THE OIL MARKET TURNAROUND IS DAMAGING FOR AZERBAIJAN
By Bedros Terzian, with permission of Petrostrategies

Civilitas Foundation
ysis/090130oil.html
Feb 2, 2009

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=2 0oil 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 of20much 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 r espected, 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 Gul to the Armenian
capital in September 2008 led to nothing in=2 0concrete 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.