MOSCOW (Bloomberg) -- OAO Transneft, operator of the world’s largest pipeline network, is struggling to combat oil theft in Russia’s Caucasus as attacks on police strain security and federal funds fail to lift the region out of poverty.

Transneft opened an office in Dagestan, between Chechnya and the Caspian Sea, and now has 700 guards along its 300-mile pipe after thieves stole 27,000 tons of oil last year, a record for the region, Jafar Nasirov, Transneft’s local chief, said in an interview.
State-run Transneft, building pipes to supply Europe and China, needs to show it can enforce security as Russia attempts to regain control of a region rocked by war and terror. Assaults on police in the republic, where inter-clan tensions have grown since the collapse of the Soviet Union in 1991, have surged in the past month and now occur almost daily.
“It will be impossible for Transneft to eliminate the problem,” said Chris Weafer, chief strategist at UralSib Financial Corp., who has followed the Russian market from Moscow for 11 years. “There’s something of a Robin Hood element to the theft. People feel they are being short-changed by Moscow and so are taking their share directly.”
The link through Dagestan, connecting the Azeri capital Baku to Russia’s Black Sea port of Novorossiysk, transported 5.8 million tons of oil last year. It ran through Chechnya until war and theft forced Moscow-based Transneft to reroute it in the 1990s.
---------------Hot taps
Thieves tap the pipeline by drilling a hole and filling oil drums they transport by car or truck. Investigating sites can be difficult because at times there are no roads or the pipe goes through farms or private land. Transneft’s security has found “hot taps” in the pipe where it runs under houses and offices.
“Someone with a car needs only about half an hour to take 2 tons of oil,” Nasirov said in an interview in Kaspiysk.
Transneft reorganized its security this year and stepped up patrols, stopping “large-scale” siphoning for now, he said. “The amount of theft could have doubled had we not done something about it.”
Dagestan is dependent on Kremlin funds, and wages in the region are about $260 a month, according to the federal statistics service, less than half the Russian average of $557. The Dagestani leadership, which can distribute federal funds largely as it chooses, is losing control, said Masha Lipman, an analyst at the Carnegie Center in Moscow.
“People steal in other regions but the amount is hundreds of times smaller,” Transneft spokesman Igor Dyomin said. “In other regions, criminals are caught and jailed. Here they have been left to go free and the blame put on terrorists.”
--------------Straining resources
The Dagestan regional government says it’s doing all it can to fight theft. Oil companies face robberies in other unstable regions, particularly Nigeria, where production by Royal Dutch Shell Plc dropped by more than half since 2005, Chief Executive Officer Peter Voser said in a presentation on July 30.
Urals Mediterranean crude averaged $95.13 a barrel last year and fell back to an average $55.64 a barrel this year.
Transneft absorbs the cost of missing oil, delivering full quotas to clients. While volumes stolen in 2008 were worth about $20 million of Urals oil, less than 1 percent of its net income of 70.5 billion rubles ($2.2 billion), the theft hurts as the company services its debt and seeks to eek out savings across its business amid financing efforts.
Transneft has taken more than $3 billion from a credit line provided by OAO Sberbank and will also receive $10 billion from China Development Bank Corp. It may also sell $1.1 billion of bonds this month as it seeks to fund major projects.
-------------Rusting tanks
“If in capitalism one is sure to make a profit of 300 percent, committing any crime is possible,” said Arkady Egorov, Transneft’s deputy head of security in Dagestan, citing philosopher Karl Marx. “Here, oil gives a chance for much more.”
Thieves sell the crude to refineries at a discount or process it themselves. Authorities shut down a so-called mini- refinery in Rodnikovy this year after the owner failed to show a bill of sale for the 80 tons of oil found on site, Nasirov said.
The operation consisted of seven partially rusting storage tanks that looked like former railcars, connected by a pipe and hose to a concrete heating unit with tanks, pumps, and temperature and pressure valves. The Azeri crude shipped through the pipe is of a high quality, so it needs little refining and can be processed at simple facilities, Nasirov said.
One metric ton of diesel produced there could fetch as much as 20,000 rubles ($850) last year, Nasirov said. That compares with a peak of $1,191 for Russian diesel in July 2008. The same amount of stolen crude brought in as much as 10,000 rubles.
-------------------Likoil chains
Dagestan has more than 40 such mini-refineries, he said. Authorities couldn’t confirm that figure, Dagestan Interior Ministry spokesman Ruslan Ibragimgadzhiev said. These types of refineries are shut down when discovered, he said.
Local filling stations that mimick national chains are also common. A “Likoil” station, resembling an outlet of Russian oil producer OAO Lukoil, can be found just outside Makhachkala. Another station advertising itself as OAO Russneft, a closely held Russian producer, bears the logo of OAO Rosneft.
Nasirov said Transneft halted one of the more “major” siphoning operations in July, when a spill from a supposedly abandoned pipe led to the chance discovery of illegal tapping.
Criminals diverted crude into an unused pipe belonging to a different company and running downhill to the coast, where it’s accessible by road and unguarded. The operation was detected after other criminals drilled into the pipe and caused a spill that attracted authorities, Nasirov said.
--------------Violence escalates
Police are focused on fighting the escalating violence. Last month, gunmen stormed a sauna, killing seven women, after murdering four police at a checkpoint. At least six other police officers were killed the same week, and a journalist was found dead, according to RIA Novosti. In the mainly Muslim Ingushetia region, a suicide bombing killed at least 24 people Aug. 17.
According to the Dagestan government’s Web site, the region is home to more than 30 ethnic groups speaking as many different languages. Avars are the most numerous, followed by Dargins.
While the attacks aren’t overtly political, the potential for separatist militants in Ingushetia, Dagestan or Chechnya to fund their operations through illegal oil sales may have prompted the tighter security, according to UralSib’s Weafer.
“The problem of oil siphoning in Dagestan is more important for Moscow than the issue of financial loss,” he said. “There is a real fear that the revenue from selling the oil may be funding the increasingly militant separatist movement in the region.”
-----------------Georgia war
Transneft compensates for the stolen volumes with Russian Urals blend at Novorossiysk. A “natural loss” clause in contracts with oil producers allows that some oil will be lost in transit due to evaporation or other means. Transneft is usually left with surplus crude at year-end, which it can sell on the domestic market, even after the theft.
State Oil Co. of Azerbaijan, or Socar, provided roughly half of the volume from Baku last year. The rest was sent by tanker across the Caspian Sea from Kazakhstan and Turkmenistan and added to the pipe at Makhachkala. Socar receives its full contracted volumes, Deputy General Manager of Marketing and Operations Nuri Guliyev said.
The pipe was the only westward route left operating briefly last year when other pipelines shut amid the seven-day Russia- Georgia war and an explosion in Turkey. The strategic role played by the pipeline at that time highlights the importance for Transneft of ensuring full control over it.
“Transneft can probably hold the line for now,” said Cliff Kupchan, a senior analyst at Eurasia Group. “But if violence in Dagestan reaches levels now seen in Ingushetia, the company will face a major challenge.”