in Russia's energy sector had totaled 
already $500 million.
    Prospects are also interesting for oil and gas field 
equipment manufacturers. Russia is currently the fifth largest 
export market for U.S.-made oil and gas field equipment, with 
U.S. exports in this sector last year totaling about $328 
million--an increase of 16 percent over 2001. There are 
opportunities for more exports, although price is often an 
obstacle as ours are often more expensive than domestic 
alternatives.
    Similarly, in the Caspian, we expect about $10 billion to 
$12 billion in service and equipment opportunities in the next 
3 to 5 years. And the figure could go as high as $200 billion 
over the next 20 years.
    At the State Department, we are working very closely with 
American businesses to help them understand the Russian and 
Caspian Basin environments and energy sector opportunities. The 
State Department, for example, along with the Department of 
Commerce, organized a Caspian Basin Energy Development 
Conference in New Orleans in January of this year that 
attracted 150 oil contractors and energy representatives. It 
was well received. And we expect that we will do similar 
seminars in the future to maximize American companies' chances 
for success.
    In addition, our Ambassadors in Russia and the Caspian 
Basin region, as well as Ambassador Steven Mann, the senior 
advisor for Caspian Basin energy diplomacy, are all working 
with U.S. energy providers and advocating on their behalf.
    In conclusion, this is a vibrant, important region. The 
U.S. Government and the State Department are focusing on it 
extensively, and we hope that we are able to continue 
translating the opportunity it represents into increases in 
both our energy security and commercial opportunities.
    Senator Hagel.  Ms. Borg, thank you.
    [The prepared statement of Ms. Borg follows:]

                    Prepared Statement of Anna Borg

    Mr. Chairman, distinguished Committee members, I am pleased to be 
here today with the Department of Energy to discuss energy issues in 
Russia and the Caspian and their relationship to U.S. energy security 
and commercial opportunities. We are particularly pleased that the 
Subcommittee has chosen this dynamic region to focus on first in its 
follow-up to the April 8 hearing on the international aspects of U.S. 
energy security. Under Secretary of State for Economic, Business and 
Agricultural Affairs, Alan Larson, appreciated the opportunity to 
appear before you on that occasion.
    The President's National Energy Policy noted the importance of 
Russia and the Caspian to global energy production, and made a number 
of recommendations to the Secretaries of State, Commerce and Energy on 
commercial conditions and the investment climate. We are working with 
colleagues at Energy and Commerce on implementation these 
recommendations, with both successes to report and areas for still 
further progress.

Current Production and Reserves in Russia and the Caspian
            Russia
    Russian oil production has rebounded from the lows of the mid 
1990s, thanks largely to capital investment by Russian oil companies 
and increasing use of Western oilfield service companies and 
technology, and has been growing at about 7 percent per year since 
1998's average of 5.85 million barrels per day (mbd) . That rate of 
growth may accelerate this year: 2002 average production of 7.6 mbd 
could climb nearly 9 percent if oil prices remain near current levels--
production in February 2003 already topped 8 mbd. Sustained firm oil 
prices could boost production over the next six years to as high as 11 
mbd. Russian producers are optimistic that they can achieve this level 
of growth.
    Estimates vary over the size of Russia's proven oil reserves, 
ranging conservatively from 50-60 billion barrels, with numerous 
identified deposits in East and West Siberia, Timan-Pechora, the north 
Caspian Sea, and Sakhalin Island. Russian off-shore Caspian may contain 
some modest reserves. In addition, there are many remote ``frontier'' 
regions that may contain oil, and Russian oil companies assert that the 
country's reserve numbers will actually prove much higher once these 
areas are explored.
    Russia contains one third of the world's natural gas reserves, with 
over 1,700 trillion cubic feet (tcf) in proven reserves--the world's 
highest. Russia's natural gas production also is the largest in the 
world, with 595 produced in 2002. Gazprom, the state-run natural gas 
monopoly, produces nearly 94 percent of Russia's natural gas, operates 
Russia's 90,000-mile natural gas pipeline grid, and employs 
approximately 38,000 people. Though a large consumer of gas, Russia has 
plenty left over for export. With 6.7 tcf in net natural gas exports in 
2001, Russia was the world's largest exporter. Though reserves are 
extensive, the undeveloped major fields lie in remote locations lacking 
infrastructure to deliver the gas to consumers, and will require much 
higher levels of investment to develop.

            Caspian
    Oil production in the non-Russian Caspian region is expected to 
increase from its current level of 1.5 million bpd, to about 4 million 
bpd by 2010. If investment increases substantially, the Caspian could 
produce even more--possibly reaching 5 million bpd by 2010. Independent 
estimates now put non-Russian Caspian (Kazakhstan, Azerbaijan and 
Turkmenistan) reserves at 34 billion barrels. To put that in 
perspective, that is slightly more than U.S. reserves, and more than 
double what remains in the North Sea. That figure could grow 
substantially; one leading consultancy estimates regional reserves 
could reach as high as 60-70 billion barrels. The Kashagan field in 
Kazakhstan, with at least 10 billion barrels of recoverable oil, is the 
fifth largest deposit ever discovered, and observers see rich promise 
of additional discoveries in Kazakhstan's Caspian waters. Estimated 
natural gas reserves in the Caspian region amount to about 170 trillion 
cubic feet (tcf), with Turkmenistan holding the lion's share of 101 
tcf. The first major foreign investment in the Caspian gas sector is in 
the Shah Deniz gas field in the Azeri zone of the Caspian; this field 
holds an estimated 400 billion cubic meters (bcm) of recoverable 
reserves.

Challenges to Further Development
    Despite the impressive production rise since 1998, there are some 
challenges to sustaining Russia's rapid growth rate over the long term. 
Its rate of oil production is exceeding its rate of discovery of new 
reserves by a significant margin, and it is clear that significant 
levels of domestic and foreign investment will be needed in order to 
maintain production levels for the next 15 years. Huge investments will 
be necessary to improve aging infrastructure and transportation 
networks, and to extend those networks to the very remote areas (the 
Arctic, offshore and Eastern Siberia) where many of Russia's greatest 
undeveloped fields lie.
    The pace and scope of actual investment are, however, in question. 
The key factors affecting the outcome are the questions of limited 
export pipeline capacity and investment climate. Russia's pipeline 
network is run by a state-owned monopoly company, Transneft, which has 
proposed its own new export pipelines, as have many private Russian 
producers, and an internal debate continues over which routes to 
develop and with what measure of private sector involvement. We agree 
with many western and Russian oil company representatives who note that 
capital needs and logistical challenges might make it difficult for 
Transneft to expand Russia's pipeline capacity quickly enough to meet 
Russia's export goals. We see merit in involving the private sector in 
pipeline development, both for its capital and for its know-how, and 
have encouraged the Russian government to do so.
    Although much is being achieved in Russia, and we have shared 
interests in Russia's being able to attract more investment and play 
the pivotal role it seeks in promoting global energy security, we 
continue to see room for improvement in Russia's investment climate and 
have concerns about the content and pace of reforms. As recommended in 
the President's National Energy Policy Plan, we continue to support 
passage of beneficial Production Sharing Agreement (PSA) amendments to 
the Russian tax code. An attractive PSA regime can facilitate 
investment particularly in the development of ``difficult''--i.e. 
remote, expensive, and technically challenging--oil and gas reserves. 
We also look forward to the development of new subsoil legislation for 
projects that do not need to be developed on PSA terms. We believe the 
Russian government should strive for a tax and license regime that is 
transparent, stable, enforceable, and that offers investors a fair 
opportunity to earn a reasonable profit. We would also welcome 
legislation giving investors access to international arbitration for 
resolution of commercial disputes. We continue to promote these 
important steps in our high-level contacts with Russia, in addition to 
within the context of the U.S.-Russia Energy Working Group, the U.s.-
Russia Commercial Energy Dialogue, and through the work of our 
Ambassador in Moscow and his staff.
    In the first wave of international focus on developing Caspian 
resources in the mid-1990's, the key challenge was to transport these 
vast reserves of oil and gas from a land-locked sea to world markets in 
a manner that diversified pipelines as part of our energy security 
policy, while observing our policy of discouraging investments in 
Iran's energy sector. The transport challenge largely has been 
overcome. Thanks in large part to efforts by successive U.S. 
administrations, with solid bi-partisan backing in Congress, we are 
succeeding in our policy of developing an East-West Energy Corridor 
involving multiple export pipelines: The Caspian Pipeline Consortium 
(CPC) line connecting the Tengiz field in Kazakhstan with the Russian 
port of Novorossisk began operations in 2001; the Baku Tbilisi Ceyhan 
pipeline will start shipping oil in 2005, transporting 1 mbd at full 
capacity; and development of the South Caucasus gas line from 
Azerbaijan to Turkey is moving ahead, and should begin operations in 
2006 with a peak capacity of 7.3 bcm/annually.
    Our focus will continue to be on both encouraging improvements in 
the investment climate, and on how these countries use their revenue. 
In working on the investment climate, we will continue to promote 
strengthening the rule of law, stabilizing tax and fiscal requirements, 
combating corruption, promoting respect for contract sanctity, and 
improving transparency. As in many countries around the world, there is 
a sincere desire by both Kazakhstan and Azerbaijan to form partnerships 
with Western companies in the energy sector--and, even more 
importantly, a willingness to engage in dialogue when problems do 
emerge.
    A prime example was the recent negotiation between the Kazakhstan 
government and the ChevronTexaco-led consortium partners of 
Tengizchevroil (TCO) over TCO's expansion. Though some issues remain on 
the table, the TCO parties did manage to reach the outlines of a deal 
and agree to proceed with Phase Two expansion. The good news in this 
disagreement was that there was extensive dialogue, and President 
Nazarbayev intervened and facilitated a solution.
    Apart from securing new oil supplies for world markets, our Caspian 
policy is intended to strengthen the sovereignty and economic viability 
of the new nation states in the region. As these countries continue 
down their path of development, we hope they use their hydrocarbon 
dollars to make the long-term investments in responsive governance, 
education and infrastructure to help avoid falling victim to the so-
called ``resource curse'' that afflicts so many hydrocarbon-exporting 
regions. That requires transparent management of oil and gas earnings 
to start, and the political will and economic know-how to use those 
earnings wisely to move development forward wisely across a multitude 
of sectors. The establishment of ``oil funds'' in Kazakhstan and 
Azerbaijan indicates a welcome recognition that revenue management is 
critical, and we will be closely engaged to see that the funds 
generated by energy exports support the broad-based development of 
these countries.

Impact of Development in the Region on U.S. Energy Supply and 
        Diversification
    Our engagement with Russia and the Caspian countries is consistent 
with the key tenets of our international energy security policy as 
outlined in the President's National Energy Policy:

          1. Promote increased and diversified production of energy 
        from a range of foreign suppliers in many regions.

          2. Coordinate effective international measures to respond to 
        physical oil supply disruptions.

          3. Encourage major oil producing countries to maintain 
        responsible production policies to support a growing world 
        economy and reduce oil market price volatility.

    U.S. energy security is improved by all increased and diversified 
production of energy that enters the global marketplace. In other 
words, that new and additional energy from different sources does not 
need to enter our ports or our refineries to improve our security--it 
only needs to enter the global supply chain.
    Developments in these countries are having a profound effect on 
global supply and diversification. The Caspian is positioned to be the 
largest source of non-OPEC supply growth globally in the coming years. 
Russia already is an energy super-power, and their new energy 
production--even if the rate of growth decelerates--will enhance U.S. 
and global energy security and contribute significantly to a well-
balanced global supply mix. Even with transportation bottlenecks, 
Russia exported about 3.5 million barrels/day in 2002, and last week 
forecast a rise to 4.3 mbd in 2003. When Venezuela went off line, and 
Nigeria shut-in, and the liberation of Iraq affected supplies, the 
steady pace of Russian exports, added to OPEC's increased production, 
helped dampen the shocks.
    With large projects in Sakhalin, Tengiz and Kashagan solidly 
underway, and a multitude of less visible projects already in 
production, a steady flow of Russian and Caspian oil into the 
marketplace is assured. Though geography suggests closer markets than 
the U.S. may be more economical targets for much of that oil, some of 
it is also likely to flow into U.S. supplies as well. The first 
supertanker shipments of Russian crude arrived in the U.S. last year 
and more will arrive over time as Russian producers recognize that 
market diversity is in their interests.
    That said, it is important to remember that neither Russia nor the 
Caspian region can replace Saudi Arabia as swing producers, nor can 
they change the fact that two-thirds of proven world oil reserves are 
in the Middle East. But their definitive arrival in the global energy 
marketplace has changed the perceptions of the market, and of OPEC.
    As for natural gas, exports from Russia to Western Europe 
contribute significantly to our allies' economic stability and 
vitality. Russia supplies Europe with approximately 25 percent of its 
natural gas, and with several new export pipelines planned or already 
under construction, Russia hopes to continue to help Europe meet 
increasing demand. With North Sea gas and oil production of slated to 
dwindle in the coming decade, Russia's gas exports will bolster its 
contribution to global energy diversification.
Impact of Energy Issues on Overall U.S.-Russia Relationship
    Our relationship with Russia on energy issues is a key part of our 
bilateral relationship, but of course is not the only part. It is a 
piece of a broader matrix of interaction on a range of issues both 
political and economic. Our cooperation on energy was revitalized with 
President Bush and Putin's Joint Statement on Energy in May 2002, and 
continues with regular meetings of an intergovernmental dialogue within 
the framework of the U.S.-Russia Energy Working Group. That process is 
supplemented by a business-to-business dialogue called the Commercial 
Energy Dialogue, which grew out of last October's highly successful 
U.S.-Russia Commercial Energy summit in Houston, and was launched in 
December by Secretaries Evans and Abraham and their Russian 
counterparts.
    Though it is difficult to quantify energy's impact in precise 
terms, it is clear that our dialogue on energy issues contributes to 
the overall vibrancy of our ties, and our support for market reforms in 
the energy sector is one part of our broader advocacy for, and support 
of, Russia's transition to a democratic, transparent and stable market 
economy. In addition, as Russian private oil and gas firms continue to 
improve their corporate governance and transparency in line with the 
requirements for Western investment, they provide a stimulus for wider 
such improvements in business practices.

Opportunities for U.S. Companies Given the Investment Climate in Russia 
        and the Caspian
    U.S. exploration and production companies are keenly interested in 
Russia's potential, though they remain concerned about the need for 
continued improvements in the investment climate, further progress 
toward a liberalized energy market, and increased export capacity. A 
sign of their continued belief in Russia's promise, however, is the 
energetic participation by a broad range of U.S. firms in the U.S.-
Russia Commercial Energy Dialogue, and their cooperation with Russian 
private sector colleagues in jointly developing draft recommendations 
to our governments on ways to facilitate increased commercial 
cooperation and investment in Russia. Those recommendations will be 
presented at the next U.S.-Russia Commercial Energy Summit in 
September, 2003. As of June 2002, total U.S. private investment in 
Russia's energy sector had totaled $500 million. Looking ahead, the 
ExxonMobil-led Sakhalin-1 Consortium plans to invest a total or $15 
billion over the lifetime of the project, which should produce 15 
billion cubic meters of gas over its lifetime, and 250,000 bpd of oil.
    The picture is somewhat different for U.S. oil and gas field 
equipment manufacturers, for whom Russia should remain a significant 
target of opportunity despite trouble spots in the investment climate 
that may affect upstream companies dollar decisions. Russia is 
currently the fifth largest export market for U.S.-made oil and gas 
field equipment, with U.S. exports to Russia in this sector in 2002 
totaling $328 million--an increase of 16 percent over 2001. Excellent 
opportunities should exist for the foreseeable future: besides Russian 
companies' reworking of existing fields and developing new ones, the 
international consortia developing the huge oil fields offshore 
Sakhalin Island are expected to invest a total of $30-$45 billion over 
the lives of their projects. Price is usually the main obstacle to even 
greater U.S. exports: though Russian oil companies often prefer U.S.-
made equipment, it is usually more expensive than domestic 
alternatives.
    In the Caspian, U.S. companies are watching the investment climate 
closely but are moving forward with alacrity--and we are engaged in 
helping them do so. We expect about $10-$12 billion in service and 
equipment opportunities in the next 3-5 years; the figure could go as 
high as $200 billion over the next twenty years. TCO's expansion alone 
will cost a massive $3 billion: America's Parsons-Fluor-Daniel JV has 
already been tapped as general contractor. In addition, with 
Icazakhstan planning to hold tenders to develop over 100 offshore oil 
and gas fields, American onshore and offshore entities have extensive 
opportunity, and precedent for success: Sante Fe Drilling and Parker 
Drilling are already engaged in projects in Azerbaijan and Kazakhstan, 
respectively.
    The State Department is working closely with U.S. businesses to 
help them understand the Russian and Caspian Basin environments and 
energy sector opportunities. The Department, along with the Department 
of Commerce, organized a Caspian Basin Energy Development Conference in 
New Orleans in January that was attended by 150 oil contractors and 
energy representatives. It was well received and we will conduct 
similar seminars in the future to maximize U.S. companies' chances for 
success. In addition, our Ambassadors in Russia and the Caspian Basin 
region, as well as Ambassador Steven Mann, the Senior Advisor for 
Caspian Basin Energy Diplomacy, are all working closely with U.S. 
energy providers and advocating on their behalf.
    In conclusion: this is a vibrant, important region; the U.S. 
government is focusing on it extensively; and we hope that we are able 
to continue translating the opportunities it represents into increases 
in our energy security.

    Senator Hagel.  Mr. Coburn.

STATEMENT OF MR. LEONARD L. COBURN, DIRECTOR, OFFICE OF RUSSIAN 
        AND EURASIAN AFFAIRS, U.S. DEPARTMENT OF ENERGY

    Mr. Coburn.  Thank you very much, Mr. Chairman. I am 
pleased to appear before you today to discuss the role that 
energy plays in Russia, Central Asia, and the Caspian region, 
and the administration's efforts to enhance our cooperation 
with these countries.
    On April 8, Deputy Secretary Kyle McSlarrow provided this 
subcommittee with an overview of the important role that energy 
plays in a global economy and the administration's efforts to 
enhance our energy security. Today we will focus and 
concentrate on the administration's energy cooperation with 
Russia and with the independent republics of Central Asia and 
the Caspian.
    The administration has been extremely proactive in its 
relations to both regions. And there is a great deal of 
progress to report on our efforts to enhance energy 
cooperation. Production and reserve status will be discussed 
first, and then our energy cooperation with Russia, followed by 
Central Asia and the Caspian.
    Oil production in Russia has rebounded significantly over 
the last several years, as you mentioned in your opening 
statement. The table that I handed out as part of my testimony 
and written statements profiles Russia's oil production over 
the last decade. In 2003, oil production continues to increase 
and is now approaching about 8 million barrels a day. As 
already mentioned, Russia is now the second largest oil 
producer, the second largest exporter of crude oil behind Saudi 
Arabia.
    In the Central Asian and Caspian region, oil production 
also has increased substantially over the last decade due to 
the influx of foreign investment primarily in Azerbaijan and 
Kazakhstan. Production in 2002 averaged about 1.5 million 
barrels per day.
    When we turn to reserve numbers for both Russian and the 
Central Asian/Caspian region, these numbers vary widely and are 
quite difficult to pin down. In Russia, oil and gas reserve 
numbers remain a state secret. Thus, there are no official 
reserve numbers. We have looked at various sources. And, for 
example, the oil and gas journal in 2002 estimates that Russian 
proven oil reserves are about 50 billion barrels. However, in 
our conversations with Russian oil companies, we have found 
that this reserve level is vastly understated. They estimate 
that reserves should be in the 90 billion to 110 billion barrel 
range. That would put them equal to about Iraq.
    In the Central Asian and Caspian region, reserve numbers 
also have varied wildly depending upon the source. The Energy 
Information Administration, which is part of the Department of 
Energy, indicates that proven reserves are somewhere between 17 
billion and 33 billion barrels. There have been estimates to 
resources, not proven reserves, but resources, in excess of 100 
billion barrels.
    Well, let's turn to Russia and our energy cooperation with 
Russia. The U.S. Government's history of energy cooperation 
engagement dates back to the early 1990s. But in the interest 
of time, I will focus on this administration's energy 
engagement with Russia.
    The President recognized the importance of the United 
States' relationship with Russia early on in his 
administration, elaborating on this relationship in the 
administration's National Energy Policy issued in May 2001. 
These policies provide a guide for Russian engagement. And 
since the policy's creation, the Department of Energy has been 
active in filling and expanding upon these policies.
    It is important to note that the National Energy Policy 
continues policies that were discussed over the last decade. 
So, for example, the U.S. Government has been unwavering in its 
support of sound, legal, fiscal, and regulatory environments in 
Russia over the last years. We have remained committed to 
supporting market reform in the energy sector.
    The U.S. has also been a strong supporter of oil and gas 
development in the region. One way in which we, the United 
States, have sought to enhance our energy supply security is to 
promote Russian energy resource development and exports. We 
have expressed our support for these efforts to export crude 
oil to the United States and the future development of transit 
routes and terminals that will allow Russian resources to reach 
American markets. And we can discuss some of these efforts in 
our follow-up question-and-answer session.
    The administration's enhanced energy engagement with Russia 
developed as a result of the summit held by Presidents Bush and 
Putin in May 2002 in Russia, where they issued a joint 
statement on a new U.S.-Russia energy dialogue. This joint 
statement confirms the importance of energy in our bilateral 
relations. And the Department of Energy is moving forward on 
the elements of this dialogue in conjunction with our 
colleagues at State and other agencies.
    In order to accomplish these objectives laid out in the 
joint statement, the Department of Energy and the Russian 
Ministry of Energy created a U.S.-Russia energy working group. 
In that working group, we will be concentrating on five areas 
of discussion: global oil markets; investment; technology, 
including energy-efficient, environmentally-friendly clean coal 
technologies, and oil spill prevention and response; energy 
information exchange; and small- and medium-sized enterprises.
    To date, the energy working group has met three times, most 
recently earlier this month, on April 7 and 8 here in 
Washington. And there has been a great deal of progress in all 
five of the areas that we have focused on.
    Last October, in Houston, the Departments of Energy and 
Commerce organized the first U.S.-Russia commercial energy 
summit. The Houston summit was co-hosted by Secretaries Abraham 
and Evans and Energy Minister Yusufov and Economic Development 
and Trade Minister Gref. The summit was acknowledged by all the 
participants as a great success.
    At the summit, we discussed how to facilitate investment in 
the Russian and American energy sectors. And we can pursue some 
of that during our question-and-answer session. Cooperation and 
partnerships already are under way. These include a variety of 
projects, such as the Caspian Pipeline Consortium, which brings 
crude oil from Kazakhstan through Russia to the Black Sea; 
Sakhalin 1, the largest of the energy development projects out 
in Sakhalin Island; most recently, Marathon Oil Corporation's 
acquisition of Khanty Mansiysk Oil Corporation; and another 
joint venture, the ConocoPhillips Polar Lights joint venture.
    We at the Department of Energy and Department of Commerce 
and State and other agencies will continue to promote 
commercial partnerships between U.S. and Russian firms in the 
U.S., Russia, and third countries. The summit we just talked 
about in Houston featured the announcement of a U.S.-Russia 
commercial energy dialogue already alluded to by Ms. Borg. And 
this is industry-led and will increase communication and 
cooperation among our companies.
    The Departments of Energy and Commerce will consult with 
this group to identify and help remove barriers to energy, 
trade, and investment. The commercial energy dialogue provides 
the opportunity for Russian and Western companies to sit 
together to solve common problems on legislation and regulation 
of the Russian energy complex. The level of cooperation among 
our companies and the Russian companies could not be better.
    The U.S.-Russia energy dialogue will focus on efforts to 
promote energy security through discussions with Russian 
officials of possible technical assistance with the Russian 
Strategic Petroleum Reserve. Technology will continue to be a 
focal point of the U.S.-Russia energy relationship. And energy 
efficiency and gas flaring elimination and reduction strategies 
will be given special attention in the short term.
    We have also included environmental issues in our energy 
dialogue. When the Secretary of Energy was in Moscow 6 weeks 
ago, he signed a statement of intent to enter into a dialogue 
on oil spill prevention and response. This is an important 
area, as we move towards the reality of increased Russian 
shipments of oil on the world's oceans.
    This fall the U.S. Departments of Energy and Commerce, 
Russian Ministry of Energy, and Russian Ministry of Economic 
Development and Trade will be holding the second Commercial 
Energy Summit. And this summit will have an expanded agenda, 
which will also include electric power, in addition to oil and 
gas.
    Lest I give you the impression that there are no concerns 
and problems in our energy dialogue and relationship, I would 
like to indicate that the path forward is not smooth and not 
straightforward. While oil production continues to increase, 
Russian oil exports are hampered by serious infrastructure 
problems. Today, Russian oil tankers do not have access to a 
deep water port where crude oil can be transported long 
distances in an economically sound and environmentally safe 
manner. Long distance markets, such as the U.S., China, or the 
Asian Pacific, are future targets of Russian crude oil. But 
these markets require either access to deep water ports or new 
long-distance pipelines or some combination of pipelines and 
ports.
    These facilities will be expensive. And they are now being 
considered by the Russian Government. But who will own them, 
operate them, and finance these projects is under active 
consideration. The results of this debate and the development 
of these new infrastructure projects will help determine 
whether additional Russian oil will flow into world oil 
markets, increasing the diversity of global supply and thereby 
enhancing the U.S.'s energy security.
    The opportunities for U.S. companies to invest in Russia 
again are not so clear and straightforward. Russia has gone 
through a series of changing attitudes towards Western 
investment and its desirability and necessity. When oil prices 
are relatively low or the Russian economy weak, Western 
investment has been attractive. And Russian policymakers have 
been active promoters of it. With a more robust Russian economy 
and higher oil prices, Russian policymakers have changed their 
tune. Regulatory, legal, and tax and other fiscal policies 
reflect this changing environment.
    The history of production-sharing legislation is a good 
example of changing attitudes. And we can talk about the ups 
and downs of production-sharing legislation and its 
attractiveness in our question-and-answer session.
    Let me turn to Central Asia and the Caspian, since the 
experience there is both different and similar. Most important, 
there have been substantial investment successes by Western and 
U.S. companies in the region. Following the breakup of the 
Soviet Union in 1991, this region attracted the interest of the 
international energy community because of the huge oil and 
natural gas reserves believed to lie both onshore and offshore 
beneath the Caspian Sea.
    With independence, both Azerbaijan and Kazakhstan welcomed 
international investors, and big production-sharing agreement 
contracts have been signed in both countries. These projects, 
developed by Western investors, including companies from the 
United States, have created thousands of jobs, provided access 
to improved technology, including training for the labor force, 
invested in social infrastructure, increased the commitment to 
environmental protection, and encouraged the establishment of 
many small- and medium-sized enterprises in these countries.
    One of the major difficulties faced by Caspian states, as 
they attempt to develop and export their energy resources, has 
been the lack of export outlets. The administration has 
consistently supported the development of new pipeline 
projects, especially the east-west transport corridor that 
would stretch from Kazakhstan, through Azerbaijan, Georgia, and 
Turkey to the Mediterranean. The fulfillment of this transport 
corridor is already in the works. The Caspian Pipeline 
Consortium that I mentioned earlier is one element of it. The 
Baku-Tbilisi-Ceyhan pipeline under construction is another 
element of it. And negotiations are under way to facilitate the 
shipment of oil from Kazakhstan for transport through this 
line.
    There is a second issue inhibiting oil and gas development 
in the Caspian Sea. And that is the unresolved legal status of 
the sea. And again, we could discuss that during the question 
and answer.
    As in Russia, the United States Government has consistently 
supported the development of Central Asian countries' sound, 
legal, fiscal, and regulatory policies to support economic 
growth, including energy development. The Department of Energy 
has maintained ongoing dialogues with energy officials from 
Kazakhstan and Azerbaijan on market reform in the energy area. 
And in December 2001, we established a U.S.-Kazakhstan energy 
partnership in order to further this dialogue.
    In Azerbaijan, Energy Department officials, including the 
Secretary, have met on a regular basis with representatives of 
the Azerbaijan Government. And we have recently begun an 
initiative to expand our cooperation beyond oil and gas to 
energy efficiencies and renewable technologies. As with Russia, 
there are problems. With economic growth, the government of 
Kazakhstan has developed somewhat ambiguous feelings about 
foreign investment, just as it has happened in Russia. 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 recent dispute over the provisions of the production 
sharing agreement with Tengizchevroil, which is the largest oil 
development in Kazakhstan and is led by ChevronTexaco, while it 
was resolved, led to a government statement that future 
production-sharing agreements would have less favorable 
provisions for foreign investors. We will continue to encourage 
the government of Kazakhstan to improve its investment climate 
and attract the billions of dollars in investment required to 
develop projects.
    This administration has had an extremely proactive approach 
to energy dialogue with both Russian and the Central Asian and 
Caspian regions. We have made good progress and have achieved 
some successes. But we are by no means finished with our 
agenda. We will continue to engage the governments of these 
countries to enhance our cooperation and build upon the work 
already under way.
    Mr. Chairman, I would like to thank you for the opportunity 
to testify before you today. And I welcome any questions that 
you might have.
    Senator Hagel.  Mr. Coburn, thank you.
    [The prepared statement of Mr. Coburn follows:]

                Prepared Statement of Leonard L. Coburn

    Thank you, Mr. Chairman. I am pleased to appear before you today to 
discuss the important role that energy plays in Russia and Central Asia 
and the Caspian region and the Administration's efforts to enhance our 
cooperation with these countries.
Introduction
    On April 8, 2003, Deputy Secretary Kyle McSlarrow provided this 
Subcommittee with an overview of the important role that energy plays 
in the global economy and the Administration's efforts to enhance our 
energy security. Today, we will narrow our focus to concentrate on the 
Administration's energy cooperation with Russia and with the 
independent republics of Central Asia and the Caspian.
    The Administration has been extremely proactive in its relations 
with both regions, and there is a great deal of progress to report on 
our efforts to enhance energy cooperation. Production and reserve 
status will be discussed first and then our energy cooperation with 
Russia followed by Central Asia and the Caspian.
Oil Production and Reserves
    Oil production in Russia has rebounded significantly over the last 
several years. The attached table profiles Russian oil production over 
the last decade. If one looks further back, Russia (the Soviet Union) 
produced about 12 million barrels per day at its peak. With the 
dissolution of the Soviet Union, oil production dropped dramatically to 
the level shown in the table and continue to drop through the mid-
1990s. The rebound started in 1999 due to several factors, including 
higher oil prices, reinvestment by the privatized companies back into 
the Russian oil industry, lower production costs due to Ruble 
devaluation, and the introduction of western technology to upgrade 
existing oil fields in Western Siberia. In 2003, oil production 
continues to increase and is approaching eight million barrels per day. 
Russia is now the second largest producer and second largest exporter 
of crude oil behind Saudi Arabia.
    In the Central Asian-Caspian region, oil production also has 
increased substantially over the last decade, due to the influx of 
foreign investment in Azerbaijan and Kazakhstan. If Russian oil 
production is excluded from the production figures, the increase of 
2001 over 1990 is about 31 percent. Production has continued to 
increase from the region and in 2002 averaged about 1.5 million barrels 
per day.
    Reserve numbers for Russia and the Central Asia-Caspian region vary 
widely and are difficult to pin down. In Russia, oil and gas reserve 
numbers remain a state secret; thus there are no official reserve 
numbers. There have been many estimates provided by consulting 
companies and Russian oil companies. Oil and Gas Journal's 2002 
estimates put Russian proven oil reserves at about 50 billion barrels. 
Several Russian oil companies indicate that this reserve level vastly 
understates the actual reserves. They estimate the reserves should be 
in the 90 to 110 billion barrel range. If Russia unlocks its data and 
no longer says that reserves numbers are a state secret, more accurate 
estimates of reserves will be available.
    In the Central Asia-Caspian region, reserve numbers also have 
varied widely depending upon the source. EIA indicates that proven 
reserves are somewhere between 17 and 33 billion barrels. The have been 
estimates of resources (not proven reserves) in excess of 100 billion 
barrels. As more exploration is done in the region and more delineation 
of deposits is undertaken, better reserve figures will be forthcoming. 
For the time being, we must make due with the current estimates.
Russia
    The U.S. Government's history of energy engagement with Russia 
dates from the early 1990's, but in the interest of time, I will focus 
on this Administration's energy engagement with Russia. The President 
recognized the importance of the United States' relationship with 
Russia early on in his Administration, elaborating on this relationship 
in the Administration's National Energy Policy, issued in May 2001.
    The National Energy Policy provides that the U.S. will:

   Make energy security a priority of our trade and foreign 
        policy,

   Improve dialogue among energy producing and consuming 
        nations,

   Deepen the focus of the discussions with Russia on energy 
        and the investment climate, and

   Assist U.S. companies in their dialogue on the investment 
        and trade climate with Russian officials, to encourage reform 
        of the Production Sharing Agreement law and other regulations 
        and related tax provisions, as well as general improvements in 
        the overall investment climate. This will help expand private 
        investment opportunities in Russia and will increase the 
        international role of Russian firms.

    These policies provide a guide for Russian engagement, and since 
the policy's creation, the Department of Energy has been active in 
fulfilling and expanding upon the policies. In the past decade, the 
U.S. government has been unwavering in its support of sound legal, 
fiscal, and regulatory environments in Russia.
    The U.S. government has remained committed to supporting market 
reform in the energy sector. The Department of Energy continues to work 
with our counterparts to promote a fair and clear regulatory framework 
and tax regime, sound corporate governance, environmental protection, 
and increased partnership and investment.
    The U.S. also has been a strong supporter of oil and gas 
development in the region. One way in which we have sought to enhance 
our energy supply security is to promote Russian energy resource 
development and export. We have watched with great interest the 
development of Russian oil and gas resources by the privatized Russian 
oil companies and especially noted the rapid increase in oil production 
over the past four years.
    We have expressed our support for the efforts of Russian companies 
to export crude to global markets, including the U.S., and the future 
development of transit routes and terminals that will allow additional 
Russian resources to reach the world market. While we are not in the 
business of picking among the various proposals for new infrastructure, 
we support efforts being made in general to enhance and expand the 
current pipeline infrastructure so that exports can increase, and be 
made on an economically and environmentally sound basis.
    The Administration's enhanced energy engagement with Russia 
developed as a result of the Summit held by Presidents Bush and Putin 
in May 2002 in Russia where they issued a Joint Statement on a new 
U.S.-Russian Energy Dialogue. It confirms the importance of energy in 
our bilateral relations and the Department of Energy is moving forward 
on the elements of this dialogue, which include:

   Developing bilateral energy cooperation,

   Enhancing our discussions on global oil and energy markets,

   Facilitating commercial cooperation among our companies,

   Encouraging investment in the Russian energy sector,

   Promoting access to world markets for Russian energy,

   Fostering the use of unconventional energy sources, 
        including energy efficient and environmentally clean 
        technologies, and

   Cooperating in the development of safer nuclear power 
        technologies.

    The emphasis that Presidents Bush and Putin place on the 
development of energy cooperation between our two countries and our 
many companies offers the promise of a bright energy future based on 
partnership for the development not just of Russia's vast untapped 
energy resources but on cooperation in energy projects of all kinds in 
both countries and around the world.
    In order to accomplish these objectives, the Department of Energy 
and the Russian Ministry of Energy created a U.S.-Russia Energy Working 
Group. We will be concentrating on five areas:

   Global oil markets,

   Investment,

   Technology, including energy-efficient, environmentally 
        friendly, and clean coal technologies,

   Energy information exchange, and

   Small- and medium-sized enterprises.

    Work plans for these areas have been finalized, and we are 
cooperating on a variety of matters beneficial to both sides. The 
Energy Working Group has met three times, most recently on April 7-8, 
2003. There has been a great deal of progress in all five subgroups. We 
have not limited our engagement just to the formal Energy Working Group 
meetings. We have met in between these meetings where we have held 
workshops and roundtable discussions to share ideas and experiences in 
a variety of areas. For example, most recently our oil market and 
investment subgroups met in Moscow in March where we engaged in 
discussions on long-term energy forecasting, fiscal regimes for oil and 
gas development and regulation of the electricity and natural gas 
industries.
    Last October, the Departments of Energy and Commerce organized the 
first U.S.-Russia Commercial Energy Summit. The Houston summit was co-
hosted by Secretary Abraham, Commerce Secretary Evans, Energy Minister 
Yusufov, and Economic Development and Trade Minister Gref. The Summit 
was acknowledged by participants, co-chairs, and industry observers as 
a great success.
    At the outset of the Summit, Secretary Abraham stressed that the 
government's job is to create the framework of laws and rules that will 
allow our companies to form partnerships with confidence in the 
security of their arrangements and to operate in a competitive market 
and free trade environment.
    At the summit we discussed how to facilitate investment in the 
Russian and American energy sectors, and facilitated opportunities for 
U.S. and Russian companies to work together on future investments in 
each other's energy industries, and in other parts of the world. In 
Houston, companies engaged in business-to business networking, learned 
from their colleagues, and discussed avenues for cooperation and 
partnership.
    Cooperation and partnerships already are underway. Last year I was 
in Russia for the opening of the Caspian Pipeline Consortium (CPC) 
pipeline, which today carries about 270,000 barrels a day of oil from 
Kazakhstan's Tengiz oil field across Russia to a deepwater port on the 
Black Sea. By this time next year, CPC is expected to ship almost 
double its present volumes as throughput reaches its design capacity of 
450,000 barrels a day. The pipeline, which has eleven international 
partners, will eventually reach a capacity of over one million barrels 
of oil per day. It represents an enormous investment in a project that 
required more than mere bilateral cooperation. There are other projects 
involving U.S. companies, including Sakhalin I, with ExxonMobil in the 
lead developing oil and gas resources off the coast of Sakhalin I, 
which will eventually be the largest western investment project in 
Russia, Marathon Oil Corporation's recent acquisition of Khanty 
Mansiysk Oil Corporation, and ConocoPhillips Polar Lights joint 
venture.
    The summit highlighted the latest advances in environmentally 
friendly energy technology. Other panel sessions focused on the 
promotion of small- and medium-sized enterprises and training and 
education programs in the energy sector. Summit participants also had 
the opportunity to engage in site visits, where oil and gas leaders 
showcased their latest technological achievements and facilities.
    At the conclusion of the Summit, the four co-chairs, Secretary 
Abraham, Secretary Evans, Minister Yusufov, and Minister Gref, signed a 
joint statement outlining the future goals of the U.S.-Russia energy 
relationship.
    They declared their commitment to common goals: enhanced global 
energy security, including through maintaining an energy dialogue 
between energy consuming and producing countries; increased 
diversification of supplies; improved business and investment 
environment; expansion of commercial partnerships; and commitment to 
environmentally responsible development of resources. The Joint 
Statement also reaffirmed our commitment to cooperation in a number of 
areas in the energy sector.
    We will continue to promote commercial partnerships between U.S. 
and Russian firms in the U.S., Russia, and third countries. The Summit 
featured the announcement of a U.S.-Russia Commercial Energy Dialogue 
that will be industry led and will increase communication and 
cooperation. The Departments of Energy and Commerce will consult with 
this group to identify and help remove barriers to energy trade and 
investment. When I was in Moscow six weeks ago, I heard first hand from 
many of the companies that are participating in the Commercial Energy 
Dialogue. What I learned from these discussions is that for the first 
time Russian and Western companies are sitting together to solve common 
problems on legislation and regulation of the Russian energy complex. 
The level of cooperation could not be better.
    Efforts to promote energy security will continue through 
discussions with Russian officials of possible technical assistance 
with a Russian strategic petroleum reserve. During the Houston Summit, 
Secretary Abraham accompanied Minister Yusufov on a visit to the 
Strategic Petroleum Reserve location in Texas. They toured the site and 
further discussed the possibility of the development of a Russian 
Strategic Petroleum Reserve. We have discussed this idea in our energy 
working group. The Russian government is still debating the need and 
purpose of creating a strategic reserve.
    Technology will continue to be a focal point of the U.S.-Russia 
energy relationship, and energy efficiency and gas flaring elimination 
and reduction strategies will be given special attention in the short 
term. Advanced technology makes environmentally responsible energy 
projects possible. It allows us to produce more, explore opportunities 
with greater success, and solve challenges posed by the entire spectrum 
of activities associated with the production and delivery of energy. 
Advanced technology offers an important arena for increased trade, 
investment and cooperation.
    We also have included environmental issues in our energy dialogue. 
When the Secretary of Energy was in Moscow six weeks ago, he signed a 
Statement of Intent to enter into a dialogue on oil spill prevention 
and response. This is an important area as we move towards the reality 
of increased Russian shipments of oil on the world's oceans. We held 
our first meetings to implement this dialogue in early April and more 
meetings are being planned for the next couple of months.
    U.S. Department of Energy, U.S. Department of Commerce, Russian 
Ministry of Energy, and Russian Ministry of Economic Development and 
Trade officials have started planning for the next Commercial Energy 
Summit to take place in Russia in the fall. This next summit will 
include discussion of electric power in addition to oil and gas. We 
have been watching with great interest the passage of electricity 
legislation in the Duma and Federation Council. In anticipation of 
final passage later this spring, DOE and the major Russian electric 
company Unified Energy Systems held an electricity markets conference 
in late February in Washington to discuss the U.S. experience in 
restructuring the electric power industry. We also heard from our 
Russian colleagues on the challenges that lie ahead. It was an 
excellent discussion and it will not be the last.
    Lest I give you the impression that there are no concerns and 
problems, I would like to indicate that the path forward is not smooth 
and straightforward. While Russian oil production continues to 
increase, Russian exports are hampered by serious infrastructure 
problems. Today, Russian oil tankers do not have access to a deepwater 
port where crude oil can be transported long distances in an 
economically sound and environmental safe manner. The major ports of 
Novorossiysk on the Black Sea and the ports either in the Baltics or at 
Primorsk in the Gulf of Finland all have constraints on the size of 
tankers that can transit the Turkish Straights or the Baltic Straights. 
The Druzhba pipeline system into Europe also has limitations and 
bottlenecks, but more importantly, there is insufficient demand in 
Europe to accommodate growing Russian oil production. Thus, long-
distance markets such as the U.S., China or the Asia-Pacific are the 
future targets of Russian crude oil. These markets require either 
access to deep water ports, or new, long-distance pipelines, or some 
combination of pipelines and ports. These facilities will be expensive, 
but are now being considered by Russia. Who will own, operate and 
finance these projects is under active consideration. The results of 
this debate and the development of these new infrastructure will help 
determine whether additional Russian oil will flow into world markets--
increasing the diversity of global supply, thereby enhancing the U.S.'s 
own energy security.
    The opportunities for U.S. companies to invest in Russia again are 
not so clear and straightforward. Russia has gone through a series of 
changing attitudes towards western investment and its desirability and 
necessity. When oil prices are relatively low, or the Russian economy 
weak, western investment has been attractive and Russian policymakers 
have been active promoters of it. With a more robust Russian economy 
and higher oil prices, Russian policymakers have changed their tune. 
Regulatory, legal, and tax and other fiscal policies reflect this 
changing environment. The history of Production Sharing Agreement (PSA) 
legislation is a good example of changing attitudes. PSAs are 
attractive to foreign investors in relatively unstable economies 
because they state in one negotiated document how much a company will 
have to pay to the government for the right to exploit the resource, 
how costs will be recovered, which legal regime will be used in the 
event of disputes and many other rights and obligations. Many nations 
around the world have used PSAs as a tool to develop their energy 
resources. At first, Russia accepted the use of PSAs and enacted 
legislation in 1995 establishing the right to negotiate PSAs on 
designated deposits. The legislation needed amending in order for it to 
be successful, and these amendments took years, but were eventually 
passed. More recently, as Russia has reformed its tax code, the PSA 
legislation had to be harmonized with the new tax code. With a 
resurgent domestic oil industry in Russia and the creation of a more 
modern tax code, the need for PSAs has been questioned by the 
government and strongly opposed by some Russian companies. Recent 
pronouncements by the government indicate that only a relatively few 
projects will be permitted under the PSA regime. This is a 
disappointment to the more than 30 projects that had been designated 
eligible for PSA treatment. Some western companies state they are not 
willing to move forward without PSA protection on their projects. 
Others have taken a more flexible approach. Still others are willing to 
move forward under the current tax regime. It is a time of uncertainty, 
especially for the large, high cost projects in high risk areas.

Central Asia-Caspian
    The experience in Central Asia-Caspian region is both different and 
similar. Most important, there have been substantial investment 
successes by western and U.S. companies in the region. Following the 
breakup of the Soviet Union in 1991, this region attracted the interest 
of the international energy community because of the huge oil and 
natural gas reserves believed to lie both on shore, but especially 
offshore beneath the Caspian Sea. The Sea is 700 miles long and 
contains six separate identified hydrocarbon basins, most of which have 
not been developed.
    With independence, both Azerbaijan and Kazakhstan welcomed 
international investors. On September 20, 1994, Azerbaijan signed the 
``Contract of the Century.'' This contact was in the form of a PSA with 
a consortium of 11 foreign companies (three American companies) from 
six nations for the development of three major oil fields in the 
Azerbaijan sector of the Caspian Sea--the Azeri, Chirag and Gunashli 
(ACG) fields.
    In April 1993, Kazakhstan signed a PSA with a consortium led by 
Chevron to develop the Tengiz oil field. The Tengizchevroil consortium 
(with ChevronTexaco and ExxonMobil owning the majority share in the 
project) is planning to invest $3 billion over the next few years. With 
adequate export outlets, 750,000 bbl/d could be provided to 
international markets by 2010. A second, huge oil deposit is being 
developed in the offshore Kashagan block (again with U.S. company 
participation).
    These projects developed by western investors, including companies 
from the United States, have created thousands of jobs, provided access 
to improved technology including training for the labor force, invested 
in social infrastructure, increased commitment to environmental 
protection, and encouraged the establishment of many small and medium 
sized enterprises in these countries.
    One of the major difficulties faced by Caspian states as they 
attempt to develop and export their energy resources has been the lack 
of export outlets. 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 bbl/d pipeline from Kazakhstan to Russia. Since 
independence, several new oil export pipelines have been built, 
including the CPC pipeline mentioned earlier. However, the relative 
lack of 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) pipeline is under construction and negotiations are 
underway to facilitate the shipment of oil from Kazakhstan for 
transport through this line. In support of the Administration's 
commitment to multiple pipelines, the Trade and Development Agency has 
funded feasibility studies of several Bosporus Bypass pipeline projects 
that would carry Russian and Central Asian oil from Western Black Sea 
ports to Western Europe.
    A second issue inhibiting oil and gas development in the Caspian 
Sea is the unresolved legal status of the Sea. Prior to 1991, only two 
countries--the Soviet Union and Iran--bordered the Caspian Sea, and the 
legal status of the Sea was governed by 1921 and 1940 bilateral 
treaties. With independence these treaties became invalid and the 
ownership and development rights in the Sea have not been resolved. 
While only the Caspian littoral states can negotiate an agreement, the 
United States has provided technical legal expertise.
    As in Russia, the United States Government has consistently 
supported the development by Central Asian countries of sound legal, 
fiscal and regulatory policies to support economic growth, including 
energy development. The Department of Energy has maintained on-going 
dialogues with energy officials from Kazakhstan and Azerbaijan on 
market reform in the energy area. In December 2001, we established a 
U.S.-Kazakhstan Energy Partnership. This Partnership has met three 
times. In September 2002, Secretary Abraham and his counterpart signed 
a Work Program that commits us to cooperation in the following areas:

   Oil and gas project development;

   Realization of multiple pipeline options for export of both 
        oil and gas;

   Improving the investment climate;

   Market reform and increased investment (including energy 
        efficiency and renewable technologies) in the electric power 
        sector;

   Energy related environmental protection and regulation;

   Energy facility security; and

   Energy science research.

    We have conducted workshops on oil spill response policy planning, 
cooperation in environmentally related marine science, and facilities 
security in Kazakhstan. A dialogue is underway in all of these areas.
    Secretary Abraham visited Azerbaijan in September 2002 for the BTC 
ground breaking ceremony and delivered a strong statement of 
Administration support for the efforts of the government and the ACG 
consortium to develop additional and alternative pipeline routes for 
Caspian oil and gas. Departmental officials, including the Secretary, 
meet on a regular basis with representatives of the Azerbaijan 
government and have recently begun an initiative to expand our 
cooperation beyond oil and gas to energy efficiency and renewable 
technologies. Use of these technologies could provide significant long-
term energy savings for the Azerbaijan government as it invests in new 
housing for its substantial refugee population.
    Speaking of the long-term, we have also underway a program to 
encourage development of joint research projects between scientists in 
Central Asia and the Caucasus and scientists in the Department's 
national laboratories. We had one meeting last August that included 
representatives of U.S. government funding programs and will hold a 
second meeting in August this year. We maintain a website (http://
pims.ed.ornl.gov/) in cooperation with the Department of Defense that 
encourages this cooperation and offers a tool for research facilities 
in these countries to demonstrate their capabilities.
    As with Russia there are problems. With economic growth, the 
government of Kazakhstan has developed ambiguous feelings about foreign 
investment as has happened in Russia. 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 recent dispute 
over provisions of the PSA with Tengizchevroil, while resolved, led to 
a government statement that future PSAs would have less favorable 
provisions for foreign investors. The Kazakhstan government concedes 
that the original investors assumed a higher level of risk when they 
entered the Kazakhstan market and appear willing to support the terms 
originally negotiated. When a new series of blocks is offered for lease 
later this year, the direction of the government with respect to 
investment terms will become more clear. We will continue to encourage 
the government of Kazakhstan to improve its investment climate and 
thereby attract the billions of dollars in investment required to 
develop these projects.




   Russia's oil industry, which was largely privatized in the 
        mid-1990s, has bounced back over the past few years, posting 
        strong profits and healthy increases in production. Buoyed by 
        relatively high world oil prices in 1999 and 2000, as well as a 
        decline in production costs following the August 1998 
        devaluation of the ruble, Russian oil companies ramped up 
        production, and by 2002 the country was pumping out an average 
        of 7.65 million bbl/d--a 26 percent increase over the 1998 
        level.

                                        Caspian Sea Region Oil Production
                                           (thousand barrels per day)
----------------------------------------------------------------------------------------------------------------
                                                                                           Estimated  Production
                              Country                                 Production (1990)            (2001)
----------------------------------------------------------------------------------------------------------------
Azerbaijan........................................................                   259                  311.2
Kazakhstan........................................................                   602                    811
Iran*.............................................................                     0                      0
Russia**..........................................................                   144                     11
Turkmenistan......................................................                   125                    159
  Total...........................................................                 1,130                1,292.2
----------------------------------------------------------------------------------------------------------------
Source: Energy Information Administration
* only the regions near the Caspian are included
** includes Astrakhan, Dagestan, and the North Caucasus region bordering the Caspian Sea


   Overall, oil production in the Caspian Sea region reached 
        approximately 1.3 million bbl/d in 2001, this represents an 
        approximately 160,000-bbl/d increase since 1990.
        
        

   Estimates of the Caspian Sea's oil reserves vary widely by 
        source. For this reason, we have presented proven oil reserves 
        as a range between 17 and 33 billion barrels.

   The upper end of this range (33 billion barrels) is based on 
        an independent geological survey, conducted in 1998 by 
        Petroconsultants. The lower end of the range comes from 2003 
        industry publications. Given the region's rapid development, 
        EIA considers the higher estimates to be most plausible, and 
        may not include recently discovered reserves.

   These 2002 figures include Oil and Gas Journal's estimates 
        of conventional world oil reserves. In 2003, Oil and Gas 
        Journal included Alberta's oil sands, which significantly 
        changes total world estimates by increasing Canadian proved 
        reserves from 5 billion to 180 billion barrels.

Conclusion
    This Administration has had an extremely proactive approach to 
energy dialogue with Russia and the Central Asia-Caspian regions. We 
have made good progress and have achieved some successes, but we are by 
no means finished with our agenda. We will continue to engage the 
governments of these countries to enhance our cooperation and build 
upon the work already underway.
    Mr. Chairman, I would like to thank you for the opportunity to 
testify before you today, and I welcome any questions you and the 
Committee might have.

    Senator Hagel.  We appreciate both yours and Ms. Borg's 
testimony.
    Let me begin with a couple of questions of Russia for each 
of you. What effect do you believe there will be on Russia's 
attitudes toward oil recovery production overall as we sort out 
the issues in Iraq? Obviously, you both are aware of the 
Russian-Iraqi oil arrangements, or at least generally some of 
those arrangements over the years. And if you each could 
amplify a bit on what your thoughts are as to what effect the 
outcome of the Iraqi situation will have or not have on 
production in Iraq, Russia's relationship with that production, 
with the United States or will it be affected at all.
    Ms. Borg?
    Ms. Borg. Thank you very much, Mr. Chairman. Iraq, of 
course, had significant--Russia had very significant economic 
ties, of course, with Iraq, being a leading supplier under the 
Oil for Food Program and having a number of contracts that I 
think we all had heard about, including the Lukoil, the large 
Lukoil contract that was abrogated right before the war.
    Dismantling the Oil for Food Program, of course, doesn't 
mean an end to their ability to be a supplier, whether it is in 
food or in oil contracts or any other ways. And so while we 
have had differences, of course, with Russia on Iraq, our hope 
is that, as we move forward in the post-conflict period, that 
we will be able to have a more cooperative, that we will be 
able to work with them in a cooperative way in addressing the 
situation there, including the end of the oil--including 
lifting sanctions.
    We can imagine that they will have an interest, that Iraq, 
of course, has huge, as Mr. Coburn has pointed out, huge oil 
reserves. And I think that people will look to that with 
interest. I think our policy has been very clear that we see, 
as the President, Secretary Powell, and others have said, we 
see Iraq oil as being for the Iraq people. And we hope that at 
the earliest opportunity it will be turned over to Iraqis to 
decide on both any existing contracts and any future contracts, 
as well as contracts for oil and supply equipment.
    Senator Hagel.  Thank you.
    Mr. Coburn?
    Mr. Coburn.  Well, I agree with everything that Ms. Borg 
stated. I think it is very clear that the future relationship 
of Russia and Iraq has to be sorted out by the new government 
that is in Iraq when it becomes stable and is able to look out 
to the future and settle its past claims and its past 
contracts, it will be its decision.
    Certainly the energy relationship with the United States 
and Russia I do not think will be affected by what happens in 
Iraq. For example, while we were at war in Iraq, we conducted 
our energy working group meetings here in Washington, very 
successful meetings. There was no discernible lessening of 
interest in our relationship and what we were trying to achieve 
because of what was going on in Iraq.
    So I think in that respect the Iraq situation is somewhat 
of a whole different element in what we are trying to achieve 
with Russia and the Caspian states.
    Senator Hagel.  So you both essentially, in a general way, 
do not believe there will be a significant impact one way or 
the other. Okay. Thank you.
    You mentioned the working group, the dialogue. You have 
presented a rather positive picture of how that has been 
progressing. Would you go a little deeper into that? What, for 
example, would you point to over the last 6 months where we 
could say that there are tangible results developing here, as a 
result of that working group dialogue?
    Mr. Coburn.  I would be very pleased to address that. My 
office at the Department of Energy, acts as the secretariat for 
the Department of Energy in the energy working group. We help 
manage this for the Government. In the five areas that we have 
focused on, I would say that, for example, in oil market 
discussions we have been able to have very robust discussions 
about the U.S. role and the Russian role in oil markets, 
something that the Russians are groping with as they become a 
very significant player in oil markets. Their need to 
understand how oil markets work, the impact of supply-demand 
issues on oil markets, forecasts for the future are something 
that they seek more information about. And we have been able to 
go into rather detailed discussions over the last year on these 
types of issues.
    Senator Hagel.  Markets for them?
    Mr. Coburn.  Markets for them, as well as the interaction 
with OPEC, for example, the Organization of Petroleum Exporting 
Countries, what the impact of spare capacity has on a market, 
what is the impact of the ability to export to foreign markets, 
how can they penetrate foreign markets, what is necessary for 
them to do that.
    So we have had some very good discussions about these 
roles. And it has a feedback into what is going on in Russia in 
terms of infrastructure development and their development of 
their own internal investment needs as they see future markets 
in the U.S. and elsewhere, as I mentioned in my statement.
    Senator Hagel.  And that would be part of it as well, where 
there are opportunities in the United States for them, as well.
    Mr. Coburn.  Exactly, I mean, they are looking towards the 
United States as a potential market. They are looking certainly 
to the Far East as a potential market. They are very interested 
in what those opportunities are, how they can set up marketing 
arrangements in the United States. One company has already done 
that. Lukoil has an arrangement with Getty and markets oil here 
in the United States. Other companies are seeking to do similar 
things, buy refineries, figure out how they gain access to deep 
water ports.
    So all those issues have been discussed and will be 
continued to be discussed in the energy working group, as well 
as in the energy dialogue that we have, the commercial energy 
dialogue.
    In the investment area, we have discussed a great deal the 
productions-sharing issue that I mentioned earlier in my 
testimony. This issue is important to U.S. companies, because 
it looked like the mechanism, and the best mechanism, for 
ensuring that companies could invest in Russia in a secure way 
in high-risk projects. We continue to work the issue, although 
we have had some disappointing twists and turns in the last few 
months. We have heard government statements that there will be 
a severe limitation on production-sharing agreements and the 
ability to use them in the future.
    But at the same time, this opens up different avenues of 
discussion in terms of trying to find other ways to address 
high-risk projects. And when I mean high risk, I mean the ones 
that will cost $10 billion to $15 billion over the life of the 
project, that are going into unexplored areas where there is no 
infrastructure, places like Sakhalin Island or East Siberia.
    The Russians are very receptive to hearing our ideas about, 
as well as the companies' ideas about, how they can address 
those types of projects and bring in investment from the 
private sector, if it requires changes in their tax regime or 
in their licensing and other subsoil laws. We have had all 
those under discussion over the last several months and years.
    Senator Hagel.  Do they bring back resolutions, concepts, 
when they come back for the next meeting after you have 
discussed some of the examples you have just mentioned, as Ms. 
Borg did, changes in tax laws, transparency, some of the other 
issues that they are dealing with? How do you move that 
forward? Do they come back with something tangible, when they 
say, now we have been able to do this or we have gone to the 
Duma, or how does that work? Other than just discussing it, how 
do they come back with some results?
    Mr. Coburn.  Well, I think the way it works is primarily we 
see progress in changes or proposals for changes in legislation 
in the Duma. Certainly there has been a lot of discussion going 
on regarding the tax regime about how to address the issue of 
high-cost, long-term investment. There are a variety of 
proposals that are on the table. We communicate, and I think it 
gets translated into discussions at the company level. It comes 
back up again in discussions at the Duma on alternatives and 
ways to address these issues.
    So if it is not necessarily brought back into the energy 
working group, you can sort of see the ideas that we talk about 
starting to proliferate through government action and 
government proposals for change in what they are trying to do. 
They certainly----
    Senator Hagel.  Has there been an increase that we have 
noted in the last year, or a decrease, in American investment 
in the Russian energy sector?
    Mr. Coburn [continuing]. I do not think we have seen a 
major change one way or the other. I think we have seen a 
little hesitancy in some of the large projects. But as I 
mentioned in my statement, we have just seen Marathon buy a 
small company, Khanty Mansiysk. So there is an example of 
continued investment. The largest investment right now is the 
Caspian pipeline. Sakhalin 1 continues to move forward. And 
they just recently announced their intent to commit to full 
development of Sakhalin, which is led by ExxonMobil.
    Some of the other companies are feeling a little under the 
gun in the sense that they are not willing to make those 
commitments absent a long-term arrangement, whether it is 
production sharing or something else in high-risk areas.
    So to say there has been a lessening, I do not think so. I 
think it has been fairly steady. One area that I think Anna 
mentioned, which has been really the best area for not 
necessarily investment but for success, has been our service 
companies working with Russian companies primarily, but also 
with Western companies, in going back into the existing 
oilfields and helping to achieve the level of production that 
the Russians are now at, because of their ability to rely on 
Western technology.
    Senator Hagel.  Before I turn to Ms. Borg--thank you. What 
about natural gas in Russia? Same set of questions.
    Mr. Coburn.  Natural gas is a challenge in the sense that 
it is controlled by Gazprom. About 90-plus percent of Russian 
production is controlled by Gazprom. All the transportation is 
controlled by Gazprom and their pipelines. I think there are 
plans on the drawing board for reform of the system. When that 
will take place is open to speculation.
    The Russians have been moving faster on the electric power 
side. And I think Gazprom is probably, and the natural gas 
industry is probably, next in line for change and reform. But I 
think that is going to take a number of years. And the pressure 
is coming not only from the West, but it is also coming from 
the Russian companies themselves, who are amassing large gas 
reserves and would dearly like to be able to transport it to 
third parties.
    Senator Hagel.  Where is most of the Russian energy sector 
investment coming from, Europe?
    Mr. Coburn.  In terms of foreign investment?
    Senator Hagel.  Foreign investment.
    Mr. Coburn.  I would say probably the largest investor 
right now is the United States. Secondly would be Europe. The 
Germans have been very active. The French have been very active 
in a variety of--the Italians, as well.
    Senator Hagel.  What arrangements are we aware of between 
the Russians and the Chinese on a number of these energy 
projects?
    Mr. Coburn.  Well, I think the most important one is the 
announcement of a pipeline from Russia to China, going from 
Angarsk, which is at the very eastern end of the Russian 
pipeline system, to Daqing. This was originally proposed by 
Yukos and has now been taken up by the Russian Government as a 
proposal that it wants to pursue. And we heard an announcement 
earlier this month from the Prime Minister indicating that that 
pipeline will be built, the one form Angarsk to Daqing. So I 
think that is an indication that Russia is attempting to 
penetrate the Chinese market and will be successful with the 
construction of that pipeline.
    Senator Hagel.  Thank you.
    Ms. Borg, we have ranged out over a number of questions. 
And so I would very much appreciate your thoughts on each of 
those questions, if you care to offer them. Thank you.
    Ms. Borg. Thank you very much, Mr. Chairman. We work very 
closely on all these issues with the Department of Energy and 
with Mr. Coburn and his colleagues. I might just make one 
additional comment, a couple of different comments.
    One, we have discussed a little bit what we are doing 
bilaterally on the issue of investment climate and 
liberalization and looking at other areas. We also work on 
these issues multilaterally through the International Energy 
Agency. I represent the State Department on the governing 
board. And together, we go to most of their meetings.
    Russia has now a very intense dialogue with the 
International Energy Agency, which we have been very supportive 
of, so that the agency has been providing advice to the 
Russians and discussions with them on the whole range, from 
liberalization of gas markets, how it is done, pricing, 
transparency, a whole range of issues, including conferences 
that have occurred and will occur in Russia and with a Russian 
focus.
    The Russian Energy Minister, for example, was a special 
guest speaker yesterday at the International Energy Agency's 
ministerial. I think this kind of dialogue, the multilateral 
dialogue, also reinforces and helps the bilateral focus on some 
of these questions. So that is also an interesting aspect.
    On the gas aspects, we also look to see what the Russians 
themselves produce when they come out with their own energy 
plan sometime later in the month of May. We are watching 
similarly with interest the proposals of private companies to 
run oil and gas pipelines in Russia. And we have certainly 
explained that we thought that would be very useful, that given 
the possibilities for export, the markets for export, and the 
constraints of the current pipeline system, that there is 
considerable merit in moving to permitting some pipeline in 
private hands.
    So that comments a little bit on some of Len's excellent 
answers already.
    Senator Hagel.  Do you care to respond to any of the 
general areas we were talking about regarding investment in any 
more depth from your perspective in the State Department?
    Ms. Borg. No. I think he covered them in great detail. I 
think we have also wanted to work very closely on commercial 
opportunities, in addition to investment, investment climate.
    And of course, as regards the Caspian, we have continued 
the practice of having an ambassador, in this case Steven Mann, 
who is our special advisor for Caspian Basin energy diplomacy, 
who has devoted considerable time and travel and energy to 
dealing with different issues as they come up related to 
investment or other challenges that have occurred along the 
Baku-Tbilisi-Ceyhan pipeline, as well as working to promote the 
Shah Deniz gas pipeline.
    So we have spent a tremendous amount of resources and time 
also on those issues.
    Senator Hagel.  What is the Russian position on the Baku-
Ceyhan pipeline?
    Mr. Coburn.  I think at this point the Russians have always 
said that pipelines need to be economically sound. If a 
pipeline is economically sound and will be supported by the 
private sector, then they have no objection to it and would 
not, certainly not get in the way of its development.
    As Baku-Tbilisi-Ceyhan has developed, it has developed into 
a pipeline that is now economically sound. It has now received 
the support of a large number of companies. They are, as we 
speak, starting to construct the pipeline. And the Russians 
have basically said, as long as the economics are there, they 
have no objection to it.
    Senator Hagel.  Would you want to add anything to that, Ms. 
Borg?
    As this committee has looked into these issues over the 
years, it is apparent that Turkey has had, still has concerns 
about the Bosporus being used as an oil way with environmental 
concerns, potential environmental damage. Would either of you 
like to respond to those concerns? Have we made, do you 
believe, progress on any of those concerns?
    Obviously, the pipelines eliminating going around the Black 
Sea would be, are, the answer. But there are still other uses, 
energy, transportation facilities that will use the Black Sea. 
And any kind of an update on the Bosporus would be important to 
hear from either of you. Thank you.
    Ms. Borg. Thank you, Mr. Chairman. I think, of course, one 
of the key updates over the last number of years on the 
Bosporus and what one can do about that was the commercial 
viability of Baku-Tbilisi-Ceyhan pipeline. I think that in 
recent weeks, in recent past weeks and months, we have heard a 
lot of discussion of alternative pipelines. I think there is 
great awareness that the Bosporus is handling a huge amount of 
shipping tankers. And, in terms of energy security, one also 
has an awareness that there need to be alternatives to that, 
that should there be some sort of a problem with the Bosporus, 
there need to be developed some diversification of supply 
routes.
    So we at the State Department have heard a number of 
different discussions of alternatives of new pipelines that 
could be built. And there are a number of different firms that 
we realize are interested in these. Many of them are at the 
discussion stage.
    Senator Hagel.  Mr. Coburn? Thank you.
    Mr. Coburn.  Well, I certainly agree with everything that 
Anna Borg said. But what I would like to add is that the 
Bosporus is an international waterway. It is under the control 
of, or at least the authority of, the International Maritime 
Organization, the IMO. And Turkey, although it has distinct 
concerns about it, as well it should, if you have ever been 
there and seen where it goes, through the heart of the city--it 
is quite amazing.
    Senator Hagel.  I have, yes.
    Mr. Coburn.  The fundamental issue is really one of safe 
passage through that international waterway. And Turkey has 
done a number of things in terms of upgrading its traffic 
navigation system and other things to ensure the safety of the 
waterway.
    One element that we have been working on, in cooperation 
with Russia, as well as all the other Black Sea countries, is a 
regional oil spill prevention and response plan. We have been 
very active working with all the six littoral states in the 
Black Sea to make sure that if something does occur, that there 
is a way to manage that very quickly and very safely. We have 
made some progress in that area. We will continue to work on 
that area, because I think it is critical, as long as Bosporus 
maintains its international status.
    I also agree with Anna that bypasses, including the BTC 
system, are essential for at least alleviating the future 
traffic through the Bosporus.
    Senator Hagel.  Thank you. You mentioned in your testimony, 
Mr. Coburn, I think you referenced that we can get back into 
this in a little more detail, the issue of ownership of the 
Caspian Sea energy resources. What can the United States do, 
what are we doing, what should we do to help facilitate 
untangling that in a peaceful way so that there is some 
productive conclusion to that issue which hangs heavy over 
probably the potential, as much as anything else, of really 
developing the Caspian? And there may well be ongoing 
activities in your departments that are addressing that.
    But if you could address that question, what are we doing, 
what should we be doing, what can we do, as well as the State 
Department? Thank you.
    Mr. Coburn.  Thank you very much for that question. The 
fundamental issue with the Caspian is how to delimit or to 
divide up the resources that lie below it, as well as how to 
regulate and control the water column, the surface as well, and 
fishing rights and everything else. Right now the status is in 
somewhat of a limbo. The treaties that were in effect on the 
Caspian essentially were signed, the most recent one in the 
1940s between the Soviet Union and Iran. There have been a huge 
number of opinions about whether those treaties still obtain, 
whether the other states have signed off and continue as part 
of that, as they have become independent.
    The U.S. has taken the position that delimitation needs to 
be solved by the five littoral states. But there are things the 
U.S. can do to help with whatever future development the 
countries have decided to take. Three countries have now signed 
treaties, Russia, Kazakhstan, and Azerbaijan, in delimiting the 
seabed through what is called a median system. The U.S. has 
provided expertise and technical assistance with respect to 
satellite imagery and other types of very hands-on work on 
where to draw that line. That has been something that has been 
very welcomed by the three states that have now signed 
treaties. Iran and Turkmenistan still have not agreed to 
anything and still continue to have their own point of view. 
But we have consistently said to all of them, it is really up 
to the five states to solve the problem, but we can help with 
technical assistance like satellite imagery and things like 
that.
    Senator Hagel.  Ms. Borg? Thank you.
    Ms. Borg. I have nothing really to add to his excellent 
rundown of the issues. We have wanted to help facilitate 
negotiations. We are not involved in the negotiations, but as 
Len has said, we have tried to provide the technical assistance 
that might help in the negotiations.
    Senator Hagel.  What is our position, the United States 
position, regarding Iran on this issue? Are we encouraging Iran 
working with these other Caspian areas to integrate some 
agreement here, or what is our position as it relates to Iran 
on these five states and trying to help untangle this?
    Ms. Borg. Iran is, of course, the only country of these 
countries that surround the Caspian that we have not provided 
the technical assistance to because of our long-standing 
position of not wanting to encourage development of energy in 
Iran. And beyond that, we have looked at issues as they have 
come up. There have been some sanctions-related issues as 
surrounded the Shah Deniz development that came up. And we have 
dealt with those on a case-by-case basis. But really, we have 
drawn the line at not providing technical assistance to them.
    Senator Hagel.  So our position is with the other nations 
in that area, you are on your own to try to work out what you 
can with Iran. And we have no third party dialogue or any other 
communication in that regard with Iran.
    Anything you would like to add, Mr. Coburn?
    Mr. Coburn.  No. I think Ms. Borg answered that quite well. 
Thank you.
    Senator Hagel.  Okay. You have both been here now more than 
an hour. And I do not want to hold you any longer. I would like 
to ask if we could keep the record open for a day in case any 
of my colleagues would like to submit questions that we would 
appreciate you answering. I again thank you on behalf of the 
committee for you coming forward and both presenting important 
testimony, which helps us here work our way through some of 
these issues.
    And I think as timely as this general area is in our 
Nation's future, with all that is going on in the areas that we 
have explored today, it is particularly important that you and 
your colleagues continue to do the good work that you are 
doing. So we appreciate it very much. Thank you.
    Now, as the first panel clears out, if the second panel 
could come in behind, we will get started. Thank you. [Pause.]
    Senator Hagel.  Welcome, again. Thank you. I appreciate 
very much the three of you taking your time and organizing your 
thoughts and making your presentation this afternoon. Since I 
have introduced each of you, let me begin with asking Ms. Nanay 
to open the second panel with her testimony. Ms. Nanay.

                 STATEMENT OF MS. JULIA NANAY,
                  SENIOR DIRECTOR, PFC ENERGY

    Ms. Nanay.  Thank you. I think the microphone is on.
    Thank you. I really appreciate the opportunity to testify. 
This is actually a very interesting topic for me to address. I 
know Ed Chow well. It is really a pleasure, also, to be able to 
be on a panel with both Andrew and Ed. I have a feeling that 
our remarks will complement each other.
    Again, my written statement is introduced for the record. I 
would like to quickly summarize some of my arguments.
    First, as it was mentioned by Ms. Borg, this issue of the 
Middle East, it is always important to keep in mind that the 
Middle East is at the core of our worldwide oil supply base. 
There is a perception that the world has to find and develop 
increasing sources of oil and gas outside of the Middle East 
and at any cost, because the Middle East producers are 
unreliable suppliers.
    But as we have seen since September 11, many have 
criticized certain Middle Eastern countries for various things. 
But the last thing you can say about any Middle Eastern 
producer is that they have been unreliable suppliers of oil; 
because as the war in Iraq illustrates, the one Middle East 
producer that has the surge capacity to balance the oil 
markets, namely Saudi Arabia, remained a staunch U.S. ally and 
kept the necessary amounts of oil flowing.
    Anyone that works in the oil industry and comes before this 
subcommittee will repeat the same fact: The Middle East remains 
a core provider of oil supplies for world markets. And now, in 
fact, in the Middle East we have a new U.S. ally, as was 
mentioned earlier, in the form of Iraq, which is going to be an 
important world oil supplier as well.
    Second is the reaction of the U.S. Government to the 
perception that we must diversify away from the Middle East at 
any cost. Over the last years, this no-cost-is-too-high 
strategy has led the U.S. Government to put the spotlight on 
the Caspian and more recently on Russia. Again, as anyone who 
comes before this subcommittee that works in the oil industry 
will repeat, world oil markets are fungible. As long as oil is 
produced somewhere, it will make it into the market somewhere, 
and prices and supplies will adjust.
    If you believe in markets, and the U.S. Government 
supposedly does, this is the view you adopt. Over the last 
years in the Caspian, the U.S. Government has challenged this 
market-based view of energy security and opted for a targeted 
destination-specific energy security view. The U.S. Government 
has been involved in micromanaging energy security in the 
Caspian by championing east-west pipeline routes that bypass 
Russia and Iran and exit through Turkey. That is with the 
exception of one pipeline going through Russia from the 
Caspian. And that is the CPC pipeline, which I will discuss 
later.
    Recently, the bypass Russia--except for CPC--part of U.S. 
policy is being dropped. The microsecurity energy agenda may 
soon be transferred to Russia, where there is talk of the U.S. 
Government lending political and maybe financial support to a 
pipeline port project focused on Murmansk in the Russian north. 
Until a few months ago, when this Murmansk pipeline import 
project gathered momentum as a possible U.S. energy security 
priority, U.S. policy in this greater Caspian region was based 
on promoting pipelines which avoid Russia and Iran.
    In fact, no heavily U.S.-backed pipeline project in the 
Caspian epitomizes this goal like the Baku-Tbilisi-Ceyhan oil 
pipeline, that by 2005, or 11 years after the upstream contract 
for this project was signed, will carry oil from the BP-led 
AIOC consortium offshore fields via Georgia to Turkey. As it 
winds its way into the construction phase, BTC seems to merit 
constant U.S. Government attention at the highest levels.
    In the long term, it is thought that up to 2 million 
barrels a day can flow through this corridor. While the U.S. 
Government tried over the last year to achieve an inclusive 
policy with BTC by encouraging Russian private companies to 
invest in this pipeline, the only Russian company that was an 
investor in the AIOC consortium which feeds BTC, Lukoil, sold 
its interest in AIOC. And it just concluded this sale these 
past days.
    The Russian companies are focused first and foremost on 
their Russian interests, which may also include Kazakhstan, as 
I will discuss, and on pipeline projects that are steered from 
Russia to various markets. They have refused U.S. Government 
overtures for cooperation in the Caspian.
    In Kazakhstan, we have what is arguably one of the most 
important new upstream frontiers since the North Sea. It is 
Kazakhstan which holds the key to great wealth in this region. 
It was here that 10 years ago this month the U.S. company 
Chevron, now ChevronTexaco, signed the region's first onshore 
joint venture for one of the world's giant oilfields, Tengiz.
    Mobil, now ExxonMobil, joined this joint venture in 1996. 
These two companies cooperated in the construction of the first 
major private oil pipeline that was built in this region from 
Tengiz to Russia's Black Sea port of Novorossiysk and which 
opened in October 2001, 8 years after the upstream contract was 
signed.
    The CPC private pipeline and the oil quality bank which 
goes with it are the model that the regional industry and other 
companies, both Western and Russian, want to repeat, namely in 
Murmansk. The CPC could easily become Kazakhstan's, and 
certainly one of Russia's, major export pipelines over the next 
decade, if it were expanded from its current approximate 
600,000-barrel-a-day capacity to at least double this size. But 
it is Russian Government, and even to some extent Russian 
company, reluctance to feed oil into this Western company-
partnered pipeline that has prevented a short spur line from 
being built in Russia that would transport Russian oil into 
this highly efficient and existing system.
    In fact, before Murmansk is addressed or any other pipeline 
options for Kazakhstan, it may be worthwhile to expand capacity 
here in the CPC.
    Fifth, a major field, Kashagan, is being developed offshore 
Kazakhstan. And U.S. pipeline advocacy has moved to securing 
substantial volumes from Kashagan to move by barge across the 
Caspian Sea to Baku for supply to the BTC pipeline, which, like 
the CPC, will have the potential for significant expansions.
    U.S. energy security advocacy is now focused on somehow 
bringing significant volumes of Kashagan oil into the BTC 
through an export corridor being referred to as Aktau BTC, or 
ABTC. At the same time, you have four Kashagan companies, 
ConocoPhillips, Inpex, TotalFinaElf, and Agip, which are ready, 
even without U.S. Government intervention, to commit about 
150,000 barrels a day to ABTC, since these four companies have 
bought stakes in the BTC pipeline.
    You have a multitude of multinational companies sitting at 
the table in the Kashagan consortium. And not all of them are 
U.S. companies. They are trying to hammer out all sorts of 
understandings with the Kazakh government on some extremely 
difficult investment issues. Anyone in the oil industry that 
follows Kazakhstan, and perhaps even some members of the 
Senate, know that other than pipelines there are some serious 
problems clouding the investment environment here.
    The last thing you want is for the Kazakh government to 
believe that the main emphasis of the U.S. Government is ABTC. 
And by expressing Kazakh support for ABTC, other more important 
issues can slip.
    At the end of the day, the decision on which pipeline to 
build or use for Kashagan exports will be based on commercial 
considerations. But experience in the Caspian region has shown 
that politics can play an important role in pipeline 
commitments. Politics, though, can be very hard for companies 
to predict. The U.S.-Russian relationship is a case in point 
here. Until 9/11, the negatives of this relationship argued for 
diversifying pipelines away from Russia. Last year saw the 
implementation of a serious U.S.-Russian dialogue. Post-Iraq, 
however, the relationship could still take other twists.
    One thing which is now confusing to foreign oil company 
producers in Kazakhstan is the ultimate U.S. strategy here with 
regard to exit routes. If the goal is to have multiple 
pipelines which bypass Russia and Iran, any policy that would 
encourage additional oil shipments across Russia beyond the CPC 
and existing Transneft options works against the diversify-
away-from-Russia element of the multiple pipeline strategy and 
further solidifies Kazakh-Russian dependence.
    Given the size and scale of the Kashagan resource base, a 
third way beyond Russia and ABTC would be the logical solution 
in the framework of stated U.S. policy which support multiple 
pipeline routes. The next route favored by many non-U.S. oil 
companies and by Kazakhstan is Iran. But this also undermines 
the stated U.S. goal of avoiding both Russia and Iran.
    So what is the primary U.S. objective now? Is it to not 
avoid Russia but to avoid Iran? And how can commercially-driven 
companies rationalize it and adjust what are long-term business 
decisions to changing U.S. policies. Non-U.S. companies in the 
Caspian are likely to stop second-guessing U.S. policies and 
opt for commercial imperatives.
    I am only going to make a few more points. And I know that 
my time is running out. But I wanted to mention Murmansk. It is 
interesting that you have many questions with this Murmansk 
project, most importantly, who will pay for the magnitude of 
costs of a project like this, which could run up to $5 billion? 
Which fields will provide the oil?
    Just today there was an announcement that the Russian 
Government supports the construction of a 400,000 to 600,000 
barrel a day Yukos-backed oil pipelines from fields in Western 
Siberia to Daqing, China, and Manchuria. If this pipeline moves 
forward, it could remove some of the oil that could have been 
designated for Murmansk. Large investments will have to be made 
and new field developments to support a pipeline the size and 
scale of Murmansk.
    If the U.S. Government takes an interest in helping this 
Murmansk project succeed, is there a role for U.S. companies in 
the upstream for oil that would feed Murmansk? And most 
importantly, would the Russian Government provide the necessary 
investment stability in the form of PSAs for U.S. companies to 
undertake such investments?
    Finally, if we notice, pipeline projects like the BTC and 
CPC take nearly a decade to accomplish, placing a particular 
burden on the direction of U.S. country policy. U.S. commitment 
to specific countries and pipelines has to last at least as 
long as it takes to construct these projects, but even longer, 
if security guarantees are required. Supporting pipelines is 
difficult geopolitical regions demands a political and military 
commitment, and therefore costs money.
    The Russian Murmansk project and the U.S.-Russian energy 
partnership raises an interesting question. If BTC is built as 
a route that intended to avoid Russia, then how is it that even 
before construction starts on BTC, that goal of needing to 
avoid Russia is being abandoned? In future decades, the 
question will be asked in one of two ways. Was this goal valid, 
or if circumstances change with Russia, then why did we abandon 
this goal?
    Similar questions might be asked if U.S.-Iran relations 
change. Alternatively if, or since, U.S. country policy can 
change within the course of a decade--the time it takes to 
plan, finance, and build a major pipeline--why should companies 
be willing to invest in policy-dependent projects? What will 
companies do with a trade route that may last 40 years, if it 
is undercut by another more efficient route that suddenly opens 
up because of policy changes?
    What this tells us is that, ultimately, projects must stand 
on their own commercial merit. The economics of a project will 
dictate its success.
    Thank you.
    Senator Hagel.  Thank you very much.
    [The prepared statement of Ms. Nanay follows:)

                   Prepared Statement of Julia Nanay

    Good afternoon. Senator Hagel and distinguished members of this 
subcommittee, thank you for allowing me to speak at this hearing. My 
name is Julia Nanay, and I am a Senior Director at PFC Energy. PFC 
Energy is a strategic advisory firm in global energy, 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. I advise our client companies 
about different elements of the investment risk in the Caspian Region. 
Today's hearing is specifically about energy security, so I will 
address this region in the context of this topic. I will look at the 
impact Azerbaijan, Kazakhstan and Russia have on the question of U.S. 
Energy Security.

                ENERGY SECURITY: PERCEPTION VS. REALITY

    Before I start talking about the Caspian region specifically, I 
want to make some general observations. There is a perception that the 
U.S. should be concerned about its energy security given recent 
developments in the Middle East. The reality is that despite a war in 
the Middle East, the U.S. has not faced problems with its energy 
supplies, nor have other nations. The U.S. is in the middle of winding 
down a war in the Middle East and the reality is that the market 
remains well-supplied. Over this past month, there was never any 
disruption of oil supplies from the Persian Gulf beyond Iraq and what's 
more, Saudi Arabia and other Gulf OPEC producers significantly 
increased production to fill the gap. Despite this, consuming nations, 
particularly Asian ones, behaved as if there would be a problem. India 
has already reported big losses from buying inventories at market 
highs, and those losses may be a fraction of what China sustained. The 
inventories, including tens of millions of barrels that the Saudis are 
holding in storage, are compounding the oil glut.
    Today's very efficient global crude and product trading system, 
combined with substantial surge capacity in Saudi Arabia, has the 
ability to compensate for interruptions in supply, as numerous recent 
examples, including Venezuela and Nigeria, demonstrate. Globally, there 
are over 1 billion barrels of strategic reserves. Refiners today are 
able to manage on lower inventories compared to 10 years ago. Increased 
efficiency, together with flexible crude and product trading markets, 
have allowed this to happen. Barring a major geopolitical fault line 
being crossed, such as the highly unlikely event of the Saudis deciding 
not to supply the US, the markets will effectively continue to manage 
short-term discontinuities. The fundamentals of the oil markets did not 
justify the high oil prices accompanying the war with Iraq. The problem 
was around perceptions, not the reality.
    The perception of energy security risk now matters a lot more than 
the reality. The reality is that world oil supplies will certainly be 
more than sufficient over the next few years. As for the longer-lasting 
legacy of the Iraq war, when it comes to energy security, all projects 
in regions other than the Middle East, will now be regarded more 
closely as potential alternatives to the Middle East. The perception 
will remain that the Middle East carries both a political and a 
contractual risk. This may not be justified, because as the Iraq war 
seems to demonstrate, the risks of depending on the Persian Gulf have 
been exaggerated and billions of dollars in national product and 
consumer income were spent unnecessarily on war premiums. The end 
result of the Iraq war, however, is that a major Middle East producer 
and exporter has been brought into the U.S. fold, and depending on how 
stable Iraq becomes and how International Oil Company (IOC) access will 
be decided, it could eventually attract investment dollars to large oil 
and gas fields, which will rival and exceed opportunities on offer 
elsewhere. By inference, this could affect investments in the Caspian 
and Russia, particularly at a time when IOCs are struggling to work 
under the right investment conditions in these places. On the other 
hand, it is precisely this phenomenon of turning away from the Middle 
East because of ``perceived'' risk that has raised the perception of 
the strategic value to the U.S. of sources like the Caspian and Russia.

            MICROSECURITY JUXTAPOSED AGAINST MACROECONOMICS

    In the macro sense, the world oil market is fungible. As long as 
oil is produced somewhere, it will make it into the market somewhere 
and prices and supplies will adjust. If you believe in markets, this is 
the view you would adopt. The U.S. government, in fact, says that it 
espouses this view and statements by various officials stress that it 
is up to the open market to determine future outcomes of oil and gas 
supplies. Over the last years in the Caspian, the U.S. government has 
challenged this market-based view of energy security and opted for the 
targeted country and destination-specific energy security view. Part of 
the U.S. involvement has been dictated by the location of the Caspian 
just north of Iran, a country with which the U.S. has had troubled 
relations since 1979. The U.S. government has been involved in 
micromanaging energy security in the southern Caspian by micromanaging 
east-west pipeline routes that bypass Iran and exit through Turkey. 
While this U.S. microsecurity agenda is now factored into the accepted 
business practices of some countries in the Caspian and many companies, 
it may soon be applied in Russia as well. There is talk of constructing 
a south-north pipeline route in Western Siberia, exiting through the 
deepwater port of Murmansk. This pipeline is already receiving 
increased U.S. government attention and even offers of possible 
financial support. One could argue, however, that the case of the 
Caspian and U.S. advocacy is different than the case of Russia in that 
when pipelines cross more than one country (Azerbaijan to Georgia to 
Turkey), intergovernmental intervention may be necessary to move the 
process along. The Russian Murmansk pipeline is within one country. 
Nonetheless, other countries which have been watching this U.S. 
targeted country and destination-specific energy security strategy are 
beginning to follow the U.S. lead. This can been seen in investments 
made by China in Azerbaijan and Kazakhstan, with a pipeline being more 
seriously discussed to target China from Kazakhstan. And, Japan is 
eager to get an oil pipeline built from Russian Eastern Siberia to the 
Russian Pacific Coast. Both China and Japan are concerned that none of 
the pipeline projects championed by the U.S. specifically target Asian 
markets, which is where Middle East oil use is the highest and where 
the major oil demand growth is expected.

             GEOPOLITICS AS THE DRIVER VS. ENERGY SECURITY

    The location of the Caspian, between Russia and Iran, determined 
the U.S. focus on this region. In part to create countries that could 
stand on their own without Russia and become U.S. allies, and in part 
to maintain the isolation of Iran, the U.S. government has devoted 
enormous attention to the Caspian region over the last few years. One 
could argue that the driver here has been geopolitics, not energy 
security, even though one of the key manifestations of U.S. government 
interest seems to be the Baku-Tblisi-Ceyhan (BTC) oil pipeline (to be 
discussed below). And, with a heightened emphasis on a U.S.-Russia 
energy dialogue, while relations with Iran remain problematic, 
attention may now shift to another pipeline corridor through Russia to 
Murmansk.

Azerbaijan
    Over the last 6 years, or since June 1997 when the U.S. State 
Department publicized very high numbers on potential oil reserves in 
the Caspian countries, the U.S. government has focused most closely on 
Azerbaijan. Sitting in a key location in the Southern Caucasus and 
bordering on Iran, Azerbaijan became the pivotal country for the U.S. 
government's investment advocacy agenda. And, under the watchful eye of 
the U.S. government, Azerbaijan and its neighbor Georgia have come a 
long way in these six years. A large number of the offshore and onshore 
contracts were signed in Azerbaijan during the 1997-1999 period, even 
though the only major offshore producing oil fields--under development 
by the AIOC consortium--are attributed to a 1994 Production Sharing 
Agreement (PSA). While the U.S. pushed and prodded to make Azerbaijan a 
much bigger upstream success story than just AIOC, in the end, most of 
the contract areas have proved disappointing. The only other field 
which demonstrated success turned out to be a huge offshore gas field 
called Shah Deniz. Based on Azerbaijan's one major oil project and its 
one major gas project, the U.S. set out to help provide the stable 
political environment necessary to create a pipeline hub in Azerbaijan, 
with oil and gas export routes running from there through Georgia and 
Turkey. The lead company in all these projects is the UK's BP with 
Norway's Statoil playing a role in the Shah Deniz gas pipeline as 
commercial operator.

            The Baku-Tblisi-Ceyhan (BTC) Oil Pipeline
    Perhaps no project in the Caspian epitomizes the U.S. vision of 
providing new pipeline corridors in the Caspian region, and ones which 
avoid Iran, like BTC. A huge undertaking, managed by BP, this 1 million 
b/d $2.9 bn pipeline that has the potential for significant expansions 
(as high as 1.8 mmb/d), is scheduled to deliver first oil by 2005. 
Winding its way through complex project finance negotiations and having 
to contend with the final details of land purchase, environmental 
approvals, and Turkish government personnel changes, the BTC pipeline 
appears to still merit the U.S. government's constant attention. At all 
levels of the U.S. government--the White House, Congress, the 
Department of Energy and other agencies--a huge commitment of staff 
time has been devoted to Azerbaijan, Georgia and Turkey and to BTC in 
the context of an east-west energy corridor. The long term goal is to 
create an energy source that is independent of Russia and Iran and 
emanates from countries we consider U.S. allies. In the long term, it 
is hoped that up to 2 million barrels a day of Caspian oil can flow to 
markets though this corridor.
    While the destination for this oil may be northwest Europe, Asia, 
as well as Israel--and not necessarily the US--since oil markets are 
global, oil from BTC is viewed as enhancing the diversity of non-OPEC 
supply sources, which again is also a U.S. goal when looking at energy 
security.

            The Key Role of Turkey
    Even while the U.S. government has stressed Azerbaijan as an 
upstream investment destination, Turkey has been designated as the 
ultimate pipeline collector for both oil and gas. Turkey's formidable 
role given its deepwater port at Ceyhan on the Mediterranean Sea 
requires that it accommodate exports of both large volumes of oil from 
Iraq (1 million b/d and eventually more) and Azerbaijan (1 million b/d 
and eventually more). Turkey will also be an important transit corridor 
for transferring Caspian, Iranian and maybe even Iraqi gas to growing 
European markets. Turkey's pre-eminent position in this regard means 
that the U.S. government has put tremendous emphasis on Turkey's 
political and economic stability.
    Because Turkey's link to new gas supply sources for Europe is also 
vital, the European Union's (EU's) involvement in ensuring Turkish 
political and economic stability is sure to increase. As Turkey is 
going through its own difficult democratic evolution, at a time of 
great strains on its economy given the Iraq situation, the U.S. 
government has been striving to maintain good relations. By creating 
pipeline corridors through Turkey in order to avoid Russia and Iran, 
the U.S. government must ensure the security of these pipelines--which 
will mean a financial and military commitment for many years to come. 
It will also mean providing political cover for Georgia and Turkey as 
they cement ties that are seen by Russia as being against its 
interests.
    As I will discuss later, while seeming to pose a threat to Russia 
in the Caucasus, the U.S. will try to balance its interests with 
Russia, since the latter is expected to be a critical growing non-OPEC 
world oil supplier.

Kazakhstan
    Moving to the East and to the North, we have what is arguably one 
of the most important new upstream investment frontiers since the North 
Sea: namely, Kazakhstan. Despite the preponderance of U.S. attention to 
Azerbaijan because of its strategic location bordering Iran, it is 
Kazakhstan which holds the key to the Caspian countries' oil wealth. It 
was here that in April 1993--10 years ago this month--U.S. company 
Chevron (now ChevronTexaco) signed the region's first onshore joint 
venture for what is even today considered to be one of the world's 
giant oil fields--Tengiz. U.S.-company ExxonMobil joined ChevronTexaco 
in Tengiz in 1996. ChevronTexaco is also partnered in Kazakhstan's 
other major onshore oil and gas producing field, Karachaganak. And, 
ExxonMobil is a member of the consortium led by Italy's Agip, which is 
exploring and developing the most exciting new offshore prospect in the 
Caspian Sea, the Kashagan structure. Kashagan holds many billions of 
barrels of oil reserves and its size and scale will probably exceed 
even that of the Tengiz oil field. But because it is offshore in an 
ecologically sensitive area and contains important volumes of 
associated high sulfur gas, Kashagan's development poses many difficult 
challenges, which are a matter of contentious debate between the 
consortium and the Kazakh government. With a large number of already 
discovered and producing oil fields, Kazakhstan's oil output keeps 
rising and has exceeded 1 million b/d (vs. about 300,000 b/d in 
Azerbaijan today).

            The Caspian Pipeline Consortium (CPC)
    The first major privately built oil pipeline to be completed in the 
Caspian was the CPC, which became operational in October 2001 and 
carries oil from Tengiz as well as some other smaller Kazakh fields to 
the Russian Black Sea port of Novorossiysk. With a capacity of close to 
600,000 b/d, the CPC could be expanded to at least twice this size and 
were it not for problems in coordinating with the Russian partner/
owners in the pipeline, the CPC would easily become Kazakhstan's major 
export route for the foreseeable future. However, problems with Russia 
and issues posed by tanker transit through the Bosporus have led to the 
serious study of other export options. It must be remembered that CPC 
is the ``flagship'' pipeline project for the Caspian region. It is the 
first pipeline to have been built without Russian pipeline monopoly 
Transneft's involvement, and it was privately built and financed by the 
western oil company partners. CPC designed and implemented an oil 
quality bank, which will equalize the values of the different types of 
oil that are fed into the pipeline. The CPC private pipeline and 
quality bank model are now the standard in the regional industry that 
other companies, both western and Russian, want to repeat.

            Aktau-Baku-Tblisi-Ceyhan (ABTC)
    Four companies which are members of the Kashagan consortium have 
joined the BTC pipeline consortium: ConocoPhillips, Inpex, 
TotalFinaElf, and Agip and could provide 150,000 b/d to BTC, with oil 
moved on barges across the Caspian Sea from Aktau to Baku. The U.S. 
government would like to see a commitment of 400,000 b/d from Kashagan 
to BTC. Committing such volumes to ABTC would be costly for the 
consortium. It would mean building the pipeline connection from 
Kashagan's onshore processing facilities to Aktau port, paying for the 
barge transport of oil from Aktau to Baku and then also for the 
pipeline fees from Baku to Ceyhan. Of course, any option for moving 
Kashagan oil will entail costs because the anticipated large volumes 
which are expected to be produced here will require new export options 
to be built in addition to the current transit opportunities across 
Russia in the CPC and via Russian pipeline monopoly Transneft's system. 
As it is, in the short to medium term, until Transneft's system is 
expanded, Kazakh crudes are likely to experience increasing problems in 
the Russian pipeline system, since Russian oil company heads (most 
notably Mikhail Khodorkovsky, the CEO of newly merged YukosSibneft) are 
agitating against Caspian crudes taking up export space that backs 
their crudes out of the Transneft system. Currently just over 400,000 
b/d can supposedly be transported through the Atyrau (Kazakhstan)-
Samara (Russia) pipeline link and the Aktau (Kazakhstan) by barge to 
Makhachkala (Dagestan, Russia) export link. Additionally, while 20,000 
b/d are currently being transferred by barge to Iran's northern Neka 
port from Aktau, Kazakhstan under a swap arrangement, these volumes to 
Iran could be increased, either through increased oil swaps or by a new 
onshore pipeline through Turkmenistan to connect into Iran's pipeline 
network.
    Longer term, the Kashagan field will require another large pipeline 
capable of transporting 1 million plus barrels in a direction other 
than CPC, Transneft and/or BTC--and that would mean either toward China 
or Iran. Russia may argue that once a major new south-north pipeline is 
in place to Murmansk, more Kazakh oil could also be exported across 
Russia--negating the need for a Chinese or Iranian pipeline. For now, 
the U.S. government is stressing 400,000 b/d for shipment through ABTC. 
However, with a multitude of multinational companies sitting at the 
table in the Kashagan consortium, trying to reach decisions on many 
different aspects of this project, U.S. advocacy for ABTC could slow 
down the ability of the consortium to agree on any export direction. It 
could also slow down the development of the overall Kashagan resource 
base.
    At the end of the day, the decision on which pipeline to build and/
or use for Kashagan exports will be based on commercial considerations, 
including the timing of alternative available export options and 
pipeline operational confidence. Still, experience in the region has 
shown that politics can play an important role in pipeline commitments, 
but politics can be hard for companies to predict. The U.S.-Russian 
relationship is a case in point here. Until 9/11, the negatives of this 
relationship argued for diversifying pipelines away from Russia. Last 
year saw the implementation of a serious U.S.-Russian dialogue. Post-
Iraq, the relationship may take other twists. One thing which is now 
confusing to foreign oil company producers in Kazakhstan is the 
ultimate U.S. strategy here with regard to exit routes. If the goal is 
to have multiple pipelines, which bypass Russia and Iran, any policy 
that would encourage additional oil shipments across Russia beyond the 
CPC and existing Transneft options, works against the ``diversify away 
from Russia'' element of the multiple pipeline strategy and further 
solidifies Kazakh-Russian dependence. Given the size and scale of the 
Kashagan resource base, a third way, beyond Russia and ABTC, would be 
the logical solution in the framework of stated U.S. policy which 
supports multiple pipeline routes. The next route favored by many non-
U.S. oil companies in Kazakhstan is Iran, but this also undermines the 
stated U.S. goal of avoiding both Russia and Iran. So what is the 
primary U.S. objective now? Is it to not avoid Russia but to avoid 
Iran? And how can commercially driven companies rationalize it and 
adjust what are long-term business decisions to changing U.S. policies? 
Non-U.S. companies in the Caspian are likely to stop second-guessing 
U.S. policies and opt for commercial imperatives.

Russia
    Perhaps the most impressive oil production gains by any single 
country over the last two years have been made by Russia, with its 
output rising from 6.8 million b/d in 2001 to close to 8.2 million b/d 
today. This has been made possible by the efficiencies introduced into 
the Russian oil industry by the Russian private companies. As Russian 
production has been rising, Russian pipelines and ports have not kept 
pace with the higher export expectations of the Russian companies. 
Russian pipeline monopoly, state-owned Transneft, has been unable to 
address the multitude of export-direction demands of the Russian 
producers. In part because of the complexities of the existing Russian 
pipeline system which spans a vast inhospitable territory and which 
demands constant attention, in part because Transneft can only do so 
much at once, and in part because Transneft has its own agenda of 
pipelines and ports which it is promoting--there is now a clash between 
private and state interests on the future of Russian oil exports. 
Transneft's alleged oil export capacity is somewhere around 3.5 million 
b/d (which also accommodates oil exports from Azerbaijan and 
Kazakhstan). In addition, about 1.5 million b/d of products can be 
exported, with considerable reliance on rail transport.
    The Russian oil companies are determined to increase export outlets 
and several of them are determined to make Murmansk in Russia's north, 
the next major deepwater port that will handle the anticipated ongoing 
growth in Russian oil production and exports. Tying into this deepwater 
port, with an estimated start-up date of 2007-2008, will be a 1.6 
million b/d oil pipeline (that could be expanded to 2.4 million b/d) 
and which would cost between $3.4 billion and $4.5 billion to build. 
Lukoil, YukosSibneft, TNK/BP, and possibly Surgutneftegaz could have an 
ownership stake of up to 49 percent in this pipeline, creating a 
consortium which somewhat mirrors the CPC formula, although Transneft 
will have a significant role. If this arrangement move forward, it 
would be a significant capitulation by the Russian state to accommodate 
private industry's interests.
    The Murmansk pipeline and deepwater port project still have many 
imponderables. Who will pay for the project is still open to question, 
although U.S. OPIC and Ex-Im have expressed an interest in providing 
some assistance. Which fields will provide the oil? Is there a role for 
IOCs, including U.S. companies, in upstream projects which could feed 
Murmansk? And, most importantly, would the Russian government provide 
the necessary investment stability in the form of Production Sharing 
Agreements (PSAs) for IOCs to undertake multibillion dollar field 
developments which might be necessary to fee a major pipeline which 
Murmansk represents?

Diversity of Supply Sources Enhances Energy Security
    Energy security is best enhanced by encouraging the development of 
a diversity of supply sources and not necessarily by advocating or 
directing pipeline flows. Pipelines are long life projects and yes, 
politics and geopolitics can determine whether they operate or shut 
down. However, over the long life of a pipeline, advocating a route one 
day doesn't mean that unforeseen political and geopolitical 
circumstances in the future will not alter the current judgment call. 
There is no predictability over long-term political and geopolitical 
relationships and alliances, especially in regions such as the Caspian 
Sea and the Middle East.
    Diversity of supply from countries where the U.S. government can 
help to create stable, long-life responsible governments would be more 
conducive to the sustainable development of resources than stressing 
pipeline routes.

International Oil Companies (IOCs) and OPEC vs. Non-OPEC in the Energy 
        Security Equation
    The Caspian region and now Russia are perceived as important for 
the U.S. because they help diversify the world's supply of oil while 
also being non-OPEC suppliers. However, the OPEC versus non-OPEC 
conundrum in U.S. Energy Security debates is often misunderstood. Non-
OPEC supplies serve as a market baseload, consistently delivering the 
full level of production those sources are capable of. Clearly, 
diversifying and increasing these non-OPEC sources provides a more 
secure core of supplies for the U.S. and other consumers to rely upon. 
Non-OPEC production is growing and will increase by 1.2 million b/d in 
2003 to 47.1 million b/d vs. OPEC production without Iraq of 24.4 
million b/d.
    After non-OPEC supplies are considered, the difference between them 
and total global oil demand is then filled by OPEC. Because of their 
domestic budgetary needs, OPEC member states have a strong self-
interest in adjusting production to promote a stable price that is 
neither so high that consumer nations (and hence demand for oil) 
suffer, nor so low that there is an oil glut that would also hurt U.S. 
energy companies. In short, OPEC and U.S. interests coincide in a 
desire for a moderate oil price as exemplified by OPEC's target $22-$28 
per barrel price band.
    So U.S. government emphasis is misplaced. The question is not OPEC 
(who wish to see a moderate oil price) versus non-OPEC (who continue to 
increase their oil production). Rather, the issue to address is how to 
continue encouraging non-OPEC supply growth and diversity, preferably 
with the involvement of IOCs (including U.S. oil companies). OPEC's 
stated $22-$28 per barrel price range is sufficient to offer IOCs the 
economic incentives to develop non-OPEC supplies. In both OPEC and non-
OPEC countries, governments determine how oil and gas reserves will be 
developed. Thus, some issues to address are: (1) how much access IOCs 
will have to support the development of these reserves and production; 
(2) in which countries do IOCs have this access; and (3) how stable are 
these countries to allow IOCs to produce and export their oil without 
impediments. In Russia, IOCs currently have limited access. It will be 
interesting to see if the recent BP equity investment in TNK/BP will be 
a catalyst for more opportunities. In the Caspian, IOCs have a great 
deal of access in Azerbaijan, but here the prospectivity is 
diminishing. In Kazakhstan, IOCs have access but the investment climate 
is difficult. Moreover, the location of Kazakhstan, bordering on 
Russia, means that its energy future will have ties to Russia but how 
strong these ties will be could be determined by the availability of 
export pipelines that steer oil in other directions.

Conclusion
    Longer term, one could argue that oil and gas supplies from the 
Caspian region and Russia will be no different than supplies from the 
North Sea or elsewhere. They will be just other sources.
    However, one note of caution: pipeline projects like the BTC (and 
CPC) take nearly a decade to accomplish placing a particular burden on 
the direction of U.S. country policy. U.S. commitment to specific 
countries and pipelines has to last at least as long as it takes to 
construct these projects but even longer if security guarantees are 
required. Supporting pipelines in difficult geopolitical regions 
demands a political and military commitment and therefore, costs money. 
The Russian Murmansk project and the U.S.-Russian energy partnership 
raises an interesting question. If BTC is built as a route that 
intended to avoid Russia, then how is it that even before construction 
starts on BTC, that goal of needing to avoid Russia is being abandoned. 
In future decades, the question will be asked in one of two ways: Was 
this goal valid? Or if circumstances change with Russia, then: Why did 
we abandon this goal? Similar questions might be asked if U.S.-Iran 
relations change. Alternatively, if (or since) U.S. country policy can 
change within the course of a decade--the time it takes to plan, 
finance and build a major pipeline--why should companies be willing to 
invest in policy-dependent projects? What will companies do with a 
trade route that may last 40 years if it is undercut by another more 
efficient route that suddenly opens up because of policy changes? 
Ultimately, projects must stand on their own commercial merit and the 
economics of a project will dictate its success.

    Senator Hagel.  I appreciate that very comprehensive 
testimony. And we will come back to some of your points, as we 
will after we hear from of your colleagues.
    Mr. Somers, please proceed. Thank you.

  STATEMENT OF ANDREW SOMERS, PRESIDENT, AMERICAN CHAMBER OF 
                       COMMERCE IN RUSSIA

    Mr. Somers.  Thank you, Senator. On behalf of the 700 
members of the American Chamber of Commerce in Russia, I would 
like to express our appreciation of this opportunity to weigh 
in on this important subject before your subcommittee.
    A brief word about the chamber, so you understand who we 
are, we are a totally independent, member-funded business 
advocacy organization. Our mission is to promote trade and 
investment between Russia and the United States in order to 
facilitate sustainable penetration of the Russian market by our 
members.
    To this end, we are engaged in an ongoing dialogue with all 
organs and all levels of the Russian Government and with the 
representatives of the most influential private sector 
businesses. We have achieved considerable bottom-line results 
in this dialogue, and we are very encouraged by the openness 
with which our Russian colleagues, both in the government and 
in the private sector, listen to our views; that is across all 
sectors.
    There is no question that we have benefited, the American 
business community, in Russia by the new Russian-American 
strategic relationship, which has evolved under the leadership 
of President Bush. And in that respect, I would like to 
acknowledge the vital support of Secretary of Commerce Donald 
Evans, as well as the American Ambassador to Russia Alexander 
Vershbow.
    It is the view of the American business community in Russia 
that it is in their interest to see Russia's re-emergence as a 
major oil producer continue, and also in our interest to see 
Russia have the opportunity to share with other exporters a 
share of the U.S. oil import market. As the Department of 
Commerce ruled in June of 2002, Russia has made the difficult 
transition to a market economy, as defined by U.S. trade laws.
    And, of course, it is noteworthy that this difficult 
transition, this change in the character of the Russian 
economy, occurred within a democracy. It may not be a democracy 
as mature as the United States, but nevertheless it is a 
democracy. We feel that with Russia's participation in U.S. 
energy strategy, in terms of import, share of import market, 
the United States would contribute to the globalization of the 
Russian economy and would help stabilize these very positive 
developments to a market economy and a democracy.
    Now of course in order for the U.S. to make this kind of 
determination that Russia should play a major role in imports 
into the U.S., Russian oil must be a viable option. We would 
suggest there are at least three criteria to look at. One is 
the Russian infrastructure and export capacity. Second is its 
production and reserves. And third is the investment climate. I 
would like to, with your permission, touch very briefly on 
each.
    It might be more logical to start with production and 
reserves, but I speak from the perspective of an American 
businessman who is living in Russia. It is an incontrovertible 
fact that everyone involved in the Russian market recognizes 
that Russian production far exceeds demand and far exceeds the 
capacity of Transneft, which is the state-owned monopoly which 
controls the transport of oil throughout Russia and to the 
export facilities.
    This is causing depression in local pricing for gasoline 
and for oil. It is also hurting the small independent oil 
companies who are struggling to compete with the larger majors, 
because they have to sell the crude oil at depressed prices. 
They lack the refining capacities of the majors to produce 
secondary products, which can be then sold at a reasonable 
markup.
    So Russia can continue to produce an enormous amount of 
oil. But if they cannot get it to their ports, it is not going 
to do anyone any good.
    My written statement that I submitted a couple of days ago 
said that there is little evidence that the Russian Government 
is making any kind of move toward relieving this pipeline clog. 
But this is Russia. And as I was leaving Russia yesterday, I 
learned that Minister of Energy Yusufov made a statement to the 
effect that it was in the interest of Russia's energy security 
to diversify its export facilities and that they were giving 
serious consideration to developing transport to various points 
in Russia which would facilitate export. So perhaps there is 
something that is going to happen there in the positive sense.
    Moving on to the future and the prospects of relieving this 
infrastructure clog and improving exports, as referred to by 
previous speakers, the Caspian pipeline exists now. It has been 
in operation since late 2002. As you know, it focuses 
primarily, at least in the initial stage, on Kazakh oil. The 
pipeline runs from the Tengiz field in Kazakhstan through 
almost 1,000 miles of Russian territory to the Russian Black 
Sea port of Novorossiysk.
    We think it is important to the relationship that although 
this primarily focused on Kazakh oil from the Caspian, it does 
involve a venture with Russia in terms of its territory and 
permissions to go through the territory and American companies. 
Russia is the largest stakeholder in the Caspian pipeline 
consortium having 24 percent of the stake. Kazakhstan has 19. 
Oman, I believe, is the third country with a much smaller 
stake. And Chevron has the largest private sector stake of 15 
percent. Exxon has about 7.5 percent.
    With very little effort, as a previous speaker mentioned, 
Russia could significantly increase the Russian production 
portion of the Caspian pipeline exports by building a 40-mile 
trunk line from its Transneft facility, its Transneft pipeline 
network, to the Russian city of Kropotkin, which is on the 
Caspian pipeline. The Caspian pipeline consortium has already 
built state-of-the-art facilities there, pumping facilities, to 
move Russian oil. And if the Russians decided to build this 
very short trunk line, within 6 months it would add 150,000 
barrels per day to the export capacity of the Caspian pipeline, 
and within 2 years at 300,000 barrels per day. So in a sense, 
Russia at least has moved to have the capacity to increase its 
exports through the Caspian pipeline.
    Perhaps more significantly is the Murmansk project, which 
has been mentioned by the previous speaker and the previous 
speakers in the first panel. Due to the lack of capacity 
building by Transneft, the infrastructure network, the private 
sector in Russia has decided that they have to do something. 
And several months ago, the majors proposed that they would 
construct at their own cost $4 billion to $5 billion, plenty of 
cash in the Russian oil companies, a pipeline from Western 
Siberia to Murmansk, Murmansk in the northwest, being a 12-
month ice-free deep water port, West Siberia being a primary 
oilfield of Russia where most of the oil is coming from.
    The prospects from the Western point of view, let me put it 
this way, if I may, Western oil companies in Russia believe in 
this project. And they believe that Murmansk, if the pipeline 
is built and the port is renovated as the Russian companies say 
they will, this facility could have the capacity of exporting 
up to 1 million barrels today out of Murmansk.
    The Russians clearly see it, that is to say the Russian 
private sector clearly sees it, as a window on the United 
States oil market. They have talked about the fact that the 
cost of transportation of oil from Murmansk to the U.S. East 
Coast would be equivalent to the transportation costs that are 
now borne from the Mideast to the U.S. I think they quote $8 a 
day.
    When they look at an Arctic route from Murmansk, the 
transportation cost would even be cheaper. So we think that 
given the financial capacity and the commitment of the large 
Russian majors, we will see development with respect to 
Murmansk. As a previous speaker said early on, when I say early 
on, a couple of months ago, the Russian Government voiced 
dismay that a pipeline would be owned by the private sector.
    But more recently, there has been some sign that there 
might be a compromise. And only yesterday, again as I was 
leaving Moscow, the Prime Minister was quoted in Itar-Tass, one 
of the wire networks, that he would shortly sign an order 
promoting a pipeline from Murmansk. It was not clear from this 
brief description if he was talking about a different pipeline 
than the one that the private sector was talking about, but I 
would suspect it is the latter, that there is going to be some 
kind of cooperation between the Government and the Russian 
majors to construct this pipeline.
    The second factor, of course, that is important for the 
U.S. to consider is Russia's production capacity, as well as 
its reserves. I will not touch on reserves. The previous 
speakers on the previous panel have talked about the difficulty 
of trying to quantify that, except everyone seems to agree that 
it is very large.
    With respect to production, almost all of the production in 
Russia is coming out of Western Siberia, about 7.4 million 
barrels a day. Western oil companies in Russia believe that 
this capacity will continue at that rate for at least 3 or 4 
more years, perhaps a couple more after that, but that then 
this production capacity will decline.
    For that reason, among others, Western companies believe 
that the Russian Government and the Russian private sector 
should be looking very hard at deep exploration to discover 
reserves which have not been proven yet. This leads to the 
discussion, and I will not dwell on it, of production-sharing 
agreements, which is basically a legal solution to providing a 
certain amount of predictability to investors who are talking 
about 20- to 30-year payback periods in transactions, or rather 
operations, which are far removed from infrastructure.
    There is a bill before the Duma right now that will 
probably pass in the spring. It is going to make some oil 
companies somewhat happy. It is going to make other oil 
companies not very happy. It will be a limited form of PSA. At 
least that is my guess. Some companies will be happy that 
something got through. Tactically in Russia in particular, 
legislative tactics often mean you get a bill through the Duma, 
and your tactic then is to try to amend it within 6 months or a 
year. So that is always a factor in whether or not a final bill 
is good or bad.
    The Russian private sector has a somewhat different view, 
some of the Russian private sector. We do find that some of the 
majors support PSA publicly. Others, such as Yukos, which is 
now the fourth largest oil company in the world after its 
merger with Sibneft, which was the number five Russian oil 
company, recently, is much less enthusiastic about PSAs, 
although they have not publicly come out against it. But 
essentially, they feel that Russia's capacity is sufficient to 
not need PSAs to a large extent.
    Recently, Yukos said there were sufficient reserves in 
Russia, proved and provable reserves, easily provable reserves, 
which would guarantee Russia over the next 30 years 9 million 
to 10 million barrels per day of production. Yukos has publicly 
said that they believe current Russian reserves could meet the 
demands with respect to U.S. imports of a 15-percent share. 
Yukos believes that Russia could provide a 15-percent share of 
the imports into the U.S. of oil over the next 30 years 
basically with the reserves that they have now. Yukos, by the 
way, is a strong supporter of the Murmansk project.
    Lastly, I will very briefly comment on the investment 
climate. I think the macroeconomic numbers are very important 
in this regard. Russia has had constant impressive GDP growth 
over the past 3 years with a very surprising 6.4 GDP growth in 
the first quarter of this year. No one expected that. The 
Russian Government did not expect it. None of the Western 
analysts expected it.
    We see a continuing growth in consumer spending. The 
reserves of the Central Bank are at the highest ever, about $55 
billion. The real estate market in Moscow and some of the other 
largest cities is growing. And overall, the economic prospects, 
we think, look pretty good. And I am speaking from the 
perspective of someone who every day has to battle the 
bureaucracy and all of the other implementation issues of the 
very progressive legislation that has been passed. So I do not 
speak as a rosy-eyed optimist. It is a tough environment, but 
it continues on an upward track.
    So we believe that given that the legislative and the 
macroeconomic situation have improved, that there is a very 
open dialogue between American business, the Russian 
Government, American business, and Russian business, that it is 
in the interest of the United States to look, as it is, 
seriously in terms of its energy security as to whether Russia 
should play a major role as a contributor.
    I will not touch upon the U.S.-Russia energy dialogue or 
the commercial energy dialogue, in which I play a role as co-
chairman, because I think that has been addressed very 
adequately by previous speakers; but I will say to the American 
business community these are very strong signals of a very 
strong potential relationship between the energy companies in 
Russia and the United States.
    Thank you very much.
    Senator Hagel.  Mr. Somers, thank you.
    [The prepared statement of Mr. Somers follows:]

                 Prepared Statement of Andrew B. Somers

    Senator Hagel, on behalf of the 700 member companies of the 
American Chamber of Commerce in Russia operating in the Russian market, 
I would like to express our appreciation for this opportunity to 
testify on U.S. Energy Security: Russia and the Caspian.
    A brief word about the American Chamber, known in Russia by the 
acronym ``AmCham.'' We are an independent, self-funded business 
advocacy organization with offices in Moscow and St. Petersburg. Our 
mission is to promote trade and investment between the U.S. and Russia 
in order to maximize sustainable penetration of the Russian market by 
our member firms. To achieve this objective we are engaged in an on-
going, and we believe, effective dialogue with all relevant organs and 
levels of the Russian government and the most influential 
representatives of the Russian private sector. We benefit greatly from 
the new U.S.-Russia strategic relationship which has emerged under the 
leadership of President Bush. In this regard I should acknowledge in 
particular the vital support of AmCham by U.S. Commerce Secretary 
Donald Evans and the U.S. Ambassador to the Russian Federation 
Alexander Vershbow.
    It is in the interests of American business for Russia to continue 
its re-emergence as a major oil producer and to gain a significant 
share of the U.S. oil import market. As the U.S. Department of Commerce 
held last June after an extensive public inquiry, Russia has succeeded 
in making the difficult transition to a market economy. Moreover, this 
fundamental change in the character of the Russian economy has occurred 
within a new democracy, an historic transformation in itself. American 
business prospers best in democratic market economies. By allowing such 
an important sector of the Russian economy to contribute with other 
oil-producing nations to meeting U.S. energy needs, the U.S. would help 
to globalize the Russian economy and stabilize these positive 
developments.
    For the U.S. to make such a commitment requires, of course, a 
judgment that Russian oil is a viable option for diversifying foreign-
sourced energy supply to the U.S. In our view 3 factors should be 
considered when making this determination:

          (1). Transportation infrastructure.

          (2). Production and reserves.

          (3). The investment climate.

1. Transportation Infrastructure.
            (a) Current export constraints.
    It is an incontrovertible fact acknowledged by all parties 
operating in the Russian oil sector that Russian oil is export 
constrained. Current production far exceeds both local demand and the 
capacity of the Russian state oil transport system, Transneft. As a 
result local oil prices are depressed and the volume of crude available 
at export points is significantly compromised. An additional negative 
effect is the decline in profitability of small independent oil 
companies who must sell at low prices and lack the refinery facilities 
common to the majors for the production and sale of secondary oil 
products at a reasonable markup. With Duma elections ahead in the fall 
and the Presidential elections looming in the spring of 2004 it is 
perhaps not surprising that no vigorous steps have been taken to 
relieve the pipeline clog and risk an increase in domestic oil prices. 
However, for Russia to be a viable import option, substantial 
improvement of the current oil transport infrastructure is imperative.
            (b) Future export constraint relief.
    Two important features of the current Russian oil environment 
suggest that relief for Russia's export constant problem could be on 
the way in the relative near term. I have in mind the existing Caspian 
Pipeline and the proposed Murmansk Pipeline project.

          (b)(i) Caspian Pipeline. Russia has already taken a 
        significant step toward the enhancement of its oil export 
        capability. A 24 percent majority shareholder in the Caspian 
        Pipeline Consortium (CPC), in which U.S.-owned Chevron Caspian 
        Pipeline holds the largest private sector stake of 15 percent 
        and Mobil Caspian Pipeline owns 7.5 percent, Russia can use the 
        pipeline to quickly increase its oil exports. Operational since 
        late 2002, the initial stage of the Caspian Pipeline delivery 
        system involves shipment from the Tengiz oil field in 
        Kazakhstan on the north-east shore of the Caspian through 
        almost 1000 miles of Russian territory to the Black Sea port of 
        Novorossisk. If the Russian state oil transport system 
        Transneft builds a 40-mile trunk line connecting its network to 
        the Caspian Pipeline at the Russian city of Kropotkin, where 
        CPC has already constructed the necessary pumping facilities, 
        Russia's export capacity on the Caspian Pipeline could be 
        increased by 150,000 barrels of oil per day in 6 months and by 
        300,000 barrels of oil per day within 2 years. As yet Transneft 
        has given no indication it plans to build this trunk line.

          (b)(ii) Murmansk Pipeline Project. Due to Transneft's failure 
        over the past several years to add capacity to Russia's oil 
        transport infrastructure, substantial private investment is 
        needed. Several Russian oil majors recently proposed the 
        construction of a pipeline from Western Siberia to the northern 
        city of Murmansk, a deep-water, ice-free port. Private Russian 
        capital would cover the cost of this several billion dollar 
        investment, which would include renovation of the port. 
        Proponents of the project see it as the gateway to the U.S. 
        market, estimating that the cost of transport to the American 
        east coast would be comparable with that from the Middle East. 
        Initially the Russian government balked at the concept of 
        private ownership of the pipeline but more recently indications 
        of a compromise solution have emerged. Some Western analysts 
        estimate that Murmank export capacity could reach one million 
        barrels of oil per day. Given the commitment and resources of 
        the Russian majors and the lack of a governmental plan for 
        substantially increasing infrastructure, the Murmansk Pipeline 
        project may well be the long term solution to export 
        constraint.

2. Production and Reserves.
    Russia's primary source of oil production is Western Siberia, with 
a volume of 7.4 million barrels of oil per day, of which about \1/3\ is 
exported by pipeline, and another \1/3\ exported as fuel oil by rail, a 
very costly method of transportation. Western estimates see this level 
of output from Western Siberia continuing for the next several years 
and then declining. For this reason a number of Western experts urge 
that Russia start developing major new reserves on both the Eastern and 
Arctic Continental Shelf and Eastern Siberia. Several such projects 
with foreign investment are already underway off the coast of Russia's 
Sakhalin Island. The Sakhalin projects are beneficiaries of so-called 
Production Sharing Agreements (PSAs). PSAs are intended to provide 
investors in long-term projects, remote from infrastructure, with a 
certain degree of predictability concerning taxes and fees over the 20-
30 year period required to make the project fully operational. PSA 
legislation to cover some projects but exclude others is now pending in 
the Duma and probably will pass into law this spring.
     Some Russian private sector sources are more optimistic about 
Russia's reserves and see little need for PSAs. Yukos, now the world's 
fourth largest oil company recently asserted that reserves are 
sufficient to assure the extraction of oil in Russia over the next 30 
years at levels of 9-10 million barrels per day, with an export 
capacity of 6-7 million barrels per day. A strong proponent of the 
Murmansk project to resolve the export constraint problem discussed 
above, Yukos claims that Russia can supply 15 percent of U.S. oil 
imports with an estimated range of 1-2 million barrels of oil per day.
    A word on the Russian Caspian: estimates put Russian Caspian 
recoverable oil at about 3 billion barrels, or less than one 10th of 
the resource base of Kazakhstan. The geology of the Russian Caspian is 
very different from the Kazakhstan Caspian. The Russian Caspian 
eventually may provide 400,000-500,000 barrels per day, a not 
insignificant volume.

3. The Investment Climate.
    There can be little doubt that the investment climate in Russia has 
significantly improved during the Putin years. Political stability, 
fiscal discipline, 3 successive years of constant GDP growth, including 
a stunning 6.4 percent GDP growth for the first quarter of 2003 testify 
to Russia's emergence as a strong investment candidate. American 
companies operating in the Russian marketplace are experiencing strong 
annual growth in revenues, market share and profit margins, with the 
Russian operations of some U.S. global companies outperforming all 
other units worldwide. In the energy sector the enormous potential for 
fruitful cooperation between the two counties is reflected by the 
creation of the government-to-government U.S.-Russia Energy Dialogue, 
which had its first summit in Houston October 2002 and has scheduled 
the second summit for St. Petersburg in September. Of equal 
significance is the private sector Russian American Commercial Energy 
Dialogue. Comprised of 5 working groups of American and Russian energy 
company executives, the Commercial Energy Dialogue will identify 
barriers to trade and investment and make concrete recommendations to 
both governments to facilitate commerce in the energy sector.

    Senator Hagel.  Mr. Chow.

    STATEMENT OF MR. EDWARD CHOW, VISITING FELLOW, CARNEGIE 
               ENDOWMENT FOR INTERNATIONAL PEACE

    Mr. Chow.  Thank you, Mr. Chairman. It is my honor to 
appear before your subcommittee to discuss the role for Russian 
and Caspian oil in U.S. energy security. I joined the Carnegie 
Endowment for International Peace in Washington only this year 
to focus on international energy policy. However, my views on 
the subject are informed by 25 years of experience in the 
international oil and gas industry, primarily with a major 
American oil company.
    In recent years, I have also advised foreign governments 
and Western companies on strategy, investment policy, and 
negotiations in the oil and gas sector, particularly in the 
former Soviet Union. I hope to bring my industry perspective 
from work not only in this part of the world but also Latin 
America, West Africa, Middle East, East Asia, and Western 
Europe to your committee's discussion on this important subject 
for U.S. energy security.
    No one can argue with the proposition that it is important 
to policymakers to have a realistic view of the policy 
environment. Otherwise political expectations are likely to be 
inflated and policy misguided on the subject of oil and gas in 
the former Soviet Union. It is, therefore, particularly 
distressing to see the volume of misinformation and hyperbole, 
not only from governments and industry in the region, which may 
have a vested interest in exaggerating the significance, but 
occasionally from our own Government.
    A number of years ago, most of us in industry were shocked 
to find a State Department report to Congress discussing the 
possibility of close to 200 billion barrels of crude oil 
reserves in the Caspian at a time when industry estimates were, 
at best, 10 percent of that level. I was glad to hear Len 
Coburn today give a more measured estimate of 17 billion to 33 
billion barrels.
    Senator Hagel.  He is sitting right behind you. So he will 
be very pleased to hear that.
    Mr. Chow.  But 30 billion barrels of crude oil reserves is 
still barely only 3 percent of total world proven reserves. The 
fact remains that there has been only one significant discovery 
in the Caspian since the fall of the Soviet Union. In the 
global context, the Caspian represents another North Sea or 
Alaska. It is significant, but even full development will not 
represent a fundamental shift in oil market dynamics or the 
world supply picture.
    It is one thing for the president of Azerbaijan to boast 
about his country's signing the contract of the century, quite 
another for U.S. officials to repeat this preposterous claim. 
Worse still, if U.S. policy is based on mistaken expectations 
and lack of understanding of petroleum industry realities.
    In testimony today, as well as that before this committee 
earlier this month, the State Department referred to Caspian 
Basin production of 1.6 million barrels per day in 2001 and the 
possibility of 5 million barrels per day in 2010. Most of us in 
industry would have a hard time finding production in 2000 to 
be much more than half of that level in what can be called the 
Caspian Basin and believe that will be doing well if production 
can be raised to 2 million barrels per day by 2010.
    Industry expectations are moderated not only by geologic 
risk, but significant technical, economic, and political risk 
in oil development in the region. Major finds are challenged by 
either being offshore or in deep high-pressure reservoirs or 
with sulfur-laden associated gas that needs to be processed and 
the sulfur removed or far away from market in a landlocked 
location, oftentimes all of the above. Investments required are 
measured in billions or tens of billion dollars.
    Peaceful political succession is unproven in the region. 
Political legitimacy of the governments in the region, as seen 
by their own population, has declined since independence from 
the Soviet Union. At the same time, the investment climate, 
which was largely welcoming a decade ago, has deteriorated with 
tougher contract terms, concerns over sanctity of contract, and 
greater appetite on the part of ruling elites for rent-seeking 
opportunities. Increased oil income has coincided with more 
autocratic rule, enhanced the ruler's ability to temporarily 
pay off parts of the elite by sharing some of this wealth, and 
allowed deferral of desperately needed fundamental economic and 
political reforms.
    These unfortunate, but often repeated, developments 
associated with sudden oil income have in the past led to 
political instability, for example, in Latin American and West 
Africa. No wonder oil folks around the world believe all the 
easy oil has been found and produced a long time ago. More 
importantly, if uncorrected, this troubling trend in the 
Caspian region can give rise to longer term threats to U.S. 
security interests beyond energy.
    Turning now to Russia, most of the commentary on the 
remarkable increase in Russia oil exports in the last 2 to 3 
years has missed the fact that this has not been due to new 
discoveries or even development of new oil provinces or new 
fields. Russian oil production is around 8 million barrels per 
day today. It was over 10 million barrels per day at peak 
Soviet oil production reached in the late 1980s.
    So the rise in exports, which has been dramatic, is driven 
by the revival of Russian production in the last 3 years, but 
more importantly by the total collapse of Russian oil demand 
following a similar collapse in its economy since the fall of 
the Soviet Union. Russian oil consumption dropped from 5 
million barrels per day in 1991 to 2.5 million barrels per day 
today, accounting for almost all of the export surge.
    This oil consumption level can be compared to the United 
States, where we consume 20 million barrels per day. This in a 
country with approximately half our population and greater 
transportation distances with twice the number of time zones 
that we have. The short-term causes of the recovery of Russian 
oil production are ruble devaluation after the 1998 financial 
collapse improving the cost structure of Russian petroleum, the 
return of domestic investment in the sector after owners of 
privatized oil companies believed their property rights would 
be largely honored by the Russian state, and the introduction 
of Western technology by using international service 
contractors in modern oilfield practices and reservoir 
management.
    Can Russian oil production increases be sustained without 
more fundamental structural changes in the sector, including 
those reforms required to attract investment not only from 
domestic sources but internationally? With the sole exception 
of Sakhalin, neither the Russian Government nor Russian 
industry has been particularly welcoming to direct foreign 
investment in the oil and gas sector, in spite of the public 
rhetoric. Government fears loss of control, and industry 
naturally wants to avoid competition.
    Having achieved production and export growth by encouraging 
domestic investment, the Russian Government seems to be 
hesitant to pursue further restructuring in the oil and gas 
structure. Reform of Gazprom, the natural gas monopoly, and 
Transneft, the state pipeline monopoly is hardly even mentioned 
anymore. Both are significant obstacles to investment, even by 
Russian oil companies. Production-sharing agreements, or PSA 
legislation, called for international oil companies wishing to 
invest in Russia has been rejected for almost all projects 
other than for frontier exploration. It remains to be seen 
whether this trend of stalled reform will be maintained after 
the coming round of Duma and presidential elections.
    Before further reform can take place, there needs to be a 
healthy political debate in Russia on the role the oil and gas 
sector should play in its overall economy and the impact on its 
politics, domestic and foreign policy. Given its population of 
130 million people, industrial base, and agricultural 
potential, it is questionable whether its economy should be 
based on maximizing oil and gas exports, potentially crowding 
out all other economic activity.
    The oil industry is capital-intensive, not labor-intensive. 
It demands centralization of decisionmaking both politically 
and economically in a few hands. Of course, this suits the 
interests of current political and business leaders. It is less 
clear whether this benefits the Russian people overall. What is 
clear is that with 5 percent of the world's known oil reserve 
and a reserve production ratio of around 20 years, Russia will 
always be a price taker in an oil market dominated by OPEC, not 
a price setter.
    Our own view of the role Russia can play in U.S. energy 
security should also be informed by this reality. Russian and 
Caspian oil development may be prospective and lucrative to 
individual countries or oil companies, but nothing that is 
happening there will challenge the fact that two-thirds of 
known oil reserves are in the Persian Gulf.
    Certainly, diversity of supply is important to the world 
oil market and benefits the United States as the largest oil 
importer in the world. So new supplies from Russia and the 
Caspian are significant, just as new supplies from deep water 
Gulf of Mexico, deep water West Africa, synthetic crude oils 
from Canada and Venezuela, under-explored acreage in Alaska, 
bringing Alaskan and Canadian Arctic gas to the lower 48s, new 
LNG projects, gas-to-liquids conversion technology, all these 
sources are important, not to mention conservation and energy 
efficiency improvements.
    These sources, diversity of supply sources, are important 
because they stretch the time when the last incremental barrel 
of oil demand must be satisfied by the Persian Gulf. However, 
we should be under no illusion that a major supply disruption 
of prolonged duration in the Middle East can be replaced by 
such sources. Given their position as the world's swing 
producers with the most abundant and cheapest oil to produce, 
sitting between major oil markets in Europe and the United 
States and rapidly rising demand in Asia, Persian Gulf 
countries have a unique and irreplaceable position in the oil 
supply chain.
    Until a technological leap allows us to move beyond oil's 
dominance in world energy consumption, a major supply 
disruption of prolonged duration in the Middle East will have a 
direct impact on U.S. energy supply and pricing, whether or not 
we are importing a drop of Persian Gulf oil ourselves. Oil is a 
largely fungible commodity in a fast-moving global market, as 
Julia has pointed out. Supply will shift according to market 
signals. We and other members of the International Energy 
Agency are also under treaty obligations not only to host 
strategic stockpiles, but also share those stockpiles in times 
of supply crises.
    Any policy on international energy security based on 
bilateral oil relationships with other countries is therefore 
unlikely to be effective. U.S. policy must be based on a 
realistic assessment of the global energy situation and the 
potential role these countries can play, not based on 
unrealistic expectations or as a substitute for well-balanced 
foreign policy in the region.
    By focusing too much on energy relationships, we give these 
countries the impression that this is all we care about. By 
explicitly discussing specific projects, like individual 
pipelines or laws that we favor, like PSA legislations, we give 
the impression that we care less about improvement and 
fundamental conditions, like the rule of law, transparency, and 
more political openness. These are the conditions that will 
lead to a better investment climate for domestic, as well as 
foreign, investors, not just in the export-oriented natural 
resource sector, but in the larger economy where the population 
lives.
    They hear our rhetoric, but do not believe us when our 
Government keeps pushing projects. Leave that to industry and 
companies. Government officials should focus on what they know 
and can impact, which is how to foster a business climate 
conducive to investment and to avoid market distortions. Better 
that U.S. officials discuss lessons we learned in sector reform 
from our own deregulation of the oil and natural gas industries 
than lecture to the Russian Duma on what laws they should pass.
    I am very sympathetic to the extremely difficult job U.S. 
officials have to perform in this part of the world, having 
traveled there on a regular basis since 1992. However, we 
cannot reinforce the rulers and the general population's belief 
that the U.S. cares only about oil and the war against 
terrorism without having to face long-term the unintended 
consequences of such a policy.
    Russia, Central Asia, and the Caucasus are important to 
U.S. foreign policy interests, whether these countries have any 
oil or not. We should not allow exaggerated expectations in one 
area, for them and for us, to detract from sound overall 
policy.
    Thank you.
    Senator Hagel.  Mr. Chow, thank you very much.
    [The prepared statement of Mr. Chow follows:]

                  Prepared Statement of Edward C. Chow

    Thank you, Mr. Chairman. It is my honor to appear before you and 
Members of the Subcommittee to discuss the role for Russian and Caspian 
oil in U.S. energy security. I joined Carnegie Endowment for 
International Peace in Washington this year to focus on international 
energy policy. My views on this subject are informed by 25 years of 
experience in the international oil and gas industry, primarily with a 
major American oil company (Chevron). In recent years, I have also 
advised foreign governments and Western companies on strategy, 
investment policy and negotiations in the oil and gas sector, 
particularly in the former Soviet Union. I hope to bring some industry 
perspective from my work not only in this part of the world, but also 
Latin America, West Africa, Middle East, East Asia and Western Europe, 
to your Committee's discussion on the important subject of U.S. energy 
security.
    No one can argue with the proposition that it is important for 
policymakers to have a realistic view of the policy environment. 
Otherwise political expectations are likely to be inflated and policy 
misguided. On the subject of oil & gas in the former Soviet Union, 
therefore, it is distressing to see the volume of misinformation and 
hyperbole not only from governments and industry in the region, which 
may have a vested interest in exaggerating the significance, but 
occasionally from our own government.
    A number of years ago, most of us in industry were shocked to find 
a State Department report to Congress discussing the possibility of 
close to 200 billion barrels of crude oil reserves in the Caspian, at a 
time when industry estimates were at best 10 percent of that level. 
Today that industry estimate may be more generous, perhaps 30 billion 
barrels of oil reserves, but still barely 3 percent of total world 
proven reserves. The fact remains there has been only one significant 
discovery (Kashagan) in the Caspian since the fall of the Soviet Union. 
In a global context, the Caspian represents another North Sea or 
Alaska; it is significant, but even full development will not represent 
a fundamental shift in oil market dynamics or the world supply picture.
    It is one thing for the President of Azerbaijan to talk about his 
country signing ``the contract of the century,'' quite another for U.S. 
officials to repeat this claim. (After all, this is the same century, 
the 20th, that had King Abdul Asis of Saudi Arabia signing the original 
Aramco concession, which holds 25 percent of known world oil reserves.) 
It is worse still if U.S. policy is based on mistaken expectations and 
lack of understanding of petroleum industry realities. Even in his 
testimony before this Committee earlier this month, Under Secretary of 
State Al Larson, referred to Caspian Basin production of 1.6 million 
barrels per day in 2001 and the possibility of 5 million barrels per 
day in 2010. Most in industry would have a hard time finding Caspian 
production in 2001 to be much more than half of that level and believe 
that we will be doing well if production can be raised to 2 million 
barrels per day by 2010.
    Industry expectations are moderated not only by geologic risks, but 
significant technical, economic and political risks in oil development 
in the region. Major finds are challenged by either being offshore; or 
in deep, high-pressure reservoirs; or with sulfur-laden associated gas 
that needs to be processed and the sulfur removed; or far away from 
market in a land-locked location--often times all of the above. 
Investments required are measured in billions or tens of billion 
dollars.
    Peaceful political succession is unproven in the region. Political 
legitimacy of the governments in the region, as seen by their own 
population, has declined since independence from the Soviet Union. At 
the same time, the investment climate, which was largely welcoming a 
decade ago, has deteriorated with tougher contract terms, concerns over 
sanctity of contract, and greater appetite on the part of ruling elites 
for rent-seeking opportunities. Increased oil income has coincided with 
more autocratic rule, enhanced the ruler's ability to temporarily ``pay 
off'' parts of the elite by sharing some of this wealth, and allowed 
deferral of desperately needed fundamental economic and political 
reforms.
    These unfortunate, but often repeated, developments associated with 
sudden oil income have in the past led to political instability, for 
example, in Latin America and West Africa. No wonder oil people around 
the world believe all the easy oil has been found and produced long 
time ago. More importantly, if uncorrected, this troubling trend in the 
Caspian region can give rise to longer-term threats to U.S. security 
interests, beyond energy.
    Most of the commentary on the remarkable increase in Russian oil 
exports in the last two to three years has missed the fact that this 
has not been due to new discoveries or even development of new oil 
provinces or new fields. Russian oil production is around 8 million 
barrels per day today. It was over 10 million barrels per day (just in 
Russia) in the peak of Soviet oil production reached in the late 1980s. 
So the rise in exports, which has been dramatic, is driven by the 
revival of Russian production in the last three years and by the total 
collapse of Russian oil demand following a similar collapse in its 
economy since the fall of the Soviet Union. Russian oil consumption 
dropped from 5 million barrels per day in 1991 to 2\1/2\ million 
barrels per day today, accounting for almost all the export surge. This 
oil consumption level can be compared to the United States where we 
consume 20 million barrels of oil per day. This is in a country with 
approximately half our population and greater transportation distances 
with twice the number of time zones as we have.
    The short-term causes of the recovery of Russian oil production 
are:

   Ruble devaluation after the 1998 financial collapse 
        improving the cost structure of Russian petroleum industry;

   Return of domestic investment in the sector after owners of 
        privatized oil companies believe their property rights will be 
        largely honored by the Russian state; and

   Introduction of Western technology by using international 
        service contractors in modern oilfield practices and reservoir 
        management.

    Can Russian oil production increases be sustained without more 
fundamental structural changes in the sector, including those reforms 
required to attract investment not only from domestic sources but 
internationally? With the sole exception in Sakhalin Island, neither 
the Russian government nor Russian industry has been particularly 
welcoming to direct foreign investment in the oil & gas sector in spite 
of the public rhetoric. Government fears loss of control and industry 
naturally wants to avoid competition. This is clearly demonstrated by 
recent events such as the rigged auction of Slavneft in December. From 
this perspective, the recently announced BP-TNK merger should be seen 
as BP deciding that, if you can't join the Russian oil party directly, 
then you must partner with a strong domestic player. It should not be 
seen as a sign that the Russian oil patch is now completely open to 
direct foreign investment.
    Having achieved production and export growth by encouraging 
domestic investment, the Russian government seems to be hesitant to 
pursue further restructuring in the oil & gas sector. Reform of 
Gazprom, the natural gas monopoly, and Transneft, the state pipeline 
monopoly, is hardly even mentioned anymore. Both are significant 
obstacles to investment, even by Russian oil companies. Production 
Sharing Agreement (PSA) legislation, called for by international oil 
companies wishing to invest in Russia, has been rejected for almost all 
projects other than frontier exploration. It remains to be seen whether 
this trend of stalled reform will be maintained after the coming round 
of Duma and presidential elections.
    Before further reform can take place, there needs to be a healthy 
political debate in Russia on the role the oil & gas sector should play 
in its overall economy and the impact on its politics, domestic and 
foreign policy. Given its population of 130 million people, industrial 
base, and agricultural potential, it is questionable whether its 
economy should be based on maximizing oil and gas exports, potentially 
crowding out all other economic activity. The oil industry is capital 
not labor intensive. It demands centralization of decision making both 
politically and economically in a few hands. Of course, this suits the 
interests of current political and business leaders. It is less clear 
whether this benefits the Russian people overall.
    With 5 percent of the world's known oil reserves and a reserve/
production ratio of around 20 years, Russia will always be a price 
taker in an oil market dominated by OPEC, not a price setter. Our own 
view of the role Russia can play in U.S. energy security should also be 
informed by this reality. Nothing that is happening or might happen in 
Russian or Caspian oil development, as prospective and lucrative as 
they may be to individual countries or oil companies, will change the 
fact that two-thirds of known oil reserves are in the Persian Gulf.
    Certainly, diversity of supply is important to the world oil market 
and benefits the United States as the largest oil importer in the 
world. So new supplies from Russia and the Caspian are significant. 
Just as new supplies from deep water Gulf of Mexico, deep water West 
Africa, synthetic crude oils from Canadian tar sands and the Venezuelan 
Orinoco belt, under-explored acreage in Alaska, bringing Alaskan and 
Canadian Arctic gas to the lower 48s, new liquefied natural gas (LNG) 
projects, gas-to-liquids conversion technology--not to mention 
conservation and energy efficiency improvement--are all important, 
because they stretch the time when the last incremental barrel of oil 
demand must be satisfied by the Persian Gulf.
    However, we should be under no illusion that a major supply 
disruption of prolonged duration in the Middle East can be replaced by 
such sources. Given their position as the world's swing producers with 
the most abundant and cheapest oil to produce, sitting between major 
oil markets in Europe and the United States and rapidly rising demand 
in Asia, Persian Gulf countries have a unique and irreplaceable 
position in the oil supply chain.
    Until a technological leap allows us to move beyond oil's dominance 
in world energy consumption, a major supply disruption of prolonged 
duration in the Middle East will have a direct impact on U.S. energy 
supply and pricing, whether or not we are importing a drop of Persian 
Gulf oil ourselves. Oil is a largely fungible commodity in a fast-
moving global market and supply will shift according to market signals, 
i.e., pricing. We and other members of the International Energy Agency 
(IEA) are also under obligation to not only hold strategic stockpiles 
(SPR in our case), but also share these strategic stockpiles in times 
of supply crisis. Any policy on international energy security based on 
bilateral oil relationships with other countries is, therefore, 
unlikely to be effective.
    U.S. policy must be based on a realistic assessment of the global 
energy situation and the potential role these countries can play, not 
based on unrealistic expectations or as a substitute for a well-
balanced foreign policy in the region. By focusing too much on energy 
relationships, we give these countries the impression that this is all 
we care about. By explicitly discussing specific projects (like 
individual pipelines) or laws that we favor (like PSA legislation) in 
bilateral meetings, we give the impression that we care less about 
improvement in fundamental conditions--like the rule of law, 
transparency, more political openness--that will lead to a better 
investment climate for domestic as well as foreign investors, not just 
in the export oriented natural resource sector, but in the larger real 
economy where the population lives.
    They hear our rhetoric but do not believe us when our government 
keeps pushing projects. Leave that to industry and companies. 
Government officials should focus on what they know and can impact--how 
to foster a business climate conducive to investment and to avoid 
market distortions. Better that U.S. officials discuss lessons we 
learned in sectoral reform from our own deregulation of the oil and 
natural gas industries, including removal of price controls and import 
restrictions, in the 1980s that can be usefully applied than to lecture 
the Russian Duma on what laws they should pass.
    I am very sympathetic to the extremely difficult jobs U.S. 
officials have to perform in this part of the world, having traveled 
there on a regular basis since 1992. However, we cannot reinforce the 
rulers and the general population's belief that the U.S. cares only 
about oil and the war against terrorism, without having to face long 
term the unintended consequences of such a policy. Russia, Central Asia 
and the Caucasus are important to U.S. foreign policy interests whether 
these countries have any oil or not. We should not allow exaggerated 
expectations in one area, for them and for us, to detract from sound 
overall policy.
    Thank you.

    Senator Hagel.  Well, Mr. Chow, we get the definite 
impression that you are not particularly enthusiastic about the 
Caspian Sea oil resources developing in the magnitude of what 
others have suggested over the last few years. Let me ask you, 
Mr. Chow, to begin with, your closing comments here, what role 
should the United States Government take, if any, in developing 
an energy policy, as you have set out limitations here which 
you think they should not do, and you have defined those 
clearly. But what should the United States Government do in 
developing an energy policy for the future security of this 
country?
    Mr. Chow.  Thank you, Mr. Chairman. First of all, I want to 
say that I spent a decade working on Caspian oil. So 2 to 3 
million barrels a day is nothing to sneeze at. That is a lot of 
supply. And companies do not want to be out of this play, just 
like they do not want to be out of any giant play in any part 
of the world.
    I would say, to answer your question more directly, that if 
the U.S.-stated policy, as Julia has referenced, is diversity 
of supply routes, that should apply in the Caspian, for 
example, to outlets, as well as to our receiving a diversified 
supply from around the world. And therefore, a policy that 
singles out a particular pipeline route forces host governments 
to subsidize the pipeline route. And I am thinking in this case 
particularly for Georgia and Turkey.
    With, if you will, a single solution to the Azerbaijan oil 
export problem, as opposed to diversified supply routes 
necessarily including Russia and Iran, I find it difficult to 
understand a Caspian policy that ignores the geographic fact 
that Iran is a littoral state in the Caspian, as well as having 
a pivotal position in the Persian Gulf, if we are interested in 
energy security. A diversified outlet from the region should be 
the answer to the world's supply question.
    I am not suggesting, therefore, that the U.S. should 
promote projects. But the U.S. should not be against projects 
just because they happen to go through countries that we are 
not particularly fond of today. We are talking about projects 
that have a 20-, 40-year project life. I would like to think 
that our relationship with countries in the region would change 
over that period of time and hopefully improve.
    Senator Hagel.  So essentially a Government, specifically 
the United States Government, policy should encourage 
diversification but not go beyond that. Is that your point?
    Mr. Chow.  That is right.
    Senator Hagel.  Why don't you begin with that? Ms. Nanay, 
would you care to respond to that question: What is the 
appropriate responsible role of the United States Government in 
developing energy policy?
    Ms. Nanay.  Well, I think if we are looking at this region, 
I think the appropriate role is to, first of all, yes, it is 
diversify routes and to try and work with governments on 
perhaps helping to install democratic values. I do not know how 
you go about doing that, but I think that investments in this 
region, and ultimately U.S. energy security and exports, will 
be better fostered by stable countries with governments that 
have some sort of democratic aura to them where you have, you 
know, some semblance of free and open elections.
    As it is now, you go around this region. And what you have 
is basically rulers who have declared themselves largely rulers 
for life. And if they are gone, then their families continue. 
And they are trying to base themselves on. What you have in the 
Persian Gulf with monarchies. And, it is--and it is also based 
on the fact that the countries that have probably the largest 
to gain from the oil resources, Azerbaijan and Kazakhstan, the 
families that are currently in power do not really want to let 
go of the revenue stream from that in the future.
    So I suppose it is a difficult one. I do believe that the 
question of Iran is very important. I do not understand how 
long this policy of isolating this country that is 
geostrategically so important in this region and strategically 
so important for the U.S. for the future, how long this policy 
can sustain itself.
    Senator Hagel.  Well, you have laid out a very excellent 
set of objectives, but they do not just happen, as you know. 
And you have acknowledged that you do not know how to do that. 
And that is not a reflection on you. But it points out how 
difficult these things are. And we are engaged in a very 
similar situation in Iraq today with noble goals and efforts to 
try to accomplish exactly what you just laid out.
    But the question that I would still like to have you take a 
crack at as well, Mr. Somers, is: What is the role of the 
United States Government here, as you protect the interests of 
your country? It is a national security interest, energy.
    Mr. Somers.  Thank you, Senator. I am going to stick to 
what I know, and that is Russia. I was interested to hear the 
remark of the previous speaker about perhaps focusing on 
supporting democracy, and I would on market economy. Of all the 
countries that were mentioned, and I think they were described 
very eloquently by previous speakers in terms of their regimes, 
Russia stands out as something different. Russia is moving 
toward the kind of society and the kind of economy that our own 
values espouse. It is a very difficult road for them.
    And I think that the U.S. energy policy, its effort to 
develop a policy and a strategy, of diversification should 
certainly consider strongly asking Russia if analysis makes the 
viability of Russian oil stand up in terms of its ability to 
export and its reserves, that certainly Russia should be 
strongly considered to be a partner with other exporters in 
contributing significantly to the import share of U.S. energy, 
because we will be supporting a country which is making an 
effort, and has made an effort now for some 10 years, to move 
in the direction that our own values support.
    So I would confine myself to Russia. That is what I know. 
And I think that the U.S. efforts right now and this 
committee's questions are something that I strongly support.
    Senator Hagel.  Thank you. Staying with Russia for a 
moment, in your testimony that you gave, you mentioned, and I 
am reading from your testimony, ``Yukos claims''--you are 
talking about the Murmansk project and to resolve the export 
constraint problem discussed above, ``Yukos claims that Russia 
can supply 15 percent of U.S. oil imports with an estimated 
range of 1 to 2 million barrels per day.''
    How would that happen?
    Mr. Somers.  Well, it is a statement by Yukos that if, 
essentially if, they solved their export constraint problem, 
and if they continue at what Westerners consider to be merely 
remedial efforts to upgrade their West Siberian fields, Russia, 
without significant further exploration, could fairly easily 
produce this type of oil output starting about--when I say the 
next 30 years, I think exactly they said starting in the year 
2005, 2006, they are in a position to produce this amount of 
oil.
    Now how mechanically and technically they do it, I do not 
know the details of that except to say they are export 
constrained now. They think the Murmansk project is going to 
relieve this, including also the project to China. Although I 
will say that the Russian oil companies have stressed that the 
pipeline from West Siberia to Murmansk is much shorter than the 
pipeline to China. It will have much quicker payoff. It will be 
much cheaper to build.
    So I cannot answer your question directly in terms of how, 
except to say that it is the opinion of the Russian oil sector 
that they are in pretty good shape right now to be able to 
produce this type of oil over the next 30 years, based on what 
they believe are their reserves now.
    Senator Hagel.  How would it be transported?
    Mr. Somers.  Well, if Transneft improves its internal 
infrastructure through a pipeline from, for example, West 
Siberia to Murmansk and some of the other routes that Minister 
Yusufov mentioned yesterday when he said that Russia has to now 
diversify its export pipelines. It would be primarily pipelines 
to ports like Murmansk.
    I should add that about of the 7.4 million barrels a day 
that West Siberia is producing today, and even Western people 
who criticize Russia for not exploring more say this will 
continue for the next 3 or 4 years, about one-third of that 
exported by Transneft. That is to say, the Transneft 
infrastructure gets it to the ports. That is about 2.4 million 
barrels a day.
    Another third is actually exported by rail in the form of 
motor oil. This is a very expensive form of transportation of 
oil. If you take the figure Yukos gave that it would cost $8 a 
day transportation costs per barrel from Murmansk to the East 
Coast of the U.S., the estimates of rail transportation out of 
Russia is about $15 a barrel.
    So Russia is inefficiently transporting its oil right now. 
And any efficient export system will have to replace that one-
third of rail transportation with the upgrade of its 
infrastructure of pipelines.
    Senator Hagel.  So the anticipation of a pipeline then is 
what we are talking about for that being cost effective.
    Mr. Somers.  That is right. That would make it much more 
cost effective. That is right.
    Now remember--excuse me. I am reminding myself that the 
Russia private sector that is advocating Murmansk and is 
stating that they could hit 9 million or 10 million barrels a 
day with basically on current and expected easily recoverable 
reserves is also a company that is not too enthusiastic about 
production-sharing agreements and is more or less on the side 
of the viewpoint that large Western investment in these 
offshore projects is not needed.
    So the statement that Yukos makes about 9 million or 10 
million barrels a day may or may not be verifiable. You just do 
not know.
    Senator Hagel.  Let me ask each of the three of you, when 
you look at the breakdown of where we are now, the United 
States, importing our crude oil from, and you have all touched 
upon the diversification factor here to some extent, number 
one, is it the--or what is each of your opinions regarding 
Middle East sources of oil? Do we need to cut back, prepare to 
cut back, diversify because it is Middle East oil, or is that 
not as big a threat? And I say that realizing that we have just 
replaced Saddam Hussein in Iraq. And you, Ms. Nanay, referenced 
the Iraqi equation in your testimony.
    Today the President of the United States, as well as the 
Prime Minister of Great Britain, laid down the Middle East 
peace plan, the road map, re-engaging, refocusing new energy, 
new leadership. So the point here is, well, maybe things are 
looking better in the Middle East than they have in a long 
time, if you take just those two factors. No guarantees. We do 
not know how Iraq is going to turn out. Iran, as you have 
mentioned, is still a wild card.
    But with that development as well, is it imperative, in 
your opinion, that the United States move away from the Middle 
Eastern crude oil sources? If it is not, why? Or you give me 
your thoughts on this, especially as we look at the breakdown 
of where we bring our oil in from today.
    Mr. Chow, I will start with you.
    Mr. Chow.  Mr. Chairman, I think it is important to point 
out that oil today is traded, bought, and sold on a spot basis 
around the world. The U.S. Government makes no decisions on oil 
purchases that I am aware of except for the strategic petroleum 
reserve. And as a free market person, I kind of like it that 
way. I am old enough to remember when government had a 
tremendous amount of control with domestic oil price controls, 
oil import restrictions into the United States, as well as 
gasoline lines that came with them. So I kind of like having a 
world that allocates supply to satisfy demand on the basis of 
market signals.
    The greatest, one of the greatest--it has been pointed out 
that Russia has a lack of deep water oil terminals. I would 
like to point out that we have a similar lack of deep water oil 
terminals in our own country. So one of the--and the only 
exception that I can think of is the Louisiana offshore oil 
port or loop. So one of the things that we can do ourselves is 
to modernize our oil-receiving facilities so that they can take 
economic cargoes from around the world, if we are serious about 
increasing our energy supply diversification.
    Of course, that is going to involve all kinds of local 
permitting, environmental concerns, and serious--and I do not 
mean to minimize them. But that is something that we could do 
and we should seriously think about doing.
    Middle Eastern oil and whether Russia can export 15 percent 
of our oil import requirements or not to me is not a relevant 
question. I mean, oil moves around the world. If Russia is able 
through Murmansk and other projects to move more oil into the 
world market, that is the important part. If that displaces 
West African crude exports to Western Europe, that crude will 
come to the United States and just sit. So the market will sort 
itself out.
    What our Government can do, in talking to the Russian 
Government, is to advocate structural reforms or at least 
removing the barriers, the structural barriers, to their 
increasing their own production and exports.
    I would like to point out to you that, you know, it is not 
that the Russians are unintelligent about these things. They 
have their own motivations as to why the system is left the way 
it is. Transneft is plain and simple a rent-extracting machine 
in the Russian oil sector. They are a system to allocate 
scarcity, because by having scarcity you can reward friends and 
punish enemies. It is part of the leverage that the Kremlin 
has. But it is also a mechanism from which the Russian oil 
sector is corrupted, as well as neighbor producing countries, 
such as Kazakhstan and Azerbaijan, as well as transit 
countries, like Georgia or the Ukraine, for example.
    So it is not that the Russians do not understand that 
having an inefficient state monopoly pipeline system, which is 
not transparent, not operated on a common carrier basis, has 
economic costs. They understand that all too well. So what we 
need to do is over a long period engage them in a discussion of 
what are the consequences of those type of policies to their 
economies, but not be so specific as to prescribe our own 
solutions in the greatest detail. Because that is something, it 
seems to me, that is up to the Russian political systems to 
sort out.
    Senator Hagel.  Ms. Nanay?
    Ms. Nanay.  Well, I think Ed has said it so well. And in my 
written testimony I outline quite a bit of this, also. I agree 
with him entirely that we are not a country that decides who is 
going to import what from where. Companies are free to do as 
they like. And moreover, I think oil is a fungible commodity, 
but it does come in different qualities. And different 
refineries in different parts of the world are geared to taking 
different oils from different places. And so, in fact, some of 
the decisions on where this oil flows from where is also based 
on this angle of the refineries.
    I think a free market is best served by a free market. 
Saudi Arabia is a very important supplier, as we have all 
mentioned. And it is, one of the terms we like to use at PFC 
Energy, it is the central bank for oil. How you manage to 
replace that, that would be extremely difficult.
    In any case, I agree, let the markets work. And I think the 
Russians are themselves as private companies, they are 
responding to price signals. This is most of what is happening 
in the Russian oil industry because these private Russian 
producers are responding to price signals, and they are 
becoming more efficient. And they want to sell more of their 
oil into world markets.
    Of course, I put one word of caution here. Let us see what 
happens if, over the next year, we get prices softening and 
even down to $20 a barrel. Perhaps that will change what oil 
comes to markets from what areas to some extent.
    Thank you.
    Senator Hagel.  Thank you both.
    Mr. Somers?
    Mr. Somers.  Thank you, Mr. Chairman. Well, to answer your 
question, I would say yes, we should move away from the degree 
of dependence we have now on Mideast oil. And I know you did 
not mean by that question that it should be eliminated. But I 
do think that given the history, at least of my lifetime, it 
has been rather unstable. It is interesting to me in that 
context that Venezuela suddenly disappeared from the map. And 
Nigeria is now number two, if I understand it correctly.
    So it seems to me that it would be of interest to the 
United States to find a way to, particularly given the new 
Russian-American strategic relationship, notwithstanding the 
blip on the radar screen with Iraq, that a way be found to 
diversify our energy supply through Russia.
    I would also like to comment just briefly on what the U.S. 
Government has been doing to support Russian reform. There has 
not been an overemphasis on energy supply or energy policy. 
There has been a lot of work on corporate governance, 
transparency, business ethics, an enormous amount of programs 
in Russia which are working the private sector, as well as with 
the Russian Government. And I actually detect very little of 
lecturing by the State Department or Department of Energy or 
Department of Commerce in my two-and-a-half years in Russia. In 
those meetings, they are very constructive. They are very, let 
us put it this way, on an equal basis. And there is a true 
dialogue of equals in terms of intellectual exchange of ideas 
in an effort to get a bottom line.
    So I think the U.S. Government under this administration 
has been doing an excellent job in supporting the private 
sector in many different ways. And certainly the private 
sector, the American private sector, has been working with its 
Russian counterparts on rule of law, redistribution of 
resources, ideas, and many other things that have nothing to do 
with energy, but which I think create an environment that 
supports a closer U.S.-Russian energy relationship.
    Senator Hagel.  Thank you.
    Would each of you address the--and you each have, to a 
certain extent, in your testimony and some of the questions--
the Caspian Sea region potential for both natural gas and oil, 
realizing that again you have each touched on it in different 
ways. And some of the legal entanglements, obviously our first 
panel addressed some of those. But I would be interested in 
getting your experienced perspective on what you believe is the 
future for the Caspian Sea region oil and natural gas 
production.
    Mr. Chow, I will start with you.
    Mr. Chow.  Having perhaps given the wrong impression that I 
do not care much about Caspian oil, I do want to state that 
Kashagan, the one discovery that I referred to, is a very 
significant discovery. I mean, except for that, I think a lot 
of us would say that exploration in the Caspian would have been 
a big disappointment. Because all of the development of the 
fields that we are talking about today are from past Soviet 
discoveries.
    Kashagan is a potentially very significant discovery. And 
if it turns out to be the size that people believe it may be, 
it will definitely be attractive to develop, but also attract 
additional exploration that might prove up additional reserves.
    The natural gas question is a slightly more complicated 
question. There is a lot of gas in the Caspian region. 
Unfortunately, it is also very far away from market. And gas is 
a business that is dominated, particularly remote gas, by 
transportation economics.
    And here we have a region that is, to get the gas out to 
market, has to pass through two other countries that both have 
even more gas than they have, namely Russia and Iran. So 
whether that gas will continue maybe to be stranded because of 
the lack of export route and the lack of equitable treatment on 
the part of transit countries that have their own legitimate 
economic interests at stake is a much longer term proposition 
for development, I feel, than oil is.
    Senator Hagel.  Thank you.
    Ms. Nanay?
    Ms. Nanay.  Well, Kazakhstan is already producing a million 
barrels a day. And that is without Tengiz at its full 
potential, without Kashagan, and without future prospects. I 
think it is very clear that not only Kashagan, but if you look 
at some of the geological maps of offshore Kazakhstan, it could 
potentially be a phenomenal oil-producing area, or maybe it is 
going to be a lot more gas than oil eventually.
    It is hard to tell, because in Azerbaijan, which I believe 
will have about a million barrels a day within this decade 
coming out of the AIOC consortium, but the future production 
out of other fields there, including Shah Deniz, may well be 
gas. So you are going to see, as Ed pointed out, a great deal 
of gas being produced in the Caspian. This will hit up against 
gas in Russia. What is interesting about Russia that we only 
touched upon, earlier today on this issue of gas, is that 
Yukos, YukosSibneft soon, the merged company, also has a major 
stake in gas and has been trying to buy up gas properties.
    There is an element to the Murmansk project, which again 
has not been mentioned, is that it would also be a port from 
where you would conceivably build an LNG facility and create 
eventually an LNG export potential to the U.S. that 
ConocoPhillips, a U.S. company, is already talking about.
    But, again, the Russian oil companies have a great deal of 
gas. There is gas that Gazprom owns in Russia. And then you 
have Caspian gas. And my view is that what you will see with 
the Caspian gas to some degree is that Russia will find a way 
to use that gas at much lower prices, as it is already doing 
with Turkmenistan to supply its own domestic needs, so that 
Russian company Gazprom and the Russian private producers 
eventually will find a way to get their gas to export markets.
    Senator Hagel.  Thank you.
    Mr. Somers?
    Mr. Somers.  Thank you. I would agree with that last 
comment on Caspian gas out of Russia. I think that is probably 
the way they may go, certainly the Russian private sector. The 
oil companies are very interested in gas.
    My understanding of the Russian Caspian oil reserves, at 
least in the estimate of American oil companies, is it is about 
three billion barrels. But that is about, I do not think, even 
one-tenth of the reserves of Kazakhstan oil. So the Russian 
oil, the Russian Caspian oil, will play a lesser role than 
certainly the Caspian Kazakh oil, perhaps producing 400,000 or 
500,000 barrels a day when it finally gets going. But the 
geology is very different in the Russian Caspian than the 
Kazakh Caspian with respect to oil. So the Russian Caspian will 
play a lesser role, but still could play a significant one.
    And the gas, I agree with the previous speaker, that 
probably this could serve the domestic, because of the 
difficulty of getting it out, serve the domestic gas market, 
which could facilitate exporting more gas abroad from Gazprom.
    Senator Hagel.  Thank you.
    What about potential markets in China and India for Caspian 
natural gas and oil, Mr. Chow?
    Mr. Chow.  Well, once again, geography raises its ugly 
head. I think that the question on China will better be 
answered after China builds its own west-east gas pipeline from 
St. John to Shanghai, which, by itself, is also not economic 
and kind of a loss leader that the Chinese, as well as Gazprom, 
Shell, and ExxonMobil, are investing in. That project to me 
only makes sense if, once it is built, it can feed additional 
gas either from Russia or Central Asia into that system and 
satisfying that the larger natural gas demands in China that 
are real and growing, both because of fundamental primary 
energy consumption growth, as well as the need to reduce coal 
construction because of the environmental impact of coal use in 
China.
    Within India, it is a geographic issue, but it is also a 
political question, because you do have to traverse difficult 
areas in terms of both topography in Afghanistan and Pakistan, 
but also political relationships in the region. India also is a 
prospective gas market, but it is much closer to Middle Eastern 
gas supplies. So a more logical supplier for the India gas 
market might be LNG from the Persian Gulf or even Iranian gas 
than compared to Turkmen or Kazakh gas.
    Senator Hagel.  Thank you.
    Ms. Nanay?
    Ms. Nanay.  Well, let me touch on one thing that you raised 
here that brings us back to another issue. It is the issue of 
China. And as the question you raised before about 
diversifying, U.S. diversifying, away from the Middle East, 
since we raised this specter of the necessity to do this, I 
think countries like China, India, Japan, they have begun 
thinking that they have to emulate the U.S. strategy in this as 
well.
    And so what you are leading up to, to some degree, is 
competition for non-OPEC suppliers and non-Middle East 
suppliers for oil and for gas, from countries in Asia, like 
China, Japan, and India, whose logical sources are really the 
Middle East. But we may be competing for the same, non-OPEC and 
non-Middle East sources of oil and gas, because we are all 
afraid of the Middle East problem.
    But on the gas issue, I think what is very interesting, 
obviously, is this question of how you would get gas to Asian 
markets, particularly India. And the question of a pipeline 
across Afghanistan keeps being proposed and studied. But quite 
honestly, it is such a longshot. If you look at what it took to 
build CPC and BTC as oil pipelines in what are reasonably 
secure areas that you are crossing through, I think this issue 
of building a gas pipeline across Afghanistan is still really 
far off into the future.
    And for the Chinese, I believe that the solutions that they 
will find could very well be related to Sakhalin. Sakhalin is a 
very important development in terms of Western companies' 
involvement, major LNG projects, which will be launched from 
there, a pipeline project that ExxonMobil is proposing to build 
to Japan. I think that area will be an important gas supplier.
    I really do not believe that the issue of Caspian gas to 
China is a realistic one to consider at this point.
    Senator Hagel.  Thank you.
    Mr. Somers?
    Mr. Somers.  Well, I would certainly agree that Sakhalin, 
which we have not mentioned much, could play a significant role 
with respect to gas or oil to China. As far as the Caspian 
goes, I think perhaps the statement by Minister of Energy 
Yusufov yesterday in Paris deserves study. Again, I do not have 
the statement, other than a summary. But he talked about 
diversifying, as I had mentioned earlier, the infrastructure to 
increase the ability to export gas and oil out of Russia. And 
the quote I had was that with foremost emphasis on North 
America and Northeast Asia, what countries in Northeast Asia 
perhaps the speech talks about.
    But he focused on the export from the north, the east, and 
the south, which could well apply to the Caspian. So perhaps 
there is some idea that the Caspian could serve a role that 
way. But the logistics will be difficult.
    Senator Hagel.  Mr. Somers, thank you.
    Well, I want to tell each of you how much I have 
appreciated your taking the time to put your thoughts together 
in very helpful and informative testimony and taking your time 
to come here. Especially you, Mr. Somers. I do not know if you 
have traveled the greatest distance to get here, but I do not 
think Ms. Nanay, unless she has been somewhere else here 
recently, has beat you on this. But Mr. Chow, I do not know 
where you--are you downtown? Yes? That is what I thought.
    So you get the prize, Mr. Somers, for the longest distance 
traveled.
    But you have all three been very helpful. And I know we 
check in with the three of you occasionally, my staff and the 
committee staff and other members of this committee, to get 
your expertise and counsel. And we are always grateful for 
that.
    If you have any additional submissions for the record, let 
the committee know, and we will assure that they are included, 
as will be your testimony.
    Thank you.
    [Whereupon, at 4:55 p.m., the hearing was adjourned.]

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