Authored by Simon Watkins via OilPrice.com,

Underlying the one-year anniversary in mid-August of the signing of the ‘Convention on the Legal Status of the Caspian Sea’ is one of the greatest oil industry swindles in recent years.

When representatives of the five Caspian littoral states meet on the 11th and 12th of August, Iran intends to seek some redress from Russia on Moscow’s manoeuvring last August. The Islamic Republic believes that it was robbed of its historical rights in the Caspian, conned out of a US$50 billion per year income, and left without Russia’s support against the re-imposition of U.S. sanctions.

Little of any apparent consequence was decided last August when the five Caspian littoral states – Russia, Iran, Kazakhstan, Turkmenistan, and Azerbaijan – signed the ‘Convention on the Legal Status of the Caspian Sea’. The limited publicity that surrounded the signing stated only that the agreement stipulated that relations between the littoral states would be based on the broad principles of national sovereignty, territorial integrity, equality among members, and the non-use of threat of force.

It refrained from specifically going into details about share allocations in the Caspian Sea resource and talked only vaguely about giving the area ‘a special legal status’. However, a senior oil and gas industry source who works closely with Iran’s Petroleum Ministry told OilPrice.com that there was a secret second part to the deal that has proven explosive for the perennially fractious relations between the Caspian states.

At stake is the massive Caspian Sea hydrocarbons resources prize that has been fought over since the dissolution of the USSR in 1991 resulted in three additional partners – Kazakhstan, Turkmenistan, and Azerbaijan - to the original partnership of Russia and Iran. Prior to the fracturing of the USSR into its constituent independent states, Iran and the USSR had struck the original agreement in 1921 to split all ‘fishing rights’ in the Caspian area 50-50. This was amended in 1924 to include ‘any and all resources recovered’, meaning in practical terms that all hydrocarbons resources would be shared equally between Russia and Iran.

“Iran should have said back then that Russia should have shared its Caspian stake with the three former USSR states, but it [Iran] was content to wait for the official legal dispute to be settled,” underlined the Iran source.

At stake is the allocation of revenues from the wider Caspian basins area, including both onshore and offshore fields, that is conservatively estimated to have around 48 billion barrels of oil and 292 trillion cubic feet (Tcf) of natural gas in proved and probable reserves. Around 41 percent of total Caspian crude oil and lease condensate and 36 percent of natural gas exists in the offshore fields, with an additional 35 percent of oil and 45 percent of gas estimated to lie onshore within 100 miles of the coast, particularly in Russia’s North Caucasus region.

The remaining 12 billion barrels of oil and 56 Tcf of natural gas are believed to be variously located further onshore in the large Caspian Sea basins, mostly in Azerbaijan, Kazakhstan, and Turkmenistan. The area accounts for an average of 17 percent of the total oil production of the five littoral states that share its resources, on average totalling 2.5-2.9 million barrels per day (mbpd).

Before the ‘Convention on the Legal Status of the Caspian Sea’ agreement was signed last August, oil output targets for each country were set three months in advance, with all revenues paid into a central Caspian oil account, which was then split in equal proportions of 20 percent between the five littoral states, said the Iran source. The revenues, at least prior to the re-imposition of sanctions against Iran by the U.S. late last year, usually comprised 95 percent U.S. dollars and Euros, but with some local currencies in the mix.

Against this backdrop, the legal designation of the Caspian as either a ‘sea’ or a ‘lake’ would have far-reaching repercussions on the assignment of revenues from it. If it was designated a sea then coastal countries would apply the ‘United Nations Convention on the Law of the Sea’ (1982), in which event each littoral state would receive a territorial sea up to 12 nautical miles, an exclusive economic zone up to nautical 200 miles, and a continental shelf. In practice, this would mean that countries such as Turkmenistan and Azerbaijan would have exclusive access to offshore assets that Iran would not be able to access.

If it was designated a lake – and this was the informal designation before the August agreement – then the countries could use the international law concerning border lakes to set boundaries, by which each country effectively possesses 20 percent of the sea floor and surface of the Caspian.

In the preparations for the signing of the ‘Convention on the Legal Status of the Caspian Sea’ last August, Iran had engaged lawyers to challenge the established 20 percent share that each littoral state had informally agreed upon, based on the fact that Russia should have used its own original 50 percent share to make good stakes for its former USSR states.

Iran was confident at that point that Russia would show some flexibility as, after the U.S. pulled out of the nuclear deal last May, Moscow immediately made a deal with Iran that would effectively have given it control of all of Iran’s oil and gas resources. Specifically, the deal was that Russia would hand Iran US$50 billion every year for at least five years. This would cover all of Iran’s estimated US$150 billion of costs to bring all of its key oil and gas fields up to Western standard, with US$100 billion left over for the build-out of other key sectors of its economy.

“Russia also pledged to veto all attempts in the United Nations Security Council [UNSC] to have sanctions against Iran increased or to have the terms of the original nuclear deal re-drawn to include further sanctionable actions such as missile testing or not allowing snap inspections of all military facilities, which it could do as it is as one of just five Permanent Members on the UNSC,” said the Iran source.

In exchange for this, Iran, in addition to giving Russia preference in the oil and gas sector, was also to tighten its military co-operation with Russia, including buying Russia’s S-400 missile defence system, allowing Russia to expand its number of listening posts in Iran and doubling the number of senior ranking Islamic Revolutionary Guards Corps (IRGC) officers that are seconded in Moscow for ongoing training, to between 120 and 130.

The catch for Iran was that, under the terms of the agreement, there was no clause that allowed Iran to impose any penalties on any Russian developer firm for slow progress on any field for the next 10 years. The Russians, though, during this entire 10-year period, would still have the right to dictate exactly how much oil was produced from each field, when it was sold, to whom it was sold, and for how much it was sold. Russia also had the right to be able to buy all of the oil – or gas – being produced from fields that their companies were supposedly developing at 55-72 percent of its open market value for the next 10 years.

“The Iranians naively thought this meant that they had entered into a genuine two-way partnership with Russia but Russia didn’t see it that way,” the Iran source said. “In the Russian way of seeing things, once it had secured Iran in this deal, effectively making it a client state, it had no reason to honour any other of its previous obligations,” he added. “The situation was also worsened for Iran by the fact that Russia had its own problems with U.S. sanctions and didn’t want to make things worse by siding so thoroughly with Iran,” he highlighted.

Given these considerations, and the fact that Russia wanted to strengthen its relations with the previous USSR states, Moscow was the prime mover in having the Caspian designated as a sea, not a lake. This was on the basis that because Russia had opened up the channel from the Volga River into the Caspian to prevent the levels dropping, the Caspian no longer conformed to the legal definition of a lake, which is that it is a localised water deposit standing independent of any river that serves to feed it.