EUR DAS BRYZA DISCUSSES ENERGY AND GAS TO EUROPE

C O N F I D E N T I A L SECTION 01 OF 05 BAKU 001472

SIPDIS

SIPDIS

EUR FOR DAS BRYZA AND S/P FOR STEVE HELLMAN
USDOE FOR CHARLES WASHINGTON
USDOC FOR 4212/ITA/MAC/CPD/CRUSNAK

E.O. 12958: DECL: 10/15/2016
TAGS: ECON EPET ENRG PREL AJ RU IR TU
SUBJECT: EUR DAS BRYZA DISCUSSES ENERGY AND GAS TO EUROPE
WITH FINANCE MINISTER SHARIFOV

Classified By: AMBASSADOR ANNE E. DERSE, PER REASONS 1.4 (B, D)


1. (C) SUMMARY: EUR Deputy Assistant Secretary Matthew Bryza
and Ambassador Derse met with Azerbaijani Minister of Finance
Samir Sharifov October 2 to discuss Azerbaijan's expanding
role as an international energy supplier and to press
Minister Sharifov to begin discussions with the Government of
Turkey on a bilateral gas transit agreement. Sharifov
reiterated President Aliyev's decision and instruction that
the GOAJ is fully committed to working with the U.S. to
realize the Southern Corridor. Sharifov said that Azerbaijan
would soon appoint a full-time energy ambassador (e.g.,
either himself or Energy Minister Natiq Aliyev) to lead the
negotiations with Turkey while reiterating his intention to
contact Turkish Energy Minister Guler once the budget process
was complete. Sharifov complained to Bryza about recent
issues with BP, including possible lower-than-expected oil
volumes in the Baku-Tbilisi-Ceyhan pipeline. Sharifov
briefed on Azerbaijan's relations with Kazakhstan and
Turkmenistan, noting that relations with Turkmenistan have
been strained due to a dispute over an outstanding
Azerbaijani commercial debt to Turkmenistan and that
President Aliyev has given permission for the GOAJ to begin
discussions to resolve the dispute and improve bilateral
relations. Sharifov said the GOAJ plans to develop a new
petrochemical plant, noting that a U.S. firm was working on a
feasibility study which would be finished by the end of 2006.
DAS Bryza briefed Sharifov on his recent energy discussion
with government officials in Turkey, Romania, Hungary and
Greece, tying the discussion to the countries' need and
desire to diversify their energy supplies with Azerbaijani
gas. The Ambassador raised the upcoming EITI meeting in Oslo
and told Sharifov that EB A/S Sullivan planned to attend.
Sharifov said that he probably would not attend but that the
State Oil Fund Executive Director would participate. END
SUMMARY.

AZERBAIJAN-TURKEY
--------------


2. (C) EUR Deputy Assistant Secretary Matthew Bryza and
Ambassador Derse met with Azerbaijani Minister of Finance
Samir Sharifov October 2 to strategize on efforts to bring
Azerbaijani natural gas to Europe. Sharifov stated that the
U.S. and Azerbaijan share the same objective of obtaining a
transit agreement with Turkey, adding that Azerbaijan will
proceed with related technical assistance from the U.S. Trade
Development Agency. Sharifov requested tangible and
sustained U.S. engagement in the process, noting that
President Aliyev had instructed the GOAJ to work with the
U.S. to realize the Southern Corridor of gas exports to
Europe. DAS Bryza said he had followed Sharifov's advice in
July to focus U.S. diplomatic efforts on a gas transit
agreement between Azerbaijan and Turkey. Such an agreement,
Sharifov had argued, provided the best insurance for gas
producers and shippers in Azerbaijan that their gas could
reach European markets regardless of whether Turkey agreed to
increase gas imports from Russia via an expanded Blue Stream
pipeline (under the Black Sea). Bryza said he had pressed
Turkish Energy Minister Guler on the above points in
mid-September, and that Guler had agreed to begin talks on a
gas transit agreement with Azerbaijan. Bryza encouraged
Sharifov to respond to Guler's invitation to him and Energy
Minister Aliyev to begin such negotiations.


3. (C) Finance Minister Sharifov, who has handled energy
policy for the Government of Azerbaijan since his tenure at
the State Oil Fund, told DAS Bryza that at this juncture,
Azerbaijan seeks bilateral negotiations with Turkey - and not
yet multilateral talks with Greece, Italy, the Nabucco
countries, and international energy companies. Sharifov
dismissed Industry and Energy Natiq Aliyev's proposal of
multilateral talks, calling it "wrong" and saying "we do not
support a wider format at this point." He said that
Azerbaijan is "ready to move forward" and that Foreign
Minister Mammadyarov would soon see the President's
appointment of a full-time energy negotiator to begin
discussions with Turkey Sharifov said he was cautiously
optimistic that the GOAJ would name a regional energy envoy
soon, to open discussions with the Turkish counterpart
Ambassador Mithat Balkan.


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4. (C) DAS Bryza stressed to Sharifov the importance of
contacting Ambassador Balkan and Turkish Energy Minister
Guler to begin gas transit talks. Bryza stated that Guler
had agreed with Bryza in mid-September to begin talks on a
bilateral transit agreement with Azerbaijan. Bryza had
argued with Guler that if Turkey did not obtain an
agreement with Azerbaijan and instead moved towards expansion
of the Blue Stream gas pipeline, Azerbaijani gas could be
shut out of European markets for a long time. Guler stressed
Turkey's desire to help their "brothers and sisters" in
Azerbaijan, and agreed to pursue a gas transit agreement with
Azerbaijan if the U.S. agreed to explore a possible working
group among Baghdad, Ankara, and Washington on production and
exports of natural gas in northern Iraq to Turkey and the
rest of Europe. Guler also sought U.S. help in discouraging
countries along the prospective Nabucco pipeline route from
securing purchase prices for gas from Iran that were cheaper
than the price Turkey pays for Iranian gas. Guler worried
that such a situation would constitute a serious political
liability for him and the GOT. Bryza told Sharifov that he
replied to Guler that the U.S. did not favor any exports of
Iranian gas to Europe via Nabucco or any other route.
Sharifov stated that Iran has had gas supply problems to
Turkey and probably could not meet any additional production
export levels.


5. (C) Sharifov told Bryza that he had received an invitation
from the Turkish Finance Minister to visit Turkey. Bryza
responded that Sharifov should accept the invitation, as the
protocol conscious Turks had arranged for Turkish Energy
Minister Guler to invite Azerbaijani Energy Minister Aliyev,
and for Turkish Finance Minister Unakitan to invite
Azerbaijani Finance Minister Sharifov. Bryza added that
Turkish Energy Minister Guler was aware that he had to talk
with Sharifov on energy issues, but due to diplomatic
protocol was bound to invite his Azerbaijani counterpart
Industry and Energy Minister Aliyev. During the visit to
Turkey, Sharifov would have an opportunity to talk with
Minister Guler. Sharifov reiterated his intention to contact
the Government of Turkey and Minister Guler as soon as the
budget process was complete by early November.

AZERBAIJAN GAS RESERVES
--------------


6. (C) Bryza told Sharifov that representatives of gas
consumer countries and gas producing companies believed that
Azerbaijan did not have the gas reserves to realize the
Turkey-Greece-Italy and/or Nabucco pipelines. Sharifov
admitted that Shah Deniz Phase I gas supplies were
insufficient, but argued that with Shah Deniz Phase II gas
and Kazakhstan gas, there would be plenty to send on to
Europe. He added that Azerbaijan could not replace Gazprom
but that Azerbaijan needed to start now to begin discussions
on gas deals that would allow production of sufficient gas
volumes in 2015 for Azerbaijan to provide a significant
option for diversified gas supplies to Europe. Sharifov
noted that energy companies are reluctant to enter into
long-term gas sales agreements without firm gas reserves data
guaranteeing commercial commitments. He added that SOCAR may
emerge as the most logical marketing agent of Shah Deniz gas.
This was due not only to SOCAR's corporate ambitions to
secure a greater share of the value chain, but also to the
reality of how "profit gas" is divided between Shah Deniz
Consortium members and the Government of Azerbaijan. Under
the existing production sharing agreement, international
companies in the Shah Deniz Consortium receive a volume of
gas for export that reflects an agreed monetary figure; thus,
as international gas prices increase, the volume of gas
available to individual companies for export decreases.
Assuming international gas prices continue to increase, SOCAR
-- rather than the international companies -- will be able to
perform on long-term gas supply contracts from the Shah Deniz
field.


7. (C) Bryza raised the idea of creating an "energy working
group" in Azerbaijan, including international energy
companies, that would meet to review Azerbaijan's growing
role in international energy markets. Sharifov said that
Azerbaijan could organize a working group, but appeared to
prefer first to work through lingering commercial differences
with BP. (See below.)

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GAZPROM
--------------


8. (C) Sharifov stated that Gazprom did not have enough gas
to meet its sales commitments. Bryza agreed, adding that
many analysts, including at the IEA, seemed to agree that
based on Gazprom's purchase and sales agreements by 2010 and
2011, it may not have the gas. Bryza noted that the
Government of Turkmenistan's contract with Gazprom extends
only to 2009, potentially placing Gazprom in a bind in 2
winters. Sharifov and Bryza agreed that Gazprom may face
pipeline infrastructure problems, given the need for billions
of dollars in investment for maintenance that Gazprom has not
been making. Sharifov noted that Gazprom was having
difficulty obtaining enough gas and was now ready to pay
higher prices for gas, citing the recent deal for Turkmen gas
at USD 100 per thousand cubic meters.

AZERBAIJAN-BP PROBLEMS
--------------


9. (C) Sharifov briefed Bryza on recent problems Azerbaijan
was experiencing with Azeri-Chirag-Guneshli field operator
BP. Sharifov stated that BP is inflating its operating
costs, including increasing its per-barrel production costs
by 40 percent. Sharifov called this increase "unacceptable."
In addition, Sharifov said that according to BP, the
Baku-Tbilisi-Ceyhan pipeline will not reach its designated
pumping capacity of 1 to 1.5 million barrels per day as
projected at the end of 2006, and was instead operating at a
capacity of only 500,000 barrels per day. Sharifov added
that BP has not provided any reasons for the problem and the
GOAJ "is concerned with the situation." Sharifov noted that
the reduced volumes in BTC will have a negative effect on the
GOAJ's budget by reducing revenues. He stated that BP is
building up its capital expenditure costs for 2006, when
these costs should actually be declining. DAS Bryza agreed
to look into the situation, but -- at Sharifov's request --
not to take any further steps. COMMENT: In a regular monthly
briefing for U.S. and UK Ambassadors, AIOC President David
Woodward gave no hint of any SOCAR discontent with BP oil
production. He did say that ACG production was increasing,
and topped 580,000 bpd on a few days by the end of August.
The BTC pipeline was moving approximately 500,000 bpd on its
good days, although Woodward confessed that there were still
"ups anddowns." He said that BTC should be moving one
mllion bpd in the FY07 first quarter.

PETROCHEMIAL PLANT
--------------


10. (C) Bryza apprised Sharifov of a proposal by Texas-based
independent Moncrief Oil to develop shipments of compressed
natural gas from Kazakhstan to Azerbaijan via barge. Richard
Moncrief had told Bryza such an arrangement would cost around
USD 100 million, and could ship 1 BCM per year. Sharifov
thought such compressed natural gas shipments could feed a
new petrochemical plant under consideration by the GOAJ. He
said that a U.S. firm was working on a feasibility study
which would be finished by the end of 2006. Sharifov hoped
that the petrochemical plant could compete with similar
ventures in the Middle East, but would be looking to supply
Europe, not East Asia. He stated that Azerbaijan would look
to purchase U.S. made equipment and technology and would
provide products to domestic customers and Azerbaijan's
neighbors, including Iran. On Iran, Sharifov asked Bryza and
the Ambassador whether supplying Iran with petrochemicals
from this plant would be a problem for the U.S. Bryza said
that it was up to the Treasury Department's Office of Foreign
Assets Control (OFAC),not the State Department, to determine
whether such a transaction would violate the Iran Libya
Sanctions Act, and that OFAC would require additional
information to make a determination.

ROMANIA, HUNGARY AND GREECE
--------------


11. (C) DAS Bryza briefed Sharifov on his recent energy
discussions with government officials in Romania, Hungary
and Greece, tying the discussion to the need and desire of
the countries to diversify their energy supplies with

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Azerbaijani gas. Bryza stated that the Romanians share U.S.
and Azerbaijani aspirations for a Southern Corridor to feed
Azerbaijani gas into the Nabucco pipeline. Government and
corporate representatives in Hungary had told Bryza of energy
giant MOL's dependence on Russian partners (especially
Gazprom) for MOL's oil refining and natural gas businesses.
But MOL's chief economist had expressed concern that
predatory efforts by Russian energy companies to force out a
Polish company at Lithuania's Mazeikiu refinery indicted a
need for MOL and Hungary to diversify gas supplies away from
Gazprom, and that Azerbaijan was a promising potential
supplier. The MOL chief economist further noted that MOL's
senior leadership seemed to have underestimated the
difficulty of raising commercial financing for the Nabucco
pipeline on the basis of Iranian gas supplies; doing business
with Iran was simply too difficult; moreover, Iran seemed to
lack sufficient gas supplies.


12. (C) Azerbaijan seemed to provide a more promising
commercial alternative. MOL increasingly believed the best
way to finance Nabucco might be through gas purchase
agreements with individual members of the Shah Deniz
Consortium. Such agreements dedicating pipeline capacity to
a single company required partial exemptions from EU
competition law. Securing such partial exemptions from the
European Commission was not difficult in the case of EU
member states (e.g., Austria and Hungary today, and Romania
and Bulgaria in a few months). Securing such a partial
exemption for non-EU member Turkey would be more difficult.
Bryza explained that the MOL economist believed that a
Turkey-Azerbaijan gas transit agreement that was consistent
with EU requirements for partial exemptions from competition
law would resolve the problem. Bryza cited this as another
reason why Sharifov was correct in arguing for a
Turkey-Azerbaijan gas transit agreement as the crucial next
step in developing the Southern Corridor.


13. (C) Turning to Greece, Bryza told Sharifov that the GOG
was planning to privatize DEPA, the national natural gas
utility company. Bryza asked if SOCAR had any thoughts about
purchasing some part of DEPA, noting that Gazprom was ready
to do the same. Sharifov expressed interest, saying he had
not thought about it before, but would contemplate such an
idea. Sharifov agreed that such an investment in DEPA might
make it easier for SOCAR to market its gas in Greece via the
Turkey-Greece-Italy pipeline.

AZERBAIJAN-TURKMENISTAN RELATIONS
--------------


14. (C) Sharifov told DAS Bryza that relations between
Azerbaijan and Turkmenistan have been strained. He stated
that there is an outstanding corporate debt dispute between
AzeriGas and the Government of Turkmenistan that has hurt
overall relations. Sharifov said that President Aliyev has
given permission for the GOAJ to begin negotiations with
Turkmenistan to resolve the debt dispute without admitting
wrong-doing. Sharifov said that Azerbaijan is looking to
improve relations with Turkmenistan, a country that could
possibly link up with a trans-Caspian pipeline through
Kazakhstan.

AZERBAIJAN-KAZAKHSTAN RELATIONS
--------------


15. (C) Turning to Kazakhstan's gas volumes and linking them
into the South Caucasus Pipeline, Bryza stated that
Kazakhstan wanted to participate, but that Timur Kulibayev,
de-facto head of Kazakhstan's oil and gas sector, had run
into Bryza in Turkey and noted that Kazakhstan lacked
sufficient gas to commit to this scheme at this point.
Kazakhstan will continue to export gas from the Karachaganak
field to Russia (and the Orenburg processing facility) for
years to come. Kazakhstan and its international corporate
partners were reinjecting gas at Tengiz, and hoping to do the
same at Kashagan. Kulibayev had said Kazakhstan hoped to
export gas from additional fields in coming years to Europe
via Azerbaijan, but that such gas might not be
evident/available for the next five years. Bryza told
Kulibayev this timeframe could work well, and wondered
whether the GOKZ might occasionally note its interest in such
a scheme. Kulibayev replied affirmatively. Sharifov agreed

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that Kazakhstan appeared to lack sufficient base gas at this
time to factor into the Southern Corridor, but anticipated
that such gas might be available in five years or so.


16. (C) The Ambassador raised the upcoming EITI meeting in
Oslo and told Sharifov that EB A/S Sullivan planned to
attend. Sharifov said that he probably would not attend but
that the State Oil Fund Executive Director would participate.
The Ambassador also told Sharifov that U.S. Ambassador to
the WTO Peter Allgeier planned to visit Azerbaijan
mid-October and would be meeting with GOAJ officials to
discuss WTO membership.


17. (U) DAS Bryza has cleared this message.
DERSE