by Max Hoyt

On September 19th, representatives of the Shah Deniz consortium met with European buyers in the Azerbaijani capital, Baku, to sign long-term contracts for Azerbaijani natural gas. The gas purchase agreements, each signed for 25 years, mark the finalization of the Shah Deniz Consortium’s June 28th decision to support the Trans-Adriatic Pipeline (TAP) instead of the rival Nabucco-West pipeline. The agreements stipulated for the total sale of 10 bcm/a to nine companies in Italy, Greece, and Bulgaria. Of this 10 bcm/a, 8 bcm/a will supply Italy and adjacent market hubs while the remaining 2 bcm/a will be split between buyers in Bulgaria and Greece with each receiving a volume of 1 bcm/a. This was a historic decision for Azerbaijan, simultaneously securing decades of hydrocarbon revenues for the small Caucasian nation and finally putting an end to the decade-long debate over proposed European market destinations for the Shah Deniz field’s estimated 1.2 trillion cubic meters of gas. Although the president of the EU Commission has declared the consortium’s decision a shared success for Europe and a milestone in strengthening the energy security of the union, this deal was made with only marginal consideration given to European energy security and Southern Corridor goals. TAP or Nabucco, the deal to construct a Caspian supplied pipeline was inked based on textbook economic incentives. In the end, TAP was a better and necessary business decision for Azerbaijan and its partners who needed to secure demand, i.e. guarantees of future profits, to continue to finance both Azerbaijan’s domestic growth and its southern corridor energy projects.

Azerbaijani Projects and Finances

This deal was inked at a critical financial moment for Azerbaijan. Since 2010, production has been waning from Azerbaijan’s flagship oil field, Azeri-Chirag-Gunashli (ACG), with no rejuvenation in sight. This forecast spells trouble for the small republic as the total government revenue is 65% dependent on sales from its gas and oil industries. In 2006, Azerbaijan’s real GDP grew by an astounding 34.5% thanks to the fortuitous timing of the Baku-Tbilisi-Ceyhan pipeline’s (BTC) commissioning and record high oil prices leading up to the 2008/2009 financial crisis. Since the crisis, however, the country has boasted modest real GDP growths of 5% in 2010 and .1% in 2011. At the same time, the State Oil Fund of Azerbaijan (SOFAZ), an organization set up in 1999 to collect and manage Azerbaijan’s oil revenues, has redoubled (actually by 18 times) its yearly spending from $686 million in 2007 to $11.64 billion in 2011. The fund’s assets are spent on construction projects such as the BTC pipeline, Baku-Tbilisi-Kars railway, canal and waterway projects, and youth training abroad programs. From only 2010-2012, SOFAZ transferred $31.6 billion to the government, an amount almost equal to the January 1st 2013 announced total assets of $34.129 billion. A leading Baku-based think tank, the Center of Social and Economic Development, predicts that these kinds of expenditures are unsustainable and, if unchecked, the fund will be dry by 2017, considering the decreasing figures of oil production.

The continuation of the Shah Deniz project is essential for the State Oil Company of Azerbaijan’s (SOCAR) long-term survival.

Furthermore, the Shah Deniz Consortium, a BP operated joint venture between Statoil, SOCAR, LUKAGIP, TOTAL, NIOC, TRAO, and BP tasked with developing the Shah Deniz gas field, is slated to make its final investment decisions on the development of phase 2 of the Shah Deniz field late this year.This is an estimated $25 billion investment deal, and the commitment of SOCAR’s foreign partners will most certainly be ameliorated by the presence of European buyers waiting in the wings. The continuation of the Shah Deniz project is essential for the State Oil Company of Azerbaijan’s (SOCAR) long-term survival. SOCAR, by way of which SOFAZ and the government itself collects a large portion of their revenues, produces less than 20% per annum of the oil pumped from Azerbaijani fields. In 2012 this was 8.4 million tons of oil out of the 45.6 million tons produced in Azerbaijan as a whole. The rest of the production is conducted by foreign companies, the leading of which are BP and Statoil, via Production Sharing Agreements (PSA). Thus SOCAR, and therefore the federal budget, is heavily reliant on foreign assistance, the gestalt of which is apparent if one simply glances at the long list of international companies working on the various fields in the vicinity of Azerbaijan’s eastern Absheron peninsula.

Nabucco was a champion of Europe’s energy security platform while TAP, a privately funded endeavor, was planned with an investor’s pocketbook in mind.

Pipelines – Strictly Business

While the long-term profits guaranteed to Azerbaijan by a secured destination market for Shah Deniz gas will definitely help to improve Azerbaijan’s current and future finances, this eventual selection of an exit-route for Shah Deniz gas was an imperative. The final decision of which route, however, was the subject of much debate and became a highly politicized matter. The pipeline politics surrounding Nabucco-West, TAP’s rival, is, in itself, a very complicated subject and outside the scope of this article; it is, however, sufficient to say that Nabucco, in all of its different incarnations, was a champion of Europe’s energy security platform while TAP, a privately funded endeavor, was planned with an investor’s pocketbook in mind. That being said, the Shah Deniz Consortium’s commitment to TAP was economically motivated, falling directly into an economic framework to minimize costs while maximizing long-term profits.

TAP, a pipeline that will stretch 870 km from Turkey, through Greece and Albania, under the Adriatic, and into Italy, carries a 4.4 billion euro price tag; the competing pipeline, Nabucco-West, planned to travel 1300 km from Turkey to the Austrian gas hub at Baumgarten would have run investors 6.6 billion euros. Furthermore, TAP’s transit tariff was agreed on at 3 euros/100km, 50 cents less than Nabucco’s tariff. Thus, TAP will cost less to build, take less time to do so, and grant sellers a higher netback from gas sold than Nabucco would have. Finally, TAP’s initial capacity demands will be completely sustainable by Azerbaijan’s own production while Nabucco’s planned capacity fluctuated between 10 – 30 bcm. The fulfillment of this top-end capacity would have forced the pipeline consortium to sign on additional supplies, a further complicating factor.

Netbacks and construction costs are not the only advantages that the Shah Deniz Consortium were looking at when they announced TAP’s confirmed selection at a Baku press conference on June 28th this summer (this final decision came with little surprise as the Consortium had, in fact, selected TAP as the priority route over a year earlier on February 21st 2012.) To make the deal even sweeter, SOCAR had just acquired a commanding 66% share in DESFA, the Greek natural gas grid operator, 10 days earlier on June 18th. With acquisition of DESFA, SOCAR, 20% shareholder in TAP, has direct access to native Greek markets whose demand is projected to grow to 5.6 bcm by 2019, the same year that Shah Deniz gas is set to flow to Europe. Finally the destination markets of TAP and the multiplicity of its buyers allows for secure market niches for Shah Deniz Gas. In Bulgaria the 1 bcm will build upon the 2.9 bcm imported annually from Gazprom, which currently makes up 100% of Bulgaria’s natural gas imports; in Greece the 1 bcm will account for 26% of the Greek gas market (based on 2010 Net imports); and in Italy, one of Europe’s biggest markets, 8 bcm will comprise 11.6% of the overall annual 69 bcm imported. Thus, with the arguable exception of in Italy, Azerbaijani gas will not meet large volume-for-volume competition vis- à-vis Gazprom, which exported 17.08 bcm of its 150 bcm Europe-bound exports to Italy in 2011 and is Italy’s 2nd biggest energy supplier. However, the multiplicity of buyers, 9 in total, of which 7 represent Italian interests, will provide the consortium with diverse, yet resilient, market shares that are predicted to neither compete with nor undercut Gazprom’s volumes pricewise.

TAP’s claim to provide long-term energy security to the Western Balkans via the Ionian Adriatic Pipeline (IAP) is at best lip-service to European Energy Security.

Last but not least, the decision to build and supply TAP opens room for further discussion of building both an additional West Balkan reaching extension as well as the gasification of Albania. The extension of TAP into the Balkans and particularly the corresponding gasification of Albania is a venture that SOCAR would stand to capitalize on. Albania, currently not gasified, is predicted to have a market for 1 to 2 bcm, a market that SOCAR would have direct downstream access to as the owner of neighboring Greece’s DESFA.

Supply Diversification and European Energy Security

As for the matter of European Energy Security that is advertised in TAP’s official material (TAP purports to be a solution to Western Balkan and Bulgarian energy security), only Bulgaria will truly benefit from this diversification of supply in the short to medium-term. As stated above, Bulgaria currently imports solely from Gazprom and was highly affected during the 2009 Ukraine-Russia gas disputes. Bulgaria has expressed its desire to diversify its energy sector in light of this dispute, first building a natural gas inter-connector to Romania and now by securing 1 bcm from Azerbaijan. According to Bulgaria’s Energy Strategy until 2020, its natural gas consumption is only predicted to grow marginally from 2.8 Mtoe in 2010 to 3 Mtoe in 2020. Based on these figures, Azerbaijani gas will likely displace Gazprom imports, thereby meeting Bulgaria’s goal of a more diverse network of suppliers. TAP’s claim to provide long-term energy security to the Western Balkans via the Ionian Adriatic Pipeline (IAP) is at best lip-service to European Energy Security. The IAP is still in the proposal stage of development and, even if its construction were decided upon immediately, it would have to wait until the additional bcms of production came online sometime in the 2020s. Thus, only 1 bcm of the 10 to be transported through the new Southern Corridor actually alters the current security of supply situation, a fact which severely mitigates any claims that Shah Deniz prioritized European Energy Security over economic incentives when choosing TAP.

The deal inked between Shah Deniz partners and European buyers is estimated to be worth $200 billion

Profitable Externalities

The deal inked between Shah Deniz partners and European buyers is estimated to be worth $200 billion and is just one in many agreements either already signed or currently on the table for Azerbaijan. The Southern Caucasian Pipeline, also known as Baku-Tibilisi-Erzurum, which currently carries natural gas from Baku to the Turkish gas hub, must be expanded from the current capacity of 20 bcm to accommodate the growth in supplies from Shah Deniz phase 2. Then, the TANAP pipeline that will run 2000km across Turkey from Erzurum to a planned connection point with TAP will be a future jumping off point for SOCAR-led expansion. SOCAR, which owns a 51% share in TANAP, will sell 6 bcm from Shah Deniz to Turkey via TANAP starting in 2018. Furthermore, there are plans to expand TANAP’s initial 16 bcm capacity to 31 bcm by 2026 to meet expanded Turkish and European needs (TAP is planned to be expanded correspondingly) and there has even been discussion between Azerbaijan and Turkey that TANAP will eventually be expanded to 60 bcm to include Turkmen and Israeli gas and maybe even gas from Iran and Iraq (while it is beyond the scope of this article to address these predictions, the author considered such statements beneficial for assessing the impact of TANAP).

Conclusion

On all fronts, Azerbaijan looks to profit on its involvement in the Southern Gas Corridor. Yes, there are small short-term (as well as potential for long-term) EU energy security victories that accompany the commitment for TAP. However, the by-volume contributions that Azerbaijan’s 10 bcm will be making to European total imports—about 403 bcm by pipeline and LNG in 2012—is minuscule in terms of overall energy diversification. If one looks at the aggregate of Azerbaijan’s decisions—several pipelines with SOCAR’s name on them, a gas distributor in Greece, and a list of wealthy investors in and buyers for Azerbaijani gas—it quickly becomes clear that this decision was done in the name of business.

Max Hoyt is an MA student in the ENERPO program at European University at St. Petersburg.