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Interview

with Nikolai Platonov, General Director, Caspian Pipeline Consortium

25.11.2011 / Energyboardroom

Mr. Platonov, would you start by introducing the current structure of the CPC to the readers of Oil & Gas Financial Journal including the division of financial and executive responsibilities between its main shareholders?

The organisational structure of the CPC is quite a complex one, and this is made particularly manifest in our wide range of shareholders. Firstly there are the two governments in question, namely the government of the Russian Federation and that of Kazakhstan. In addition major international oil and gas companies such as Chevron, Lukoil, Shell, Exxon Mobil, BG, ENI and several others also feature amongst this diverse shareholder portfolio.

From a structural point of view, it should also be noted that the CPC comprises two joint-stock companies; one called the CPC-R and registered in the Russian Federation and a second, CPC-K, which is registered in Kazakhstan. This organisational structure makes sense in view of the fact that the company is operating a trans-national pipeline and has facilities located in both the Russian Federation and in Kazakhstan. It is thus essential for CPC that these two joint-ventures exist to match with these two separate operational environments. Whilst the two countries have harmonized certain policies in recent years, nevertheless they remain two separate entities and we must comply with the laws of each. This explains the choice of the company’s somewhat complex structure from the project’s outset.

Another crucial element of the company’s structural design is the fact that shareholder organisations can delegate representatives into the managerial apparatus of CPC. This is of great significance since it allows for experience and expertise – Russian, Kazakh and international – to be shared at the highest level within the company. Thanks to this feature of the company’s organisation, we believe we are able to bring together and benefit from a very broad range of experience which in turn allows CPC to operate better and in accordance with demanding international standards regarding safety and corporate governance.

However, whilst this structure undoubtedly brings the benefits which I have just described, it might also be said that it also gives rise to certain challenges involved in managing the CPC associated with the diverse interests which lie at the heart of the company.

As a shipper-owned pipeline, the CPC is a unique pipeline in Russia combining both private and governmental interests. What are the advantages of this business model?

Indeed, the fact that CPC is an organisation created by shareholders who themselves extract oil in Kazakhstan and in Russia does make it a unique entity. From a global point of view there are two basic business models for the running of pipelines. The first includes those pipelines which operate independently of the shippers themselves and thus deliver oil produced by third parties – Transneft’s operations provide a suitable example of this type of model. The CPC however, belongs to a second group which, being created by the oil-producing shareholders for their own use, is much more conservative with regard to transporting third-party oil. It should be said that both of these two models have advantages as well as disadvantages.

One particular advantage of the CPC model is that the supply of oil into the pipeline is guaranteed, since it is produced by the very organisations which are shareholders in the company. We can also be confident that in cases where problems arise in connection with the flow of oil, feeding supply to CPC will remain a priority for our shareholders. However, there will nonetheless be occasions when for various reasons the company’s shareholders alone cannot provide enough oil to operate the pipeline at full capacity and in such instances CPC would certainly need to be more cautious about approaching third-party companies for additional supply than a non-shareholder organisation would.
Ultimately it is the shareholders themselves who make decisions on such matters.

On the 21st of September 2011 company shareholders met in Almaty to hear about progress on the first phase of the company’s $5.4bn expansion project which intends to increase throughput to 67 million tonnes per annum. What is the reason behind the extension project from the perspective of governmental and private shareholders?

This plan to increase the throughput capacity of the pipeline to 67 million tonnes per year has been present from the very inception of the CPC project as declared in one of the articles in the company’s original 1996 shareholder agreement. This was to be implemented in the event of greater extraction capacity on the part of the shareholders in Kazakhstan and in the Russian Federation. Thus this idea has been around for over 15 years and during that time the company’s management has been debating just how to approach the question of throughput expansion since it is an important step for the CPC itself, for the shareholders and for the countries where the company’s facilities are located.

As a result of the expansion, the company’s revenue will double from the current $1.1 billion per year to $2.3 billion on completion of the project which according to our current schedule will take place in 2015. Revenue increases are of course good for the company’s shareholders but in addition to this, the expansion project is also increasing the overall volume of delivery to the Caspian Sea, another feature of great importance to the shareholders.

Governments too stand to benefit, and not only because they are amongst the company’s shareholders. CPC is concluding contracts with Russian and Kazakh suppliers of construction materials and administration services and is thus bringing tangible benefits to the local economies. In fact, the management of the expansion is also uniquely structured since all negotiations and organisational operations are being carried out by affiliate companies of Transneft, KazMunaiGaz and Chevron which talk to contractors and construction companies on CPC’s behalf.

Finally CPC is also engaged in social projects in Russia and Kazakhstan during the expansion period and has managed to persuade its shareholders of the benefits of supplying over one billion rubles for such projects. In concrete terms, this means that the company is responsible for the construction of hospitals, schools and playgrounds and for the purchase of equipment and supplies for other similar institutions. As a result the populations of the regions in which CPC facilities are located, both old and young, stand to benefit. Such projects are greatly appreciated by local governments and will be ongoing since the CPC recognises the need to put something back into local communities. This way local populaces and the CPC both profit from the project.

Looking at CPC from a more general supply-and-demand perspective, what is the importance of supply from the pipeline and the challenges of maintaining these volumes?

It is important for the CPC as the expansion project continues that there will be an increase in the amount of oil produced in Kazakhstan, and we have reason to believe that this will be the case. Indeed we have seen recently efforts on the part of Russian companies such as Lukoil to increase capacity at some of their Caspian production sites. The CPC hopes of course to transport the results of this extra capacity and believes that the more oil it exports to the world market, the greater contribution it will be making to overall global energy security since oil remains the only commercially viable means of generating energy in large volumes.

To speak of other aspects of energy security, it is certainly the case that challenges lie ahead. Firstly it is crucial that a safe environment is created in the Black Sea region where we currently see limitations in the throughput capacity of the Bosphorus and Dardanelles. This is a big issue for CPC and we will continue to follow the situation closely. In terms of ways to avoid tanker pile-ups in the Black Sea, there are already proposals to construct pipelines according to the Burgas–Alexandroupoli or Samsun-Ceyhan plans. CPC is not a shareholder in either organisation but I personally feel that some sort of bypass mechanisms must be developed in order for safe operations to continue in the Black Sea in the future. A limit will soon be reached in Black Sea throughput capacity and the organisations and companies concerned must be prepared for this eventuality when it arises. From an environmental and security point of view, a bypass seems like the best option given the growing volumes of oil being extracted in Kazakhstan and other countries surrounding the Black Sea.

The CPC is not alone in providing export services for oil produced in Russia and competes with Transneft’s other export pipelines. What are the challenges in actually filling the new capacity made available by the expansion project?

As already highlighted, CPC certainly feels that having its shareholders made up of oil-shippers themselves brings many safeguards in this regard since they will continue to provide reliable flows of oil into the pipeline. Nonetheless, this does not mean we do not need to be competitive in what is undoubtedly a competitive market. The company has already experienced market forces in action, for example at the Kropotkinskaya pumping station where a client decided to withdraw the volume it was previously shipping through us and reroute it to another supplier. We are of course aware that this can happen but agreeing with producers in advance regarding how the new capacity will be filled has been a core consideration of the expansion project from the start. the CPC has also implemented the ‘pump or pay’ principal for the expansion project which will permit us to receive payments from the shippers even if they are unable to provide enough oil to fill the pipeline. Such guarantees form the bedrock of the expansion project’s stability.

A further source of confidence that capacity will be met are our predictions for expanding production capacity in Kazakhstan. This will provide more stable volumes for CPC’s use notwithstanding other export options open to Kazakh producers. The CPC is not afraid of the competition and believes that its image as a safe and reliable transporter of oil will ensure the stability of supply for the expanded pipeline. The combined implementation of confident predictions regarding expanded production and legal safeguards such as pump or pay mean that the company has nothing to worry about regarding the use of its greater transportation capacity in the future.

With 2015 as the target date set for the completion of the expansion project, how do you see the company’s shorter-term milestones over the next two to three years?

The project is made up of three phases and at the completion point of each phase, the pipeline will be able to handle additional volume. The first phase involves the upgrade and modernisation of facilities including pumping stations of which CPC currently has five, two in Kazakhstan and three in the Russian Federation. Phase one also includes a plan to construct three new tanks at the company’s tank farm near Novorossissk, this will be in addition to the six tanks already at the site which each have a capacity of 100,000 cubic metres. Finally we also intend to build a new Single Point Mooring (SPM) at the Yuzhnaya Azereivka marine terminal at the Novorossissk port, this will add to the existing two SPMs already in situ. Finally CPC also intends to change 80km of piping in Kazakhstan in order to increase the size and therefore the capacity of the pipe.

Phase two features the construction of five further pumping stations, one in Kazakhstan and four in Russia and a further three tanks in Novorossissk which will help us on our way to the 67 million tonne target. On the way to this CPC intends to reach 35 million tonnes not using a Drag Reducing Agent (DRA) after the completion of the first phase, this will mark a considerable step-up from the current figure of 35 million tonnes which includes DRA – incidentally this is a world record. The completion of phase two will see the figure reach 48 million tonnes without DRA and finally phase three will permit the company to reach the 67-megatonne target exclusive of DRA. According to our calculations this figure will rise to up to 78 million tonnes if DRA is included.

One highly particular feature of the project is that CPC’s operations will continue while the expansion work is in progress, thus aside from a few minor stops required for certain stages of the expansion project, flow will continue largely uninterrupted throughout the expansion. Since current throughput capacity will not be curtailed, CPC’s shareholders will not feel any adverse effects with regard to revenue during expansion.
Thus far there have been no problems sticking to the schedule the company has laid out for itself and construction is underway in Russia. Contractors have also been mobilised, or are about to be so, in Kazakhstan including at the sites of the marine terminal and tank farm. Information about the current state of play was delivered to the shareholders at the recent company meeting in Almaty and everyone expressed confidence in the project.

The expansion is predominantly financed by CPC shareholders but they are not the project’s exclusive backers. What proportion of the project’s finances could come from other sources?

The mainstay of funding for the project is naturally generated by CPC’s own operations in the form of revenue from oil shipments through the pipeline, this is a basic principal which lies at the heart of the project and we are satisfied that we will be able to stick to this principle. Nevertheless, this does not exclude the possibility of receiving additional financing through loans from external sources although this is not a measure the company intends to take for the foreseeable future. For as long as it is possible to continue funding from our own resources we shall do so, and in any case even if loans of this kind become necessary their value will not exceed 10-15% of the overall $5.4 billion budget for the project. A financial consultant has been hired in order to look into the mechanics of a potential loan and the CPC will thus be well prepared should steps in this direction need to be taken in the future.

The CPC has been seen by some as having paved the way for developments on Sakhalin and even the current collaboration on Russia’s Arctic Shelf. In your opinion, what have been the main lessons to be learned from this type of international collaboration balancing a broad range of interests?

As one of the most successful joint operations in the energy sphere across the former USSR, the CPC certainly acts as a kind of showcase for large-scale international projects, as well as providing a model of how to operate within Russia and in Kazakhstan. This status was achieved through shareholder compromise on a number of important issues which we faced from the project’s outset. Business in Russia is invariably a question of such compromises, and this is even more the case when dealing with a list of shareholders like that of the CPC which includes governmental interests as well as those of private and public companies. Compromise at every stage of the process is vital for a venture in which so many entities have a stake and an enterprise which lacks the ability to compromise is very unlikely to do its job successfully.

Behind every key step, such as the memorandum of understanding regarding the expansion project or the final decision on investment passed last December in Moscow, lies the conviction of the CPC’s shareholders that the project must remain successful, profitable and safe, as well as realistic with regard to the goals it sets for itself. In addition, ensuring that there is no separation between different ‘types’ of shareholders is a matter of principal for the company, thus we do not recognise a distinction between ‘major’ and ‘minor’ shareholders. Even if a shareholder’s stake is small, this should not deprive that shareholder of the right to influence CPC policy – managers and shareholders alike must recognise this principal in order to promote equitable dialogue between shareholders. We thus have a situation where shareholders respect each another and are inclined to cooperate rather than compete with one another in order to secure a successful future for the CPC. This atmosphere of dialogue and negotiation is undoubtedly one of the ingredients of our success and for as long as things continue in this vein the company will continue to be successful.

Mr Platonov, you already have previous experience negotiating for Russia’s entry into the WTO and in serving the Ministry of Economic Development and Trade. How important has the CPC project been in influencing global perception of Russia’s reliability as a partner in major economic projects and trade?

The CPC sets a good example and helps to create a positive image for external investors looking to cooperate with Russia. Admittedly the oil industry has a reputation as a sector in which it is hard to fail, but nevertheless the company believes its example can be carried over to sectors beyond oil and gas or energy in general. This is because the company’s success lies much deeper than simply the product we are selling – the CPC has demonstrated quite clearly that diverse foreign partners can and will work together in the right environment. The CPC is not alone in the Russian Federation in displaying a successful model for cooperation in the energy sector, but it is also the case that much of the success of other projects can be attributed to the good example set by the CPC. The company’s project is not a straightforward one and it has certainly helped change a few minds regarding the possibilities involved in cooperating with Russian enterprise, since we have shown that business can be carried out successfully in Russia in compliance both with Russian laws and global regulations governing commerce. External observers recognise this aspect of the company’s work and the positive implications it has for their own future business plans in the Russian Federation.

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