Some hydrocarbon exporting countries are suffering more than others from the decline in oil prices for economic, and sometimes political reasons, too. Azerbaijan belongs to the latter category. The fall in prices is occurring just as the country’s production is on the verge of peaking. If prices continue to flag, they could deprive Baku of what should have been its golden oil age. Unlike other producer countries, Azerbaijan extracts the lion’s share of its oil from a single group of fields: the ones being developed and exploited by the AIOC consortium, i.e. Azeri, Chirag and Deep Guneshli (ACG). The AIOC’s production plateau risks lasting for only a short period of time. As a result, it is the entire Azeri production that will decline, as its profile cannot be enhanced by contributions from other fields, unlike countries that have a large number of fields.
The exploration work carried out by over a dozen foreign oil groups, which have spent more than $1 billion in two decades (ExxonMobil being the latest to date), have led to no new oilfield discoveries in Azerbaijan, putting aside that of Shah Deniz, since it contains gas. Peak oil production is thus expected in 2010 and the decline could commence as of 2013 for the ACG. The scheduled arrival of condensates from phase 2 of the Shah Deniz development could help postpone the downturn in Azeri liquid hydrocarbon production until 2014-15 at the latest. Two possible sources could emerge thereafter to slow down this decline in production growth: an EOR program on ACG and/or the service start-up of the Inam field, which is currently being explored.
For the time being, Azerbaijan is channeling a large chunk of its oil revenues into amortizing the investments made by foreign firms to develop ACG and Shah Deniz. According to the IMF’s statistics in 2007, Azerbaijan put $5.2 billion into reimbursing the oil expenditure (opex and amortizing capex) of foreign companies, and this left it with $5.3 billion in net export revenues. The country started reimbursing past investments in 2006 (see table). But new development investments are currently being made: $2.5 billion were planned for 2008, after the $3.2 billion spent in 2007, for ACG and Shah Deniz. Thus, it will take several more years of reimbursements to amortize these. Added to the latter are operating expenses, which in 2008 were estimated at around $750 million/annum for ACG and Shah Deniz and which are 100% reimbursed over the year. The lion’s share of the investments coincided with the rise in costs in the global oil industry as of 2003-4, while prices are falling just as Baku is preparing to reap the fruits of its production hike. In short, low-priced oil will be used to reimburse oil developed at high costs.
The fall in global oil demand is another source of disappointment for Baku. Not that it is hard to sell its crude oil: no, Azeri oil is of a high quality (apart from a number of recent problems related to temporary sourness, it seems) and is generally sold at a comfortable premium compared with Brent. The problem has more to do with the fall in global demand, which has given rise to a production capacity surplus of 5-8 million b/d around the world and which risks continuing up to 2016, according to Cambridge Energy Research Associates (CERA – Petrostrategies, January 12, 2009). Thus, while in 2006 and 2007, the world could not do without Azeri oil (nor could it do without any producer country of an equivalent or bigger size than that of Azerbaijan), this crude oil is today no longer essential for ensuring the balance of the international oil market.
The political consequences of these evolutions are of no benefit at all to Azerbaijan. Baku was pinning high hopes on its strengths as an oil producer to boost its negotiating power with Armenia in the Nagorno Karabagh conflict. But now this trump card is being undermined, as worrying signals are being sent from Georgia and Turkey, two key countries for Azeri oil exports. The deterioration of the situation in Georgia following the short Russia-Georgia war in August have been the cause of much concern: Baku made a public statement in which it regretted “putting all its eggs in the same basket”, which proved to be fragile” (Petrostrategies, October 6, 2008), by having all its new hydrocarbon pipelines transit Georgia. But now that this has been done, the Azeri government is left with no other choice; it is doing all it can to help Georgia. At the beginning of December 2008, Baku guaranteed that it would cover 85% of this country’s gas demand by committing to supply it with 900 million cu.m/annum at a cut price. Baku has acquired the Kulevi oil terminal in Georgia, has opened service stations in the country, and has granted a $300-million loan at a 1% interest over 25 years for the construction of a Baku-Akhalkalaki-Kars railroad to Turkey, etc. At the same time, Baku is coming to the aid of the Azeri minority, which has a very strong presence in the North-east border region (transited by the BTC oil pipeline) of Georgia, providing it with social, medical and schooling assistance.
Azerbaijan is starting to experience problems with Turkey too, its most powerful ally in the region. Over the last few months, three energy sector disputes have come to light between the two countries. The first of these involves the price at which Turkey has been purchasing the gas (of Shah Deniz) from Azerbaijan since 2007. A price of $120/1,000 was agreed for the first year. This was respected, despite the price hike on the international market. But this agreement expired in July 2008; Azerbaijan rejected the new price of $150 that Turkey was offering, saying Ankara should pay double this. The second stumbling block concerns Turkey’s purchase of part of the gas to come from phase 2 of Shah Deniz and which will be exported to Europe. Ankara is asking for 8 bcm/annum, while Baku is offering only 4 bcm/annum. The third dispute is over the transit fees that Turkey is charging for the Azeri oil that is piped through the Baku-Tbilissi-Ceyhan (BTC) oil pipeline. At the outset, in order to encourage the construction of this expensive structure ($4 billion), the Turks had agreed to charge a fee of only $0.35/b. But as a result of the crude oil price hike, they considered that a rise was justified, which Baku contests, arguing that long-term agreements were reached with Ankara.
Turkey is in a very strong negotiating position. Not only does the country serve as a transit corridor for two Azeri pipelines (the BTC oil pipeline and the Shah Deniz gasline), but at any time it wishes, it can open up the Armenian border, which it closed in 1993 to support Baku in the Nagorno Karabagh conflict. Azerbaijan is now anxiously observing how relations evolve between Armenia and Turkey. True, the historical visit by Turkish President Abdullah Gül to the Armenian capital in September 2008 led to nothing in concrete terms and Ankara is maintaining its blockade on the border, but an increasing number of people in Turkey are talking about re-opening it. Furthermore, public opinion in Turkey, which had previously been homogenous, is now riddled with contradicting opinions, even on the ultra-sensitive issue of the Armenian genocide. Thus, in mid-December, 300 Turkish intellectuals launched a petition entitled: “We ask them for forgiveness” for “the Great catastrophe that the Ottoman Armenians suffered in 1915”. More than 27,000 people signed the petition and it is the source of hot debate in Turkey. Such an initiative was inconceivable only a few months ago in this country, where even the mention of genocide is punishable with a prison sentence. At the beginning of January 2009, a Turkish state prosecutor opened an inquiry in order to establish whether the intellectuals’ initiative violated the famous Article 301 of the penal code, which punishes “insults against the Turkish national identity”. The Prime Minister has spoken out against the petition, while the President of the Republic says it proves that freedom of speech does exist in Turkey. Baku is following these developments with much concern.
Petrostrategies, France
January 30, 2009