AZERBAIJAN IN 2006 LOOKS TO SOLIDIFY ITSELF AS

C O N F I D E N T I A L SECTION 01 OF 03 BAKU 000249

SIPDIS

SIPDIS

E.O. 12958: DECL: 02/16/2016
TAGS: ECON EPET PGOV PREL AJ
SUBJECT: AZERBAIJAN IN 2006 LOOKS TO SOLIDIFY ITSELF AS
REGIONAL ENERGY PLAYER

REF: (A) BAKU 152 (B) 05 BAKU 1918 (C) BAKU 197

Classified By: Ambassador Reno L. Harnish III, Reasons 1.4(b) and (d).


1. (C) SUMMARY: With the completion of the
Baku-Tbilisi-Ceyhan oil pipeline scheduled for late May and
the South Caucasus Pipeline scheduled for October, Azerbaijan
in 2006 looks to solidify itself as a regional energy hub and
energy provider to foreign markets, including Europe. Over
the next decade, Azerbaijan oil and gas capabilities will
expand and flourish and it has the potential to become a
major hub for oil and gas. Many internal factors, however,
will influence whether Azerbaijan can take full advantage of
this opportunity. Domestic politics, internal bickering and
political vision, will ultimately affect Azerbaijan,s
ability to stay at the forefront of energy exploitation and
distribution to international markets, including diversifying
European gas supplies away from reliance on Russia. These
goals also serve U.S. strategic interests and Azerbaijan
should be encouraged to pursue them. END SUMMARY.

Azerbaijan as International Source of Energy
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2. (C) With BTC finally nearing completion after significant
delays (REF A) and oil scheduled to reach Ceyhan in late
spring, Azerbaijan's energy clout and economic resources will
quickly increase. On the heels of BTC, the South Caucasus
Pipeline (SCP),also known as the Baku-Tbilisi-Erzurum gas
pipeline, is scheduled to come online in late October 2006
and Shah Deniz gas, at least eight billion cubic meters of
gas, will begin flowing to Turkey. By Phase II, Shah Deniz
will send approximately 16 billion cubic meters of gas a year
to Turkey, and possibly beyond. Both BTC and SCP raise
Azerbaijan's international geopolitical profile and highlight
its role in providing Western energy markets with diverse
supplies (i.e. non-Russian or non-Iranian).


3. (C) Presidential Energy Advisor Ali Asadov told PolEcon
Couns that the Shah Deniz gas field may hold as much as two
trillion meters of gas and that he could envision Azerbaijan
building a second pipeline parallel to SCP to send additional
gas to Europe. Asadov indicated that Azerbaijan needed to
double its potential production to 30 to 40 bcm per year.
Asadov's comments were not the first time that we have heard
such unproven high estimates for Shah Deniz gas reserves (REF
B). Asadov also noted that with future Azerbaijani gas
demands reaching 15 to 20 billion cubic meters a year, there
will plenty of additional gas to send to European markets
(assuming Azerbaijan can produce and send 35-40 bcm per
year). Asadov argued that it was in Europe's interest to buy
Azerbaijani gas in order to lessen GAZPROM and Russia's
monopoly over gas supplies to Europe.


4. (C) Both BP and Statoil executives in Baku openly discuss
the possibility of a second pipeline to further tap the Shah
Deniz reservoir. Without another way to exploit Shah Deniz,
after Phase II development the gas field will end up
primarily serving the domestic needs of Azerbaijan and
Georgia, with a small amount for export. But with a second
pipeline, Azerbaijan could both meet projected domestic
demand and still be a major exporter to Europe. Recent
Russian behavior and Iranian rhetoric have created a window
of opportunity in Europe that Azerbaijan could exploit.


5. (C) Azerbaijan has already begun to play an emerging role
in international energy politics. During the January energy
crisis in Georgia, Azerbaijan quickly came to its Caucasus
neighbor's aid and supplied 2.4 million cubic meters of gas a
day. Newly appointed Minister of Energy and Industry and
former SOCAR president, Natiq Aliyev, played a critical role
in organizing the GOAJ,s response to the crisis and also
coordinating multiple ministries and agencies. In addition,
Azerbaijan facilitated Iranian gas transiting to Georgia
during the crisis. Allowing Iran to send gas to Georgia, a
natural market for Azerbaijani gas, shows one facet of the
GOAJ's delicate balance with its regional rivals - Iran and
Russia.


6. (C) Being situated between Russia and Iran, the GOAJ is
keenly aware of the importance of balancing its relationship
with Russia. In 2005, Azerbaijan agreed to buy Russian gas
at higher prices over the next coming years even though
Azerbaijan may not need the gas with the start of Shah Deniz.
Azerbaijan also allowed Georgia and Iran to sign an
agreement to send gas through Azerbaijan to Georgia. Asadov

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downplayed the benefits of the deal to Azerbaijan, noting
that Iran provided Georgia with only 3.65 million cubic
meters of natural gas that transited Azerbaijan and the GOAJ
had levied only USD 10 per thousand meters as transit fees
(REF C). Many GOAJ energy officials openly note that,
compared to Russia and Iran, Azerbaijan's energy and
political resources are limited and so it must be a "good
neighbor" in order to stay out of trouble.

Kazahkstan Oil, BTC and the Inter-Government Agreement
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7. (C) A key part of Azerbaijan's growing regional energy
role is the long-discussed project to ship Kazahkstan's oil
and gas to Western markets through BTC and SCP. The
inter-governmental agreement which would facilitate this,
however, remains stalled. American and international energy
executives told Ambassador Harnish that international
pressure from abroad (i.e. the U.S.) is required to break the
impasse and to sign the deal. The same contacts noted,
however, that Azerbaijan reportedly wants to renegotiate the
IGA, potentially stalling the agreement even further. Former
SOCAR executive, now Deputy Speaker, Valekh Alasgarov,
reportedly is pushing this renegotiation. He is allegedly
taking his cues directly from President Aliyev. In terms of
other regional projects, there is talk about bringing Central
Asian gas into SCP. Generally, Kazakhstan is mentioned as
the likely partner rather than Turkmenistan. Many in the
international energy community in Baku still see Turkmenistan
in terms of the failed TCP project of some years ago, and are
skeptical that a new project would proceed any differently.


8. (C) Reportedly, President Aliyev thinks Azerbaijan
deserves a better deal due to its emerging role as a vital
transit country. He also is reportedly still irritated with
Kazakhstan President Nazarbayev for the latter's last-minute
refusal to sign an IGA in May at the BTC First Oil
ceremonies. Previously, international companies did not seem
worried about the slow progress of the IGA. Now, as the date
when their Kashagan production will require an outlet comes
closer and closer, some are beginning to express concern. It
is unclear how progress on the IGA will affect the
smaller-scale project to bring Kazakhstan's Tengiz oil into
BTC, which is expected to start as early as 2007.

Will the Lack of Energy Coordination Hurt the GOAJ?
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9. (C) Azerbaijan,s ambitious plans to expand its regional
goals clash with the GOAJ,s recent reorganization of SOCAR,
the Energy and Industry Ministry and the move of energy-guru
Valeh Alasgarov to Parliament. At a meeting with Ambassador
Harnish, U.S. and international energy executives
characterized the move of Natik Aliyev from SOCAR to Minister
of Energy and Industry as a lateral promotion. Aliyev was
reportedly upset at his appointment and complained that the
GOAJ did not appreciate his work. In addition, most energy
observers had initially expected Aliyev to play a more active
role in Azerbaijan,s energy affairs, even corralling all of
the energy players, including SOCAR, into the Energy
Ministry. This scenario, however, appears to have not played
out and Aliyev has openly said that he devote more of his
time to the industry part of his portfolio.


10. (C) SOCAR,s new President, Rovnaq Abdullayev, arrived
with plans to reorganize and restructure the state-owned
company. He quickly created several new vice president
positions and appointed several confidants in key positions.
Several of his deputies are politically connected and
influential. Energy executives remark that Abdullayev would
like to remake SOCAR into an internationally competitive
firm, such as StatOil of Norway. SOCAR's new management,
however, appears paralyzed and unable to make decisions.
This paralysis may be short-term and some energy executives
note that SOCAR will probably increase its influence and
power in energy decision-making. Abdullayev's efforts to
reorganize SOCAR into an internationally competitive company
would be a positive step forward and could lead to greater
transparency at the company.


11. (C) The one wild card in Azerbaijan,s energy politics
is the role of Valekh Alasgarov, formerly the foreign
investments chief of SOCAR and now one of parliament's three
deputy speakers. It appears that Alasgarov,s move to
Parliament has not meant his removal from energy politics --
indeed, he chairs parliament's energy committee. Several

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energy executives believe that Alasgarov will play an ad hoc
role in energy policy, and his apparent role in the IGA
process on behalf of President Aliyev bears this out. With
the relationships undefined among these three powerful
individuals -- Natik Aliyev, Alasgarov and Abdullayev --
there is a void in Azerbaijan,s energy affairs. Until a new
division of responsibilities is agreed upon, Azerbaijan's
energy policy will likely emerge from a process of trade-offs
and impromptu decisions.

Projects End & Int'l Companies Think of Future
-------------- -


12. (C) The lack of coordinated GOAJ energy policy, much like
general economic decision making in the government, has put
at risk Azerbaijan,s regional energy hub role and its
competitive advantage. American and international oil
executives noted to Ambassador Harnish that with BTC and Shah
Deniz projects in Azerbaijan nearing completion and the GOAJ
unable to focus on future projects, many companies will move
on to other countries and new projects. In addition, the
domestic core of trained professional Azerbaijanis are
leaving for other countries, such as Russia, to work in the
petroleum sector. This double negative on the Azerbaijani
energy sector could have a tremendous effect on the country's
ability to exploit future energy resources and retain the
necessary technical capacity. One executive noted that
Azerbaijan needed to create duty free zones for international
companies to spur greater investment. He cited Azerbaijan,s
export tax as a penalty and one of the impediments to
competition.


13. (C) Despite the recent internal GOAJ upheavals,
Azerbaijan in 2006 will solidify its regional and
international role as an energy hub and supplier. Its
long-term success, however, depends on whether it can focus
on long-term goals and projects. The completion of the BTC
and SCP projects may have moved Azerbaijan's focus from
future exploitation projects to reaping the economic benefits
now. The country has already begun to feel the effects of
its oil wealth without preparing its financial and economic
systems. If the GOAJ loses focus on energy transit issues,
Azerbaijan's role as a regional energy hub may come to a
close over the next ten to fifteen years. The ACG oil field
will be exhausted, and Shah Deniz will be meeting primarily
the domestic needs of Azerbaijan and Georgia, with a small
amount left for export. If the GOAJ focuses on bringing
Central Asian oil and gas into its pipelines, and also
exploits the full potential of Shah Deniz, Azerbaijan can
look at being an energy hub well towards the middle of the
century. Given that this would contribute to economic
stability in the south Caucasus, diversify world oil supplies
and diversify European gas supplies away from relying on
Russia and/or Iran, the United States should support
Azerbaijan's efforts to play this role.
HARNISH