Energy Politics Summer 2005

Energy Politics
Issue VI: Summer 2005

Table of Contents

Economics
Can Another Oil Price Crash Be Avoided
by Peter Odell 3
Using Tax Incentives to Compete for Foreign Investment: Do

They Work?
Government by Orighoye Rewane 7
Why Does OPEC Continue to Price Its Oil in Dollars?

by A. F. Alhajji, Ph.D. 36
Business Pipeline Gas Introduction to the Korean Penninsula

by Keun-Wook Paik, Ph.D. 41
Letter to the Editor: Angra III Brazils Third Nuclear Power Plant
by Edmilson Moutinho dos Santos and Rafael Judar Vicchini 96
People Country Assessment: India
by Colin Campbell 102
Commentary: “Bank on It”:Economic Theory and Some Oil

Markte Realities
Regular by Ferdinand E. Banks 104
Features
Issue VI: Summer 2005 2

Editorial Board Letter from the Editor

Jennifer I. Considine, Canada
Thomas Dawson, Canada
Keun‐Wook Paik, United Kingdom
Joy Dunkerley, United States of America
Bob Ebel, United States of America
Eugene Khartukov, Moscow
Can another Oil price Crash be
Avoided?
Tony Reinsch, Canada
Angela Tu Weissenberger, Canada
Stephen O’Sullivan, Russia
Alex Kemp, Scotland
G. C. Watkins, Canada
Alpheus Jessup, United States of America
Gavin Longmuir, United Kingdom
Mamdouh G. Salameh, United Kingdom
Michael Lynch, United States of America
Colin Campbell, Ireland Peter R. ODELL
William Kerr, Canada
Jean Laherrere, France
Roland George, Canada By pure chance the traumatic events in the international oil
John Roberts, United Kingdom market over the past 12 months have coincided with research I was
Richard Marshall, Canada
Thomas Walde, United Kingdom asked to undertake on the circumstances surrounding the 2nd oil price
Garth Renne, Canada shock in 1979/80. The similarities between the two upheavals are
May Yeung, Canada
Peter Adams, United States of America disconcertingly similar: not only in terms of the more than doubling in
Barbara Baker, Canada the price of internationally traded crude, but also in the
Len Coad, Canada
Edmilson Moutinho dos Santos, Brazil misrepresentation and misinterpretation of events. The latter can best
Alli Marshall, Ca nada be summed up as ‘panic’ amongst policy makers and experts who

should have known better and, as an inevitable result, the imposition of
self-inflicted wounds on the global economy in general, and on the

OECD nations, in particular.

A “crisis” has thus been created –

even though both OPEC’s and the The initial cause of the 1979/80 shock was the revolution in Iran
IEA’s monthly statistics on oil and consequential fears for supply availability in the main oil
supply and demand have revealed importing countries. As the Iran revolution temporarily inhibited
no evidence of a pending scarcity. production (though in large part compensated by increased supplies
from other OPEC countries and from the newly discovered North Sea
oil province), scarcity fears were rampant amongst the analysts. These
encouraged stockpiling by consumers – ranging from refineries, power
plants and industrial users to the man-in-the-street motorist. Thus, 3
million b/d were added to oil consumption – and to the competitive
upwards-bidding of prices by both real buyers of oil and by speculators
in the spot markets.
The initial cause of the present oil price shock, though superficially
different from 25 years ago, is little different in principle. First,
specious propaganda emanating from the so-called “peak oilers” and
other Jeremiahs on prospective near-future oil scarcity has grabbed the
headlines in the media: in which the presentation of potential supply
problems are coupled with misinterpretations of demand growth, most
Contrary to the reality of an oil notably in China. A “crisis” has thus been created – even though both
surplus, western-world leaders OPEC’s and the IEA’s monthly statistics on oil supply and demand
castigated OPEC countries for have revealed no evidence of a pending scarcity. Their recently
under-production instead of published overall figures for 2004 now show that oil supply in 2004
recognising their 10% increase in comfortably exceeded demand – even when the latter incorporates the
2004; while not even politely consequence of excessive stockpiling, to give a 6-year high in the
requesting the multi-national oil volume of oil stocks. In 2004 global oil production at 83.2 million b/d
corporations to enhance their was up by 3.34 million b/d over 2003. Demand, meanwhile, rose by
production and their investments only 2.7 million b/d to 82.5 million b/d – with about 25% of the
in oil supply facilities in the rest of increase accounted for by stock-building.
the world. OECD’s
Contrary to the reality of an oil surplus, western-world leaders
castigated OPEC countries for under-production instead of recognising
their 10% increase in 2004; while not even politely requesting the
multi-national oil corporations to enhance their production and their
investments in oil supply facilities in the rest of the world. OECD’s oil
production – only one-third less than that of OPEC – was allowed to
stagnate.

A curb – or even the temporary Even more important from the broader economic standpoint,
suspension of these nefarious western governments – excluding that of Germany – have made
speculative activities – would have no efforts to control the 2004/5 version of the spot-market speculators
eliminated not only the intense of 1979/80. Yet this most recent enterprise of the oil speculator’s virus
volatility of the markets, but would is much more virulent and globally-wide in its activities; through the
also have engendered price myriad of dealings in “paper” barrels (rather than in real oil) on the
developments which reflected the uncontrolled oil exchanges of New York, London and Singapore. A
innate stability of the market in curb – or even the temporary suspension of these nefarious speculative
real oil supply/demand activities – would have eliminated not only the intense volatility of the
relationships. markets, but would also have engendered price developments which
reflected the innate stability of the market in real oil supply/demand
relationships.
In the aftermath of the 1979/80 oil shock, the instability produced half-
a-decade of severe problems for the oil producing and oil exporting
countries. The consequential fall in the price of oil for six consecutive
years ended up in 1986, with the price of oil (in real terms) down by
about 65%: and demand by over 20%. The impact on the global
economy was highly negative – with economic recession and
In today’s “crisis”, the high oil accompanying social and political problems.
price of about $50 per barrel
hardly matches up to the 1980 In today’s “crisis”, the high oil price of about $50 per barrel hardly
level of over $80 (measured in matches up to the 1980 level of over $80 (measured in 2005 dollar
2005 dollar terms). Nevertheless, terms). Nevertheless, the current price is at a record-breaking high
the current price is at a record- (except for 1979/80) since the 1870s. It is not, moreover, a sustainable
breaking high (except for 1979/80) price in what will inevitably become a more competitive market, as
since the 1870s. oil’s contribution to total energy supply continues to fall.
As the long-run supply price does not exceed $25 per barrel, then, given
the additional factor of relatively cheap money available for investment
in the oil sector, today’s market price seems as unlikely as that of 1980
to remain so high. Competition from coal and gas – as well as the still
improving efficiency in the use of oil (especially in aviation and for
motor vehicles) will bring strong downward pressure to bear on present
prices.

The failures of policy makers in the

first five years of the 21st century The failures of policy makers in the first five years of the 21st
to treat oil as anything other than century to treat oil as anything other than just another commodity have
just another commodity have quickly come home to roost. Let us hope that they quickly come to
quickly come home to roost. Let us their senses and then positively try to re-establish “order” in the market;
hope that they quickly come to first by curbing or even eliminating the interference of the speculators;
their senses… and then, by securing the success of a meaningful dialogue with OPEC,
plus Russia and China, so create conditions whereby long-term stability
for both producers and consumers of oil can be achieved. If so, then a
second mid-80’s style crash could be avoided. If not, then prepare for
fireworks and the onset of economic doom and gloom.
About the Author:

Peter Odell is Professor Emeritus of International Energy
Studies at Erasmus University Rotterdam. He recently published a two-volume study,
'Oil and Gas:Crises and Controversies,1961-2000' (Multi-Science Publishing
Company, Brentwood, UK.

Economics
Using Tax Incentives to Compete for
Put simply, although these Foreign Investment: Do They Work?
governments own most of the Orighoye Rewane
world’s petroleum resources,
they have neither the capacity to
carry out such technical tasks as
drilling wells and laying pipelines 1 INTRODUCTION
nor the financial stability or
security necessary for such
projects. In most of the countries that possess petroleum resources, these deposits
are regarded as the crown jewels.1 This view is no more emphasised
anywhere else than it is in developing countries, where the exploitation
of these deposits is an important (and for some essential) source of
revenue, representing a means for them to emulate the economic success
of their industrialised counterparts.2 However, petroleum exploration and
development projects are major long-term capital investments - requiring
heavy front-end capital expenditure, detailed expertise, advanced
technology and marketing outlets – characterised by long lead times and
high risks of failure. Put simply, although these governments own most
of the world’s petroleum resources,3 they have neither the capacity to
carry out such technical tasks as drilling wells and laying pipelines4 nor
the financial stability or security necessary for such projects.
1
Johnston D., International Petroleum Fiscal Systems and Production Sharing
Contracts 1 (1994).
2
Cameron P., Lecture Notes on Petroleum Agreements, CEPMLP (October 2003).
3
Cameron P., Petroleum Licensing: a Comparative Study (1984).
4
Jok J., The Concession and the Licence as Oil Production Titles, 3 (Unpublished Dip.
Pet. Law dissertation submitted to CEPMLP, University of Dundee, 1982).

Consequently, many governments are compelled to turn to

international oil companies5 who hold most of the financial and
technical wherewithal needed for the exploration and exploitation of
petroleum resources.6
The recognition of this need for The recognition of this need for foreign direct investment (FDI), coupled
foreign direct investment (FDI), with the gradual elimination of barriers to foreign investment (FI) in
coupled with the gradual other States with similar attractive features, has led to most host
elimination of barriers to foreign governments (HGs), over the past two decades, actively competing
investment (FI) in other States amongst themselves to promote their countries as investment locations.7
with similar attractive features, They are increasingly striving to create a favourable and enabling
has led to most host governments climate to attract FDI as a policy priority by adopting such measures as
(HGs), over the past two decades, liberalising the laws and regulations for the admission and establishment
actively competing amongst of FI projects; providing guarantees for repatriation of investment and
themselves to promote their profits; and establishing mechanisms for the settlement of investment
countries as investment locations. disputes.8 Tax incentives (TIs), the subject of this paper, are also part of
these promotional efforts.
The efficacy of these incentives as a determinant for attracting FDI is

often debated, with some schools of thought arguing that the offering of
tax incentives to foreign investors will (a) increase the aggregate amount
of FI available to developing countries; and (b) affect the spatial
distribution of investment9, even if the first argument does not fully
stand up.10
5
These companies will be referred to as international oil companies (IOCs) or
multinational oil companies (MNOCs) in an interchangeable manner throughout this
paper.
6
Anenih O., The UK Petroleum Production Licence – Is it a Contract or Regulation
and Does it Matter? 1 (2003).
7
UNCTAD, Tax Incentives and Foreign Direct Investment: A Global Survey, 11
(2000).
8
See id., 11.
9
That is to say that if governments of locales that are alternative locations for foreign
investors offer incentives, then the govt eager to ensure that it gets the investment must
match those incentives or face the prospect of losing investment to the competing
countries.
10
Wells L.T. & Allen N.J., Tax Holidays to Attract Foreign Direct Investment: Lessons
From Two Experiments, viii (2001).

However, other schools argue that TIs have little, if any effect on the
total FI that is made world-wide, and thus in the aggregate, incentives
create a net transfer from taxpayers to investors.11 In the case of foreign
investors in developing nations, this transfer is primarily from a poor
In the case of foreign investors in country to a richer one.
developing nations, this transfer
is primarily from a poor country
Despite the foregoing, developing countries have increasingly resorted to
to a richer one.
such measures in recent years,12 especially those that consider
themselves to be alternative locations for FDI, as they are in close
geographical proximity to other countries with similar attractive features,
as it is thought that the importance of TIs may be more pronounced in
these situations.13 In addition to this, there has been the emergence of a
new issue, i.e. the recognition that the tax policies of the home and host
countries are interconnected, breeding the view that this link influences
the behaviour of MNOCs. There has been a great deal of evidence,
especially after the changes in the United States’ (US) tax laws during
the late 1980s, that home country tax policy affects both the MNOC’s
There has been a great deal of
behaviour and the effectiveness of tax policy in the countries where
evidence, especially after the
these firms operate and invest.14
changes in the United States’
(US) tax laws during the late
1980s, that home country tax These issues, which have added a considerable amount of fuel to the
policy affects both the MNOC’s original debate generated about the efficacy of these TIs and whether
behaviour and the effectiveness of governments have offered unreasonably large incentives to entice those
tax policy in the countries where firms to invest in their area, form the scope of this paper, which aims to
these firms operate and invest. establish whether using tax incentives to compete for FDI in oil and gas
(O&G) projects actually work. The paper proceeds as follows. Chapter
two is a brief, analytical excursion into the configuration of tax
incentives, including their objectives and categories.
11
See id., viii.
12
Morisset J. & Pirnia N., How Tax Policy and Incentives Affect Foreign Direct
Investment: A Review, 4 (2001).
13
This has a lot to do with investment experts, particularly from investment promotion
agencies, viewing incentives as an important policy variable in their strategies to attract
FDI for economic development – see UNCTAD, supra note 7, at 11.
14
See Morisset & Pirnia, supra note 12, at 4.

Chapter three explores the merits of the current debate on the

efficacy of TIs in the context of Indonesia, as this country,
having sporadically offered TIs to foreign investors over the past
twenty-five years, offers a “natural experiment” for testing which of the
arguments stand up andwhich do not. In addition to this, graphs showing
the number and value of projects approved each year before and after the
Chapter three explores the merits elimination of incentives will be analysed to compare growth rates and
of the current debate on the FDI inflows, as will tables showing the average shares of total FI in 5
efficacy of TIs in the context of Association of South East Asian Countries (ASEAN), including
Indonesia, as this country, having Indonesia, during these periods, in order to gauge whether the ending of
sporadically offered TIs to incentives caused investors to shift their investments to neighbouring
foreign investors over the past countries where HGs continued to offer incentives. A grouping and
twenty-five years, offers a tabulation of investors is also done in order to examine the influence of
“natural experiment” for testing home country tax policy on investment flows, with all the results mostly
which of the arguments stand up supporting the arguments made against incentives.
andwhich do not.
Next, chapter four presents the outcome of three sets of empirical

research that are generally consistent with the findings of the research in
Indonesia, notably that TIs neither affect significantly the amount of FDI
that takes place nor usually determine the location to which investment
is drawn.
This paper concludes that TIs

attract some investors some of the This paper concludes that TIs attract some investors some of the time, as
time, as although chapters three although chapters three and four have evinced that TIs are poor FDI-
and four have evinced that TIs determinants for O&G projects in developing countries, it cannot be said
are poor FDI-determinants for that that they have absolutely no effect on FDI. It is, however, further
O&G projects in developing suggested that instead of competing amongst themselves and blindly
countries, it cannot be said that offering TIs, which this paper has shown to have minimal effect on FDI,
that they have absolutely no effect to any MNOC that will have them, countries may want to harmonise
on FDI. their tax policies under regional or global agreements or consider
whether some other sort of regional or global collective action might be
in their better interests.

2 TAX INCENTIVES
This chapter makes a brief, analytical excursion into the
definition, objectives and classification of the major tax incentives used
in the international petroleum industry, with Table I on page 7
TIs, the subject of this paper, can containing a description of these TIs, as well as definitions of all the
be defined as any incentives that technical terms used in this chapter.
reduce the tax burden of an
enterprise in order to induce them
to invest in particular projects or 2.1 What is a Tax Incentive?
TIs, the subject of this paper, can be defined as any incentives that
sectors .
reduce the tax burden of an enterprise in order to induce them to invest
in particular projects or sectors.15 Put simply, they are exceptions to the
general tax regime. Specific to the international petroleum industry, they
are those fiscal elements emplaced by HGs that make petroleum
exploration and production (E&P) more economically attractive,16 and
would include, for example, mechanisms such as tax or royalty holidays
or tax abatement, etc.17
However, to be considered an However, to be considered an investment incentive, a TI must not be

investment incentive, a TI must available to all investors but, rather, must be tailored to specific investors
not be available to all investors or types of investors,18 this would explain why in developing countries,
but, rather, must be tailored to where TIs are especially common, they are aimed at FD investors and
specific investors or types of not available to domestic investors.19
investors
15
See UNCTAD, supra note 7, at 12.
16
See Johnston, supra note 1, at 304.
17
There are also other mechanisms that HGs can use to try to influence investor
behaviour, like lower government take, reduced government participation or widening
of the ring fence. However, these mechanisms are more contractual in nature, and
therefore, have not been included here.
18
Thus, for example, accelerated depreciation offered to all investors would not be an
investment incentive in the sense used here, even if accelerated depreciation might
benefit certain specific investors – those operating in highly capital-intensive sectors –
more than others.
19
The granting of incentives to desirable investors and not to others raises the issue of
discriminatory treatment. Although such discrimination is opposed by the US on the
ground that it distorts international trade, this is nothing more than an economic reason,
for as long as the discrimination is not on racial grounds, there is nothing in
international law against discrimination between foreign investors if the discrimination
is based entirely on economic factors - Sornarajah M., The International Law on
Foreign Investment, 99 (1994).

Because TIs are intended to encourage investment not just in E&P,

but also in certain geographical areas, they are rarely provided
without conditions attached. Very often countries design special
incentive regimes that detail the tax benefits as well as the key
Because TIs are intended to restrictions. For instance, these regimes may require that a project be
encourage investment not just in established in a certain region(s), have a certain turnover, require the
E&P, but also in certain transfer of technology from abroad or employ a certain number of
geographical areas, they are individuals.20
rarely provided without
conditions attached. Very often 2.2 Objectives of Tax Incentives
countries design special incentive Apart from attracting desirable investment, TIs also have a number of
regimes that detail the tax other objectives, namely:
benefits as well as the key
restrictions. (a) Regional Investment: Countries with untested or/and unproven
regions, wanting to attract E&P investment to these areas, often employ
a mix of incentives to channel investment to these areas.21
(b) Performance Enhancement: TIs are a useful way of ensuring that the
foreign investor enhances the performance of the industry in a manner
desired by the HG, whereas a direct requirement may give the
impression of hostility to foreign investors.22
(c) Transfer of technology: An important objective of using TIs to attract

investment to oil and gas projects in developing countries is the transfer
of technology. Certain types of tax incentives are designed specifically
for this purpose.
20
For instance, China offers foreign-invested firms a tax refund of 40% on profits that
are re-invested to increase the capital of the project or launch another firm. The profits
must be re-invested for at least five years. If the re-invested amounts are withdrawn
with five years, the firm has to pay the taxes. India, similarly, offers a tax exemption on
profits of firms engaged in tourism or travel, provided their earnings are received in
convertible foreign currency – see UNCTAD, supra note 7, at 12.
21
For example, Nigeria has a regional incentives scheme that gives allowances ranging
from 5 to 100% to MNOCs that establish operations in areas where little or no
exploration work has been carried out – see id.
22
In a non-petroleum example, Ghana taxes companies engaged in the export of non-
traditional products at a reduced rate of 8% instead of the standard 35% - see id.

(d) Some countries, such as Malaysia and Singapore, have

introduced a specific set of incentives directed towards research and
development (R&D) activities including tax-exempt technology funds
and tax credits for expenditures on R&D.23 For import of technology, tax
incentives provided may take the form of allowing transfer costs of
Some countries, such as patent rights and import fees, etc to come under operating costs, thereby
Malaysia and Singapore, have permitting them to be expensed.24
introduced a specific set of
incentives directed towards 2.3 Classification of Tax Incentives
research and development
(R&D) activities including
Most of this paper focuses on the corporate income tax (CIT) and the
tax-exempt technology funds
different options used by HGs to relieve MNOCs. It is, however, worth
and tax credits for
underscoring at this point that unlike the actual tax instruments, e.g.
expenditures on R&D
royalties and income tax – which are fairly limited and more or less the
same in most countries - the range of TIs available to HGs are quite vast.
Andrews-Speed P., Lecture Notes on Mineral and Petroleum Taxation, 3.3 (2004).
1
This premium consists of an option where the investor purchases the right to maintain
its corporate tax rate at a given level, even if the tax regime is modified in the future –
see Morisset & Pirnia, supra note 12, at 13.
1
For example, a reduced CIT rate is a good incentive as it allows, inter alia, investors
to keep a larger portion of profits, however, international linkages can undermine a
country’s efforts to make its tax system relatively neutral. Similarly reduced taxes on
dividends and interests paid abroad are also good TIs. But on the other hand, the lower
the dividend tax, the lower the penalty for remitting dividends, and the lower the
incentive to reinvest profits – see UNCTAD, supra note 7, at 21
1
For instance, the UNCTAD survey found that - in terms of the types of TIs granted -
although there was clearly an increasing trend towards offering full or partial tax
holidays or tax rate reduction for specific types of activities, with nearly 85% of the
countries surveyed offering such incentives, another trend was the increasingprevalence
of duty draw-backs, import duty exemptions and deductions for social security
contributions - see id.
1
This premium consists of an option where the investor purchases the right to maintain
its corporate tax rate at a given level, even if the tax regime is modified in the future –
see Morisset & Pirnia, supra note 12, at 13.

This is because in order to make a fiscal regime more

Therefore, it is worth noting that competitive, a HG has a number of options available to adapt a relatively
despite the classification given standard set of taxes to suit its needs.25 Therefore, it is worth noting that
here, the variety of incentives that despite the classification given here, the variety of incentives that can be
can be offered can be as far- offered can be as far-reaching in range, from the “stability premium”
reaching in range, from the that has been offered to investors by countries such as Chile and
“stability premium” that has been Colombia,26 relief from import duties or value-added taxes to flow-
offered to investors by countries through shares, and there is no clear-cut answer in favour of one or the
such as Chile and Colombia, another mechanism, as each has its own inherent advantages and
relief from import duties or value- disadvantages27, and ultimately the type of TI offered will depend on the
added taxes to flow-through HGs objectives.28
shares, and there is no clear-cut
answer in favour of one or the Bearing this in mind, one can therefore attempt to broadly categorise the
another mechanism, as each has main types of TIs found in the O&G industry into 2 groups:
its own inherent advantages and
disadvantages , and ultimately the 1. Tax deductions: These are those incentives that serve to give
type of TI offered will depend on a direct reduction of the actual tax base29, i.e. final tax base =
the HGs objectives. (original tax base) – (tax deduction). Most TIs take the form of such
“deductions,” for example expensing of costs, capitalisation of costs
through depreciation and amortisation, loss carry forward,
enhancement of allowable costs through “uplifts”, reduction of the
tax base via tax “abatement”.
26
This premium consists of an option where the investor purchases the right to
maintain its corporate tax rate at a given level, even if the tax regime is modified in the
future – see Morisset & Pirnia, supra note 12, at 13.
27
For example, a reduced CIT rate is a good incentive as it allows, inter alia, investors
to keep a larger portion of profits, however, international linkages can undermine a
country’s efforts to make its tax system relatively neutral. Similarly reduced taxes on
dividends and interests paid abroad are also good TIs. But on the other hand, the lower
the dividend tax, the lower the penalty for remitting dividends, and the lower the
incentive to reinvest profits – see UNCTAD, supra note 7, at 21
28
For instance, the UNCTAD survey found that - in terms of the types of TIs granted -
although there was clearly an increasing trend towards offering full or partial tax
holidays or tax rate reduction for specific types of activities, with nearly 85% of the
countries surveyed offering such incentives, another trend was the increasingprevalence
of duty draw-backs, import duty exemptions and deductions for social security
contributions - see id.
29
The tax base is that portion of the revenue, assets or expenditure, or some other
feature of the business which is targeted by the tax in question – see Andrews-Speed,
supra note 25, at 2.5.

(2)Tax Reductions: An alternative method would be to

provide a TI which would serve to reduce or temporarily eliminate
the tax rate, i.e. the amount of tax payable - i.e. a direct deduction
from the amount of tax payable, rather than from the tax base –
perhaps through a reduced CIT rate, tax credits, tax holidays or tax
abatement.
Table I – Description of Tax Incentives Used in O&G industry
Term/
Incentive Definition
Accelerated Writing off an asset through depreciation or amortisation at a

Depreciation rate that is faster than normal accounting straight-line
(J) depreciation. There are a number of methods of accelerated
depreciation, but they are usually characterised by higher rates
of depreciation in the early years than the latter years in the life
of the asset. Accelerated Depreciation allows for lower tax
rates in the early years.
Amortisation Amortisation is an accounting convention designed to emulate

(J) the cost or expense associated with the reduction in value of an
intangible asset (See depreciation infra) over a period of time.
Amortisation is a non-cash expense, and the techniques for
amortisation of intangible costs are similar to those of
depreciation, see infra.

Capitalising Capitalisation allows certain costs - the most important of which are
Costs those associated with exploration and development - to be
(AS) recovered later than they were incurred, possibly many years later,
when the project starts to earn revenue. In order to calculate the tax
base, the methods of depreciation or amortisation are used to
calculate how these costs will be deducted from the revenue, with
amortisation applying to intangible costs such as feasibility studies
and depreciation applying to the costs of intangible assets.
Depreciation Depreciation is an accounting convention designed to emulate the

(AS) cost or expense associated with reduction in value of an asset due to
wear and tear, deterioration, or obsolescence over a period of time.
Depreciation is a non-cash expense. There are several techniques
for depreciation, including (a) Straight-line depreciation: whereby
the cost is depreciated in equal instalments over a defined period of
time. For a tangible asset this period may be equivalent to the
nominal life of the asset, e.g. a $1m cost depreciated over five years
would result in a tax deduction of $200,000 per year for five years;
(b) declining balance: The percentage rate of depreciation is derived
from the total depreciation period. E.g., a 4-year period would have
a 25% rate of depreciation. Each year that proportion (25%) of the
remaining value of the asset is depreciated for the defined number
of years (4). The balance is depreciated in the subsequent year; (c)
double declining balance: is the same as the declining balance
except that the rate of depreciation for a fixed period of
depreciation is double. So a 4-yr double declining balance involves
depreciation of 50% of the remaining value of the asset, not just
25%; (d) sum-of-the-year’s digits: is an alternative approach to
providing the investor with earlier tax deductions than the straight-
line method. A fraction is defined by an inverted scale of all the
year’s digits. The depreciation for a particular year is calculated by
multiplying the relevant fraction by the original value of the asset;
(e) unit-of-production: this approach relates to the amount of
depreciation each year to the ratio of annual production to the
remaining reserve of the deposit.

Employment In many countries, governmental-mandated social security

based deductions contributions can be a burden to enterprises, especially new ones.
(UN) To encourage investment in O&G projects, governments may
reduce social security contributions or provide tax credits or
allowances based on the number of employees hired. Incidentally,
Bulgaria, on the other hand, offers TIs to further its social goal of
providing employment to persons with disabilities.
Expensing Costs This is where a fiscal regime allows for certain costs - usually
(AS) operating costs, and sometimes royalty - to be expensed, i.e.
deducted from the tax base in the year that they are incurred.
Flow-through Provide a mechanism for individual shareholders in a company to

share(s) benefit from the tax allowance(s) of the company. The value of
(AS) specified tax allowances is passed through to the shareholders.
Investment credit A fiscal incentive where the HG allows a MNOC to recover an

(UN) additional percentage of tangible capital expenditure. Investment
credits (ICs) may be flat or incremental. A flat TC is earned as a
fixed percentage of investment expenditures incurred in a year on
qualifying (targeted) capital. In contrast, an incremental IC is
earned as a fixed % of qualifying investment expenditure in a year
in excess of some base that is typically a moving average base
(e.g. the average investment expenditure by the taxpayer over the
three previous years).
1
Hong Kong (China), Indonesia, Ireland, the Lao People’s Democratic Republic,
Cambodia and Estonia are a few countries that use this type of incentive.
1
Hong Kong (China), Indonesia, Ireland, the Lao People’s Democratic Republic,
Cambodia and Estonia are a few countries that use this type of incentive

Loss carry This is a mechanism whereby losses incurred in one year can be
forward or carried forward (or backward – especially for oil field
backward abandonment after production has ceased) for a specified number
(UN) of years (usually three to five years) for tax accounting purposes.
Usually only a fixed ratio of the loss with an upper limit is
allowed to be carried forward (or backward). This measure is
particularly valued by oil investors whose projects record losses
both before production starts (when there are costs but no
revenues) and after the deposit comes on production (if costs are
too high or the price too low). Taken together, a low tax rate
accompanied by loss carry forwards for tax purposes and
accelerated depreciation – which also allows investors to reduce
their tax burdens in the years immediately following investment
when cash flow is important to pay off debt - is considered to be a
major element in an effective tax system and one that is highly
attractive to foreign investors.
Preferential Many countries accord preferential tax treatment for appreciation

treatment of in value of capital (assets) held by enterprises if the capital (or
long-term capital assets) is held over a fixed period of time (usually six months to a
gains year). Long-term capital gains (capital gains (capital retained for
(UN) longer than the minimum period) are usually taxed at half the rate
of short-term capital gains (capital retained for less than the
minimum period). Short-term capital gains are usually taxed as
ordinary income. Preferential tax treatment of long-term capital
gains is intended to encourage investors to retain funds for longer
periods.
Reduced taxes These taxes, typically about 10%, may be reduced in order to
on dividends and attract FDI – the lower the dividend tax, the greater the TI.
interest paid However, it is noteworthy that the lower the dividend tax, the
abroad lower the penalty for remitting dividends, and the lower the
(UN) incentive to reinvest profits.

HGs may set a lower CIT rate as an exception to the general tax
regime in order to attract FDI into specific sectors or regions.30 It
Reduced CIT may be targeted at the income of foreign investors who meet
Rate specified criteria, or it may be applied for additional FDI, as was
(UN) the case in Malaysia the mid-1980s when investment inflows were
below expectations.
Reinvestment Operate in the same way as investment credits, discussed above,

Credit but are targeted at the companies’ re-investment in a country
(AS) where they already have revenue.
Royalty Holiday This mechanism is similar to the tax holiday. It is a specified

(J) period of time in years or months, during which royalties are not
payable to the government. After the holiday period, the standard
royalty rates apply.
Tax Abatement Is a mechanism for giving preferential treatment to a particular

(AS) sector of the economy without changing the general income tax. It
can act by either (a) reducing the tax base by a specified
percentage or (b) the tax rate by a specified percentage. Tax
abatement may be available for the whole life of the project or for
a specified period only. Abatement may also be used by one level
of govt in order to allow for a significant amount of tax to be
taken by another level of government.
Tax Credit A tax credit (TC) is an allowance, which is deducted from the
(AS) amount of tax payable. In the petroleum industry, tax credits, if
available are generally applied to either investments or re-
investments.
Tax Holiday A specified time period (usually 5-10 years) in the early stages of
(UN) a project, when its exempt from paying a defined tax (usually
CIT) or set of taxes. At the same time, tax holidays deny firms
certain tax deductions over the holiday period or indefinitely (e.g.
depreciation costs and interest expense), tending to offset at least
in part any stimulative effect.

Uplift Common terminology for a TI whereby the HG allows the

(J) contractor to recover some additional percentage of tangible
capital expenditure. For example, if a contractor spent $10m on
eligible expenditures and the HG allowed a 20% uplift then the
contractor would be able to recover $12m. The uplift is similar to
an investment credit. However, the term often implies that all costs
are eligible where the investment credit applies to certain eligible
costs. The term is also used at times to refer to the built-in rate of
return element in a rate of return contract.
Sources: AS – Adapted from Andrews-Speed P., Lecture Notes on Mineral &

Petroleum Taxation (2004).
J– Adapted from Johnston D., International Petroleum and Fiscal
Systems and Production Sharing Contracts (1994).
UN – Culled from UNCTAD, Tax Incentives and Foreign
Investment: A Global Survey (2000).

From 1967 - following the end of 2. THE INDONESIAN EXPERIENCE

President Sukarno’s regime,
which had kept Indonesia closed This chapter explores the issue of the impact of TIs on FI in the context
to FI in the first half of the 1960s of Indonesia, as the Indonesian government has offered TIs to foreign
- to the early 1980s, Indonesia, investors during some periods of recent history, but not during others.
offered foreign investors tax Thus, the country offers a “natural experiment” for testing which of the
holidays (THs) - that were similar arguments, noted earlier, stand up and which do not.
to those granted by many other
countries at the same time…
3.1 The Natural Experiment
From 1967 - following the end of President Sukarno’s regime, which
had kept Indonesia closed to FI in the first half of the 1960s - to the early
1980s, Indonesia, offered foreign investors tax holidays (THs) - that
were similar to those granted by many other countries at the same time,
and today, as it was claimed that THs were important in light of the
The enacting law, Law I of 1967, country’s high corporate income taxes (60%, under the 1925 Company
was introduced exempting foreign Tax Ordinance) and dividend withholding taxes.31
investors from corporate income The enacting law, Law I of 1967, was introduced exempting foreign
tax for a period of up to five years investors from corporate income tax for a period of up to five years and
and from dividend withholding from dividend withholding taxes on those profits even if they were
taxes on those profits even if they remitted later. Once the basic tax holiday expired, the applicable tax rate
were remitted later for foreign firms could be reduced up to 50% for an additional five
. years.32 This law was later amended in 1970,33 enabling a project to
receive tax exemptions – from corporate income tax and from
withholding taxes on dividends34 - for up to six years.
31
The legislation added other incentives, such as guarantees against expropriation,
guarantees on remittances abroad, exemptions from duties on capital equipment, and
exemptions from duties on capital equipment for two years – Mohammad S.,
Recollections of My Career, 35 (1995).
32
World Bank, Managing Capital Flows in East Asia (1996).
33
Law II of 1970 concerning Amendment and Supplement to Law I of 1967
Concerning Foreign Investment.
34
It has been suggested that the exemption from dividend withholding tax applied only
if the investor’s home country did not tax the income. This is unsubstantiated, as the
basic laws show no evidence of a distinction by source of investment, however,
practice may have done so.

The clock on holidays started running when commercial

production commenced (a date to be certified by the director
general of taxation, in the ministry of finance).35 With only small
adjustments, the system remained the same until 1984.In a dramatic
turnaround in 1984, Indonesia became one of the very few developing
countries to eliminate tax holidays,36 commencing with those investors
approved after 1983.
The change, presenting a lower The change, presenting a lower CIT rate of 35%, but leaving intact the
CIT rate of 35%, but leaving other incentives (tariff exemptions, guarantees, and so on),37 set in
intact the other incentives (tariff motion the natural experiment, the results of which support the broad
exemptions, guarantees, and so conclusions of this paper: TIs are not the most influential factor for
on), set in motion the natural multinationals in selecting investment locations for O&G projects.
experiment, the results of which
support the broad conclusions of
this paper. 3.2 The Results from the Experiment
3.2.1 Impact on Foreign Investment
Figure 1, above, shows the number and value of projects approved each
year from 1978 to 1993. As can be seen, although the first data available
after tax holidays were dropped show that foreign investment approvals
declined from those of the previous year, they also show that FI flows
recovered soon afterwards.
35
See World Bank, supra note 32.
36
Due largely to the following three reasons. Firstly, their need to attract role model
firms had disappeared as several name investors had established themselves in
Indonesia. Secondly, the CIT rate in Indonesia had fallen to 45% and treaties for the
avoidance of double taxation had lowered dividend withholding taxes for many foreign
investors. Thirdly, empirical studies in Indonesia and elsewhere were showing
reformers that tax holidays played only a relatively minor role in foreign company’s
decisions about where to place new investment. These empirical studies also seemed to
show that taxation of world-wide income and foreign tax credit systems in some home
countries, meant that THs in Indonesia led to larger tax payments to investor’s home. It
was also pointed out that the holiday system introduced distortions across sectors and
classes of firms, favouring large investors, a class that policymakers were no longer so
eager to encourage – see id.
37
See id.

Investors gained from 1983

approval dates, since the
grandfathering of pre-1984
incentives meant they would
receive tax holidays as well as
enjoy the new lower tax rate.
Source: Culled from Wells L.T. & Allen N.J., Tax Holidays to Attract Foreign Direct
Investment: Lessons from Two Experiments (2001)
Interestingly enough, as more encouraging data on FI began to come in,

it emerged that the reason for the low FI figures in 1984 had been due to
an upward blip in FI approvals for the year preceding reform, as a
number of investors, widely expecting THs to be reduced, accelerated
their applications for investment licenses.38
Also, there was some evidence that the investment agency, Badan
Koordinasi Penanaman Modal (BKPM), responsible for drawing FI into
the country, had been induced to predate some 1984 approvals to 1983.39
Investors gained from 1983 approval dates, since the grandfathering of

pre-1984 incentives meant they would receive tax holidays as well as
enjoy the new lower tax rate.
38
See Wells & Allen, supra note 10, at 10.
39
See id.

3.2.2 Impact on Growth Rate of Foreign Investment

Figure 2, below - reporting the logs of the number and value of projects
for the same period as Figure 1, to make it easier to compare growth
Figure 2, below - reporting the
rates before and after the elimination of incentives - shows that there was
logs of the number and value of
not a measurable change in the growth rate after the tax holidays were
projects for the same period as
eliminated, although one might have expected some slowdown in this
Figure 1, to make it easier to
rapid growth simply from market.
compare growth rates before and
after the elimination of incentives
- shows that there was not a
measurable change in the growth
rate after the tax holidays were
eliminated,
Source: Culled from Wells L.T. & Allen N.J., Tax Holidays to Attract Foreign
Direct Investment: Lessons from Two Experiments (2001)
Further confirming what the figures show graphically, are a series of

statistical tests, carried out by Wells and Allen,40 of the differences
between growth rates before and after 1984.
40
See id.

Considering the crudest of these tests first, Wells and Allen

show that if one examines the values of FI, the rate of growth
from 1978 through 1983 was slightly higher than that for 1984 to 1993,
Considering the crudest of these but the difference between the growth rates in the two periods was not
tests first, Wells and Allen show significantly different from zero. On the other hand, if the comparison is
that if one examines the values of based on the number of projects approved, the growth rate after the end
FI, the rate of growth from 1978 of tax holidays was slightly higher than that before; again, the difference
through 1983 was slightly higher between the two growth rates was not significantly different from zero.
than that for 1984 to 1993, but
Secondly, to test the robustness of these findings, Wells and Allen41
the difference between the growth
adjusted the numbers in various ways, e.g., similar tests were made on
rates in the two periods was not
the figures without including a very large refinery project that was never
significantly different from zero.
implemented. The handling of the transition years 1983 and 1984 was
adjusted: first, by averaging the number of projects and the values for
those two years and then, by eliminating the two years. Whatever the
adjustments or combinations of adjustments, the conclusions held. The
differences between growth rates in investment with tax holidays and
those without tax holidays were not significantly different from zero.
Table II, above, shows that
despite the fact that other 3.2.3 Effect on Foreign Investment of Neighboring Countries Tax
neighbouring countries Incentives
continued offering, and in some
case increased, TIs to attract FI, Table II, above, shows that despite the fact that other neighbouring
rather than losing long run countries continued offering, and in some case increased, TIs to attract
share of FI in the region, by the FI, rather than losing long run share of FI in the region, by the period 5-
period 5-10 years after it had 10 years after it had eliminated THs, Indonesia had managed to almost
eliminated THs, Indonesia had double its share. Further confirming the fact that if THs had been
managed to almost double its decisive factors in the location decisions of investors, Indonesia would
share. have lagged behind investment in other countries that continued to offer
tax holidays and tax rates comparable to the new Indonesian rates.
41
See id.

Table II – Average Shares of Total Foreign Investment in 5

ASEAN Countries (Percent)
Country
Year Indonesia Philippines Thailand Singapore Malaysia Total
1970-84 10.8 2.6 7.7 46.4 32.5 100.0
1985-90 9.2 6.9 17.0 49.3 17.6 100.0
1991-96 19.8 6.5 11.7 3.8 28.1 100.0
Note: ASEAN is Association of Southeast Asian Nations.

Source: Culled from Wells L.T. & Allen N.J., Tax Holidays to Attract Foreign Direct
f ( )
As a practical matter, such offsets

3.2.4 Effect on Foreign Investment of Home Country Tax Policy
result when the home country
taxes income of its investors on a It has been argued that one reason that TIs might be ineffective as a
world-wide basis and rejects “tax determinant of location of investment is that some home country policies
sparing” provisions in treaties to offset the tax savings created by the incentive.42
avoid double taxation
As a practical matter, such offsets result when the home country taxes
income of its investors on a world-wide basis and rejects “tax sparing”
provisions in treaties to avoid double taxation.43 The US does so; hence,
one might expect that US investors would be relatively indifferent to the
offer of tax incentives when deciding whether to invest in a particular
country. Some other countries, by contrast, tax only the domestic income
of their residents or agree to tax sparing arrangements.44
42
Morisset J., Using Tax Incentives to Attract Foreign Direct Investment, 3 (2000).
43
Winters J.A., Power in Motion: Capital Mobility and the Indonesian State, 26 (1996).
44
See id.

There is, in fact, some econometric evidence to suggest that in

making FI location decisions, investors domiciled in countries
with the latter practices do indeed respond more positively to tax
incentives than do investors based in the US.45
There is, in fact, some However, it is difficult to identify any such influence of the home
econometric evidence to suggest country in the investment flows set out in figures 1 and 2 above. Wells &
that in making FI location Allen46, however, suggested grouping and examining the behaviour
decisions, investors domiciled in patterns of three groups of investors:
countries with the latter practices
do indeed respond more 1. Those from the US, which taxes foreign-earned income but gives
positively to tax incentives than tax credits for taxes paid abroad;
do investors based in the US.
2. Those from the industrialised countries of the Netherlands,
France, the UK, and Japan, which do not tax foreign-earned income
or give foreign tax credits under tax-sparing arrangements; and
3. Those from the emerging economies of Hong Kong, Singapore,

Korea, and Taiwan, which probably pay no tax at home on foreign-
earned income.
On the other hand, the share of
Dutch investors increased As can be seen from Table III above, the results of this test show that
substantially, as did the share of figures on shares of investment at the end of the tax holiday period and
investors from Singapore and 10 years later show, at most, a very weak impact of the home country tax
Korea, contrary to predictions system. The share of US investors in total FI in Indonesia went up, as
based on home country tax one might predict, since US investors benefited relatively little from tax
systems. holidays in the first place and would continue along their old path. The
increase however, was quite small. The share of UK and Japanese
investors fell somewhat, consistent with their having benefited from tax
holidays. On the other hand, the share of Dutch investors increased
substantially, as did the share of investors from Singapore and Korea,
contrary to predictions based on home country tax systems. In sum, it is
hard to find evidence in Indonesia that the home country tax system had
a large and consistent impact on investors’ reactions to THs.
45
See Wells & Allen, supra note 10, at xiii.
46
See id.

Table III – Shares in Total Foreign Investment in Indonesia, 1967 –95
1967-85 1967-95
Home Country $ million % $ million %
United States 1,381 9.0 10,660 10.0
United Kingdom and Japan 5,249 34.1 30,472 28.8
Singapore and Korea 346 2.2 13,216 12.4
Netherlands 499 3.2 7,320 6.9
Other 7,9393 51.5 45,132 41.9
Total 15,414 100.0 106,800 100.0
Note: The end years in these sources are close to, but not identical to, those
used in Figures 1 and 2 and Table II.
Source: Culled from Wells L.T. & Allen N.J., Tax Holidays to Attract Foreign
Direct Investment: Lessons from Two Experiments (2001).
In summary, the experiment in Indonesia provides strong evidence that a

country can attract growing amounts of FI without offering tax holidays,
at least if its general income tax rate differs little from that of its
neighbours.47 FDI in Indonesia increased over the 1978-93 period at a
striking rate of 25% per year compounded (215 for number of projects;
28% for value), with even domestic investment showing a pattern almost
identical to that of FI; it remained flat until 1982, spiked in 1983,
In summary, the experiment in declined in 1984, and climbed thereafter.48
Indonesia provides strong
evidence that a country can Moreover, Indonesia’s experience suggests that with regards to the
attract growing amounts of FI impact of TIs, home country policies matter less than one might expect.
without offering tax holidays, at Although Japanese investors (whose Indonesian income was covered
least if its general income tax rate under tax sparing arrangements) complained regularly about the
differs little from that of its elimination of tax holidays, they still flocked to the country.49 In fact,
neighbours.
47
Anwar S., Fiscal Incentives for Investment and Innovation, 95 (1995).
48
49
See Morisset, supra note 42, at 4.

Indonesia gained over its neighbours in the competition for

Japanese investment, even without TIs50. One has to conclude
that investors will go to a country – if its petroleum reserves,
climate, and policies are attractive – whether the country offers
THs or not.
One has to conclude that

investors will go to a country – if 4 CONSISTENCY WITH OTHER FINDINGS
its petroleum reserves, climate, To give strength to the conclusions made in the last chapter about the
and policies are attractive – Indonesian experience, this chapter presents the outcome of three sets of
whether the country offers THs or empirical studies that show that the overall impact of TIs on the
not. investment decisions of MNOCs is minimal.
4.1 Theoretical Research
In a stream of conflicting theoretical research, scholars have calculated

the financial impact of THs on the returns from hypothetical investment
projects. They then assume that investors in the O&G industry, act in
simple, profit-maximising ways, i.e. if THs increase the net present
Not surprisingly, researchers
value of projects, they will attract more investors.51
using this approach find that,
under assumptions that make
calculations feasible, tax holidays Not surprisingly, researchers using this approach find that, under
will increase the returns to assumptions that make calculations feasible, tax holidays will increase
investors; therefore, researchers the returns to investors; therefore, researchers conclude, investors will
conclude, investors will invest invest more in countries offering them. However, researchers following
more in countries offering them. this approach usually do not address the question of whether the greater
investment flow to a country offering incentives is a net addition to the
flows to the developing world, or whether it simply represents a
diversion from countries offering smaller incentives to those offering
greater ones.52
In spite of the great care with which one is sure that some of this
research has been done, the results remain unconvincing. First, the
studies do not adequately account for the complexity of the tax situation
50
See id.
51
De Mooij R.A. & Ederveen S., Taxation and Foreign Direct Investment, 32 (2001).
52
See id.

facing multinational firms. Some home country tax codes, e.g.,

impose no tax on foreign-earned income.53 The tax systems of
some other home countries result in a different outcome: the
In the real world of investors, the benefits of TIs in developing countries may be largely offset by
impact of tax systems such as that increased liabilities of the parent enterprises to the tax authorities of the
of the US is very complicated. The home governments (this can be the impact of the US foreign tax credit
foreign tax credits that a firm can system).54
use to offset home country taxes
can depend on the extent that
earnings are retained in the In the real world of investors, the impact of tax systems such as that of
operations in the HC, on tax rates the US is very complicated. The foreign tax credits that a firm can use to
in other countries in which the offset home country taxes can depend on the extent that earnings are
MNOC operates… retained in the operations in the HC, on tax rates in other countries in
which the MNOC operates, on how the investment is financed (in
particular, the proportion declared as debt), and on administrative
choices made by tax authorities.55 Second, to some extent, firms that
operate under more than one tax regime have ways of allocating their
profits within their networks; by assigning them to minimise taxes, they
make any simple calculations suspect.56 These kinds of problems have
led most theoretically oriented researchers simply to ignore the home
country regime. Although the omission makes the calculations easier, it
sharply reduces the plausibility of results.
Recognising that investors may
not always respond in ways
assumed by calculations, a (4.2)Survey of Investors
number of researchers have
carried out selective surveys of
investors to determine if tax Recognising that investors may not always respond in ways assumed by
policy was one of the key factors calculations, a number of researchers have carried out selective surveys
in the decision-making process of of investors to determine if tax policy was one of the key factors in the
MNOCs. decision-making process of MNOCs.
Below is presented a brief summary of the major findings, which are

generally consistent with the findings of the research in Indonesia,
notably that TIs neither affect significantly the amount of direct
53
Edminston K.D., Mudd S., Valev N.T., Incentive Targeting, Influence Peddling and
Foreign Direct Investment, 5 (2003).
54
See id.
55
See id.
56

investment that takes place nor usually determine the location to

which investment is drawn:57
In 1955, in one of the first type of
these survey studies, Barlow and
Wender interviewed 247 US In 1955, in one of the first type of these survey studies, Barlow and
companies about their strategies Wender58 interviewed 247 US companies about their strategies to invest
to invest abroad. Only 10% of the abroad. Only 10% of the companies listed favourable foreign taxes as a
companies listed favourable condition for FDI, ranking these inducements fourth after currency
foreign taxes as a condition for convertibility, guarantee(s) against expropriation, and HC’s political
FDI, ranking these inducements stability.
fourth after currency
convertibility, guarantee(s)
against expropriation, and HC’s A 1961 Robinson Survey of 205 companies confirmed these
political stability. findings.59Next came a 1966 field research by Aharoni60 on the way FI
decisions were made by US manufacturing firms, in which, the
conclusions were that HG concessions did not bring about the decisions
to invest. Income tax stimulation was considered a very weak stimulant.
Those investors, who did consider it, did it only marginally. In the words
of one of the interviewed investors, “Tax exemption is like a dessert, it is
good to have, but it does not help very much if the actual meal is not
there!”In a 1984 survey of 31 oil companies (OCs), the Group of Thirty
found that among 19 factors that were identified as influencing FDI
“Tax exemption is like a dessert,
flows, inducements offered by the host country rank seventh in
it is good to have, but it does not
importance for investment in developing countries and eighth in
help very much if the actual meal
developed countries.61
is not there!”
In recent years, several investors’ surveys have explored the
effectiveness of tax policies on FDI using alternative samples or asking
57
Indeed, in respect to the former, one striking finding reported in several surveys is
that there is a large discrepancy between the way investors view tax incentives and the
way government officials view the same incentives; surveys of investors tend to rank
incentives quite low as determinants of investment. It should be noted, however, that
studies using econometric tolls rank them high.
58
59
Perhaps the most important result of the Robinson survey was the considerable
difference of opinion between the business community and the governments, with
regards the major factors influencing investment decisions: tax concessions headed the
list of govt responses, while they were omitted from the list of private investor
responses – see id.
60
Id.
61

more detailed questions (for example, JETRO in 1995, Ernst &

Young in1994 and Deloitte & Touche in 1997).62 In general,
these surveys have confirmed the conclusions summarised
above; that if tax policy matters it is not the most influential factor in the
Last but not least, in 2000, the site selection of MNOCs.63
Oman Chamber of Commerce &
Industry (OCCI) and Muscat Last but not least, in 2000, the Oman Chamber of Commerce & Industry
Security Market (MSM) (OCCI) and Muscat Security Market (MSM) conducted a survey of 106
conducted a survey of 106 foreign foreign equity ventures examining the factors that influence foreign
equity ventures examining the investors to engage in projects in Oman. Analysis of the data revealed
factors that influence foreign that political and economic stability are the two most important motives
investors to engage in projects in for investing in Oman.64
Oman.
These results support the view that political and economic stability are
sine qua non for attracting FDI. This is not to say that these two factors
differentiate countries and make them more attractive for FDI. They are
These results support the view simply a threshold that all countries, and in particular developing
that political and economic countries, must achieve in order to be considered for FDI.65
stability are sine qua non for
attracting FDI.
62
Id.
63
In the Deloitte & Touche’s survey, TIs ranked at the 13th position out of 26 factors.
64
Mellahi K., Guermat C., Frynas G. & Al Bortamani H., Motives for Foreign Direct
Investment In Gulf Co-operation Countries: The Case of Oman, 10 (2000).
65
Id.

Econometric Analysis
Although an exhaustive evaluation of the available econometric

evidence is beyond the expertise of this author, it is nonetheless, perhaps
still worthwhile noting that most econometric studies have tended to
confirm the results of surveys,66 i.e. that TIs appear to have little effect
on the location of FDI.
But that does not mean that TIs
have no effect on FDI, as there
have been some spectacular In summary, the overwhelming conclusion of the empirical research is,
successes as well as some notable again, that tax incentives do not have a major impact on actual
failures in their role as investment location decisions.
facilitators of FDI
5 CONCLUSION
Although at first glance the impact of TIs on FDI appears to be

ambiguous, the results of the Indonesian experience, time-series
econometric analysis and numerous surveys of international investors
have all shown that TIs are not the most influential factor for
multinationals in selecting investment locations for O&G projects.
66
In their article, How Tax Policy and Incentives Affect Foreign Direct Investment: A
Review, Morisset & Pirnia evaluate a selective sample of studies – Root & Ahmed
(1978), Agodo (1978), Shah and Toye (1978) and Lim (1983) - and conclude in that
direction. With Root & Ahmed performing an econometric study with data for 41
developing countries during the period 1966-70. In which they classified countries into
3 categories of unattractive, moderately attractive according to their average per capita
inflow of FDI. 44 variables were chosen as potentially significant discriminators of the
3 defined country groups. Among the six policy related discriminators were three
relating to tax levels. Of these, CT rates proved to be an effective discriminator of the
three defined country groups; however, TI laws and liberality were not found to be
effective discriminators. Agodo analysed a sample of 23 US firms and tax concessions
were found to be insignificant as a determinant of FDI in simple and multiple
regressions – see Morisset & Pirnia, supra note 12, at 7.

The point to be made is that as a factor in attracting FDI,

incentives are secondary to more fundamental determinants, such
as size and prospectivity of reserves, political and macroeconomic
Investors generally tend to adopt stability, methods of foreign enterprise participation, attitudes and
a two-stage process when overall business environment.67
evaluating countries as
investment locations. In the first
stage, they screen countries based Investors generally tend to adopt a two-stage process when evaluating
on these and other fundamental countries as investment locations. In the first stage, they screen countries
determinants. Only those based on these and other fundamental determinants. Only those countries
countries that pass these criteria that pass these criteria go on to the next stage of evaluation where tax
go on to the next stage of rates, grants and other incentives may become important.68 Thus, more
evaluation where tax rates, grants accurate would be to say that TIs affect the decisions of some investors
and other incentives may become some of the time.
important.
In conclusion, TIs seem to be neither necessary nor sufficient for a
country to attract FDI in the first instance. Using them to compete for
FDI carries the covert risk of “racing to the bottom” with competitive
TIs,69 with countries either (a) ending up in a bidding war, favouring
multinational companies at the expense of the State and the welfare of its
citizens, or/and (b) facing reduced fiscal revenue and creating frequent
It is, therefore, suggested that opportunities for illicit behaviour by companies and tax administrators.70
instead of blindly offering TIs to
any MNOC that will take them, It is, therefore, suggested that instead of blindly offering TIs to any
which is just one method of MNOC that will take them, which is just one method of attracting FDI,
attracting FDI, policy-makers policy-makers may find it more beneficial to stick to the fundamentals,
may find it more beneficial to realistically appraising their national FDI balance sheet with the strategic
stick to the fundamentals, intelligence to target the right investors, while implementing
macroeconomic and political reforms to ensure stability and
predictability of policy measures, and then promote their countries as
investment locations with a prowess that has been effectively and
efficiently tailored. It may also be advisable for these governments to
67
Barrows G., A Survey of Incentives in Recent Petroleum Contracts, 227 (1988).
68
Ogutcu M., OECD: Attracting Foreign Direct Investment for Russia’s Modernisation
– Battling Against the Odds, 5 (2002).
69
Such competition has already started in some regions, most notably in Asia
70
These issues have become crucial in developing countries, which face more severe
budgetary constraints and corruption than do industrial countries – DPRU, What are
the major trends and determinants of foreign direct investment in SADC countries? pp
4-10 (2000)

try to harmonise their tax policies under regional or international

agreements71 or consider whether some other sort of regional or
global collective action might be in their better interests: e.g. maybe a
call for a World Trade Organisation obligation to limit selective
incentives, as is done in the European Union, or ban them altogether.
About the Authors:
Ms Orighoye Rewane is an attorney-at-law of the Federal Court of New York and

recently completed an LL.M in Petroleum Law & Policy (with Distinctions) at the
Centre for Energy, Petroleum Mineral Law and Policy.
71
Recent efforts to harmonise tax systems have been launched in both the industrial
and the developing world. In the European Union, for example, member countries are
discussing more stable, predictable, and transparent tax rules. As a first step, in
December 1997, member states adopted a code of conduct for business taxation,
agreeing not to introduce “harmful” tax measures and to roll back existing harmful
measures. Similarly, several West African countries have been working to harmonise
their tax incentives for FDI in one unified investment code within the Monetary Union
of West African states – see id.

Government
Why Does OPEC Continue to Price
Its Oil in Dollars?
A. F. Alhajji, PhD
Why do OPEC members Why do OPEC members continue to price their oil in US dollar despite
continue to price their oil in US their hefty losses from the decline in the value of the dollar relative to
dollar despite their hefty losses other world currencies? The answer is not as easy as some people think.
from the decline in the value of OPEC has tackled dollar devaluation issues for more than 30 years, yet it
the dollar relative to other world still uses the dollar to price its oil.
currencies?
Several economic, technical, and political factors have in the past

prevented OPEC from switching the pricing of oil to another currency or
basket of currencies. These same factors prevent OPEC today from
switching currencies.
Pricing oil in the euro instead of

the dollar or even in a basket of
Economic Factors
currencies will not change the
world price of oil. Exchange
1- Pricing oil in the euro instead of the dollar or even in a basket of
rates will determine the price of
currencies will not change the world price of oil. Exchange rates will
oil in other currencies.
determine the price of oil in other currencies. For example, if the price
of oil is $50/b and the exchange rate is one euro to $1.30, the price of oil
in euro would be €38.46/b. In this case, the producing country is
indifferent to whether it gets $50/b or €38.46/b. The world price of oil
would stay the same. Supporters of pricing oil in euro cite the success of
Iraq when it asked the UN to receive euros instead of dollars for its oil
exports under the UN oil-for-Food Program. Those supporters ignore
the fact that as the euro started to appreciate the benefits to Iraq came
from the money held in euro accounts, not from receiving euros for oil
exports. In other words, Iraq did not "price" its oil in euros.

Iraqi oil was still prices in dollars, but the Iraqi government
insisted on payments in euros. The UN converted the dollar revenue
from Iraq oil sales into euros and deposited them In Iraq’s accounts.
Pricing oil in a single currency Receiving euros did not change the price of Iraqi oil in the market.
other than the dollar, such as the
euro, will not solve the problem of 2- Pricing oil in a single currency other than the dollar, such as the
declining purchasing power, euro, will not solve the problem of declining purchasing power,
especially when the euro starts to especially when the euro starts to decline relative to the dollar. Once the
decline relative to the dollar. euro starts to decline, those who have been calling on OPEC to switch to
euro pricing instead of the dollar will then start calling on OPEC to
return to dollar pricing. The use of any single currency in oil pricing
will have the same effect, whether that currency is the dollar, the euro, or
the yen.
3- Benefits from pricing oil in a basket of currencies are limited,

especially in the long run. OPEC will not benefit greatly from adopting
a basket of currencies to price its oil, especially if the objective is to
stabilize the purchasing power of its oil exports. Given the share of the
US trade in OPEC trade balances, the dollar will still have an influential
role in such a basket.
4- Pricing oil in a basket of currencies will not benefit all members.

OPEC members stretch from Latin America, to the Middle East, to
Southeast Asia. Their trading partners are different, and the weight of
Pricing oil in a basket of each trading partner differs greatly. For example, the main trading
currencies will not benefit all partner for Venezuela is the US, for Indonesia is Japan, and for Algeria
members. OPEC members is the EU. When the dollar declines relative to the euro and the yen,
stretch from Latin America, to the Algeria and Indonesia stand to lose more purchasing power than
Middle East, to Southeast Asia. Venezuela.
Their trading partners are
different, and the weight of each
trading partner differs greatly. 5- Some studies indicate that a switch to a non-dollar pricing might
cause a shock in the US economy and reduce US economic growth.
Regardless of the political reaction, a decline in US economic growth
would lower the demand for oil, and consequently lower oil prices. The
losses from lower oil prices could outweigh any benefits from switching
to a new pricing mechanism.

6- The economic problems that the oil producing countries

suffered from in the last three decades have nothing to do with
the value of the dollar. However, these problems force governments to
The economic problems that the focus on short term rather than long term problems and solutions. Dollar
oil producing countries suffered devaluation causes problems in the short run. But in the long run, it
from in the last three decades appears that these countries benefited from several years of dollar
have nothing to do with the value appreciation. In fact, dollar appreciation and deprecation in the last 30
of the dollar. However, these years even out. In other words, the disadvantages of a single-currency
problems force governments to pricing are limited to the short run. These disadvantages do not exist in
focus on short term rather than the long run.
long term problems and solutions.
Technical Factors
Which currencies should be included in the basket? What is the weight

of each currency in the basket? What are the factors that determine the
weight of each currency in the basket? How to monitor the basket and
the price of each currency? How often should OPEC review the basket?
How often should OPEC change the currencies in the basket or the
Efforts to insure the success of the weight of each currency? Should OPEC become the Grand Marshal of
basket pricing are costly. They world central banks to monitor their moves so it can adjust the weight of
require a long period of time of currencies in the basket before it is too late? What is the cost of such
research, negotiations, consistent monitoring? Do benefits of a basket of currencies outweigh
implementation, and monitoring. the cost of establishing such a basket and the consistent monitoring?
These are some of the technical problems that OPEC will face if it
decides to switch to a basket of currencies instead of the dollar to price
its oil.
Efforts to insure the success of the basket pricing are costly. They
require a long period of time of research, negotiations, implementation,
and monitoring. Such a shift would require highly skilled experts from
around the world who are expensive to recruit. In addition, pricing oil
in a basket would complicate world oil markets and will reduce
transparency. Simply stated, the cost of using a basket of currency
would outweigh its benefits.

However, these technical issues may have prevented OPEC from

switching to a basket of currencies in the past, but they may not
be as problematic nowadays. Most technical analyses are
handled by advanced computer programs that reduce the cost
substantially. The main issue that may not be solved by such programs
is the choice of currencies, which subject to several economic and
political factors.
However, these technical issues

may have prevented OPEC from
switching to a basket of Political Factors
currencies in the past, but they
may not be as problematic
nowadays Ultimately, the decision to price oil in a non-dollar currency or a basket
of currencies is political. The decision of the deposed Iraqi president,
Saddam Hussein, to receive euros instead of dollars for Iraqi oil exports
under the UN Oil-for-Food Program was a political decision, not
economic. Iraq lost a massive amount of revenues in the beginning. At
the time, the euro was declining relative to the dollar. Pricing oil in
another currency would carry a political price that OPEC members
cannot handle, especially if the switch to non-dollar pricing hurts the US
We should not forget that even if economy. We should not forget that even if the switch to non-dollar
the switch to non-dollar pricing pricing does not affect the US economy, the US will not let OPEC
does not affect the US economy, members slap it in the face. It will not quietly accept such an insult in
the US will not let OPEC front the whole world. The dollar is a symbol of America's strength, and
members slap it in the face. It the US will not let others disregard this symbol. OPEC members are
will not quietly accept such an part of the world community. Its leaders fully understand the political
insult in front the whole world. ramifications of pricing oil in a currency other than the dollar.
The dollar is a symbol of
America's strength, and the US
will not let others disregard this Conclusion
symbol.
The economic benefits from switching to non-dollar pricing are limited.
Political costs would be very high. Technical factors, while costly,
might be resolved, but OPEC members may not agree on the contents of
the basket. Therefore, OPEC will not switch to a currency other than
the dollar in the foreseeable future, even if the dollar continues to
decline. The unexpected massive increase in oil revenues in the last two
years provide another reason for OPEC members to do nothing.

The only way for OPEC members to reduce the negative effect
of dollar devaluation is to diversify their imports. Import
The only way for OPEC members diversification will guarantee higher purchasing power than import
to reduce the negative effect of concentration. OPEC members can further improve their purchasing
dollar devaluation is to diversify power by adopting flexible trade polices that will allow them to switch
their imports. Import imports from one country to another as exchange rates change.
diversification will guarantee
higher purchasing power than
Reprinted with the permission of the Gulf Research Center
import concentration. Copyright © Gulf Research Center 2005
All rights reserved
www.gulfinthemedia.com.
About the Author:
A. F. Alhajji, PhD is an Associate Professor at theCollege of Business

Administration Ohio Northern University.

Government
Pipeline Gas Introduction to the
Korean Peninsula
Dr Keun-Wook Paik
1.1.Pipeline Gas Supply Sources for the Korean Peninsula

Until the end of the Cold War, the concept of developing a trans-national
When China’s energy self- pipeline network in Northeast Asian region was a mere pipe-dream. It
reliance policy virtually ended in was inconceivable to have a long distance pipeline from Russia to Korea
1993, the trans-national pipeline or Russia to Korea via China. However, the establishment of diplomatic
concept was looked at afresh. relations between Former Soviet Union (FSU) and Korea in September
PRC energy planners took the 1990 and China and Korea in August 1992 opened a new chapter for
proposal seriously, and the energy cooperation in the region.
concept was well thought of by
Dr. Wang Tao (then president of When China’s energy self-reliance policy virtually ended in 1993, the
China National Petroleum trans-national pipeline concept was looked at afresh. PRC energy
Corporation). planners took the proposal seriously, and the concept was well thought
of by Dr. Wang Tao (then president of China National Petroleum
Corporation), particularly when it appeared in June 1996, as part of the
proposal to establish a Pan-Asian oil and gas pipeline grid covering
Russia, Japan, Korea and central Asian Republics.

During the first half of the 1990s, Japan carried out a comprehensive
study of the potential for Russia’s oil and gas supply into Northeast Asia.
The study identified a number of major oil and gas export sources,
including the Yurubchonskoye oil field in the Krasnoyarsk region,
Verkhechonskoye oil field in the Irkutsk region, Talakanskoye and
Sredne-Botuobinskoye oil fields in Sakha Republic, Kovyktinskoye gas
field in the Irkutsk region, and a cluster of gas fields in Sakha Republic
In Northeast Asia there are (at that time the Chayandinskoye field reserves were only 200bcm).1
currently six pipeline gas supply
sources targeting mainly China,
Korea and Japan. In Northeast Asia there are currently six pipeline gas supply sources
targeting mainly China, Korea and Japan. As shown in Table 1, the
Russian Federation has four gas supply sources for China, and in the
central Asian Republic region there are two gas supply sources. There
In recent years it has been China are three major pipeline gas supply sources for the Korean Peninsula.
that has been driving the
introduction of a transnational
pipeline in Northeast Asian In recent years it has been China that has been driving the introduction
region. Despite ten years of a transnational pipeline in Northeast Asian region. Despite ten years
preparation and negotiations, preparation and negotiations, agreements on the pipeline have been
agreements on the pipeline have prevented by geopolitical tensions and the expense involved. In the
been prevented by geopolitical meantime, the decision to supply LNG into both Guangdong and Fujian
tensions and the expense provinces introduced LNG to China.
involved. In the meantime, the
decision to supply LNG into both
Guangdong and Fujian provinces When the breakthrough comes, trans-national pipeline development will
introduced LNG to China. bring a new dimension to the Korean Peninsula and Northeast Asian
region’s energy structure. The implications of a long distance pipeline
development will be broad in scale, since they will not be confined to the
Korean Peninsula.


Irkutsk gas export to the Korean Peninsula
The year 1992 witnessed two major initiatives by the China National
Petroleum Corporation (CNPC) with regard to pipeline gas imports. The
The year 1992 witnessed two first involved East Siberian oil and gas development and their export to
major initiatives by the China China. In July 1992, Professor Zhang Yongyi, then vice president of
National Petroleum Corporation CNPC, proposed the export of oil from East Siberia to Russia and Japan.
(CNPC) with regard to pipeline Prof. Zhang added that the oil pipeline could be extended to Japan via
gas imports. The first involved Korea if Japan got involved in the project. The second initiative was the
East Siberian oil and gas importation of Central Asian gas into China. This was proposed by
development and their export to CNPC together with Mitsubishi at the end of 1992.
China. In July 1992, Professor
Zhang Yongyi, then vice president
of CNPC, proposed the export of During 1993-1994, CNPC identified the Kovykta gas project in the
oil from East Siberia to Russia Irkutsk region as the priority project for the trans-national pipeline
and Japan. development between Russia and China, and in November 1994 a
memorandum of understanding (MOU) was signed between CNPC and
Mintopenergo for the construction of a long distance pipeline to promote
East Siberian oil and gas resources. The 1994 agreement was the first
official expression of shared determination for the pipeline development.
In September 1993, CNPC began The trans-boundary pipeline, proposed by Sidanco, then the major
to negotiate with the Russians for Russian share holder, aims at transporting 20- 30bcm annually from the
exploration rights for the Irkutsk region in East Siberia to the coastal cities of East China, and
Markovskoye and Yaraktinskoye possibly to Korea and Japan.
oil and gas fields in the Irkutsk
region.
In September 1993, CNPC began to negotiate with the Russians for
exploration rights for the Markovskoye and Yaraktinskoye oil and gas
fields in the Irkutsk region.2 CNPC’s Russian counterpart was Irkutsk's
Petroleum and Gas Geological Company and Geophysical Research
Institute, together with 14 other local companies and entities. CNPC’s
two exploratory wells were drilled in two virgin fields.3 As a result of
this initial investigation, CNPC understood the potential of Kovykta gas
exports to China.

Another major agreement was made in late June 1997, when a

Russian delegation led by Premier Viktor Chernormyrdin, visited
Beijing and signed a governmental framework agreement between
Russia and China to export natural gas and electricity from East Siberia
Under the deal, Russia would to China. Under the deal, Russia would export 25bcm/y of gas over
export 25bcm/y of gas over thirty thirty years, from the Irkutsk. $1.5bn worth of electricity will be
years, from the Irkutsk. $1.5bn exported over 25 years, based on a supply of 20 billion KW/h of
worth of electricity will be electricity from Irkutsk to either Shenyang, Liaoning province or to
exported over 25 years, based on Beijing. This framework agreement is effectively a re-confirmation of
a supply of 20 billion KW/h of the 1994 MOU.
electricity from Irkutsk to either
Shenyang, Liaoning province or The most important agreements were signed in February 1999 after the
to Beijing. fourth meeting between Premier Zhu Rongji and his counterpart
Yevgeny Primakov. Both sides signed 11 agreements, of which three are
related with oil and gas.4
• The first was for a preliminary feasibility study for crude oil
exports from Angarsk to Daqing through a 20-30 mt/y capacity
pipeline.
Based on this 1999 agreement, a
three-year study by the parties • The second was for a feasibility study on natural gas exports
(CNPC, Korea Gas Corp and from the Irkutsk region t north-eastern China through a long
Russia Petroleum) was distance pipeline.
undertaken in November 2000
and the results were submitted in • The third was for a preliminary feasibility study on gas exports
November 2003. from western Siberia` Shanghai by a trans-national pipeline
passing through the Xinjiang region.
Based on this 1999 agreement, a three-year study by the parties (CNPC,

Korea Gas Corp and Russia Petroleum) was undertaken in November
2000 and the results were submitted in November 2003.

Kovykta Gas Development5
The ten years preparation period for the Kovykta gas project can be
divided into five stages as Table 2 explains.
Table 2 –
The Five Stages of the Kovykta Project
1994-1996 This period is characterized as ‘bilateral relationship
development period’ between CNPC and Mintopenergo.
1996-1997 This is the first stage for the western investment, initiated by
Korea’s Hanbo group and then by BP’s serious move.
1998 This is the negotiation period for ‘five country FS work’ (Had it
hammered out a compromise, it would have opened the door for the
genuine ‘multilateral cooperation era’ in Northeast Asia). The driving
force of this negotiation was Japan, but its initiative to lend a major loan
for the FS work was not supported due to its failure to open their gas
Even though the official market for the development.
agreement for the feasibility study
of the Irkutsk gas project was 1999-2000 The focus is once again on bilateral relationship between
signed in November 2000, the Russia and China until the three party FS work agreement is signed.
negotiation was suspended for at
least 7-8 months due to a number 2000-2003 Both Russia and China agree to invite South Korea to the
of unresolved issues since Autumn project, to minimize the risk of market availability in the early stage of
2001 the project. Even though the official agreement for the feasibility study
of the Irkutsk gas project was signed in November 2000, the negotiation
was suspended for at least 7-8 months due to a number of unresolved
issues since Autumn 2001. The negotiation resumed in Summer 2002.
The result of the FS was completed in November 2003.
Source: Keun-Wook Paik, ‘Sino-Russian Oil and Gas Co-operative Relationship:

Implications for Economic Development in Northeast Asia’, presented at Northeast
Asia Cooperation Dialogue XIII: Infrastructure and Economic Development
Workshop’, organised by Institute for Far Eastern Affairs, Russian Academy of
Sciences, and Institute on Global Conflict and Cooperation, University of California,
Moscow, 4 October, 2002.

The Kovyktinskoye gas/condensate field discovered by

Vostsibneftegasgeologiya, a subdivision of the former Ministry
of Geology of Russian Federation, is located in the Zhigalovsky
region, 350 km to the north-northeast of Irkutsk.
When the project was initially

introduced to the western world,
the proven reserves of the field
stood at 870 bcm, of which C1
was only 277 bcm. However, as of
2002 the figure became 1932
bcm, of which C1 was 1,000 bcm.
When the project was initially introduced to the western world, the
proven reserves of the field stood at 870 bcm, of which C1 was only 277
bcm. However, as of 2002 the figure became 1932 bcm, of which C1
was 1,000 bcm. The scale of the proven reserves was large enough to
justify a major export scheme.

The turning point of the Kovykta project development was BP’s

acquisition of a 45% equity stake in Russia Petroleum, achieved by
providing $172m to the cost of appraising the Kovykta field. BP’s
involvement helped accelerate the exploration, which confirmed the real
The project’s three-year scale of the proven reserves.
feasibility study was completed in
November 2003. The main The project’s three-year feasibility study was completed in November
objective of the study was to show 2003. The main objective of the study was to show whether gas supply
whether gas supply to China and to China and Korea would be effective and commercially viable. The
Korea would be effective and study assumed that Russia Petroleum would sell 600bcm of gas
commercially viable. (20bcm/y) to CNPC and 300bcm (10bcm/y) to Korea Gas Corp (Kogas)
over 30 years. The supply would start in 2008, reaching 30bcm/y by
2017. The study called for up to 4bcm/y of gas to be supplied to Irkutsk,
Chita and Buryatia regions. The required investment for the project
would total $17bn, much higher than the $12bn price tag suggested in
1995.
About 400-500 wells with average depth of 3,000 meters would be

If the project was approved by all needed to develop the Kovykta field. The project includes the
three governments, its value construction of nine gas treatment plants, 20 compressor stations and 20
would soar. In 2003 the biggest collection stations. Russia’s projected demand for the Kovykta gas was
share holder is BP-TNK, with a 4bcm, while that of north-eastern China and northern China was 12bcm
62% controlling stake, as table 4 and 8bcm respectively, and that of Korea were 10bcm per year.6 The
shows. next step was to obtain the approval of the governments involved.
If the project was approved by all three governments, its value would
soar. In 2003 the biggest share holder is BP-TNK, with a 62%
controlling stake, as table 4 shows. It is worth noting that Interros
Holdings Company’s 25.8% stake was put on sale for approximately
$500m soon after the feasibility work was completed. However, the
most important players that will decide the fate of the project – Gazprom
and CNPC – did not make an offer.

A number of issues need to be resolved for this project to move forward:

There has been considerable
confusion about the role of co- 1. Who should co-ordinate the negotiations? There has been
ordinator. Gazprom argues that it considerable confusion about the role of co-ordinator. Gazprom argues
has a mandate from Russia’s that it has a mandate from Russia’s central government to co-ordinate
central government to co-ordinate gas export project.8 In fact, during a keynote speech at the 22nd
gas export projects. International Gas Conference held in Tokyo in June 2003, Alexei Miller,
CEO of Gazprom, confirmed that Gazprom had been authorised to co-
ordinate the establishment of a united system for gas production and
transportation.9 However, his talk did not give any details about how
Gazprom would approach its coordinating role. TNK-BP understands
that Gazprom’s commitment is vital for the project’s implementation.
Industry officials have said recently that Russia is considering changing
the source of the gas supply to China and South Korea, using gas from
the Republic of Sakha instead of Kovykta. In January 2004, Gazprom
said there were ‘numerous violations’ in the Kovykta’s exploration and
development license that would have to be resolved before it would
participate. Gazprom has an outstanding offer to join the project from all
the shareholders. Vekselberg, TNK-BP managing director, said
Gazprom "is a little afraid to lose its position (as the gas export
monopoly), but we don’t want to change Pipeline Gas Introduction to the
Korean Peninsula Page 8 Dr Keun-Wook Paik (January 2005) anything."
He said it might be possible to find an arrangement that would allow
Gazprom to participate without taking an equity stake. 10

‘We’re ready to organise gas exports through Gazprom,’ he said,

noting that while Gazprom could have ‘operational control’ it
would not have absolute control.11 Considering that Gazprom has agreed
Gazprom strongly indicated that to make a swap deal with Shell for its positioning in Sakhalin II’s LNG
the gas export source for China project,12 there is a possibility that TNK-BP might do the similar deal
and Korea could be the with Gazprom to minimize the entry time of pipeline gas to Northeast
Chayandinskoye field rather than Asian region. Gazprom strongly indicated that the gas export source for
Kovykta field.13 Gazprom knows China and Korea could be the Chayandinskoye field rather than Kovykta
too well that the Chayandagas field.13 Gazprom knows too well that the Chayandagas project is not
project is not ready for immediate ready for immediate export, and a compromise betweenTNK-BP and
export, and a compromise Gazprom is a very likely possibility.
betweenTNK-BP and Gazprom is
a very likely possibility. 2. The pipeline route. During the third meeting of the coordinating
committee for managing the Kovykta feasibility study, China asked that
the western route of the gas pipeline (the Mongolian line) should be
rejected. China seems to prefer the eastern route because:
• China prefers to minimize the political risks involved in
transiting through Mongolia.
The elimination of the Mongolia
route was a serious blow to South • The economic benefits brought by the pipeline could make the
Korea, since the cost of either Mongolians suddenly richer than inhabitants in China’s Inner
eastern route meant that the Mongolia.
pipeline could not be as
competitive as LNG shipped into • China would be able to channel some of the economic benefits of
Guangdong and Fujian the pipelines to its Northeast region, areas in desperate need of
provinces. economic stimulus.The Mongolian route is the most economic
for each of the parties due to the easy terrain and relatively short
distance to the main gas market. However, the discovery of the
Sulige-6 field in the Ordos Basin provided the opportunity for the
Chinese planners to reconsider their stance towards the
Mongolian route. Sulige gas was good enough to be the main gas
supplier for Beijing and Tianjin areas in the short term. The
elimination of the Mongolia route was a serious blow to South
Korea, since the cost of either eastern route meant that the
pipeline could not be as competitive as LNG shipped into
Guangdong and Fujian provinces.

It is worth noting that Gazprom’s

confirmation on the Asia-Pacific
direction export route was made
soon after China’s decision to
terminate the negotiations with
western energy firms – Shell,
ExxonMobil and Gazprom
consortium – for the WEP (West-
East Pipeline) project.
South Korea’s preference is the Manzhouli II route since it would bypass
North Korea, and the construction and maintenance costs would be
cheaper than Manzhouli route I. 14However, a recent report has
suggested that Gazprom does not support this route. During a Moscow
meeting with Kogas in early August, Gazprom confirmed that the route
towards Nakhodka and then a sub-sea pipeline to South Korea is being
The Russians want a $100/1,000
seriously considered. This route would bypass China, and the project
cm price, but eventually a
would target Korea as the main buyer.15 It is worth noting that
compromise price is likely to
Gazprom’s confirmation on the Asia-Pacific direction export route was
come down to the range of $70-
made soon after China’s decision to terminate the negotiations with
80/1,000cm, considering that western energy firms – Shell, ExxonMobil and Gazprom consortium –
Russia’s Energy Strategy 2020 for the WEP (West-East Pipeline) project.16
envisages the domestic gas price
will reach to $ 40-41 / 1,000 cm 3. The price of the gas. It will be the city gate price of the imported gas
by 2006, and $ 59-64 / 1,000 cm that will decide the fate of this Kovykta project, and difficult
by 2010. negotiations are continuing. The Russians want a $100/1,000 cm price,
but eventually a compromise price is likely to come down to the range of
$70-80/1,000cm, considering that Russia’s Energy Strategy 2020
envisages the domestic gas price will reach to $ 40-41 / 1,000 cm by
2006, and $ 59-64 / 1,000 cm by 2010.17 The Chinese would like the
gas to be priced at $20-25/1,000cm, since consumers in North-eastern
China cannot afford to pay more. According to Gazprom’s calculations,
the production cost alone is $30/1,000cm, while transportation will cost
at least $30/1,000 cm, excluding tax and a profit margin. Gazprom is
unsure whether China could accept even the price of $70/1,000cm.

The drop in LNG prices heralded a new era in which Northeast

Asia did not have to pay more than other regions. LNG suppliers
were very unhappy about this price discount that wiped out the premium
which Japan and Korea have paid for a long period.

During the first of half of 2003, the Sakhalin II project announced

that a total of 2.8 mt/y LNG would be supplied to Japanese utilities
such as Tokyo Electricity, Tokyo Gas, and Kyushu Electricity,
starting from 2007. Sakhalin Energy Investment Co (SEIL) refused to
expose anything related to the delivered gas price, choosing only to
During the first of half of 2003, highlight the short distance from Sakhalin Islands to Japan. However,
the Sakhalin II project announced industry sources confirm that the price is about $3.5/mmbtu. As shown
that a total of 2.8 mt/y LNG in Table 8, the average LNG price paid by Japan in 2002 was
would be supplied to Japanese $4.27/mmbtu. The figure indirectly confirms that less than 20% discount
utilities such as Tokyo Electricity, was made.18 In other words, Japan received some discount from the
Tokyo Gas, and Kyushu Sakhalin LNG price.
Electricity, starting from 2007.
Sakhalin Energy Investment Co
(SEIL) refused to expose anything
related to the delivered gas price,
choosing only to highlight the
short distance from Sakhalin
Islands to Japan.
In August 2003 when Indonesia’s Tangguh project was chosen as the

POSCO & SK’s 1.15 mt/y LNG supplier, price was the most important
factor. The price reported to the Korean government was as good as the
Guangdong and Fujian LNG price. (In August 2004, Kogas decided to
invite a bidding for 5 mt/y of LNG for 20 years from 2008 and quite a
number of potential suppliers expressed their interest in supplying the
LNG. However, no supplier is willing to offer Guangdong and Fujian an
LNG supply price due to the combination of strong LNG demand from
the United States and high oil prices.) In the context of low LNG prices,
securing a pipeline gas price that is 20-25% cheaper than LNG is

.
.
simply not possible. Even to secure a pipeline gas price of
$3.0/mmbtu is a very tough target to achieve.
PetroChina announced that the PetroChina announced that the average gas price for the West-East
average gas price for the West- Pipeline (WEP) will be Rmb1.327/cm (US $4.332 / mmbtu). This is a
East Pipeline (WEP) will be guideline price prepared by the State Development Planning
Rmb1.327/cm (US $4.332 / Commission (since renamed the National Development and Reform
mmbtu). This is a guideline price Commission) for the WEP’s 12bcm gas. The guideline price is
prepared by the State composed of Rmb0.45/cm ($1.47) as the wellhead price and
Development Planning Rmb0.877/cm (US $2.87 / mmbtu) as the transportation tariff. Pipeline
Commission (since renamed the Gas Introduction to the Korean Peninsula Page 12 Dr Keun-Wook Paik
National Development and (January 2005).
Reform Commission) for the
WEP’s 12bcm gas.
Due to this expensive domestic pipeline gas price, power producers are
If the Chinese authorities change refusing to sign the take-or-pay contract with PetroChina. The producers
their stance and agree to accept are arguing that a price exceeding Rmb1.1/cm is not acceptable.
the Mongolian route, the pipeline
gas price to the Bohai Bay areas If the Chinese authorities change their stance and agree to accept the
could be lower than $3/mmbtu, Mongolian route, the pipeline gas price to the Bohai Bay areas could be
and there is a very strong lower than $3/mmbtu, and there is a very strong possibility of setting the
possibility of setting the city gate city gate price in Inchon at $3.0-3.2/mmbtu. A pipeline passing through
price in Inchon at $3.0-3.2/mmbtu Manzhouli will not offer the kind of price that the Mongolian route can
provide, and this pricing issue will present difficulties in the negotiations
over the introduction of Kovykta gas into China and Korea. The meeting
between Gazprom and Kogas in early August 2004 in Moscow
confirmed that Gazprom does not like CNPC’s price negotiation strategy
and would like to give priority to the Nakhodka export route.

Kovykta gas to Nakhodka will be too expensive and a big

question will be who will buy the expensive pipeline gas. The most
likely possibility is that Gazprom will make a compromise, in
order to protect the entry timing of Russia’s pipeline gas to Northeast
The initiative to export gas from Asian region.
East Siberia to Northeast Asia
came from the Sakha Republic. As 1.1.2. Sakha gas exports to the Korean Peninsula
early as the 1960s the possibility
of Yakutian gas exports to Japan The initiative to export gas from East Siberia to Northeast Asia came
was explored and promoted, but from the Sakha Republic. As early as the 1960s the possibility of
activities were suspended in the Yakutian gas exports to Japan was explored and promoted, but activities
wake of the Former Soviet were suspended in the wake of the Former Soviet Union’s Afghanistan
Union’s Afghanistan invasion in invasion in late 1979. In the late 1980s Korea’s Hyundai group revived
late 1979. the forgotten project, and in 1995 the preliminary feasibility study on
Sakha gas development, funded by Russia and South Korea at $10m
each, was eventually implemented. However, the outcome of this study
was not encouraging, and no further steps were taken.
The conclusion was that Sakha gas exports to Korea were not feasible
because of the remote location, harsh environment and poor economic
rationale. However, the Sakha Republic now boasts a relatively large
proven gas reserve (over 1 tcm), and argues it has enough proven
In the late 1980s Korea’s reserves to justify a long distance, trans-national pipeline.
Hyundai group revived the
forgotten project, and in 1995 the According to Vasiliy Moiseyevich Efimov, then president of
preliminary feasibility study on Sakhaneftegas, as of 1998 the registered C1 category reserves in the
Sakha gas development, funded Vilyuisk region (10 fields: 437.8bcm) and Pipeline Gas Introduction to
by Russia and South Korea at the Korean Peninsula Page 13 Dr Keun-Wook Paik (January 2005)
$10m each, was eventually Botuobinsk region (21 fields: 586.3bcm) were 1,000bcm. Besides this,
implemented. However, the the reserves of Chayandinskoye field in Botuobinsk region were
outcome of this study was not estimated at 755bcm (previously 208bcm), of which 535bcm is
encouraging, and no further steps exploitable. Already 64 wells have been drilled in the field. Desperate to
were taken. become the main gas export source in the region, Sakhaneftegas has
proposed a East-Siberian consortium based in the Irkutsk region, Sakha
Republic and Evenki Autonomous region of Krasnoyarsk Krai in 1998.

The proposal is supported by Rosneft, the administration of the

Chita region, JSC UES of Russia, the administration of the
Evenki Autonomous region and Russia Petroleum. Interestingly,
The proposal is supported by Sakhaneftegas has signed an agreement with Russia Petroleum for the
Rosneft, the administration of the joint development of Kovyktinskoye and Chayandinskoye fields,
Chita region, JSC UES of Russia, although the priority will be given to Kovyktinskoye. At that time, the
the administration of the Evenki only way to remove any suspicion on the reliability of the proven
Autonomous region and Russia reserves scale was to combine both Kovykta gas and Chayandagas. The
Petroleum. Interestingly, significance of the proposal lay in the fact that the combined
Sakhaneftegas has signed an development of the Kovyktinksoye and Chayandinskoye fields would
agreement with Russia Petroleum provide proven gas reserves enough to justify a 4000kmlong pipeline
for the joint development of development. The combined or hybrid export scheme has two options,
Kovyktinskoye and even though there is no difference in the pipeline section within the
Chayandinskoye fields, although Chinese territory. The first is a 4,961km pipeline, of which the Russian
the priority will be given to section is 1,960km in length, and the two pipelines from Kovykta and
Kovyktinskoye. Chayanda fields meeting at Bodajbo (adjacent to the northern tip of the
Baikal lake). The second option is a 5,626km pipeline of which
2,2625km is in Russian territory. This second option gives the absolute
priority to the Kovykta project as the Chayanda is connected as a back-
up supply source.
As Kovykta’s gas reserves are large enough to pursue a level of exports

of 30bcm/y for 30 years, there is actually no need to make the
Chayandinskoye gas field the back-up supply source for the project. The
As Kovykta’s gas reserves are Chayandgas project could be pursued on its own though in terms of
large enough to pursue a level of preparation, it is far behind the Kovykta project.
exports of 30bcm/y for 30 years,
there is actually no need to make However, significant work has been carried out during the last few years.
the Chayandinskoye gas field the First, on July 26th 2002 Sakhaneftegaz completed a preliminary
back-up supply source for the feasibility study for a gas pipeline that will export gas from Chayandgas
project. to Shenyang.19 The initial export volume will be 12- 15bcm/y and the
figure could expand to 20bcm/y later. Second, the Central Commission
for Reserves of the Russian Federation’s Ministry of Natural Resources
approved the revised figure of Chayandagas proven gas reserves as
1,240bcm as of 2002. Thirdly, in October 2002, Gazprom and the Sakha
Republic Government signed a framework agreement on forming a joint
venture to make a tender bid for a development license for the
Chayandinkskoye and other fields in the Sakha Republic.

Gazprom’s strategic alliance with the Sakha Republic

Government has special implications. In early 2002, the Sakha
Government reported to the local legislative assembly that Yukos has
secured a 47% controlling stake in Sakhaneftegas (which was originally
controlled by Sakha Republic government). Yukos’ initiative forced the
Sakha Republic Government to be a minor shareholder. The Sakha
Republic government’s response was to form a strategic partnership with
Gazprom, which itself has neglected.
The Sakha Republic government’s
response was to form a strategic 1.1.1. Sakhalin Gas exports to the Korean Peninsula
partnership with Gazprom, which
itself has neglected. In 1991 the Development of Yakutian and Sakhalin Gas and Mineral
Resources of Eastern Siberia and the USSR Far East, the so-called
Vostok (East) Plan, was announced. The key element of the plan was the
construction of a 3230km gas pipeline from Sakhalin across Russian
territory through North Korea to South Korea, and a 3050km pipeline
If the figures in Table 10-15 are from Yakutsk to Khabarovsk. Like Sakha gas, Sakhalin offshore
proved after exploration, development has been discussed since the 1960s, but until the early
Sakhalin offshore could produce 1990s no real development was made partly because of uneasy relations
enough gas to be exported not between the former Soviet Union and Japan, and partly because of the
only to Japan, but also to other costbenefit analysis.
gas markets in Northeast Asia.
As shown in Table 13-14, the gas reserves in Sakhalin I (owned by
Exxon 30%, Sodeco 30%, Roseneft and Sakhalinmorneftegas 20%, and
ONGC Videsh Ltd 20%), and Sakhalin II (Shell 55%, Mitsui 25%, and
Mitsubishi 20%) stand at 485bcm and 460bcm respectively. Besides this,
the ExxonMobil-Texaco consortium estimates the gas reserves of the
Kirinskya prospect in Sakhalin Block III at 720bcm.
If the figures in Table 10-15 are proved after exploration, Sakhalin

offshore could produce enough gas to be exported not only to Japan, but
also to other gas markets in Northeast Asia.24



Japan is interested in the Sakhalin projects, despite long

standing territorial disputes between Japan and the Russian Federation.
Around 1998, Japex and four Japanese steel companies investigated the
possibility of building a 2,225km pipeline connecting the Sakhalin
Islands with mainland Japan.
The pipeline was composed of three sections: the first section, 625km
from Katangli to Prigorodnoye, the second section, 1300km from
The pipeline was composed of Prigorodnye to Niigata via an offshore route, and the last section 300km
three sections: the first section, from Niigata to Tokyo. In May 1997, minister Shinji Sato of Japan’s
625km from Katangli to Ministry of International Trade and Industry (MITI) announced that
Prigorodnoye, the second section, Japan was considering the Sakhalin offshore gas import pipeline.
1300km from Prigorodnye to
Niigata via an offshore route, and During April 1999 and Spring 2002, both Exxon Japan Pipeline and
the last section 300km from Japan Sakhalin Pipeline (JSPC) carried out a feasibility study at a cost of
Niigata to Tokyo. $40m.
The contracts with the Japanese

utilities have eliminated the
possibility of a pipeline gas
supply from Sakhalin I to Japan The contracts with the Japanese utilities have eliminated the possibility
until 2013-14. Thus, it is no co- of a pipeline gas supply from Sakhalin I to Japan until 2013-14. Thus, it
incidence that Sakhalin I began to is no co-incidence that Sakhalin I began to float the idea of gas supply to
float the idea of gas supply to the the north-eastern provinces of China soon after SEIC’s LNG deal with
north-eastern provinces of China the Japanese utilities. The idea of a gas supply to China was 27 JSPC is
soon after SEIC’s LNG deal with composed of Japex 45%, Itochu 23.1%, Marubeni-Itochu Steel Inc.
the Japanese utilities. 18.7%, and Marubeni Corp 13.2% and was the operator in efforts to
develop the FS.28 Russian Petroleum Investor, Nov/Dec 2002.
On June 10, 2004, it was announced that the Sakhalin-1 Project signed
Letters of Intent to sell natural gas from Sakhalin offshore fields with
two buyers in Khabarovsk Krai, Russia. According to the operator for
the Project, Exxon Neftegas Limited (ENL), the Sakhalin-1 Participants

will endeavor to begin gas deliveries to OAO

Khabarovskenergo and OAO Khabarovskkraigas as early as the
start of the 2005-2006 heating season. Gas sales to buyers in
Khabarovsk Krai could grow to up to 3 billion cubic meters of gas per
Gas sales to buyers in year by 2009. See, http://www.sakhalin1.com/en/index.htm & Interfax
Khabarovsk Krai could grow to Petroleum Report, June 10-16, 2004. Author interviewed a number of
up to 3 billion cubic meters of gas Russian specialists and the suggested price hovers $60-65 plus VAT.
per year by 2009. Pipeline Gas Introduction to the Korean Peninsula Page 19 Dr Keun-
Wook Paik (January 2005) originally promoted by Rosneft, a
shareholder in the Sakhalin I project.
The Sakhalin I consortium plans to resume the talk with the Chinese,
which were halted in 2002 over disagreements on the gas price
The government of President

Moo-Hyun Roh has shown a
serious interest in the option of a
Sakhalin gas supply to the Korean
Peninsula by pipeline via North
Korea.
The government of President Moo-Hyun Roh has shown a serious
interest in the option of a Sakhalin gas supply to the Korean Peninsula
by pipeline via North Korea. The socalled ‘peace pipeline’ is also
supported by the United Nations. Compared with the Kovykta gas
project, the Sakhalin pipeline gas project is far behind in terms of a
feasibility study and marketing, despite Sakhalin II’s LNG scheme being
well advanced. Even if a political breakthrough is made with

regard to the DPRK nuclear crisis, special efforts will be required

to move the Sakhalin gas project to the same level of preparation as the
Kovykta gas project. In a recent seminar held in Seoul, the Russian
In the wake of the collapse of the government confirmed that the following pipeline gas supply options are
Cold War era, the energy being reviewed:
relationships among the countries
in Northeast Asian region have • Sakhalin offshore gas to South Korea and Chayandagas to
changed significantly. Northeast China
• Sakhalin offshore gas to both China and South Korea
• Kovykta gas and Chayandagas to Northeast China and South

Korea
The details of these options will be reviewed by Russia’s Ministry of

Industry and Energy and Gazprom until February 2005, and the
development plan of Unified Gas Supply System in East Siberia and
Russia’s Far East will be finalised in Spring 2005.32
1.2. North and South Korea’s approach to pipeline gas development
1.2.1. South Korea’s initiative
In the wake of the collapse of the Cold War era, the energy relationships
among the countries in Northeast Asian region have changed
significantly. Based on the Northern Policy adopted by the Ro Tae-Woo
government, South Korea established diplomatic relationships with the
Former Soviet Union (FSU) in September 1990, and with China in
August 1992 respectively. This altered political environment opened the
door for South Korea to consider the options of energy cooperation with
Korea’s interest in a trans- these two countries.
national pipeline gas dates back
to the late 1980s when Hyundai Korea’s interest in a trans-national pipeline gas dates back to the late
Group founder Jung Ju-Young 1980s when Hyundai Group founder Jung Ju-Young began to explore
began to explore the possibility of the possibility of Sakha gas development and a gas pipeline to the
Sakha gas development and a gas Korean Peninsula. In July 1992, a Korean consortium led by Korea
pipeline to the Korean Peninsula. Petroleum Development Corporation (PEDCO, now Korea National Oil
Corp: KNOC) was established, and Daewoo Corp became the driving

force from the private sector in pursuing this Russian gas

import project.
In November 1994, a preliminary feasibility study between Korea, Sakha

Republic and Russia, was signed. The 12 month study cost $20m,
consisting of $10m in the form of data provision from Russia and a
$10m cash payment from Korea. The route was as follows – Gas fields
in south-western part of Sakha Republic - Yakutsk - Tynda -
Blagoveshensk - Khabarovsk - Vladivostok - DPRK – ROK, a 5,143km
length, of which the Russian section was 4,383km.
It is worth noting that in 1995, there were only five gas fields with over
100bcm (C1 reserves) in Sakha Republic. At that time,
Chayandinskoye’s proven reserves were only 209.5bcm, and
Chayandagas was the biggest gas field. It can be compared with the
Tarim Basin’s Kela-2 field, with only around 250bcm proven reserves,
which supplies China’s 4,000km west-east pipeline. However,
Chayandinskoye’s reserves significantly increased to 755bcm in 1997
and eventually to 1240bcm in 2002.
In December 1995 the study was completed and, due to the poor
economics of the long distance pipeline development, the verdict was
not positive. No further steps were taken.
While KNOC failed to take further steps for pipeline gas development,
Kogas saw pipeline gas imports as an opportunity to expand its business
domain. Since Irkutsk Oblast had asked Korean companies to develop its
giant gas field in 1994, Kogas decided to take an initiative towards
Irkutsk region’s Kovyktinskoye gas field development. A Korean
Consortium composed of Kogas, PEDCO, Kohap, Halla, LG,Hyosung,

.
Daewoo, and Yukong (which joined in April 1996 and the
company name changed as SK) was established in mid-1995. Prior
to this consortium, both Halla and Kohap were competing with each
other to take the initiative for the Kovyktinskoye gas project.
It was the Hanbo group that had

made the initial running for this
giant gas project. In early 1996,
the Hanbo group (later declared
bankrupt due to the financial
strain from its ambitious steel
plant building) set up the East
Asia Gas Company (EAGC) as its
sole subsidiary, with an initial
capital of $12m, to act as a
vehicle for its participation in
Irkutsk region gas development.
In July 1996, EAGC announced

that the Hanbo group had bought
27.5% of equity of Russia It was the Hanbo group that had made the initial running for this giant
Petroleum having exploration and gas project. In early 1996, the Hanbo group (later declared bankrupt due
development license in to the financial strain from its ambitious steel plant building) set up the
Kovyktinskoye and East Asia Gas Company (EAGC) as its sole subsidiary, with an initial
Verkhnechonskoye gas and oil capital of $12m, to act as a vehicle for its participation in Irkutsk region
fields in Irkutsk region gas development. In July 1996, EAGC announced that the Hanbo group
had bought 27.5% of equity of Russia Petroleum having exploration and
development license in Kovyktinskoye and Verkhnechonskoye gas and
oil fields in Irkutsk region. A total of $44m, of which $25m was for the
27.5% equity stake and $19m for a three year loan to Sidanco, was
invested.

Due to Hanbo group’s bankruptcy in early 1997, EAGC had

difficulty in keeping the 27.5% equity stake. Consequently, the
20% was re-sold to Sidanco in November 1997 when BP decided
to invest $571m in Sidanco.
• Kogas believed that the Korean gas market, with a capacity of

10 bcm pipeline gas import, would provide significant leverage
at negotiations with Russian gas producers. The possibility of
10bcm gas market provision in the early stage of this trans-
national pipeline development was the key point, and CNPC was
respecting Kogas position as the gas market provider. It would
have been ideal if the Kogas consortium and EAGC made a
compromise by joining forces, but the opportunity was missed;
Due to Hanbo group’s
bankruptcy in early 1997, EAGC • The Kogas consortium was slow to grasp the importance of
had difficulty in keeping the securing an equity position in the giant Kovyktinskoye field as
27.5% equity stake. the consortium was suspicious of the real scale of the field’s
Consequently, the 20% was re- proven gas reserves. Now it is clear that Kovyktinskoye gas
sold to Sidanco in November field’s reserves are large enough to satisfy not only the Irktusk
1997 when BP decided to invest region itself but also both China and Korea’s gas demand;
$571m in Sidanco.
• The Kogas consortium was reluctant to admit that EAGC’s
initiative was correct. When EAGC announced its equity
positioning in Russia Petroleum, the Kogas consortium, together
with the Ministry of Trade, Industry and Energy (MOTIE),
lobbied strongly against approval being given. Kogas had
virtually no experience in upstream business, and they argued
that importing pipeline gas is solely a downstream business. This
only confirms that at that time Kogas consortium did not have a
clear picture of its equity positioning in the upstream sector in the
major transnational pipeline development. Kogas consortium’s
preference was to pursue the feasibility study first and to make a
decision later. In 1998, a Japanese consortium led by Japan
National Petroleum Corp (JNPC) and Sumitomo Corp took an
initiative by proposing a five country feasibility study on a
pipeline connecting the Kovykta gas field with China, Korea and
Japan via Mongolia.

However, due to the failure to reach consensus, negotiations

collapsed at the end of 1998. Neither the PRC authorities nor BP
took the role of Japan as a coordinator of the study seriously since Japan
was not offering any gas market for the development. In other words,
Neither the PRC authorities nor two important players in the negotiations did not see the necessity for
BP took the role of Japan as a accepting the Japanese consortium’s(led by Sumitomo Corp and JNOC
coordinator of the study seriously Corp) proposal to protect their carried interest in the project. A unique
since Japan was not offering any opportunity to start a five-country project in Northeast Asia was missed.
gas market for the development.
In other words, two important The collapse of the negotiations in 1998 meant that the region had little
players in the negotiations did not choice but to return to the formula of Sino-Russian cooperation. Without
see the necessity for accepting the Korea’s participation, it would have been a bilateral project. In May
Japanese consortium’s(led by 1999, Korea expressed its interest in the Sino- Russian feasibility study
Sumitomo Corp and JNOC Corp) on the Kovykta gas project, and its participation laid the ground for a
proposal to protect their carried trilateral project.
interest in the project.
In November 2000, Kogas, CNPC and Russia Petroleum signed an
agreement for a full feasibility study on Kovykta gas development. In
January 2001, the Kogas Consortium was restructured, from seven to
nine members.Dr Keun-Wook Paik (January 2005) present, Gazprom’s
A breakthrough of Kovykta gas stance towards the project and the border price issue are the two major
project can be made if stumbling blocks for the project.
governmental approval is given
by the Chinese and Korean A breakthrough of Kovykta gas project can be made if governmental
governments in 2005, and this approval is given by the Chinese and Korean governments in 2005, and
looks realistic due to the this looks realistic due to the changing political environment. Even
changing political environment. though Roh Moo-Hyun government has paid special attention to
Sakhalin pipeline gas option for the settlement of the DPRK nuclear
crisis during the first two years of his presidency, the US administration
did not show its serious interest in accepting the formula of DPRK’s
disposal of nuclear in return for economic and energy aid. The US
administration’s rigid stance towards DPRK regime has prevented
progress on the Sakhalin pipeline. This situation is forcing the Roh Moo-
Hyun government to reconsider the Kovykta gas option despite
Gazprom’s UGSS (Unified Gas Supply System) plan.

If South Korea’s commitment to the Kovykta gas project were to

be made without delay, it could lead to an introduction of Russia-China-
Korea energy alliance. The issue of energy supply to DPRK can be
solved by a sideline pipeline from Dandong to DMZ via Pyongyang with
Korea’s Ministry of Commerce, a capacity of 1.5 bcm per year, and this compromise would also solve
Industry Energy (MOCIE) the problem of energy supply security once and for all.
decided to allow Korea Electric
Power Corp (KEPCO) to pursue Korea’s Ministry of Commerce, Industry Energy (MOCIE) decided to
its own 5.7 mt/y of LNG supply allow Korea Electric Power Corp (KEPCO) to pursue its own 5.7 mt/y of
contract in November 2004. LNG supply contract in November 2004. Assuming KEPCO pursue this
Assuming KEPCO pursue this 5.7 5.7 mt/y separately, there will be a real difficulty in finding a sizable gas
mt/y separately, there will be a market in South Korea. The Russian government has been very slow to
real difficulty in finding a sizable understand this situation, and it remains to be seen how quickly the
gas market in South Korea. Russian authority will take steps to save this gas market in South Korea.
If a quick response is made, it may still be possible to introduce pipeline
gas to both China and Korea by around 2010-2012. If not, another ten
years delay from 2010 will be inevitable. 37 UN’s Working Group on
Energy for DPRK has been evaluating these pipeline introduction
options. The group was established and is chaired by Mr. Maurice
At present, the DPRK authorities Strong, Special Envoy to Secretary General of the United Nations to
are not willing to change their DPRK. 38 China Daily, January, 1, 2005. 39 Nihon Keisai Shimbun,
stance towards the KEDO project Dec 14th, 2004.
and to accept the pipeline gas
option.
1.2.2. The DPRK’s stance towards pipeline gas
The DPRK authorities have shown reluctance to express any interest

towards the idea of pipeline gas despite the fact that they have been
studying the import option since the mid-1990s.
It took a while for DPRK authority to understand that the KEDO project,
which aims at producing 2000 MW capacity electricity, cannot be
completed without the transmission line development.
At present, the DPRK authorities are not willing to change their stance
towards the KEDO project and to accept the pipeline gas option.

However it is likely that they will take the pipeline gas option
seriously once the nuclear crisis has been permanently settled.
Assuming that 1.5bcm/year of The scale of benefit in terms of DPRK’s economic development from
natural gas would be allocated to the introduction of a long distance gas pipeline passing through its
the DPRK as a transit fee plus territory will be very different from that of the KEDO project. Assuming
subsidy, pipeline gas would that 1.5bcm/year of natural gas would be allocated to the DPRK as a
deliver at least a minimum level transit fee plus subsidy, pipeline gas would deliver at least a minimum
of gas and power to a number of level of gas and power to a number of major cities. Unlike the KEDO
major cities. project, which did not allow any role for both Russia and China, this
pipeline project envisages a major role for both countries. To observe the
progress of trans-national natural gas pipeline projects in Northeast Asia,
the DPRK established a Natural Gas Research Society, DPR Korea
(NGRS DPRK), under the leadership of DPRK’s Asia Pacific Peace
Committee in 1998. NGRS DPRK has sent its delegate to the 1998
Ulaan Baator (4th) and 1999 Yakutsk (5th) Northeast Asian Gas &
Pipeline Forum conferences.

In February 2001 Kogas announced a joint study on pipeline gas,

and in September 2001 South Korea announced that it had reached
Later however, Kogas argued a preliminary agreement with the DPRK on a joint feasibility study
that the firm’s work on the DPRK for a pipeline passing through DPRK territory. Later however,
section could not progress since Kogas argued that the firm’s work on the DPRK section could not
the DPRK authorities had progress since the DPRK authorities had demanded Kogas’s preliminary
demanded Kogas’s preliminary commitment that the pipeline would pass through DPRK territory.
commitment that the pipeline Kogas could not take any further step due to this condition.
would pass through DPRK
territory. Kogas could not take
any further step due to this MOU with a Dutch Consortium
condition.
On April 6, 2001, the NGRS DPRK signed an unpublished 18 point
MOU with a consortium of three Dutch trading companies (HS
International Trading, Tamalone International, and Boscalis
International). The MOU gave the consortium exclusive rights to build
the North Korean portion of the pipeline from the Russian border to the
South Korean border. DPRK expected that the Dutch consortium would
act as an intermediary in promoting the pipeline project with
ExxonMobil, Japanese companies, and South Korean gas officials.
The MOU envisaged the construction of three gas-fired power stations

The agreement gave FSI Energy along the pipeline route with a total capacity of 500 MW (2 units of 200
exclusive transit rights with MW + 1 unit of 100 MW).40
regard to the pipeline from
Northern Sakhalin to the Korean Agreement: KoRus Project41
Peninsula. Under this agreement,
FSI Energy needed to identify the On 3 August 2002, FSI Energy signed an agreement with Chairman
source of natural gas supply by 1 Kyung-Bong Kim, NGRS DPRK. The agreement gave FSI Energy
June 2003. exclusive transit rights with regard to the pipeline from Northern
Sakhalin to the Korean Peninsula. Under this agreement, FSI Energy
needed to identify the source of natural gas supply by 1 June 2003. FSI
Energy was seeking the support of Congressman Curt Weldon
(Republican, Pennsylvania), chairman of the House Armed Services
Committee. A Korea’s Weekly Sisa Journal has reported on this project
comprehensively : 42 FSI Energy is the driving force behind the KoRus
pipeline project which aims at supplying Sakhalin gas to North and
South Korea by pipeline. In late May 2002, a US delegation composed
of 12 congressman and led by Congressman Weldon planned to visit
Pyongyang but the DPRK authorities refused to issue visas. On August
3rd, 2002, according to Dr. Roy Kim’s interview with the Sisa Journal,

FSI Energy signed a twelve clause-agreement with DRPK

Natural Gas Research Society (led by Prof. Kyung-Bong Kim,
former head of DPRK Academy of Science) with regard to the
The story claimed that US exclusive right of pipeline construction development for the
Department of Energy secretary DPRK section. This agreement is conditional on gas supply source
Abraham had helped the securing until June 1st 2003 and approval from both governments. The
introduction of US DOE officer to story claimed that US Department of Energy secretary Abraham had
review the project, and FSI helped the introduction of US DOE officer to review the project, and FSI
Energy had applied for a $10m Energy had applied for a $10m grant for the feasibility work.This KoRus
grant for the feasibility work.This project was officially presented at the KIEP-KEI policy Forum on
KoRus project was officially Northeast Asian Energy Cooperation conference held in Washington
presented at the KIEP-KEI policy D.C. on 7 January 2003.
Forum on Northeast Asian
Energy Cooperation conference However, the project was not taken seriously by major institutions in the
held in Washington D.C. on 7 United States and South Korea. The KoRus project failed to identify and
January 2003. secure the gas supply until 1 June 1 2003. The project has no supply
source and as a result cannot be implemented. Both the 2001 MOU and
2002 agreement indirectly confirmed that the DPRK authorities were
interested in pipeline gas, but were very ignorant of the pipeline gas
It is worth noting that the North- business. DPRK authorities were not ready to officially discuss the
South Korea dialogue in June issues with Washington and Seoul since this would potentially signal
2000 offered an opportunity for willingness to compromise with respect to the settlement of the KEDO
both Koreas to discuss the project.
pipeline routes from China and
Russia. In early 2001 Kogas It is worth noting that the North-South Korea dialogue in June 2000
proposed that the DPRK offered an opportunity for both Koreas to discuss the pipeline routes
authorities look into the from China and Russia. In early 2001 Kogas proposed that the DPRK
possibility of laying a gas pipeline authorities look into the possibility of laying a gas pipeline from the
from the Kovykta gas field Kovykta gas field through North Korea. The relevant document was sent
through North Korea. to the DPRK government in early February 2001, and a Kogas
delegation led by Jong-Sool Kim, then a senior vice president of Kogas,
visited Pyongyang in September 2001. A proper feasibility study on the
DPRK section was not possible as the DPRK authorities again
demanded that the South Korean government make an advanced
commitment that the pipeline would not bypass the DPRK’s territory, a
demand which could not be accepted.
1.3. The Prospects of Energy cooperation between the two Koreas
South Korea is ideally positioned to help revitalise the sluggish energy

industry in North Korea. As of 2002, South Korea’s GNI scale is over

13 times of that of DPRK (See table 21), and as of 2000, South

Korea’s crude oil import reached 894 million barrels, while
DPRK imported only 2.9 million barrels (See table 22) In terms of
primary energy supply, the ratio between South Korea and DPRK was
only 3.9 in 1990 but this figure became 12.3 in 2000 (See table 23)
Tables 24-26 show that DPRK’s energy supply and consumption
structure could change significantly, with a significant decline of the role
DPRK was contracted to receive of coal, and a big increase in oil and gas. DPRK’s energy situation is
a 0.5mt/y worth of heavy oil until currently extremely dire. Even a relatively small volume of oil supply to
the completion of the KEDO DPRK would make a big difference.
project, based on the 1994
Geneva Agreement. The DPRK DPRK was contracted to receive a 0.5mt/y worth of heavy oil until the
remained at the amount until completion of the KEDO project, based on the 1994 Geneva Agreement.
2002, when the second DPRK The DPRK remained at the amount until 2002, when the second DPRK
nuclear crisis occurred. With this nuclear crisis occurred. With this heavy oil supply, the operation of
heavy oil supply, the operation of Seonbong Thermal Power Plant was possible during the 1990s.
Seonbong Thermal Power Plant
was possible during the 1990s. However, even then, the plant could only be run at 30% capacity.
Currently the power generation volume from this plant stands at
1,700GWh, less than 10% of DPRK’s total power generation volume.
Fully fledged energy cooperation between the two Koreas seems

Fully fledged energy cooperation unlikely until the settlement of the second DPRK nuclear crisis .
between the two Koreas seems Nonetheless, energy cooperation is moving from a remote possibility to
unlikely until the settlement of the a potential reality. Pipeline gas into the Korean peninsula, LNG and LPG
second DPRK nuclear crisis . supply to North Korea, electricity supply from either Russia or South
Korea to North Korea, coal and mineral resources development
cooperation; and joint exploration and development of North Korea’s
offshore oil and gas resources are all potential areas for substantive
cooperation.
Table 26 is the projection made by Korea Energy Economics Institute

for DPRK’s primary energy consumption until 2020. The projection
envisages a significant growth of both oil and gas consumption.



Pipeline gas cooperation
Energy cooperation between South and North Korea is a very

real possibility. Unlike the Kim Dae-Jung government which focused on
East Siberian gas supply and Sakhalin LNG supply to South Korea, the
Roh Moo-Hyun government has shown interest in a Sakhalin pipeline
gas to the Korean peninsula. The ‘gas for peace’ formula has been laid
Energy cooperation between out by National Security Advisor Jong-Il Ra. The FT reported that :
South and North Korea is a very …thermal power stations drawing from Russian gas would provide a
real possibility. peaceful alternative to Pyongyang’s nuclear programme… This is one of
the possibilities we are looking at… Gas could be drawn from either
Irkutsk or Sakhalin. Advisor Ra added that Seoul’s plans for a gas
pipeline were at early stage and had not been discussed in detail with its
allies or North Korea.
Reportedly, during a recent visit to Pyongyang (May 2004), Mr. Strong

met DPRK Military Commission Chairman Jong-Il Kim, and both sides
When the option of Sakhalin gas agreed that the United Nations would study the options of long term
supply to the Korean Peninsula energy and economic aid to DPRK. Mr. Strong made it clear that the
was floated at the beginning of DPRK authorities should provide the UN with economyrelated
2003, there was a very strong information if the DPRK wanted to win UN-led aid, and Chairman Kim
resistance from Kogas, the main unexpectedly agreed to provide this information. Energy specialists for
market provider in South Korea, the UN group will mainly come from Japan and Korea, while the
and the conservative Ministry of economic specialists will come from the United States.Six party member
Commerce, Industry and Energy countries will also be asked to send specialists..45 These reports suggest
(MOCIE). there is a strong chance that the inter-Korean cooperation on pipeline gas
could be a reality.
When the option of Sakhalin gas supply to the Korean Peninsula was
floated at the beginning of 2003, there was a very strong resistance from
Kogas, the main market provider in South Korea, and the conservative
Ministry of Commerce, Industry and Energy (MOCIE). However, the
adoption of a compromise route for Kovykta gas (Kovykta – northern
line – Skovorodino – Heilongjiang and Liaoning province) and the
delivery to Inchon via the Yellow Sea with a separate branch line
constructed from Dandong to DPRK means the branch line development
would not affect the main trunk pipeline development at all.

In April 2004, South Korea’s LPG and LNG supply cooperation

LPG firms decided to supply LPG
to the Kaesung Industrial In South Korea, the completion of a natural gas trunk pipeline network
Complex. Although detailed plans was good news for natural gas expansion, but very bad news for LPG
are not available yet, the project business. The LPG business in South Korea has already reached
is thought likely to handle a saturation stage and urgently needs to find a new market for the
supply of 250 tonnes of LPG per industry’s survival. LPG supply to North Korea offers a very attractive
day, 6,500 tonnes of LPG per opportunity for market development.
month, and envisages a 200-500
tonne storage facility within the In April 2004, South Korea’s LPG firms decided to supply LPG to the
Kaesung Industrial Complex. Kaesung Industrial Complex. Although detailed plans are not available
yet, the project is thought likely to handle a supply of 250 tonnes of LPG
per day, 6,500 tonnes of LPG per month, and envisages a 200-500 tonne
storage facility within the Kaesung Industrial Complex. The LPG
industry projects that LPG sales will initially be 200tonnes per month,
1,000 tonnes per month once the project is on track, and in 2006 the
scale will reach to 4,000 - 6,000 tonnes per month.
It is also worth noting that Kogas explored the possibility of supplying

LNG gas to the Kaesung Industrial Complex much earlier. In August
2001, the Chosun Ilbo reported that Kogas had lobbied to supply 18,000
tonnes of natural gas (5.9 billion Korean won or $4.6m) to North Korea
from the beginning of 2003, gradually increasing the supply up to
0.71mt, worth 210 billion Korean won or $161.5m by 2009. Kogas had
The pipeline development would undertaken a 45 Joong-Ang Ilbo, 19 May, 2004 & June 20, 2004.
have cost in the region of 50-60
billion and Kogas suggested that The pipeline development would have cost in the region of 50-60 billion
some of the funding should come and Kogas suggested that some of the funding should come from the
from the Inter-Korean Inter-Korean Cooperation Fund. According to the feasibility study, the
Cooperation Fund.. best supply network would involve a pipeline connecting the Grand
Unification Bridge in the South with the Kaesong Industrial Complex
across the DMZ. The two Koreas have been promoting the construction
of a large-scale industrial estate in an area contiguous to Kaesong in
their joint efforts to expand inter-Korean economic cooperation.

MOCIE said however, that it had According to the Chosun Ilbo, in July 2001 the South Korean
never reviewed the option of Ministry of Unification gave a green light to Kogas to contact the
supplying natural gas to the DPRK. In the same month the Ministry of Commerce, Industry and
Kaesong Industrial Complex, and Energy (MOCIE) minister Jae-Shik Chang said that the government
that the Kogas’s feasibility work would be able to review the supply of electricity to North Korea if the
would not necessarily be adopted North was positive about inter-Korean economic cooperation. However,
as government policy. This was the minister’s remarks invited criticism from the opposition party (GNP)
carried out by a local engineering and the United States. MOCIE said however, that it had never reviewed
firm. the option of supplying natural gas to the Kaesong Industrial Complex,
and that the Kogas’s feasibility work would not necessarily be adopted
as government policy. This was carried out by a local engineering firm.
This news confirmed that, without a breakthrough in the political

tensions, even LNG supply to the DPRK is not an easy option. At the
beginning of 2003 when the concept of Sakhalin gas supply to the
Korean Peninsula received coverage by the Korean media, both Kogas
and MOCIE floated the concept of LNG supply to DPRK again. Both
argued that a pipeline passing through DPRK territory would not be
acceptable due to concerns over energy-supply security, but that LNG
supply from ROK to the DPRK could be considered.
As a LNG supply option would
require an extension of pipeline As a LNG supply option would require an extension of pipeline from
from South to the North, the LPG South to the North, the LPG option would be somewhat easier to handle.
option would be somewhat easier In the short term perspective, LPG option is easier to be accepted by
to handle. In the short term both North and South.
perspective, LPG option is easier
to be accepted by both North and Electricity supply cooperation
South.
In early April 1999, KEPCO (Korea Electric Power Corp) president
Chang Young–Shik announced that DPRK leader Jong-Il Kim had asked
Hyundai Group founder Ju-Young Chung to build a 100MW capacity
power plant nearby Pyongyang in late October 1998.
Besides this, KEPCO was also planning to pursue another independent

power plant development in a port city Haejoo (Hwanghae Namdo),
once the Haejoo Industrial Complex (HIC) plan was agreed between
Hyundai Group and the DPRK authorities.

Mr Chang added that the state firm was also considering the
option of supplying electricity to HIC by constructing a 80km
After the historic summit meeting power transmission line between Moonsan and Haejoo, rather than
between President Dae-Jung Kim developing an independent power plant in Haejoo After the historic
and Chairman Jong- Il Kim in summit meeting between President Dae-Jung Kim and Chairman Jong-
June 2000, the issue of electricity Il Kim in June 2000, the issue of electricity was officially discussed
was officially discussed during during the 4th ministerial meeting held in Pyongyang. In this meeting,
the 4th ministerial meeting held in the DPRK authorities asked ROK to provide them with 2,000MW worth
Pyongyang. of electricity, of which the immediate provision of 500MW electricity
was given priority.
• In October 2001 a memorandum was signed between

Vostokenergo and a DPRK delegation led by Power and Coal
Industry deputy minister Nam-Chil Park in Khabarovsk, after
discussions over Russian electricity supply to the DPRK (based
on available electricity (2-4%) from Primorskii Krai. Both parties
also agreed to have a second DPRK-Russia working level
meeting in Vladivostok to discuss technical issues, such as the
development of a transmission line between Khasan and the
In this meeting, the DPRK DPRK, voltage conversion facility construction, and the
authorities asked ROK to provide electricity supply volume and price.
them with 2,000MW worth of
electricity, of which the • In February 2002, Chairman Jong-Il Kim asked about Russia’s
immediate provision of 500MW electricity supply to DPRK during his meeting with the Russian
electricity was given priority. Ambassador and then RFE region’s presidential representative
(plenipotentiary) Constatin Fulikovsky when the later visited
DPRK. Following this, Power and Coal Industry Minister Tae-
Rok Shin met Vostokenergo director general Victor Minakov’s
deputy to discuss the signing of an 49 Joong-Ang Ilno, Decemebr
19, 2000. 52 In July 2000, when President Putin visited
Pyongyang, the DPRK-Russia Economic Cooperation Co-
operation Committee discussed energy co-operation.

In September 2000, Power & Coal Industry Minister Tae-

Rok Shin visited Russia and discussed the related projects. In August
2001 when Chairman Jong-Il Kim visited Russia, the countries
adopted a Moscow Declaration including the refurbishment of
DPRK’s thermal power plants and officially announced power sector
co-operation between the two countries. In August 2002, the third
summit between Chairman Jong-Il Kim and President Putin was held
In August 2002, the third in Vladivostok. Chairman Kim asked Russia to supply electricity.
summit between Chairman Both leaders also discussed the issue of nuclear power plant
Jong-Il Kim and President development in the border area of DRPK and Russia and the joint
Putin was held in Vladivostok. use of the electricity.
Chairman Kim asked Russia
to supply electricity.
• In April 2002, DPRK Cabinet Deputy Premier Chang-Deok Cho
visited Russia and proposed the exchange of 400MW scale
Both leaders also discussed electricity in return for joint logging and construction manpower
the issue of nuclear power provision. He also discussed a power transmission line project
plant development in the linking southern Primorskii region with the DRPK.
border area of DRPK and
Russia and the joint use of the
electricity. • In September 2002, a memorandum among ACE Engineering Inc
(S. Korea), Korea National Energy Committee (DPRK), and
Vostokenergo and Energy System Institute (Russia) was signed
for the preliminary FS on Northeast Asian region’s Electric
Power Interconnection.
The concept of electricity supply from Primorskii Krai to the DPRK is

as follows:
The basic concept is Russia – DPRK Interconnection line

Development
• Section: Vladivostok – Khasan – Chongjin
• Transmission line capacity: AC 500 KV
• Length: 375 km
• Power Generation Installation Capacity: 500 MW & 3.0 billion
KWh
• Capital Cost: $130-150m

Both Primorskii Krai Administration and DPRK authority are anxious to

initiate this project development, but both parties do not have the
financing source. On top of this pilot project, there is also a relatively big
project - the so-called Podkovalnikov commissioned study
On top of this pilot project, there which covers the inter-connection of Amur & Khabarovsk –
is also a relatively big project - Primorskii – DPRK and ROK. Transporting surplus electricity
the so-called Podkovalnikov from Russia requires a large amount of investment, and the
commissioned study which covers DPRK authorities are expecting the ROK to take part in the
the inter-connection of Amur & project.
Khabarovsk – Primorskii – DPRK
and ROK. It is not surprising that Korea Energy National Committee Secretary
General Park Seong-Hee argued during the Northeast Asia Power
Network Connection Symposium held in Seoul in May 2004 that “the
power network connection project among the six countries in Northeast
Asian region should move to the implementation stage, and the project
will not only help to ease the energy shortage problem but will also
realise cooperation among the states in the region”.
He added that “the above mentioned Russia-DPRK interconnection

The core problem facing this project reached the implementation stage”.55 The core problem facing
power project lies in the this power project lies in the financing. Who is going to finance it? The
financing. Who is going to DPRK authorities may expect South Korea to be the main financier, but
finance it? The DPRK authorities this will be difficult to achieve until a breakthrough in the North and
may expect South Korea to be the South relationship is made. It is worth noting that in early December
main financier, but this will be 2004 both the North and South authority agreed that the method of
difficult to achieve until a electricity supply to Kaesung Industrial Complex. Korea Electric Power
breakthrough in the North and Corp has already completed the site investigation and expects to supply
South relationship is made. the electricity from late January 2005. The initial scale of power supply
will be 15 MW but it will increase to 100 MW by 2007.
Coal and mineral resource development cooperation
In 2003, South Korea’s Mining Promotion Corporation and North

Korea’s Samcheoli Company agreed a joint investment In the
development of graphite deposits in Jeongchon, Hwanghae South
Province in DPRK. At present, the two sides are also planning to pursue
joint development of iron ore deposits in Moosan, Hamkyung North
Province, gold deposits in Woonsan, Pyongan North Province, and
Bookboo coal deposits in Eundeok, Hamkyung North Province. A total

of eight private companies from South Korea are interested in

taking part, due to the large deposits in place.
Coal is a main energy source in For example, the proven reserves of iron ore in Moosan are estimated to
the DPRK and its important role be 1bn tonnes (the projected production capacity is 8mt per year), and
is unlikely to change in the the proven reserves of gold in Woonsan are 1,000tonnes. Coal is a main
foreseeable future. In the DPRK, energy source in the DPRK and its important role is unlikely to change
there are quite significant coal in the foreseeable future. In the DPRK, there are quite significant coal
reserves but the quality of coal is reserves but the quality of coal is not high. This is the reason why less
not high. than 40% of coal production is allocated for power generation and the
steel sector. DPRK’s coal production was 37.5mt in 1985 but production
declined to as low as 18.6mt in 1998, even though the figure rose to
23.1mt in 2001. The production level could significantly increase if a
new investment is made. Currently domestic coal supplies almost 90%
of fuel for industry, 45% of energy for power generation, and 80% of the
energy for household usage.
Crude oil exploration cooperation
Until the early 1990s, the DPRK used to receive 2 mt/y of crude oil from
the FSU and China but this decreased to well below 1mt/y during the
second half of 1990s. This was due to the fact that crude imports from
Until the early 1990s, the DPRK the FSU were completely suspended and China cut its supply to only one
used to receive 2 mt/y of crude oil third of the amount it provided during the 1980s. From the DPRK
from the FSU and China but this government’s viewpoint, the way to solve the energy shortage was to
decreased to well below 1mt/y make an oil 56 Yonhap News, 3 December, 2004.
during the second half of 1990s.
This was due to the fact that On 19 May 2004 a Korean newspaper, Dong-Ah, reported that the
crude imports from the FSU were DPRK’s Oil Industry Ministry has asked the Korea National Oil
completely suspended and China Corporation to take part in an oil and gas exploration project off North
cut its supply to only one third of Korea’s west coast.
the amount it provided during the
1980s. The US Energy Information Administration said “West Korea Bay is
geological analogous to China’s Bohai Bay”. There could be a chance to
make a discovery if a comprehensive exploration is done in the West
Korea Bay. North Korean sources give this site the potential of Nampo 5
to 40bn barrels of oil, but this is considered a highly speculative
judgement.

1.3. The implications of energy cooperation between the two

A string of six party meetings Koreas
have been held in Beijing in an
attempt to resolve the crisis Real progress in energy cooperation between the two Koreas depends
peacefully. upon the resolution of the second nuclear crisis. No party in the region is
interested in being involved or witnessing another military confrontation.
Even the DPRK authorities say that that they are willing to give up their
nuclear programme as long their security is guaranteed. A string of six
party meetings have been held in Beijing in an attempt to resolve the
crisis peacefully. If a breakthrough is made after the 2004 presidential
election in the United States, the energy supply issue will be at the centre
of any economic aid package to the DPRK. Energy cooperation between
the two Koreas could then reach a significant level. Energy cooperation
is not an issue confined to the two Koreas, however, but extends to all
parties in the Northeast Asian region. A successful settlement of the
If a breakthrough is made after crisis will open the door for the systematic development of energy
the 2004 presidential election in infrastructure not only in DPRK but also in Northeast Asia, cooperation
the United States, the energy leading to a Northeast Asian Energy Community.
supply issue will be at the centre
of any economic aid package to
the DPRK. Energy cooperation
between the two Koreas could
then reach a significant level.

According to IEA’s World Energy Investment Outlook 2003, the

projected investment in Russia and China’s energy sector will
reach to $1,050bn (of which $328bn is for oil and $332bn is for gas) and
$2,253bn (of which $119bn is for oil and $98bn is for gas) respectively
until 2030. Massive investment is needed to develop this type of energy
In Russia, the development of oil infrastructure development. In China the development of a nation-wide
and gas fields in East Siberia and pipeline network prepared by CNPC, and coastal pipeline network being
Far East region and the related planned by CNOOC, and a number of LNG terminals in the coastal areas
trunk oil and gas pipelines will will be the beneficiaries of these major investment. In Russia, the
require the big scale financing. development of oil and gas fields in East Siberia and Far East region and
the related trunk oil and gas pipelines will require the big scale
financing. Korean Peninsula is very well located to have an extension of
the major oil and gas pipeline infrastructure from Russia and China to be
extended once the political settlement of current DPRK nuclear crisis
In Northeast Asia, however, there opens the door for an active energy cooperation between North and
is no regional co-operative South Korea.
framework that could protect the
large scale of investment. Most of In Northeast Asia, however, there is no regional co-operative framework
the cross-border energy trade and that could protect the large scale of investment. Most of the cross-border
investment projects inevitably energy trade and investment projects inevitably incur the problem of
incur the problem of incompatibility between the laws and regulations among nations and
incompatibility between the laws different investment environments. Negotiations for cross border energy
and regulations among nations trade often means a long process of co-ordination between producers,
and different investment transit countries, consumers, investors, central and local governments,
environments. Negotiations for etc. This is why Northeast Asian region really needs to introduce
cross border energy trade often regional co-operative framework. Multilateral cooperation in Northeast
means a long process of co- Asia is not a remote possibility but will be a reality in the foreseeable
ordination between producers, future.
transit countries, consumers,
investors, central and local Reprinted with the permission of the Royal Institute of International Affairs (Chatham
governments, etc. House
About the Author:

Dr. Keun-Wook Paik as an Associate Fellow at the Sustainable Development
Programme Royal Institute of International Affairs (Chatham House).
Endnotes:
1 Energy Research Institute of the Russian Academy of Sciences and Institute of
Energy Economics, Japan, Study on Comprehensive Energy Plan in East Siberia and
Far East of the Russian Federation: Second Phase Executive Summary, September
1995.

2 These two fields are located between Kovyktinskoye and Verkhnechonskoye

fields.
3 Keun-Wook Paik, ‘Energy Cooperation in Sino-Russian Relations: The Importance

of Oil and Gas’, The Pacific Review, vol. 9, no. 1 (1996), pp. 77-95.
4 Keun-Wook Paik, ‘Sino-Russian Oil and Gas Cooperative Relationship: Implications

for Economic Development in Northeast Asia’, presented at Northeast Asia Co-
operation Dialogue XIII: Infrastructure and Economic Development Workshop’,
organised by Institute for Far Eastern Affairs, Russian Academy of Sciences, and
Institute on Global Conflict and Co-operation, University of California, Moscow,
October 4, 2002.
5 Some work had been done before 1994 when the memorandum was created for the
development of East Siberian gas development between CNPC and Mintopenergo (the
Russian Ministry of Fuel and Energy). In 1991 Baikalekogaz consortium and
BP/Statoil alliance conducted a study on East Siberian oil and gas resources in East
Siberia in the early 1990s, but BP/Statoil concluded that the study had no incentive for
taking further steps, due to the lack of immediate market for East Siberian oil and gas
export. In 1992 the Baikalekogaz consortium was converted into Russia Petroleum.
The same year Canada’s SNC and Lavalin, under the sponsorship of Canadian Bitech
Corp., carried out a pilot feasibility study on the Irkutsk region’s gas supply project
based on Kovyktinskoye development.
6 Alastair Ferguson, ‘Kovykta Project’ presented at an International Seminar on

Policies and Strategies toward Korea-Russia Energy Co-operation organised by Korea
Energy Economics Institute, Vladivostok, October 7, 2003.
7 Whatever suggested or reported, author’s view is that Gazprom aims at securing a

blocking stake, that is 25% plus one share eventually.
8 Interfax Petroleum Report, June 3-9, 2004.
9 Alexey B. Miller, ‘Eurosian Direction of the Russia’s Gas Strategy’ presented at

22nd World Gas Conference.
10 Gazprom could, for instance, buy shares in Russia Petroleum from the regional
government and Interros, which own respectively 10.78% and 25.82% of the company.
Interfax Petroleum Report, April 16-22, 2004.
11 Dow Jones China Energy Report, April 23rd 2004.
12 Moscow Times, Nov 29, 2004.
13 Alexey M. Mastepanov and Victor P. Timoshilov, ‘Perspectives of Development of

Eurasian Gas Pipeline System and Energy Resources of Northeast Asia: Gazprom’s
Point of View’, presented at International Conference on Northeast Asian Natural Gas

and Pipeline : Multilateral Co-operation, organised by Northeast Asian Gas

and Pipeline Forum, and Asia Gas & Pipeline Co-operation Research
Center of China, Shanghai, March 8-10, 2004. Pipeline Gas Introduction to
the Korean Peninsula Page 9 Dr Keun-Wook Paik (January 2005)
14 At a parliamentary hearing in late September 2003, Kogas president Kang-Hyun Oh

said that the cost of pipeline gas passing through the DPRK would be 1.8 times more
expensive than that of the Yellow Sea line, assuming the gas supply period was 30
years. He added that the timing of pipeline gas supply could be delayed from 2008 to
2010-2013. ‘The Gas Industry News’, 30 September 2003.
15 Dong-Ah Ilbo, 5 August, 2004. Interestingly, the route that would bypass China is
strongly supported by Prof. Tai-Yoo Kim, former advisor to the president. In fact he
highlighted this point in the Korea Leader’s Forum on ‘Next Generation Growth Drive
and Energy, What is the issue?’, held in Seoul on July 15, 2004. See, Choong-Ang Ilbo,
July 16, 2004.
16 Hoyos, Carola and McGregor, Richard, ‘PetroChina ends talks on pipeline’

Financial Times, 4August, 2004.
17 In fact, the Russian side indicated that it was prepared to see gas for US$ 75 / 1000
cm as minimum. See Russian Petroleum Investor, March 2003, P. 52. Pipeline Gas
Introduction to the Korean Peninsula Page 10 Dr Keun-Wook Paik (January 2005) The
real pressure on the price comes from the Guangdong and Fujian LNG price secured by
China in August 2002, a breakdown of which are shown in tables 6 and 7. CNOOC
initially projected that China would pay an LNG price of $3.84/mmbtu. However, this
figure is over $1.0/mmbtu higher than the price agreed for Tangguh in Indonesia.
According to interviews with industry and financial sector specialists, the LNG price
delivered to China will be as low as $2.5/mmbtu; even after regasification.
18 ABARE Economics and ERI’s joint research report pointed out the average real
LNG import price to Japan over the period 1995-2001 ranged from $3.27 to
$4.84/mmbtu, in 2001 prices. The average price over the period was $4.02/mmbtu. The
report also argued that LNG import prices to eastern coastal China could be marginally
($0.10/mmbtu) lower than those to Japan. (See, ABARE Economics and Energy
Research institute, Natural gas in eastern China: The role of LNG, ABARE Research
Report 03.1, p. 7). It remains to be seen whether this projection is accurate. Pipeline
Gas Introduction to the Korean Peninsula Page 11 Dr Keun-Wook Paik (January 2005)
the scale of discount from the SEIL project is not as considerable as the discount for
Australia’s Northwest Shelf and Indonesia’s Tangguh project for the Guangdong and
Fujian LNG price.
19This work started based on the agreement signed between CNPC and Sakhaneftegas
in April 1999, soon after the Feb 1999 agreement. Pipeline Gas Introduction to the
Korean Peninsula Page 14 Dr Keun-Wook Paik (January 2005) the Kovykta project
and became a dominant player in the solely Russian Federation government asset,
Chayandagas. In February 2003, Gazprom chairman Alexei Miller and Rosneft
president Sergei Bogdanchikov asked President Putin to instruct the Ministry of
Natural Resources and other relevant ministries to consider developing the

Chayandinskoye, Talakanskoye, Sredne-Botuobinskoye, Kovyktinskoye and

Verkhnechonskoye oil and gas fields under a single project and initiate an
auction for it, in accordance with legislation. Putin accepted the proposal.
20 In March 2003, the Russian government held its first cabinet meeting to discuss the
development of oil and gas reserves in Eastern Siberia and the Far East. During this
meeting, the government adopted a draft entitled ‘Programme to Establish a Unified
System of Production, Transportation and Supply of Gas in Eastern Siberia and the Far
East’ which outlined possible exports to markets in China and other countries in the
Asia Pacific region. Besides this, the government also decided to include the
Gazpromdeveloped programme in the draft ‘Principal Provisions of the Energy
Strategy of Russia for the Period until 2020’.
21Interfax reported in early 2004 that the proposals from the state energy firms, in
particular Gazprom, Transneft and Rosneft were being taken very seriously byPresident
Putin.
22In February 2004, Transneft revealed its revised pipeline plan and won the approval
of the Amur region administration, as well as the governments of Khabarovsk and
Primorye. Interestingly, the authors of this revised plan ignored the previous plan of
Angarsk-Nakhodka line which had a branch line to Daqing. Transneft’s Semyon
Vainshtok said it would take a year to draft a new feasibility study of the revised
pipeline project, a further year to design it and about four years to build it. The new
route begins much further west in Taishet and the distance from the pipeline to Lake
Baikal has been doubled. Transneft is no longer considering routes that would send the
pipeline south of Lake Baikal. The new pipeline will be 4,130km long, compared with
3,765km for the Angarsk-Nakhodka pipeline, and will be able to transport 56mt/y of
oil. The project includes the construction of 32 pumping stations, of which 13 will have
oil storage facilities. The route includes 48 river crossings and 115 road and railroad
crossings.
23Besides Transneft’s revised plan, the government of the Sakha Republic (Yakutia)
along with Gazprom, the Natural Resources Ministry, and Surgutneftegaz have drawn
up an alternate route to the Pacific Ocean with oil and gas pipelines in a single corridor.
This route would run from Nizhnyaya Poima (Transneft pipeline system) –
Yurubcheno- Tokhomskoye field-Verkhnechonskoye field-Talakan field-Chayanda
field-Lensk- Olekminsk-Aldan-Neryungri-Tynda-Skovorodino-Blagoveschensk-
Khabarovsk Vladivostok-Nakhodka. Fields like Kovykta, Dulsimininskoye, and
Yaraktinskoye would
20 Russian Petroleum Investor, April 2003. 21 Russian Petroleum Investor, April &
September 2003. 22 Interfax Petroleum Report, March 26 – April 1, 2004. 23 Interfax
Petroleum Report, June 17-23, 2004 ; Russian Petroleum Investor, May 2004. Pipeline
Gas Introduction to the Korean Peninsula Page 15 Dr Keun-Wook Paik (January 2005)
be linked in later. Thus, a single network would include all the major oil and gas fields
in the Yakutia and Irkutsk regions, as well as the Krasnodar territory. The pipeline
would stretch for 6,224km.

24 The project that combines the oil and gas pipelines was submitted to
President Putin at a meeting on the development of Far East transport
infrastructure on February 26th 2004 in Khabarovsk. Putin designated the
pipeline as being of national strategic interest and told Sakha President Vyacheslav
Shtyrov to continue work on the project. President Putin also said that all designs for
the pipeline must be included in the documents to be submitted to the government.
25It is worth noting Gazprom’s intention to develop the Eurasian gas pipeline system.
Prof. Alexey M. Mastepanov, Gazprom argued that “the export of Kovyktinskoye gas
will lead to the temporary closure of the Chayandinksoye gas field for the long-term.
This will complicate the organisation of gas supplies to the Far East region. As a result
the gas fields of Yakutia will lose the market for a long period of time. It will involve a
loss of profits for the Russian state. The Chayandinkoye gas field can satisfy the
prospective demand of China and Korea, and Gazprom proposes to realise this project
starting from 2009-2010”.
26 If this approach is accepted and supported by Russian authorities, then Kovykta gas
export to China and Korea will have no choice but to consider a new route different
from the one adopted by the feasibility study.
27 The study assumed a pipe diameter of 26-28 inch (65-70 cm) and delivery capacity
of 8bcm/y. The distances from Sakhalin I to Tokyo and Niigata are 900 miles (1,400
km) and 700 miles (1,120 km) respectively. The FS concluded the project was
technically and commercially viable.
28However, the Japanese utilities companies decided to back Sakhalin LNG rather than
Sakhalin pipeline gas. A breakthrough was made with Sakhalin II’s LNG exports to
Japan during the first half of 2003. Three firms, Tokyo Gas, Tokyo Electricity and
Kyushu Electricity, agreed to import a total of 2.8mt of LNG from Sakhalin II from
2007. In 2004, SEIC announced that Toho Gas and Tokyo Electricity agreed to import
0.6mt/y of LNG from the Sakhalin Islands (see Table 16).
29 In terms of location, China’s north-eastern provincesare well positioned to be the

beneficiaries of Sakhalin offshore gas development. According to the State Reform and
Development Commission (SDPC), China is also considering importing Sakhalin
offshore gas to the Heilongjiang province during 2011- 2020. China studied the
possibility of Sakhalin gas imports to Heilongjiang, Jilin and Liaoning provinces in the
late 1990s, but the suggested supply volume was not sufficient. During the first half of
2004, the issue was revisited, but this time it was the border price that has blocked the
negotiation. Korea’s interest in Sakhalin gas dates back to early 1994 when the Korean
government and companies considered the possibility of initiating LNG supplies from
the Lunskoye gas field. Since 2000, the Sakhalin Islands authorities have intensified
efforts to secure the LNG export market for Sakhalin II’s 9.6mt/y LNG scheme, but the
administration’s 2005-2006 export timetable was ambitious. The administration was
slow in understanding the difficulty in securing the commitment from the gas buyers.
Sakhalin regional governor Igor Farkhutdinov has repeatedly announced that the
Sakhalin region is interested in supplying gas to Korea, and that this supply could begin
in 2005-2006. Shell, which has a 55% equity stake in Sakhalin Energy, has lobbied

hard to secure an early commitment from the Korean government. Due to the
privatisation drive in Korea’s gas industry, however, Sakhalin Energy
Investment Corp (SEIC) lobbying to penetrate Korea’s gas market has not yet been
successful.
30In August 2004, Kogas announced a 5 mt/y of LNG long term supply bidding and
SEIC’s proposal was included in the short list of the five potential supply sources. Very
recently it was reported that Gazprom agreed to swap the asset for its entry in Sakhalin
2`project.
31 Industry sources are saying that Gazprom would take 25% equity in Sakhalin 2
project and in return Shell would take equity in the Zapolyarnoye oil field, which is
located in west Siberia and is owned by Gazprom. This development would strengthen
the chance of SEIC’s LNG supply contract (1.5 mt/y) with Kogas. 29 FT International
Gas Report, August 1, 2003, p. 14.
30 In November 2000, Mr. Yong-Soo Kang, vice president of Kogas, delivered an

interesting paper at an international conference. He said that “The most possible
candidate in Russian gas project for the Northeast Asian gas market are the Irkutsk
project and the Sakhalin project…..Kogas hopes to carry out the feasibility study on the
Sakhalin project to see how much the Sakhalin project will contribute to the Korean gas
market and to find possible ways to cooperate with each other in the region. Then he
added that for the implementation of Sakhalin Project, two different options can be
considered. One is the pipeline gas option which is to construct the pipeline through
Khabarovsk, Vladivostok, and North Korea, and the other is the LNG option which is
to construct the export terminal in the ice free southern port of the island.The length of
pipeline from Sakhalin to Korean gas market is about 2,300 km and the day ofvoyage
for LNG carrier is about 2.5 days compared with 7 days from Southeast Asian
countries and 15 days from Middle East countries”. Yong-Soo Kang, ‘The Potential to
supply Natural Gas from Sakhalin project to Korean market’ presented at the Fourth
Annual Conference on Sakhalin Oil and Gas organised by IBC Gllobal Conferences
Ltd in London, 20-21 November 2000.
31 Initially Nihon Keizai Report (Nov 27, 2004) covered this story and it was quoted
by the Moscow Times, Nov 29th, 2004.Pipeline Gas Introduction to the Korean
Peninsula Page 20 Dr Keun-Wook Paik (January 2005) However, the management of
the Sakhalin I project has not shown any interest in the option of supplying gas to the
Korean Peninsula by pipeline via North Korea. In addition, the Kovykta gas project
cannot compete with the Sakhalin offshore gas project, as the latter is much more cost-
effective if the sizeable gas markets of South Korea and southern Japan are to be
supplied. In fact the distance from northern Sakhalin to Korea is around 2,700km and
the majority of the Russian section terrain is flat. In terms of price, the Sakhalin
pipeline option could be very competitive against Kovykta project if a sizable gas
market (17 bcm/y) from South Korea and southern Japan were to be offered
simultaneously.
32 The Gas Industry News, December 20, 2004. Pipeline Gas Introduction to the
Korean Peninsula Page 22 Dr Keun-Wook Paik (January 2005)

33In the same year, through its 1995 energy plan, the Korean government
made it clear for the first time that it intended to replace a substantial portion
of LNG imports by long distance pipeline gas, and intended to balance the
ratio between LNG and pipeline gas over the next decade. According to the report
prepared by Kogas for the Korean parliament’s Trade and Industry Committee annual
inspection in October 1997, pipeline gas introduction would take place in 2006 (see
Table 19). At the core of the plan is the fact that the pipeline gas could be supplied to
South Korea at a much cheaper price than LNG.
33 It is China National Petroleum Corp who have taken advantage of what KNOC has
done. In1997, CNPC made a strategic alliance with Sakhaneftegas, and in 2001 a
preliminary FS work on the giant Chayandinskoye was completed.
Pipeline Gas Introduction to the Korean Peninsula Page 23 Dr Keun-Wook Paik
(January 2005) reserves are added and a proper project structure is developed.
34 EAGC kept the remaining 7.5% for and the figure became 8.37% after the 4th
emission during 1998-1999. However, it was diluted in 1999 to 7.1% due to its failure
to join in the 5th emission. It was early in December 2000 that the remaining 7.1% was
sold to BP-Amoco and Tyumen Oil Company (TNK).
35When the Korean press reported of the secret disposal of EAGC shares, the Korean
government admitted that there was nothing the government could do to stop EAGC’s
share disposal. It also argued that it would not affect its plan to join in the Kovykta gas
development project. Kogas consortium did not want to take an equity stake in Russia
Petroleum for the following reasons:
34 Soon after the November 2003 FS work completion, Interros announced that its
25.8% equity in Russia Petroleum is on sales. The estimated cost for the equity is at
least $500 million.
35 Considering that the 12.88% of Irkutskenergo’s Russia Petroleum was sold at over
$40 million in December 2000, the price of EAGC’s 7.1% shares is estimated to be
around $20-30 million.
36 In June 2002, feasibility work was due to be completed but was postponed until
June 2003. A total of $6.0m (of which 50% was supplied by the government, 50% by
Korean consortium) was paid for the Korean portion of the study. Eventually,
feasibility work was completed in November 2003. At 36 The members are Kogas
27.3%, LG Corp. 14.8%, KNOC 14.0%, Hyosung 12.8%, Daewoo Construction 7.7%,
Daesung Industry 6.7%, Hyundai Corp 6.7%, Daewoo International 5.0%, and Hanwha
5.0%.
37 This pipeline gas alliance will be very different from the KEDO formula whose
driving force was US-Japan-Korea alliance, and its implications towards Northeast
Asian region’s power balance will not be small. At the end of 2004, the Russian
Government decided to construct the crude oil pipeline to Nakhodka.

38 Before this official announcement, Transneft asked for priority to be given to the
development of the Taishet-Skovorodino section - 2,000 km at a cost of US$ 6.0
billion, much less than the estimated total cost, US$ 11.5 billion - and to the
development of the Skovorodino-Daqing section.
39 Since the government raised the possibility of a CNPC buy-out of 20% of Yugansk
oil assets, there is a very strong possibility of a parallel crude oil and gas pipeline
towards Skovorodino. The Kovykta gas pipeline can be constructed alongside this
crude oil pipeline, which would save 30% of the pipeline construction cost. However,
the difficulty would lie in the timing of this pipeline development.
40 Selig S. Harrison, ‘Toward Oil and Gas Co-operation in Northeast Asia : New
Opportunities for Reducing Dependence on the Middle East’, Woodrow Wilson
International Center for Schloars, Asia Porgram Special Report No. 106 (December
2002), and author’s interviews.
41 Author was told by a DPRK senior officer that the DPRK government believed the
introduction of pipeline gas from Sakhalin Islands would be possible regardless of a
sizable gas market provision from South Korea. The remarks confirmed that DPRK
authority did not fully understand the fundamentals of natural gas development and
related the gas trading.
42 Sisa Journal, February 6/ 13 & March 13, 2003.
43 If the six party talks finds a way of resolving the security issue, the option for gas
for peace could be a real alternative for the KEDO project. At present both Kogas and
MOCIE are not supportive of the pipeline gas passing through DPRK territory. They
prefer East Siberian gas flowing to north China and then the Yellow Sea to South
Korea, bypassing DPRK territory entirely.
The United Nations is more open-minded to pipeline gas passing through DPRK
territory. In an interview with a Korean newspaper Dong-Ah Ilbo, Mr. Maurice Strong,
special envoy to the Secretary General of the United Nations with regard to the DPRK
issue, said: ‘Energy is a humanitarian issue. DPRK urgently needs energy and it is only
possible with the international community’s support. To tackle the DPRK’s long term
energy shortage problem, Russia’s natural gas could be an option. In particular
Sakhalin gas project is worth taking note of as it can be done with the shortest pipeline
route with a short working period. For this project, an energy specialist group is being
established and feasibility work is being studied.’44 43 Ward, Andrew, ‘Deal for gas
pipeline could solve Korean nuclear crisis’, Financial Times, 31 March, 2003.
44 Dong-Ah Ilbo, 24 Nov, 2003. This remark was reconfirmed by his interview with
NHK on 4 March 2004, that natural gas pipeline to the Korean peninsula passing
through DPRK can be studied assuming that DPRK nuclear crisis would be resolved.
See, JoongA-ng Ilbo, 5 March, 2004.
45 Joong-Ang Ilbo, 19 May, 2004 & June 20, 2004.

46In December 2003, the Korea Energy Economics Institute (KEEI)

published a study on
DPRK’s LPG demand and the potential for LPG cooperation between DPRK
and ROK. The scale of LPG demand under the high growth scenario is predicted to
reach 1.26mt in 2020 and the study confirmed that there is ample space for LPG
development in the DPRK.
47 Meil Kyungje Economic Report (Weekly), October 2001, p. 10.
48 Dong-Ah Ilbo, April 3, 1999.
49 Considering that the cost of a 500MW power plant is around 600-700bn Korean
won (roughly $0.5-0.6 billion), the ROK authorities could not give a positive
response.During the 3rd six party meeting in Beijing in late June 2004, the DPRK
authorities asked for 2,000MW worth of electricity supply in return for the suspension
of their nuclear programme. If the electricity supply is calculated in terms of heavy oil
supply, the volume would reach 2.7mt.
50 The total volume of heavy oil supply to DPRK during 1995 and 2002, based on the
1994 KEDO agreement, was 3.56mt and in money terms, the total cost was $511.3m,
of which $347.5 was covered by the United States.51 Until the political situation has
progressed, it is very difficult to make a positive response to such expensive requests.
The DPRK authorities have also actively explored the option of importing power from
Russia through power transmission lines. Chairman Jong-Il Kim has met President
Putin three times since 2000, and the two leaders discussed power cooperation at each
of these meetings.
51 Of which 0.15mt in 1995, 0.5 mt during 1996/2001 annually, and 0.411 mt in 2002.
Ahn Choong-Young and Lee Chang-Jae, ed., Northeast Asia Economic Co-operation :
First Step towards Unification ( Seoul : Pakyoungsa, 2004), p. 183 (written in Korean)
52 In parallel with the summit meetings between the two leaders, a number of working
level meetings have taken place.
53 In 1997, Kap-Koo Yoon, head of ACE Engineering Inc made the presentation on
‘Peac Network Project’ for the first time during the Autumn Seminar organised by
Korea Electricity Society.
54 Victor Kalashnikov, ‘Electric Power Interconnections in NEA : Perspectives from

the Russian Far East’ presented at an International Workshop on Upgrading and
Integration of Energy Systems in the Korean Peninsula : Energy Scenarios for the DPR
of Korea, organised by Landau Network – Centro Volta, Como, Italy, 19-21 Sep, 2002.
55 Dong-Ah Ilobo, 18 May, 2004. Primorskii Krai governor Darkin confirmed the
export scheme of Russian Far East surplus electricity export to South Korea via North
Korea is almost completed.See, Jong-Ang Ilbo, 5 July, 2004.
56 The project scale is small but it is a very significant development in energy

cooperation between the two Koreas.

57 Meil Kyungje Shinmoon, 29 June, 2004. 58 The share of coal in energy

consumption is electricity generation 39%, household 15%, railway 2%,
metallurgy 8%, industry 33%, and other 3%. Coal production share between
anthracite and brown coal is divided into 80 vs 20 ratio.See, Jong Jin-Chang, ‘Clean
Coal Technology in DPR Korea’, presented at an international workshop on Upgrading
and Integration of Energy Systems in the Korean Peninsula : Energy Scenarios for the
DPRK of Korea, organised by Italian Ministry of Foreign Affairs, Landau Network-
Centro Volta, World Information Service on Energy, and Fondazione Opera Campana
dei Caduti, , Como, 19-21 September, 2002.discovery offshore. Since the 1960s,
Pyongayng authority has made a huge effort to explore its offshore.
58 In the DRPK there are over 100 centrally-controlled mines, of which 70 are
anthracite mines, the remainding 30 being bituminous mines. Besides this, there are
regional based 500 minor mines.
59North Korea achieved its dream of becoming an oil producer in 1998. Even though
the scale of annual crude oil production from the Sook-Cheong County’s Anju Basin is
very small (0.3 mt/y), to the North Korean authorities it is a significant volume.
60 Besides the West Korea Bay exploration, the authorities have initiated the
exploration in Anju Basin by inviting Russian specialists with experience in West
Siberian oil development.The Chosun Ilbo reported that overall supervision of oil
development is being led byDPRK premier Sung-Nam Hong. Under his leadership,
both the Oil Bureau (headed byMr. Jung-Shik Ko) and KOEC (headed by Mr. Jung-
Shik Ko) are responsible for the oilexploration and development.
61In 2000, reportedly both UK’s Soco International and Sweden’s Taurus Petroleum
proposed to Hyundai Corporation and Korea National Oil Corporation (KNOC) to form
a
consortium for oil and gas exploration in the Yellow Sea.
62 Hyundai estimated the Block B and C’s reserves at around 100m – 1bn barrels, the
estimate being based on two discoveries from the ten drilling wells. The firm believed
that the economics of exploration in the west Korean Bay would be justified given a
minimum discovery of 40- 50m barrels worth of reserves. The firm wanted to apply to
the Korean government for exploration rights. No significant step was taken after the
summit. In late August 2002, Singapore-based Sovereign Venture Pte Ltd. announced
that it had found oil and gas reserves from the contracted area in northern Hamkyung
province and expected to be able to recover a minimum of 1tcf of natural gas and 10m
barrels of oil reserves from the concession area.
63In South Korea, KNOC is responsible for continental shelf exploration and
development.In the DPRK, its counterpart is KOEC, which has responsibility for oil
development and oil concession matters.64 KNOC and KOEC have never discussed the
Yellow Sea boundary issue of the question of West Korea Bay exploration. Ideally,
KOEC, KNOC and CNOOC should discuss together the Yellow Sea boundary issue
and the question of joint exploration (regardless of the settlement of the boundary
issue). In particular, joint exploration in the Yellow Sea and any discoveries would
offer a unique opportunity to settle the boundary issue.

59 For the details of DPRK’s exploration effort, see Keun-Wook Paik, ‘North
Korea’s Approach for Oil Exploration & Production’ presented at an
International Workshop on ‘Seabed Petroleum in the Yellow Sea : Geological
Prospects, Jurisdictional Issues, and Paths to Cooperative Development’, co-organised
by Woodrow Wilson International Center for Scholars and China Institute of
International Studies, April 16-17, 2004.
60 In 1991 the import volume of crude oil was 1.89 mt but the volume recorded only
0.61 mt in
1998.
61 Chosun Ilbo, May 26, 2001.
62 Meil Kyungje Shinmoon, May 13, 2000.
63 http://www.rmfdevelopment.com/political/NorthKoreaOil.htm For an interesting

article on DPRK’s potential oil reserves, see http://www.hartford-
hwp.com/archives/55a/161.htmlandhttp://210.145.168.243/pk/073rd_issue/98120902.ht
m
64 Until the beginning of 2004 there was no organization representing the oil
developing issueswithin the Cabinet, except some of the energy specialists working
within the advisory committeewithin the governmental structure. Now KOEC is
converted into Ministry of Oil Industry.
65 An officer from the Ministry of Commerce, Industry and Energy (MOCIE) said that
DPRKauthority proposed a working group meeting in Kumkang mountain to review
the proposal. A KNOC official was quoted as saying that the company was seeking
talks with North Korean officials in June or July.
65Global GeoServices of Norway reported in October 2003 that it planned to do

seismic surveys in DPRK’s offshore, but KNOC said its contract has expired on 30
April. Concessions previously held by Taurus Petroleum of Sweden, Soco International
of the UK, and Beach Petroleum of Australia have lapsed. Petronas of Malaysia took
over Block A, previously held by Soco.
66 Dong-Ah Ilbo, May 19. 2004 ; Oil and Gas Journal, ‘Exploration off N. Korea
might include S.Korean participation’, June 7, 2004, P. 42
66 A rumour is that Petronas decided to withdraw from the project due to the invisible
pressure from the Chinese authority. In mid-May 2004 KNOC was considering
participation in an exploration project off North Korea’s west coast.
67 North Korean sources placed potential off Nampo 5 to 40 billion bbl of oil, but this
is considered highly speculative. In October 2003 Global GeoServices of Norway
reported that it planned to acquire seismic surveys offshore, but KNOC said its contract
has expired. A KNOC official was quoted as saying the company was seeking talks
with North Korean officials in June or July. See, Dong-Ah Ilbo, May 18, 2004 : Oil and

Gas Journal, “Exploration off N. Korea might include S. Korean

participation”, June 7, 2004.
67 However, the behind-the-screen approach backfired when the on unexpected media

coverage of communications between KNOC and KOEC, hindering further progress on
cooperation between the two parties. DPRK authority stance towards the collaboration
between KNOC and KOEC was indirectly explained by the British Newspaper report.
The Observer reported that “Aminex Plc clinched a deal with the government of North
Korea to explore and develop all the country’s potentially oil-bearing territory, with a
decisive say in production…. The deal – signed secretly in Pyongyang during the
summer in the presence of the British ambassador – gives Aminex 20- year rights over
the industry, via a joint venture with the government. It has also negotiated the right to
receive royalties, revenues and the pick of the best acreage should it prove productive”
68 The Observer, “British company strikes first deal for oil prospecting in North
Korea”, September 19, 2004.
68A more detailed interview story by the Financial Times exposed the characteristics
of the deal Aminex has signed with Pyongyang authority. “The North Koreans
proposed to draw the contract up under Swiss commercial law. It was finally signed in
Pyongyang in June in the presence of the British. ambassador… Under the agreement,
Aminex will provide technical assistance such as analyzing seismic data and
introducing foreign investment in return for a share of future production and royalties.
The company also has the right to cherry-pick and drill wherever it considers promising
and is eyeing an area off the western coast”.
69If these reports are the case, the deal is extremely good for Aminex but terribly bad
for Pyongyang authority. This Aminex deal indirectly confirms that Pyongyang
authority’s frustration in attracting a reliable western energy firm for its offshore
exploration. Unfortunately Aminex deal will serve as obstacle rather than facilitator for
DPRK’s offshore exploration. Until comprehensive exploration work is done the real
scale of the DPRK’s offshore oil and gas reserves will remain unknown. However
significant investment from the West, which is needed for effective exploration work,
is very unlikely until the nuclear crisis is resolved.
69 Friederike Tiesenhausen Cave, “Aminex makes rare foray deep into the ‘axis of
evil’”, Financial Times, October 6, 2004.
70 Through Khabarovsk Communique (2001 October) and Vladivvostok Statement

(2003 April), Korean government was the most active in this initiative. Japan has
promoted the so-called ASEAN + 3 (Japan, Korea and China) initiative (Hiranuma
Initiative). Japan’s initiative is not extended to the Russian Federation.

70At the beginning of 1990s, Professor Masaru Hirata, the driving force of
North Asian Gas and Pipeline Forum proposed a large-scale Pan Asia-Pacific
Natural Gas Network.
71 After reviewing Prof. Hirata’s proposal, author touched the issue of Northeast Asian
Energy Charter Treaty for the first time. See, Paik Keun-Wook, ‘Towards a northeast
Asian energy charter’, Energy Policy, Vol. 20, No. 5 (May 1992), pp. 433-443.
71 The current behind-the-scenes competition between Japan and China with regard to
crude oil pipeline development from East Siberia to Northeast Asia is only one small
part of a regional energy infrastructure. South Korea has already established a 2,440km
nation-wide trunk pipeline network and this domestic trunk pipeline played a pivotal
role in natural gas expansion in Korea. In China, China National Petroleum Corp
(CNPC) is planning to complete a 20,000km onshore trunk pipeline by 2020, and
China National Offshore Oil Corp (CNOOC) is planning to build a 3,759km coastal
pipeline network (of which 2,259km onshore and 1,500km offshore) before 2010. If the
CNPC trunk and the CNOOC network are connected, China will have a nation-wide
gas pipeline network in place by 2020. In 2003 Russia announced a blueprint for
energy infrastructure development in the western part of the Federation. In addition to
this ‘Energy Strategy of Russia up to 2020’, a federal programme, ‘Economic
Development of the Far East and Zabaikal up to 2010’ has also been written. The
intention is to establish a trunk oil and gas pipeline network in East Siberia and the Far
East. The only issue being that although Japan has spent almost 15 years feasibility
study on a trunk pipeline introduction to Honshu, the main island of Japan, no action
has been yet taken.
72 Keun-Wook Paik, ‘Geopolitics of Pipeline Development in Northeast Asia : The

Reality and the Implications’ presented at 11th LawAsia Energy Law International
Conference on Towards Energy Co-operation in the Asia Pacific Region’, organised by
LawAsia Energy Section, Seoul, June 22- 25, 2004 ; Victor D. Kalashnikov, Russian
Far East Energy Sector Development and Cooperation Strategies towards Northeast
Asia, presented at 2004 COE Summer International Symposium on Siberia and the
Russian Far East in the 21st Century : Partners in the Community of Asia’ organised by
Slavic Research Centre, Hokkaido University, Sapporo, July 14-16, 2004.
72Even if the trunk pipeline is not built in Japan, pipeline development in the Korean
peninsula, China and Russia will form the basis of a Northeast Asian Natural Gas
Pipeline Grid in the future. Ideally, the network should be comprised of Russia, China,
Korean Peninsula, and Japan, as shown in the map. Such a larger circular pipeline
could also include two inner circular pipelines to ensure minimal disruption to gas
flow. However, without Japan’s trunk pipeline, the greater circular pipeline will not be
completed.
73 The concept of this pipeline was initially suggested by author’s paper ‘Sakhalin

Hokkaido Gas Pipeline Introductions and Its Implications towards Circular

Pipeline Development in Northeast Asia’, presented an international
conference on Advancing the Japan Pipeline Project for Introducing Sakhalin Natural
Gas, organised by Hokkaido Sakhalin Natural Gas Pipeline Study Committee, 2nd
April 1999. However, the concept was drawn as a map by Mitsubishi Research Corp in
early 2000, and Dr. Kengo Asakura introduced this map in his article on Trans-Korean
gas pipeline could help Asia energy security, environmental problems (Oil & Gas
Journal, May 15th, 2000), p. 75. Author used the map without this clarification in his
paper titled “Revitalising North Korea’s Energy : Based on Pipeline gas option”,
presented at LNCV’s conference on Korean Peninsula : Enhancing Stability and
International Dialogue, 1-2 June, Rome
(http://www.mi.infn.it/~landnet/corea/proc/033.pdf). To prevent any further confusion,
author decided to clarify this issue in this paper.

Letter to the Editor

ANGRA III Brazil’s Third
Nuclear Power Plant
Edmilson Moutinho dos Santos

Rafael Judar Vicchini
Dear Sirs,
We have been following the likely revival of the nuclear industry in the
world. Due to safety concerns and financial troubles, things have not
gone well for the nuclear energy since the Three Mile Island accident in
America in 1979. But lately, things are changing again and Nuke’s
social, political and economic pictures seem much improved. In Asia,
nuclear energy was never ruled out. In the interests of their energy
security, countries such as China, Korea Taiwan, Japan and Russia
In the interests of their energy
continued to move towards energy diversification, including some
security, countries such as China,
nuclear capacity. Now, primarily due to climate change and energy
Korea Taiwan, Japan and Russia
security concerns, even western governments are increasingly looking
continued to move towards
anew at nuclear energy.
energy diversification, including
some nuclear capacity. Now,
The debate is still opened worldwide. Clearly, as climate change rises up
primarily due to climate change
the political agenda, the nuclear lobbyists can make the case that nuclear
and energy security concerns,
energy is the leading and most cost-effective carbon free energy
even western governments are
alternative for the world. Better management is allowing nuclear power
increasingly looking anew at
plants to run more efficiently and to perform much better
nuclear energy.
environmentally. In many countries, nuclear electricity has become the
cheapest in the market. However, many uncertainties are present and
studies still indicate that new nuclear power plants are not economic and
can not be built without subsidies.
The impetus of this discussion internationally has also helped to revive

the nuclear debate in Brazil. The nuclear lobbyists have grown their

pressure on government to retake the construction of Angra III,

which is supposed to become Brazil’s third nuclear power plant.
It is interesting and somehow amazing to follow up the current domestic
discussion on whether or not the government should pursue the
The Nuclear Program with construction of this nuclear plant.
Germany also failed and only one
power station, Angra II, was Nuclear power is a historic project in Brazil. The first reactor, the
built, coming on service by the Westinghouse PWR Angra I, was launched in the middle 1960s and only
end of 1990s. begun to operate in the early 1980s. Then, disappointed with its
partnership with the USA, Brazil decided to co-work with the former
West Germany in the 1970s. A broad Nuclear Program previewed the
construction of up to 8 major KWU PWR reactors plus the full
technology transferring to allow the command of the uranium cycle,
from mining, processing and enrichment. The Nuclear Program with
Germany also failed and only one power station, Angra II, was built,
coming on service by the end of 1990s. Both Angra I and II have never
performed greatly during reasonable period of time. From 1985 to 1995,
the average utilization factor was lower than 40%. Then, it grew
gradually up to 70%. In 2001, the role of nuclear power turned very
positive. From its historical “lower than 2%”, nuclear energy increased
Both Angra I and II have never its share in the national energy mix to 4.8% in 2001. The electricity
performed greatly during generated by Angra I and II increased from 1,806 toe (tons of oil
reasonable period of time. From equivalent), in 2000, to 3,783 toe in 2001, with the average utilization
1985 to 1995, the average factor growing to 80%. Therefore, the nuclear reactors were useful for
utilization factor was lower than the country to overcome its electricity shortage when the hydro system
40%. Then, it grew gradually up failed to deliver enough energy and the government was obliged to
to 70%. impose a major electricity rationing.
The searching for alternative forms to generate power rose up the

political agenda. Thermal generation was seen as essential strategy for
Brazil to reduce its dependence on the “humors of water”. Beyond
Angra I and II, the Federal government, supported primarily by the state-
owned Petrobras, built up many oil-and-gas-fired power plants. On the
other hand, the discussion about resuming the construction of Agra III
heated up again. By mid-2002, having rained substantially and created
over supply of hydro power (also resulting by many rationalization
initiatives taken in 2001, which reduced the Brazilian electricity
consumption by almost 20%), the thermal power plants started running
into financial difficulties. Thermal power could no longer co-exist in a
market dominated by low-cost hydroelectricity.

Angra I and II can only survive on subsidies. In 2004, Brazil

generated about 11,550 GWh of nuclear power, representing
something like 3% of the total national energy mix. While Angra I struck
its production record, generating 4,125 GWh, Angra II presented new
major operational troubles, resulting in interruptions and load reductions.
Both plants are operated by Eletronuclear, a state-owned enterprise,
which sells all the generated energy to Furnas, another state-owned
enterprise. Furnas is a major hydroelectric generator. After tough
Angra I and II can only survive negotiation, the two companies agreed on a tariff of 91.52 R$/MWh
on subsidies. In 2004, Brazil (about 37 US$/MWh), applied since December 2004. This tariff does not
generated about 11,550 GWh of reflect the full cost of nuclear power in Angra I and II. It resulted from
nuclear power, representing an adjustment mechanism by which Eletronuclear sells its energy at a
something like 3% of the total price compatible to Furnas hydroelectric plants and the difference is
national energy mix. balanced by the Federal government.
Yet the debate regarding the construction of Angra III was not frozen.
Actually, it became a political issue, engendering controversies and
divisions within the Federal government and also outside. More and
more, respected voices have been making the case that nuclear energy is
essential for Brazil. As a result, also here there is a growing and unlikely
alliance between the nuclear industry, the academic community and
many environmentalists. Important scientists are lending their support
based on the argument that Brazil must keep developing the nuclear
technology for tomorrow needs. Others just argue on practical topics
such as the fact that Brazil has already invested about US$700 million
buying Agra III equipments, which, in addition, represent annual
maintenance cost of up to US$50 million.
The political splitting within the Federal government has caused special
While Angra I struck its consternation among energy specialists and the whole nuclear
production record, generating community. Initially, on one side, the Ministries of Mines and Energy
4,125 GWh, Angra II presented (MME) and Environment (MMA) have sat as the environment and
new major operational troubles, energy's long-standing opponents of Angra III. On the other side, the
resulting in interruptions and Ministries of Internal Affairs (or Casa Civil – Civil House), Defense, and
load reductions. Science & Technology (MCT) supported Angra III rather as a political
(non energetic) issue, raising primarily the technological aspect of
keeping developing a domestic nuclear expertise.
Before we give our opinion on this theme, let’s position ourselves

immediately. We are not Anti-NUKE per se nor believe any energy
technology should be ruled out on ideological basis. Yet, we are totally

against the construction of Angra III. Personally, we are

convinced that the energy future of the human race may firmly
need more nuclear power, especially if the world will decide to speed up
the efforts to stabilize CO2 concentrations in the atmosphere. However,
a country like Brazil, with lots of hydropower and important natural gas
reserves (particularly considering those on neighboring countries such as
Bolivia). does not need to lead the nuclear technology challenge. Brazil
However, a country like Brazil, can in fact benefit substantially from letting others make the inevitable
with lots of hydropower and expensive mistakes in developing a new nuclear reactor generation
important natural gas reserves (more safety and cost-effective).
(particularly considering those on
neighboring countries such as The Brazilian Environment Ministry (MMA) alleges that the nuclear
Bolivia). does not need to lead the energy still involves high risks and not yet solved environmental issues.
nuclear technology challenge. Many scientists would not completely agree with that argument, saying
Brazil can in fact benefit that technologies are available and current reactors operate with
substantially from letting others acceptable safety levels. However, why should Brazil accept to subsidize
make the inevitable expensive Angra III, which is from old generation, rather than invest on future and
mistakes in developing a new much better technological possibilities? Moreover, Eletronuclear must
nuclear reactor generation (more still achieve long-term adequate performance on Angra I and II, before
safety and cost-effective). the company can convince the society about its competence in managing
well and holding high safety standards in a larger nuclear program.
The Science and Technology Ministry (MCT) suggests that building up

Angra III is necessary to allow Brazil to keep pursuing the development
of nuclear technology and the full command of the uranium cycle. Angra
But, it is a misunderstanding to III should allow the country to construct its first commercial uranium
think that Angra III or enrichment plant. But, it is a misunderstanding to think that Angra III or
Eletronuclear will guarantee the Eletronuclear will guarantee the domain of nuclear technology in Brazil.
domain of nuclear technology in Actually, the domestic excellence centers are located at IPEN (Institute
Brazil. for Energy and Nuclear Researches in Sao Paulo) and CTM/SP (the
Navy’s Center for Nuclear Technology in Aramar, Sao Paulo). Those
institutions developed domestic technology outside the former Nuclear
Program with Germany, which Eletronuclear came from. If the country’s
objective is to build up competence on enriching uranium and
developing the full uranium cycle at industrial level (which is
questionable), then those activities, rather than Angra III, should receive
investment and eventual subsidies.
The uranium market and particularly the enriching activity are far from
being competitive businesses. Therefore, Brazil should not really care
whether its enrichment plant will be poorly economical. But there should

be an open and democratic debate whether enriching uranium for

domestic uses (eventually for exporting) is the most strategic
decision to prioritize the public investments. It is unacceptable
the argument that Angra III, which still requires minimum investments
Whenever something appears up to US$ 2 billion, is necessary to justify the enrichment plant.
more complex, Eletronuclear will According to the Brazilian Navy, expending about US$ 200 million in
contract out with foreigners or - the research centers, Brazil could have the access to the full uranium
for simpler cases – with small cycle by 2010. But the government keeps reducing the Navy’s budget
Brazilian firms. The state due to macroeconomic instabilities and the country’s major nuclear
company counts upon a small research centers find themselves in an almost calamity. So, it is hard to
group of high skilled operational believe that Angra III is the best strategy for Brazil to keep pace with the
professionals. development of nuclear technology. The country should rather rescue
those nuclear institutes and maintain its nuclear intelligence for the
future through credible and feasible projects.
Eletronuclear actually lost its expertise in managing large nuclear works.

As far as engineering knowledge is concerned, Eletronuclear is no longer
independent to solve more intricate problems. Often, the company is
How can we possibly imagine that obliged to join together with the Brazilian research centers to find
Angra III is necessary in the next specific expertise and this improves synergies. Whenever something
10 or even 20 years in a country appears more complex, Eletronuclear will contract out with foreigners or
where much cheaper hydro - for simpler cases – with small Brazilian firms. The state company
possibilities are still available? counts upon a small group of high skilled operational professionals. The
more seniors have been retiring and transferring operational experience
to the juniors, who are entering the company. It is not necessary to build
up Angra III to keep this process going.
Finally, the last relevant point is raised by the Energy Ministry (MME)
and regards energy costs. Angra I and II´s total costs were greater than
US$ 10 billion. Long delays led to uncontrollable additional financial
costs. Now, imaging that Angra III might cost significantly lower sounds
like a fantasy still to be proved. How can we possibly imagine that
Angra III is necessary in the next 10 or even 20 years in a country where
much cheaper hydro possibilities are still available? Moreover, with so
many natural gas resources in place, nuclear power does not seem the
most cost-effective thermal option either. Since 2001, Brazil invested
from 7 to 10 billion US dollars in gas-fired power plants. Those units are
not working or receive strong subsidies to cover losses, since they are
not competitive with hydro. Now, firstly, Brazil should give any
economic sense for those plants before even starting thinking about
Angra III. Then, considering gas prices usually found in Brazil, even

new gas-fired power plants would be cheaper than new nuclear

facilities (both are more expensive than several other hydro
plants though). And even more important, the direct use of natural gas to
substitute thermal uses of electricity would certainly be the most rational
In the 1970s, Brazil made two and cost-effective energy strategy for the country. Angra III will not help
serious mistakes: (i) it invested Brazil to improve the final use of electricity. By creating additional
excessively in energy excess of electricity supply, energy rationalization will be postponed
infrastructure instead of investing again.
in human capital, i.e., education
for its people; and (ii) it opted for In the 1970s, Brazil made two serious mistakes: (i) it invested
thermal power stations, which excessively in energy infrastructure instead of investing in human
must operate with high load capital, i.e., education for its people; and (ii) it opted for thermal power
factor, more than 80%, to stations, which must operate with high load factor, more than 80%, to
complement its hydro plants. complement its hydro plants. Those thermal plants are not consistent
with a huge and strongly liked hydro system. Are we planning to repeat
the same mistakes again?
In 2001, when the country was running out of water, creating an energy
shortage, for despair of the government, the Civil House, on behalf of
Those thermal plants are not the President, took over all the power on Energy Affairs. The result was
consistent with a huge and a billion dollar gas-fired power program, which made little or no
strongly liked hydro system. Are economic sense. Unbelievably, the Civil House is still trying to move
we planning to repeat the same back into the energy forum. After major changes in government, the
mistakes again? former Energy Minister took power at the Civil House and, surprisingly,
became to be more favorable to Angra III. Will the Civil House continue
on its present course, even at the risk of driving the country to another
mistaken energy policy?
About the Authors:
Edmilson Moutinho dos Santos is an Associate Professor at the Graduate Energy

Program of the University of Sao Paulo, Brazil, specializing in energy economics and
policy. He is a member of the editorial committee for
Energy Politics.
Rafael Judar Vicchini is graduate student in economics at the University of Sao Paulo,
researching in energy economics and policy. He holds a scholarship from the Brazilian
government - The Human Resource Program from the National Petroleum Agency
(PRH-04/ANP).

EP Regular Features
INDIA Regular Oil

Country Assessment – India
Population M 1000
Rates Mb/d Colin Campbell
Consumption 2.4
2004
per person b/a 0.9
Production 0.685 The Republic of India covers an area of some 3M km2, making it the
2004 seventh largest country in the World. Topographically, it is divided into
Forecast 2010 0.52 a mountainous north, flanking the Himalayan Range; the North Indian
Plain, drained by the Indus and Ganges Rivers; and the Deccan Plateau
Forecast 2020 0.33
in the south, which itself is flanked by the Western and East Ghat
Discovery 5-yr average 0.01 mountain ranges, locally rising to around 3000m. Its climate is
Gb
characterised by three seasons: hot and wet from June to September;
Amounts Gb cool and dry from October to February; and hot and dry from February
Past Production 6.1 to June. But they are subject to marked annual variations, spelling
Reported Proved 5.37
famine if the rains are late or weak, or flooding in the opposite case.
Reserves* Much of the country is forested.
Future Production - 5.4
total In geological terms, India forms a segment of the ancient southern
continent of Gondwanaland that moved northwards to collide with the
From Known Fields 4.5
Eurasian Plate some 50 million years ago. In regional terms, this
From New Fields 1.0 continent was deficient in oil prospects, primarily because the
Past and Future 11.5 conditions for oil generation were restricted in high southern latitudes.
Production It is not surprising, therefore, that India is not rich oil territory, although
Current Depletion Rate 4.4% some marginal basins have delivered modest results. The largest of
these, with some 2.5 Gb, is the Bombay High, off the west coast, which
Depletion Midpoint 2003
Date was found in 1974. The industry is dominated by the State Company,
ONGC, although some small foreign private firms are also active.
About 1300 wildcats have been drilled, finding 10.5 Gb of oil, of which
Source: Oil and Gas 6 Gb have been produced. Exploration drilling peaked in 1991 when 88
Journal

wildcats were drilled, but is now down to about half that number. A
fairly high level of activity is likely to continue, as the country is in
desperate need of oil, but is unlikely to be rewarded by more than
perhaps another billion barrels, mainly in small fields. Some interest is
India now being devoted to deepwater possibilities, but the outcome is far
700 5
from assured.
600
4
Discovery Gb (shaded)
500
Production stands at 685 kb/d, which is likely to be the peak, the
Production kb/d
3
400
midpoint of depletion having been passed in 2002. At the current
300
2
Depletion Rate of 4.4%, production is set to fall to about 500 kb/d by
200
1 2010 and 330 kb/s by 2020. Consumption stands at 2.4 Mb/d, giving
100
the country a large and growing need of imports, which will be
0 0
1930 1950 1970 1990 2010 2030 2050 increasingly difficult to obtain. This readily explains why State-backed
Indian companies are taking up rights overseas in for example the
Sudan, Libya, Iran and Venezuela (see also Items 511 and 513).
The country’s gas potential is also limited. Only 42 Tcf have been
discovered, of which 13 Tcf have been produced. Production stands at
about 2 Tcf/a. The country has substantial coal deposits, although some
have a high arsenic content which has caused serious environmental
damage in the past.
About the Author:
Colin Campbell is the Chairman of the Association for the Study of

Peak Oil and Gas.

.
Bank on It
Commentary by Ferdinand E. Banks
Economic Theory and Some Oil Market

Realities
The major dilemma is simple and

widespread, and cannot be Not too long ago I had the great pleasure of giving a long lecture on oil
referred to often enough: Mr and at the Royal Institute of Technology in Stockholm, where I once
Ms consumer are still unable to studied mathematics in a building that is still known as ‘Sing-Sing’
comprehend that are moving (after the US prison of the same name.) And once again I discovered,
toward a world in which we are to my great surprise, that even at this late date the realities of the
not going to have access to the present world oil market have not been absorbed by the future
inexpensive oil to which we believe engineering elite to a desirable extent.
we are entitled.
The major dilemma is simple and widespread, and cannot be referred
to often enough: Mr and Ms consumer are still unable to comprehend
that are moving toward a world in which we are not going to have
access to the inexpensive oil to which we believe we are entitled.
Eleven years ago the Energy Journal presented a special issue called
‘The Changing World Petroleum Market’ (1994) in which the future
oil and gas scene was systematically misrepresented by a number of
prestigious energy economists. In their vision of the 21st century, not
only was oil “plentiful”, but OPEC was a fragile construction due to
the enormous amount of oil and gas that could or would eventually be
discovered in the unexplored or only partially explored regions of the
globe. In terms of mainstream geology, this kind of thinking hardly
deserved to be labeled bizarre, but even so it attracted a sympathetic
audience.
A basic difficulty was and is the inability of many observers to accept

that technology cannot discover or produce oil that does not exist; and
where it does exist, it may not be what many students of this subject
think that it is. A perfect example here is the tar sands of Northern

Canada, whose resources have now been officially added to

proved Canadian reserves of oil, thereby turning that country
into a rival to Saudi Arabia in the oil reserves league.
Professor Douglas Reynolds has examined the realities of Canadian tar

Professor Maureen S. Crandall of sands in the latest issue of the OPEC Review (2005). As he makes
the United States National clear, “Physics, economics and engineering management all point to
Defense University, in a one thing – oil sand is not the same as crude oil. By defining oil sand
discussion of the huge resources bitumen as proven reserved of crude oil, we are setting up the oil and
that ostensibly will be made energy markets for a large price spike – a shock.” A version of this
available by extensive comment could probably be applied to the heavy oil of Venezuela,
exploitation of the Caspian region along with a reminder that from a thermodynamic point of view, both
(2005), makes the following heavy oil and oil from tar sands do not have a great deal to offer.
unwelcome observation: “But this
producing region as a whole,
while accounting for billions of Another important issue in these matters concerns attracting
dollars in investments, is unlikely investment dollars to non-profitable undertakings, which is something
to be a large and sustained future that I touched on in my energy economics textbook (2000) and several
producer and contributor to the recent papers, but which apparently was not appreciated by a number
world’s energy supplies, and of influential readers. However Professor Maureen S. Crandall of the
cannot be considered of strategic United States National Defense University, in a discussion of the huge
energy importance to the US.” resources that ostensibly will be made available by extensive
exploitation of the Caspian region (2005), makes the following
unwelcome observation: “But this producing region as a whole, while
accounting for billions of dollars in investments, is unlikely to be a
large and sustained future producer and contributor to the world’s
energy supplies, and cannot be considered of strategic energy
importance to the US.”
This decline is not certain, but it The same judgement applies to other ‘oil producing regions of great
might be useful to remember that promise’, but it is best at this time to sum up the situation introduced
the major part of today’s oil above with a quote from Craig Bond Hatfield (1997). “The coming era
production – at least 70% – comes of permanent decline in oil-production rate and the economic and
from deposits discovered before social implications of this phenomenon demand serious planning by
1970. This is hardly worth the world’s governments.” This decline is not certain, but it might be
pondering, given that global oil useful to remember that the major part of today’s oil production – at
discovery peaked about 1965. least 70% – comes from deposits discovered before 1970. This is
hardly worth pondering, given that global oil discovery peaked about
1965. Similarly, rumors have started making the rounds that the

relatively new discoveries in Russia and West Africa may not

live up to expectations.
At the present time Saudi Arabia

supplies almost a third of OPEC SOME BASIC ECONOMICS
oil, and given their reserve
situation relative to the other
OPEC (and non-OPEC) Recently the International Energy Agency (IEA) published its latest
countries, this fraction will hardly ‘World Energy Outlook’, in which the conclusion was advanced that
decrease. (Saudi Arabia has the availability of oil in terms of reserves and production will not be a
proven reserves of 260 billion problem as long as a few trillion dollars can be mobilized to finance
barrels, while second place Iraq new wells and pipelines, as well as capital intensive items such as
has 120 billion barrels.) refineries and tankers.
Accordingly, it seems that IEA
experts believe that Saudi Arabia
will supply about 20 mb/d in In addition, that organization has postulated an increase in the world
2030. oil demand from the present 84 mb/d to 121 mb/d in 2030. Normally, I
would express some curiosity as to the scientific background for that
estimate, however I have heard it a number of times, and it is almost
the same as a recent estimate of the United States Department of
Energy (USDOE). At the time when this 121 mb/d is supposed to be
produced, OPEC is pictured as being responsible for about one-half (as
compared to approximately 38% just now). This suggests an OPEC
production of approximately 60 mb/d. At the present time Saudi
Arabia supplies almost a third of OPEC oil, and given their reserve
situation relative to the other OPEC (and non-OPEC) countries, this
It will not be easy for Saudi fraction will hardly decrease. (Saudi Arabia has proven reserves of
Arabia to supply 20 mb/d in 2030, 260 billion barrels, while second place Iraq has 120 billion barrels.)
or at any other time in the near or Accordingly, it seems that IEA experts believe that Saudi Arabia will
distant future. A high-ranking supply about 20 mb/d in 2030.
Saudi official recently stated that
15 mb/d should be possible, which
It will not be easy for Saudi Arabia to supply 20 mb/d in 2030, or at
undoubtedly sounded lovely to
any other time in the near or distant future. A high-ranking Saudi
motorists in the large oil
official recently stated that 15 mb/d should be possible, which
importing countries – if they were
undoubtedly sounded lovely to motorists in the large oil importing
listening.
countries – if they were listening; but although my knowledge of
geology is limited, the energy economics that I have taught left me
with the belief that the 12.5 mb/d recently promised by the Saudi
Arabian king to President George Bush is a more realistic goal. This
particular output is supposed to become available by 2010.

There is also some question as to what OPEC as a whole will

be able to achieve. A report from the consulting firm PFC
Energy (as mentioned in the Petroleum Economist, October
2004) states that OPEC is producing about 8 billion barrels a year
more than it has been finding. This situation might change if e.g. Libya
and Iraq intensify their exploration activities, however there is little or
no reason to believe that this will be of other than marginal
A report from the consulting firm significance for the IEA and DOE targets mentioned above.
PFC Energy (as mentioned in the
Petroleum Economist, October During the question and comment phase of the lecture mentioned in
2004) states that OPEC is the first paragraph of this paper, I was cheerfully informed that OPEC
producing about 8 billion barrels producers are increasingly aware that erratic behavior on their part
a year more than it has been might result in their being confronted by a deluge of synthetic liquids,
finding. with natural gas being the most popular input. This kind of situation
sounds consistent with the approach taken in a mainstream
intermediate microeconomics textbook – assuming that you and your
teacher did not confine your reading to the first few chapters – but
even so it has no basis in reality: there is not enough natural gas to
bring this about except in the fantasies of journalists, and for various
reasons coal is no longer a contender. Of course, even if it were
This situation might change if e.g. possible, the producers of onventional oil might – in theory – merely
Libya and Iraq intensify their dump their prices when the new oil comes on the market, and therefore
exploration activities, however wipe out the profit of the intruders.
there is little or no reason to
believe that this will be of other
than marginal significance for the Almost thirty years ago Crown Prince Fahd of Saudi Arabia informed
IEA and DOE targets mentioned the large oil importing countries that their best strategy was to
above. moderate their consumption of oil, while introducing as rapidly as
possible alternative sources of energy. (Similar thoughts were
expressed by the very visible and highly respected oil minister of
Saudi Arabia, Sheikh Zaki Yamani.) Prince Fahd also emphasized the
need to preserve his country’s petroleum wealth for future generations,
and made it clear – by actions as well as words – that Saudi Arabia
recognized its position as a critical component in the global oil supply
nexus – both present and future – and would do everything possible to
maintain an adequate margin of spare capacity that could be used in

the event of an unforseen escalation in global demand. A large

part of this is forgotten or overlooked by many journalists and
pseudo-scholars in the consuming countries, however it is an
undeniable part of the history of the past thirty or forty years.
CONCLUSION: GENIUS AT WORK
Given the actual and potential economic growth in the world economy,
there is no such thing as an enormous reserve base! There is instead a
limited amount of oil in the crust of the earth that it is in the interest of
both buyers and sellers to preserve for many more years in both the
stock and flow sense – that is, not just as petroleum in the ground, but
available as inputs for the durable items that were purchased by
consumers and producers in the belief that they would not be kept from
using them because of the lack of a critical input, where by by “critical
input” I mean what George Monbiot calls “the resource on which our
lives are built”.
REFERENCES
Adelman, M.A. (1994). ‘The world oil market: past and future’. The
Energy Journal.
Banks, Ferdinand E. (2005). ‘Logic and the Oil Future’.
(Forthcoming)
______. (2004). ‘A new world oil market’. Geopolitics of Energy
(December).
______. (2000). Energy Economics: A Modern Introduction.
Dordrecht and Boston: Kluwer.

______. (1998). ‘World energy and the 21st Century’. The

OPEC Bulletin (July).
Carr, Donald E. (1978). Energy and the Earth Machine. London:
Abacus.
Crandall, Maureen (2005). ‘Realism on Caspian Energy’. IAEE
Newsletter (Spring).
Griffin, James M. and Lawrence Vielhaber (1994). ‘OPEC
production’. The Energy Journal.
Hatfield, Craig Bond (1997). ‘Oil back on the global agenda’. Nature
(May).
Odell, Peter R. (1994). ’World oil resources: reserves and production.’
The Energy Journal.
Reynolds, Douglas (1995). ‘The economics of oil definitions’. OPEC
Review (March).
About the Author:
Ferdinand E. Banks is an Occasional Lecturer in Industrial Organization

at the Nationalekonomiska Inst., Uppsala University and a Visiting
Professor at the ENI Corporate University, Milan Italy.
e-mail: ferdinand.banks@telia.com

The Energy Politics Editorial

Committee
Prof. Khartukov is a leading international expert on Russian and ex-
Editorial Committee – Moscow
Soviet oil and gas issues. During 1970-82, he worked in various
Office
research centers, departments and enterprises of the USSR ministries of
geology, of oil and gas industry, of foreign trade and of foreign affairs.
EUGENE (YEVGENY)
Since 1980, teaches world oil and energy markets research at the
KHARTUKOV
Moscow State University for International Relations (MGIMO),
USSR/RF Ministry of Foreign Affairs. Since 1984, heads the Moscow-
based World Energy Analysis & Forecasting Group (GAPMER),
advises and consults on oil and gas economics and policies and energy
pricing to various Soviet/Russian ministries, international agencies,
foreign governments, private oil and gas companies, consulting firms
and financial institutions, as well as to Gorbachev, Yeltsin and Putin
administrations. In 1994-95 – Head of Russia Energy Project, East-
West Center, Hawaii, USA. Since 1995 – Vice President (for Eurasia)
of Petro-Logistics Ltd, Switzerland. Since 1996 – General Director of
(International) Center for Petroleum Business Studies (ICPBS/CPBS),
Moscow, and Professor of Marketing & Management at MGIMO. Since
2003 – Director (for International Affairs) of PetroMarket Research
Group, Moscow. Prof. Khartukov has authored and co authored over
250 articles, brochures and books on petroleum and energy economics,
politics, management, and Russia’s Far East. Participated as a speaker
and/or a session chairman in more than 150 international energy, oil and
gas and economic fora.
Alli Marshall is a Fundamentals Analyst with EnCana Corporation's

Editorial Committee – Calgary
Gas Marketing group in Calgary, Alberta. She began her current role in
Office
Sept, 2004 after 5 years of work as a geophysicist. Her geophysics
Western Division
background includes several years of seismic processing and new
technologies such as inversions and attribute analysis and 2 years of
Alli Marshall
exploration in the Deepwater Gulf of Mexico with a focus on salt
tectonics. She graduated from the U of C in 1999 with an H.B.Sc. in
geology and geophysics and a minor in philosophy. Alli's current work
responsibilities include country-specific gas market analysis (regulatory
environment, supply, demand, pricing, and market risks), LNG, and
global natural gas and oil production forecasting.

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Energy Politics Summer 2005

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Energy Politics Summer 2005

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Using Tax Incentives to Compete for Foreign Investment: Do

Why Does OPEC Continue to Price Its Oil in Dollars?

Business Pipeline Gas Introduction to the Korean Penninsula

Commentary: “Bank on It”:Economic Theory and Some Oil

Issue VI: Summer 2005 2

Editorial Board Letter from the Editor

Issue VI: Summer 2005 3

A “crisis” has thus been created –

Issue VI: Summer 2005 4

Issue VI: Summer 2005 5

The failures of policy makers in the

About the Author:

Issue VI: Summer 2005 6

Issue VI: Summer 2005 7

Consequently, many governments are compelled to turn to

The efficacy of these incentives as a determinant for attracting FDI is

Issue VI: Summer 2005 8

Issue VI: Summer 2005 9

Chapter three explores the merits of the current debate on the

Next, chapter four presents the outcome of three sets of empirical

This paper concludes that TIs

Issue VI: Summer 2005 10

However, to be considered an However, to be considered an investment incentive, a TI must not be

Issue VI: Summer 2005 11

Because TIs are intended to encourage investment not just in E&P,

(c) Transfer of technology: An important objective of using TIs to attract

Issue VI: Summer 2005 12

(d) Some countries, such as Malaysia and Singapore, have

Issue VI: Summer 2005 13

This is because in order to make a fiscal regime more

Issue VI: Summer 2005 14

(2)Tax Reductions: An alternative method would be to

Table I – Description of Tax Incentives Used in O&G industry

Accelerated Writing off an asset through depreciation or amortisation at a

Amortisation Amortisation is an accounting convention designed to emulate

Issue VI: Summer 2005 15

Depreciation Depreciation is an accounting convention designed to emulate the

Issue VI: Summer 2005 16

Employment In many countries, governmental-mandated social security

Flow-through Provide a mechanism for individual shareholders in a company to

Investment credit A fiscal incentive where the HG allows a MNOC to recover an

Issue VI: Summer 2005 17

Preferential Many countries accord preferential tax treatment for appreciation

Issue VI: Summer 2005 18

Reinvestment Operate in the same way as investment credits, discussed above,

Royalty Holiday This mechanism is similar to the tax holiday. It is a specified

Tax Abatement Is a mechanism for giving preferential treatment to a particular

Issue VI: Summer 2005 19

Uplift Common terminology for a TI whereby the HG allows the

Sources: AS – Adapted from Andrews-Speed P., Lecture Notes on Mineral &

Issue VI: Summer 2005 20

From 1967 - following the end of 2. THE INDONESIAN EXPERIENCE

Issue VI: Summer 2005 21

The clock on holidays started running when commercial

3.2.1 Impact on Foreign Investment

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Investors gained from 1983

Interestingly enough, as more encouraging data on FI began to come in,

Investors gained from 1983 approval dates, since the grandfathering of

Issue VI: Summer 2005 23

3.2.2 Impact on Growth Rate of Foreign Investment

Further confirming what the figures show graphically, are a series of

Issue VI: Summer 2005 24