Last month, Gurbanguly Berdymuhammedov became the first Turkmen president to visit Azerbaijan since his deceased predecessor, Saparmurad Niyazov, traveled there in 1996. Any reconciliation between Azerbaijan and Turkmenistan would be doubly important from the perspective of world energy markets. First, the two countries possess extensive oil and gas reserves within their territories. Second, their geographic location allows them to function as potential gateways for energy exports from Central Asia through the South Caucasus to Europe and the Mediterranean region.

BACKGROUND: A week after Berdymuhammedov visited Baku, the leaders of Azerbaijan and six other former Soviet republics met in Kyiv to launch a new initiative to transport Caspian oil through Ukraine without traversing Russian territory. In addition to calling for a “Caspian energy space,” they announced ambitious plans to send oil from Azerbaijan and Kazakhstan through Georgia to Ukraine’s Black Sea port of Odessa, then on to the Ukrainian town of Brody and, by extending an existing pipeline through Poland, onward to the Baltic Sea port of Gdansk. Meanwhile, American and European government representatives recently visited several Caspian countries to reaffirm interest in importing natural gas through pipelines that would run under the Caspian Sea.

The improvement in relations between Azerbaijan and Turkmenistan could help remove one major obstacle to the desired increase in Caspian Sea energy deliveries to Europe. Niyazov and former Azerbaijani leader Heydar Aliyev argued over the repayment terms of Baku’s multi-million dollar debt to Ashgabat as well as over several Caspian hydrocarbon fields located between them. At their recent summit, Berdymuhammedov, who replaced Niyazov last year, and Ilham Aliyev, who succeeded his father as president in 2003, agreed to repay the debt and negotiate ownership, or possible joint use, of the fields. The younger Aliyev evidently considered it an acceptable downpayment to initiate a potentially lucrative energy partnership with Turkmenistan.

Until now, the feud between the two governments had complicated the already difficult negotiations among the five littoral states regarding how to divide and manage the Caspian Sea and its valuable undersea natural resources. The main issue in dispute is whether to treat the Caspian as if it were a sea (despite its being landlocked) or an inland lake (despite its enormous size and natural resources) according to international law. If the littoral states were to manage the Caspian as if it were a sea, then each country would control the territorial waters along their coasts and corresponding seabeds. If the Caspian is treated legally as if it were a large inland lake, there would be room to argue that all five littoral states should own the sea in common and share equally in its collective natural resources, though this is by no means standard international practice. The protracted legal stalemate has long discouraged multinational energy firms from investing the large-scale capital required to exploit the deep-sea oil and gas fields located far from the countries’ coasts.

In addition, the bilateral Azerbaijani-Turkmen dispute and the failure of all five littoral governments to agree on uniform legal principles for maritime commerce has stalled plans to construct undersea pipelines to transport oil and gas from Turkmenistan, Kazakhstan, and possibly Uzbekistan across the Caspian in a direct route to European markets. Using seabed pipelines is more economically rational than the current practice of loading and unloading cargo on surfacing-going tankers.

Moscow and Tehran maintain that all five littoral governments must approve the construction of trans-Caspian energy pipelines because any country could suffer economic losses from environmental damage caused by the pipelines. Whatever the sincerity of these concerns, the desire to block east-west energy routes that circumvent Russian and Iranian territory might also explain their respective governments’ demands for veto rights.

The Kremlin collects considerable dividends from Central Asian oil and gas deliveries that pass through its territory, which it resells to Europe. Tehran, which recently had to accept a hefty price increase for Turkmenistan’s natural gas imported through the Korpezhe-Kurt Kui pipeline, presumably also wants to limit third-party competition for Caspian energy exports. In addition, Iran has been improving its Caspian port infrastructure to induce Central Asian governments to send more oil and gas southward to its Persian Gulf ports. For example, Iranians are constructing a massive trade and port facility at Bandar-e Anzali.

IMPLICATIONS: The governments of Turkmenistan as well as Kazakhstan recently reaffirmed their intent to expand their deliveries of oil and gas northward through Russian-controlled pipelines connecting Central Asia with European markets. In addition, both capitals remain interested in delivering large quantities of oil and gas through Iran to South Asia. Nonetheless, they are eager to diversify their export routes westward to supplement their hydrocarbon exports through Russia, Iran, and China.

In late April, Kazakhstan’s senate ratified an energy export treaty with Azerbaijan that would formally launch the long-planned Kazakhstan Caspian Transport System (KCTS). Following the construction of an oil terminal at Kuryk, ships will load as much as 500,000 barrels of crude oil daily and transport it across the Caspian to Azerbaijan, where their cargo will be unloaded and channeled into the Baku-Tbilisi-Ceyhan (BTC) pipeline. Energy analysts expect that, should the tanker system prove inadequate, Azerbaijan and Kazakhstan might commit to the construction of an undersea pipeline that would feed oil directly into the BTC. An obvious route, for either oil or gas, would utilize pipelines traversing Azerbaijan and Turkmenistan’s sectors of the Caspian seabed since the distance between their shores is the shortest—and therefore the most economical—path across the sea.

Ignoring Iranian opposition to such undersea pipelines as well as offshore energy production might prove risky. The uncertainties regarding Iran could discourage risk-averse foreign investment. In addition, Tehran boasts the second-strongest navy in the Caspian, which Iranian leaders have used previously to enforce their claims over Caspian resources. In 2001, Iran dispatched military ships and aircraft to threaten two Azerbaijani research vessels exploring oilfields in the southern Caspian.

However, Tehran has engaged in a charm offensive in Central Asia in recent years. Iranian officials wish to sustain Central Asian opposition to any military solution by the United States or its allies to the current confrontation over the status of Iran’s nuclear program. In addition, Tehran needs Central Asian support to gain membership in the Shanghai Cooperation Organization (SCO). Iran currently has observer status in the SCO, but Tehran recently applied (again) for full SCO membership, which would help end its regional isolation as well as bolster its ties with Moscow, Beijing, and Astana, which all enjoy considerable diplomatic influence in Western capitals.

CONCLUSIONS: One factor that might encourage Moscow to compromise is a desire to secure Kazakhstan’s and Turkmenistan’s implementation of their recent trilateral deal to expand the amount of oil and gas they would export through Russian-controlled energy pipelines. On June 2, moreover, Gazprom CEO Aleksei Miller visited Baku, where he offered to pay “European prices” (the market price minus transportation fees) for Azerbaijan’s natural gas. Since Azerbaijan does not currently ship gas through Russia, such a deal would bolster the Kremlin’s position as the key transit state for Caspian gas to Europe. The Kremlin recently announced that President Dmitry Medvedev would visit Azerbaijan and Turkmenistan in early July.

AUTHOR’S BIO: Richard Weitz is Senior Fellow and Director for Project Management at the Hudson Institute.