AZERBAIJAN

NICK COLEMAN Senior Reporter

AZERBAIJAN

20 YEARS ON... With production from its main oil fields 20% below peak and gas mega-projects facing market uncertainty – plus the threat of conflict escalation – the celebrations for Azerbaijan’s 20th anniversary of the Contract of the Century were somewhat overshadowed.

Shifting geopolitics, production declines and escalating military tension detracted somewhat from this year’s 20th anniversary in Azerbaijan of the so-called “Contract of the Century,” the momentous deal which heralded the rebirth of the country’s oil industry and an opening for international companies. The September 1994 production sharing agreement for the Azeri and Chirag fields plus a deepwater portion of the Guneshli field was Azerbaijan’s first offshore PSA. With the subsequent Baku-TbilisiCeyhan (BTC) pipeline it marked a big advance into the former Soviet Union by

Courtesy: bp.com

THEN: President Heydar Aliyev and BP’s John Browne shake hands in 1994.

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Western companies and won heavyweight political backing from Washington. But the celebrations in September led by President Ilham Aliyev, whose father Heydar Aliyev oversaw the original contract, could not disguise the fact that the Caspian oil boom has shown signs of faltering. Falling Azeri production mirrors declining political interest from countries outside the region, partly reflecting more recent production surges from places like Iraq and the US. BP, the leading Western player in the country, has been working to sustain Azeri-Chirag-Guneshli output following a row with Aliyev in 2012, who was furious over the production decline and the consequent hit to state coffers, accusing the company of having made “grave mistakes.” The British major has managed to stabilize ACG production with the start of production from the 183,000 b/d West Chirag platform, the centerpiece of the $6 billion Chirag Oil Project, taking cumulative investment

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in ACG to $29 billion. Output in the first six months of this year was up 0.1% from the 2013 full-year level, at 656,000 b/d. However this level, 17 years after production began, is already 20% below that in ACG’s peak year, 2010. Azeri oil production as a whole was 14% lower last year than in 2010, at 877,000 b/d. Consultancy Wood Mackenzie expects ACG production – which has totaled more than 2.5 billion barrels of oil so far, out of a total 5 billion allowed under the current PSA – to stay above 600,000 b/d for the next few years, but to decline further before the end of the PSA in 2024. “The peak of those [ACG] fields is over,” BP’s CEO Bob Dudley admitted in July, although he noted that “there could be other sources … to put in the [BTC] pipeline that are not our projects.”

Liquids to gas In the view of many industry observers, Azeri oil production is entering a sunset period and the country will need to face up to production being more based on gas, plus an important role transporting resources from countries on the eastern side of the Caspian – oil from Kazkahstan and gas from Turkmenistan, if the proposed TransCaspian Gas Pipeline ever becomes a reality. As part of the 20th anniversary celebrations this year, a ceremony was held at the Sangachal terminal near Baku to mark the groundbreaking for the Southern Gas Corridor, a network of pipelines that will stretch from Azerbaijan across Turkey to Europe.

Courtesy: yeniazerbaycan.com

NOW: Leaders at the Southern Gas Corridor groundbreaking ceremony (left to right: Azerbaijan, Georgia, Turkey, Greece, Bulgaria, Albania, Italy, Montenegro, the UK, the US, BP and Socar)

President Aliyev was joined by the president of Bulgaria, the prime ministers of Turkey, Georgia, Greece and Montenegro, and senior government officials from Italy, Albania, Croatia, the US and the UK who all put their signatures on the first piece of pipe for the Southern Gas Corridor. Speaking at the event, BP’s Dudley said: “Today we are not only looking back to celebrate the last two decades, but looking ahead to the next chapter in Azerbaijan’s energy story as we start the building of the Southern Corridor to carry gas from the Caspian’s giant Shah Deniz field to Georgia, Turkey, Greece, Bulgaria, Albania and ultimately, Italy.” The ceremony came after BP and partners in late 2013 took a final investment decision on the $28 billion Shah Deniz phase 2 project, which includes expansion of the South Caucasus Pipeline. With gas production of 16 billion cubic meters/year, phase 2 will also increase Shah Deniz condensate production to 120,000 b/d from 55,000 b/d. BP also hopes to unlock the ShafagAsiman structure with its “20K” program, a high-pressure, high

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AZERBAIJAN: A HISTORY OF HYDROCARBONS

temperature drilling technology project aimed at handling pressures of up to 20,000 pounds per square inch and temperatures up to 350 degrees Fahrenheit. Shafag-Asiman is thought to contain 500 billion cubic meters of gas and 65 million mt of condensate.

Azerbaijan’s signing of the Azeri-ChiragGuneshli PSA in 1994 was a powerful symbol of the return of international oil companies to the former Soviet Union. It was not the first PSA of the post-Soviet era – Kazakhstan’s Tengiz PSA was signed the year before – but it had particular resonance because of Baku’s history as the so-called Black Gold Capital, the birthplace of the modern oil industry outside the US. Azerbaijan has long been outgrown as an oil producer by Russia and more recently Kazakhstan. But it holds a special status both as a gateway to the Caspian, and symbolically as the place where finance and expertise came together in the late 19th century to form an industry that for a time rivaled the US in levels of production and comprised a multinational cast of characters, including Russians, Britons, Azeris, Armenians and above all the Swedish businessman and engineer Ludvig Nobel, whose Branobel company operated in both Azerbaijan and Turkmenistan. A young Georgian called Ioseb Jugashvili – later to be known as Josef Stalin – also cut his revolutionary teeth agitating among Baku’s oil workers in the early part of the century. That heady mix was largely snuffed out with the 1917 Russian Revolution. By the time of Branobel’s nationalization in 1920, Azeri production had fallen far behind the giant leaps made in the US. Azeri oil wealth continued to capture imaginations however, not least that of German Nazi leader Adolf Hitler, who in World War II diverted his forces

THEN: Baku’s oil towers.

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Also on the horizon is the giant Total-operated Absheron field, thought to contain 5-10 Tcf (142-284 billion cubic meters) of gas and due on stream around the end of the decade.

NOW: Baku’s Flame Towers.

away from Moscow and towards the Baku oil fields in what some historians consider a fatal tactical error. With a shift in post-war attention to Siberia and its oil fields, Soviet geologists still managed to make major discoveries in the Caspian region. Today, most Caspian production comes from fields discovered in the Soviet era, including ACG in Azerbaijan and Kazakhstan’s Tengiz and Karachaganak. Today’s oil industry perhaps owes a debt of gratitude to Nobel however, partly for pioneering industrial production in Baku, but also for the refining, transportation and trading methods he employed. The Contract of the Century signed by President Heydar Aliyev in 1994 was in some sense a re-embrace of those international values, and sparked an economic boom from the late 1990s until the latter part of the 2000s that transformed the country. But the story has been soured by questions about the glamorous lifestyles of Azerbaijan’s first family and the methods it has used to stay in power, including suppression of democracy and human rights. Kazakhstan’s rise as an oil producer has been just as controversial. In both countries stagnating production and recent falls in oil prices have added to pressures on their political leaders.

Such projects are questioned by critics who point to diminished expectations of European gas demand and a possible increase in LNG volumes in the Mediterranean in years to come. Proponents of Caspian gas however point to the steady development of the Southern Corridor, which promises to reduce Europe’s reliance on Russian gas – notably Russian gas that transits Ukraine – and also highlight Turkey’s growing gas demand. “We know Turkey will be a gas importing country. We are working to find the best development for Absheron, and we are relatively confident we’ll find access to market,” Total’s president for exploration and production, Arnaud Breuillac, told Platts in September.

‘Status quo can’t last’ From a geostrategic viewpoint, the Caspian oil boom was never just about Azerbaijan. The BTC pipeline provided a counterweight to Russia’s energy dominance in the European sphere and has underpinned Turkey’s rise as a Mediterranean oil hub, both

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key strategic aims of the US and Europe.

CASPIAN SEA OIL AND GAS FIELDS

In terms of the security situation, BTC has to some extent justified hopes that it would help dampen down conflict in the historically unstable region by giving Azerbaijan a stake in the security of the whole of the southern Caucasus and thus restraining ongoing tensions over the Armenia-backed NagornoKarabakh area. But 20 years since the end of a six-year war over Nagorno-Karabakh in which tens of thousands of people died, that unresolved conflict is also in danger of reigniting. Deadly clashes involving small arms and artillery fire have intensified this year around NagornoKarabakh, which the BTC route skirts around, and have widened to include the less fortified Azeri-Armenian border close to Georgia. In the latest escalation in November, Azerbaijan shot down an Armenian helicopter, killing the three crew members.

KAZAKHSTAN

Astrakhan field

RUSSIA

Kashagan field

Korchagin field

UZBEKISTAN

AZERBAIJAN

ACG fields Shah Deniz field

TURKMENISTAN

Cheleken contract area

Sardar Jangal field

IRAN

Agreed-upon maritime boundaries Theoretical Caspian equidistant line Oil field Natural gas field

Oil refinery Natural gas processing plant

Source: EIA

SOUTHERN CORRIDOR PIPELINES BELARUS

POLAND

GERMANY CZECH REP.

UKRAINE

SLOVAKIA

Lanzhot Baumgarten Lanzhot MOLD.

HUNGARY AUSTRIA

3 Trans-Anatolian Pipeline (TANAP) 4 South Caucasus Pipeline (SCP) 5 Ionian Adriatic Pipeline

1 Trans Adriatic Pipeline (TAP)

6 Interconnector Greece Bulgaria (IGB)

2 Nabucco West

7 Baku-Tbilisi-Ceyhan (BTC)

Atyrau

Odessa

Tarvisio SLO.

Petrovsk

Russian artery (simplified) Existing pipelines Proposed pipelines

Brody

Waidhaus

President Aliyev has sworn to recapture lost Azeri territory. As for Armenia, its worries about Azerbaijan’s growing military strength, one of the fruits of its oil wealth, have led to talk in government circles of making preemptive strikes against Azeri infrastructure, says Lawrence Sheets, analyst at International Crisis Group.

Tengiz field

2

CRO.

ROMANIA

Constanza

BOS. SERB.

5

ITALY

BUL.

Stara Zagora Brindisi

Komotini

Otranto

GEORGIA

Bourgas Samsun

3

Istanbul

Tbilisi

Caspian Sea

7

ARMENIA 4

AZERB.

Ankara GREECE

Aktau KAZAKHSTAN

Dzhugba

6

AL. MAC.

1

RUSSIA Black Sea

Erzurum

Baku

Turkmenbashi

Sangachal TURKMENISTAN

7

Korpedzhe

TURKEY

Ceyhan Kort-Kui Mediterranean Sea

“I don’t see the status quo as something which can last forever. The statements out of Baku were always belligerent, but it has become more than threatening,” Sheets said, adding that a diplomatic effort is urgently needed involving the return to Azerbaijan of territory around Nagorno-Karabakh.

CYPRUS

SYRIA

IRAQ

Tehran

IRAN

Source: Platts

Kashagan embarrassment Meanwhile, with throughput of 744,000 b/d in the first six months, BTC is operating at less than two-thirds of its 1.2 million b/d capacity. This partly 

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reflects the technical and governance problems that have engulfed Kazakhstan’s giant Caspian field, Kashagan, which was supposed to be creating transport bottlenecks in the region by now. It had long been intended that BTC would carry growing production from landlocked Kazakhstan as Azeri output declined.

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Critics point to diminished expectations of European gas demand and a possible increase in LNG volumes in the Mediterranean in years to come.

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But instead it has been an embarrassment, described by Total’s chief financial officer, Patrick de la Chevardiere, as a “failure of the industry.” Kashagan was originally due on stream in the middle of the last decade, but that goal proved hopelessly optimistic and after problems last year with leaking sulfurous crude it is not now expected on stream before the second half of 2016. Beyond these present and proposed projects, Azeri production is largely confined to the declining mature assets of state company Socar, together with the Gum Deniz offshore field, which is operated by US-Azeri joint venture Bahar Energy and has produced less than 2,000 b/d of oil this year. The Azeri onshore is generally seen as an unattractive prospect due to its heavy exploitation, dating back to the 19th century, and resulting environmental damage. However, US company

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ConocoPhillips is pursuing exploration in one unexploited area, the Kura Valley. And Norway’s Statoil, a key player in European gas, is upbeat on Azerbaijan, despite having sold its 25.5% stake in Shah Deniz in the last 12 months. It retains an 8.6% stake in the ACG fields along with a stake in the BTC pipeline. Statoil senior vice president for Europe and Asia Katie Jackson notes that ACG remains a “truly huge field” with its 2.5 billion barrels still to be produced under the current agreement. In addition she is optimistic that new oil and gas resources will be discovered in what is a relatively restricted offshore zone, still restricted by territorial disputes, and generally prone to high drilling costs. Azerbaijan will have to compete against other destinations in a cost-conscious environment as global oil prices drop, but the country has earned respect for its stable fiscal regime, Jackson says. “We continue to see the region as very interesting in terms of having a rich petroleum system and also well positioned in terms of infrastructure … for exporting both oil and gas, and also positive – Azerbaijan in particular – having been very stable from a fiscal perspective for a long period of time,” she said in a recent interview. Others are less convinced. “It’s just the opportunity set – it’s low value onshore and then very high cost and technically challenging offshore,” Nick Gellatly, the head of Caspian upstream research for Wood Mackenzie, said. “To have opportunities for mid-cap players, international players – there probably aren’t any that stick out at the moment in the upstream.”