July 13 was a red letter day for Azerbaijan’s energy industry. When the BP-led consortium loaded its first tanker from the long-awaited Baku-Tbilisi- Ceyhan (BTC) pipeline, the country’s politicians, financiers and oil industry experts breathed a sigh of relief. The BTC pipeline not only promises to guarantee Azerbaijan an independent energy supply, and source of oil revenues for many decades, it was also a feat of management that gave the country confidence and self belief.
The pipeline runs 1600 kilometres from the Azerbaijan capital city of Baku, via Georgia, to the Mediterranean port of Ceyhan. At a cost of almost $4bn, the BTC pipeline allows oil to bypass the crowded Bosporus and Dardanelles Straits.
Gregory Jedrzejczak, the World Bank’s country manager, says: “BTC is very critical. It is the second longest pipeline in the world. It is a massive bet for the oil companies and for Azerbaijan. BTC goes through difficult places both in international and geographical terms.
“The next test will be to see if they can pull off the gas pipeline along the same route. That comes on stream very soon. This opens Azerbaijan to the global markets.”
The pipeline offers both economic and political stability, says Mr Jedrzejczak. “You need political stability for the pipe, and the pipe gives political stability. It is a very smart solution. At some stage the local resources will be exhausted and the pipeline will be used for oil transit.
“It adds to the region’s political stability. It is not only in the interests of Azerbaijan, but also in the interests of the global markets. They expect it to function. They support a country where oil is being carried. It is nice these days to be energy-resource rich. It takes you to different league of global politics. Azerbaijan is playing it very skilfully.”
A World Bank document outlines the speed of the oil gush and the likely swift demise. It reports: “The oil sector is expected to grow rapidly for several years, after which it will gradually slow and begin declining over the medium and long term. At the end of 2003, Azerbaijan’s proven energy reserves stood at 7 billion barrels of oil and 1.34 billion cubic metres of gas.
“Long-term revenue projections, based on an average oil price of $43 a barrel for the next 20 years suggest gross revenues of about $340bn from oil and gas fields plus BTC transit before operation costs. After operating costs of $65bn, fiscal revenues to the state are expected to reach $175bn, of which about $20bn will accrue to the state budget in the form of tax revenues, and $155bn to the State Oil Fund of the Republic of Azerbaijan (Sofaz), in the form of royalties.
“The private sector consortium is expected to repatriate the $40bn invested at a rapid rate and $60bn in profits. This implies an oil windfall of $1000 per capita per year for the next 20 years. But unless new oil and gas reserves are discovered, that will be the end of Azerbaijan’s oil boom.”
Huge reserves
The country’s key developer of its oil potential is the State Oil Company of the Azerbaijan Republic (Socar). Socar estimates total probable reserves at the much higher 17.5 billion barrels. The majority of Azerbaijan’s oil output (59% in 2005) comes from Socar, but the Azerbaijan International Operating Company (AIOC), which represents more than 70% of Azerbaijan’s total oil exports, has a growing role.
The privatisation of Socar has been widely mooted, but finance minister Samir Sharifov discounts it. “We don’t believe the state-owned company of Azerbaijan should be privatised. Socar has a number of oil fields that were given by the government to the state-owned company.
“Our production agreements are in the way of privatisation. If you take out all the oil fields from Socar, who would be interested in buying Socar. What are you buying, the building?
“Foreigners are only interested in the Socar licences. So you could say that Azerbaijan has pursued a privatisation route anyway. BP is working here and has a licence to operate the oilfield. Exxon-Mobil, Chevron, Total, Statoil are here already. They have access to oil. It is thus a form of privatisation.”
The other force in Azerbaijan energy is the AIOC consortium. This operates the offshore Azeri, Chirag and deep-water Guneshli structure, which is estimated to contain crude oil reserves of 5.4 billion barrels according to BP, the field’s operator and largest stakeholder. In 2005, Socar raised its assessment of the field’s recoverable reserves from 5.4 billion barrels to 6.9 billion barrels.
Socar was established in September 1992 with the merger of Azerbaijan’s two state oil companies, Azerineft and Azneftkimiya. Socar and its many subsidiaries are responsible for the production of oil and natural gas in Azerbaijan, for operation of the country’s two refineries, for running the country’s pipeline system (except BTC), and for managing the country’s oil and natural gas imports and exports.
Although government ministries handle exploration and production agreements with foreign companies, Socar is party to all of the international consortia developing new oil and gas projects in Azerbaijan.
According to a reported published by Michael Cohen, an energy analyst at the Energy Information Administration (EIA) in Washington DC: “The company does not have effective control over output levels and the state is re-organising the company to create greater operating and fiscal efficiency.”
Since 2003, Socar has owned the oil it produces; previously, Socar relinquished ownership once the oil had been sent to processing facilities. The restructuring also involved transferring some of the non-oil-producing businesses to the Ministry for Economic Development. Further restructuring of Socar is likely in upcoming months as the company implements recommendations of an international consulting consortium that was funded by a European Bank for Reconstruction and Development grant.
Almost half of Socar’s oil production in recent months came from the offshore field ‘shallow water Guneshli’. The EIA report says that production levels have been falling as equipment is in disrepair and the structure is losing reservoir pressure. Although production from Socar’s Soviet-era fields is in decline, foreign direct investment has revitalised the country’s oil sector through the development of large-scale new projects and the refurbishment of existing facilities.
Azerbaijan has signed more than 20 major field agreements with approximately 30 companies from 15 countries. Azerbaijan’s increase in oil production since 1997 has mainly come from the AIOC international consortium.
Oil exports
During 2004, Azerbaijan exported approximately 211,000 barrels per day (bbl/d), but exports are expected to more than double to 478,000 bbl/d in 2006 and reach as high as 1.1 million bbl/d by 2008, according to Azeri government estimates. Government estimates assume additional production from new offshore discoveries as well as the modernisation of old fields.
Azerbaijan’s other export route is the Baku-Novorossiysk pipeline, which sends approximately 50,000-90,000 bbl/d of Azeri crude oil to the Russian Black Sea. This pipeline closed briefly in late June 2004 after oil thieves set off an explosion when they attempted to steal oil from the pipeline.
The Azeri state company began reducing oil exports via the Baku-Novorossiysk pipeline in August 2005, according to EIA, in order to divert crude to the BTC pipeline, once it became operational.
Azerbaijan also produces liquefied petroleum gases (LPGs) at the Heydar Aliev refinery. In 2005, the plant produced 1.8 million barrels, 127,000 of which was exported. Socar forecasts production growth of about 1.6% in 2006. Azerbaijan plans to build two high-quality gasoline production units at the Baku Heidar Aliyev refinery between 2006 and 2008 at a cost of $120m-$140m. This will boost production by almost 50%. Azerbaijan’s automobile gasoline output rose 6.4% on the year to 7.7 million barrels in 2005.
Mr Cohen says in his report that both of the country’s refineries are in need of modernisation and pollution control equipment. Under a $500m modernisation project approved in 2004, new equipment will be installed at both refineries and at the specialised port of Dubendi to increase throughput to 260,000 bbl/d by 2010.
Natural gas
Azerbaijan has natural gas reserves of about 30,000 billion cubic feet (bcf), according to The Oil and Gas Journal.
BP estimates rather more, saying that the country has 48,000 bcf of reserves. In 2004, state statistics showed that the country extracted 177 bcf, a 4.4% increase from 2003.
Some 77% of natural gas production in Azerbaijan is produced by Azneft, a Socar subsidiary, and the rest is produced by joint ventures (the largest of which is AIOC).
State officials project that Azerbaijan will produce up to 390 bcf by 2008. The EIA says that until the requisite infrastructure is completed, natural gas will be flared off rather than be piped to markets.
Azerbaijan is importing roughly four times more natural gas than it was in 2001. Besides higher economic growth rates, one main cause of the natural gas dependency is that oil-fired power plants have been converted into gas-fired ones. This has forced Azerbaijan to import 160-175 bcf per year from Russia at a price of $1.70 per 1000 cubic feet (mcf), up from $1.47 per mcf in 2004.
Virtually all of Azerbaijan’s natural gas is produced from offshore fields. The country’s leading natural gas producer, the Bakhar oil and gas field, is located off the southern tip of the Absheron Peninsula and accounts for slightly over half of the country’s natural gas output.
Over the next 10 years, the EIA says that Socar plans to invest $224m to expand natural gas production in Azerbaijan by drilling 23 gas wells in the shallow-water Gunashli field, by expanding existing platforms, and by building underwater gas pipelines. The company hopes this will help increase production to about 330 bcf a year by 2010.
Future development
Azerbaijan’s major natural gas production increases in the future are expected to come from the development of the Shah Deniz offshore natural gas and condensate field. Industry analysts estimate that Shah Deniz is one of the world’s largest natural gas field discoveries of the past 20 years.
According to the project’s operator, BP, the field contains “potential recoverable resources” of about 15,000 bcf of natural gas and 600 million barrels of condensate. However, other industry and trade sources estimate the field’s size to be as high as 35,000 bcf.
Shah Deniz is located offshore, approximately 100km south-east of Baku, and is being developed by the Shah Deniz consortium.
The first phase of the Shah Deniz field’s development was officially approved on February 27, 2003, and estimates place its cost at more than $4bn.
Despite the large Shah Deniz natural gas field, Azerbaijan is a net natural gas importer. Azerbaijan produced 190 bcf of natural gas in 2004, while consuming roughly 360 bcf. The long-term contract with Gazprom, Russia’s largely state-owned gas company, came into effect on January 1, 2004, and lasts until December 31, 2008.
Azerbaijan’s natural gas dependency is a temporary security issue due to pipeline sabotage in southern Russia and political disputes over natural gas pricing between Russia and Turkmenistan. As natural gas production from domestic fields such as Shah Deniz increases, this dependency on Russian natural gas imports will decrease.
