AMBASSADOR'S INTRODUCTORY MEETINGS WITH

C O N F I D E N T I A L SECTION 01 OF 04 BAKU 000996 SIPDIS CORRECTED COPY - ADDED ADDRESS EU MEMBER STATES SIPDIS DEPARTMENT FOR EUR/CARC AND EB/ESC DEPT OF ENERGY FOR FE - SWIFT AND OS - WILLIAMSON E.O. 12958: DECL: 07/11/2016 TAGS: ECON EFIN EPET ENRG PREL PINR RU AJ SUBJECT: AMBASSADOR'S INTRODUCTORY MEETINGS WITH INTERNATIONAL ENERGY EXECUTIVES BAKU 00000996 001.2 OF 004 Classified By: DCM JASON P. HYLAND, REASONS 1.4 (B,D). ¶1. (C) SUMMARY: In the Ambassador's introductory calls, executives from BP and other international energy companies operating in Azerbaijan painted a complex picture of fragmented leadership within Azerbaijan's energy sector, indecision within the GOAJ over whether to move forward on new energy projects and a toughening of SOCAR's stance toward international companies, due largely to the onslaught of energy revenue. The companies also rued Azerbaijan's inability to export its growing, "world-class" abilities in the energy industry, due to Caspian states' "local content" provisions and the lack of an appropriate duty-free zone in Azerbaijan. BP and Statoil separately commented that Azerbaijan's ability to export gas to Europe will depend on Turkey's willingness to forego already agreed volumes from Azerbaijan, and Azerbaijan's ability to withstand possible changes in Gazprom's supplies to Azerbaijan. In a separate meeting, AIOC President David Woodward speculated that Azerbaijan "certainly" would seek USG support if Iran moves its "Alov" oil rig to the disputed Alov field. END SUMMARY. FIRST MEETING WITH AIOC PRESIDENT WOODWARD -------------- ¶2. (C) In a July 6 meeting, AIOC President David Woodward provided the Ambassador with brief background regarding BP, AIOC, and BTC focusing on several key issues. Woodward stressed that BTC was successful because the venture was commercially viable and a single large operator, BP, was ready to take control. In addition, he highlighted that all the countries involved in the venture, Georgia, Turkey and Azerbaijan, were able to agree on pipeline principles and logistics. Finally, he noted that strong U.S. support for the pipeline made it an international reality. DYNAMIC POLITICAL AND ECONOMIC ENVIRONMENT -------------- ¶3. (C) Woodward told the Ambassador that in recent years, principally since the death of former President Heydar Aliyev, the political and economic environment for the international energy companies had changed. Woodward said that current President Ilham Aliyev did not wield the same level of control and leadership over the various government entities, such as SOCAR. Woodward opined that with current projects winding down individual government actors are looking to expand their interests, noting that the President has not set a clear agenda or direction. Woodward added that President Aliyev appears less focused on the energy sector now that most projects have moved towards the operating stage and characterized him as not as "tough" as his father. Woodward concluded that this political environment is making operating in Azerbaijan more complex and complicated. ¶4. (C) Woodward noted that the appointments of Heydar Babayev as Minister of Economic Development, Samir Sharifov as Minister of Finance and Shahmar Movsumov as Director of the State Oil Fund were positive moves that have led to greater inter-ministerial coordination and cooperation. In addition, Woodward warned that while these ministers had a more long-term economic vision for the country, they may actually be taking on too many issues, calling it an "initiative overload." Woodward believes Minister of Finance Sharifov has good access to the President. Overall, Woodward lamented that the GOAJ lacked the technical capacity to handle the multiple key economic and political issues that it will face in the near-term. ¶5. (C) Woodward noted that a new negative sentiment had emerged in the past six months against the international energy companies. He explained that certain people in the GOAJ now criticize the energy companies for taking too much of Azerbaijan's resources. Leading this campaign, according to Woodward, was the State Oil Company, SOCAR. Woodward characterized Abdullayev Rovnaq, the president of SOCAR, as not capable of handling SOCAR's large operations and not a "big picture thinker." Woodward lamented that he painted a "gloomy" picture of SOCAR, adding that Rovnaq and SOCAR were making work for the international companies in Azerbaijan extremely difficult. Woodward continued by saying that SOCAR BAKU 00000996 002.2 OF 004 was attempting to restrict oil companies' activities, putting up barriers and slowing down decision making. ¶6. (C) Regarding future energy projects, Woodward told the Ambassador that the GOAJ is looking to decrease the number of projects. Woodward believed that the GOAJ may be interesting in taking on future projects independently after the expiration of the production sharing agreements with the international companies. Woodward also added that the GOAJ may be wary of the increasing energy wealth and revenue and the political risks it brought. Woodward explained that he had shown President Aliyev a graph that indicated that in 2009 alone Azerbaijan will receive USD 20 billion in oil revenue. The President, according to Woodward, was not happy and explained that in such a case the pressures from the population would increase, possibly leading to political problems. ¶7. (C) On the macroeconomic side, Woodward highlighted that Azerbaijan's economy and financial sector were unprepared for the coming "tsunami of money" and the GOAJ did not have an energy revenue plan. In addition, he noted government spending was not going to slow down in the near-term and would lead to disproportionate profits and higher inflation. In order to assist the GOAJ increase its revenue management plans, BP planned to house a macroeconomic quantitative forecasting unit, led by Oxford Economic Forecasting, at the Oil Fund. The memorandum of understanding for this new quantitative unit, however, has not yet been signed but the BP-led group was well received by the GOAJ. ¶8. (C) Turning to the political landscape, Woodward thought that in the next five to seven years there was a real possibility for political upheaval and turmoil. Woodward thought that as the gap between rich and poor grows, pressure would grow in the population to improve living standards leading to problems. Woodward recognized that so far the GOAJ has done a good job controlling the political situation, adding that the opposition was not viewed as a viable option by the population. AZERBAIJANI NATURAL GAS TO EUROPE -------------- ¶9. (C) Turning to Azerbaijan's future plans of selling natural gas to Europe, Woodward told the Ambassador that Azerbaijan wants to develop further its gas production, eyeing the possibility of exporting small quantities to Greece in the near-term. To facilitate these plans, Turkey would need to refuse to receive an initial part of its gas share as part of Shah Deniz, allowing this amount to be sold to Greece. While Turkey did not need this gas for domestic supplies, according to Woodward, it was unclear whether Turkey, Georgia, and Azerbaijan could agree to move forward. Woodward told the Ambassador that Azerbaijan will most likely be reliant on Russian natural gas supplies until 2012 when Shah Deniz Phase II is completed. Woodward noted that BP, while not a major stakeholder in the Shah Deniz project, was providing the GOAJ with advice and guidance on moving gas supplies to Europe. IRAN AND THE ALOV FIELD -------------- ¶10. (C) Responding to the Ambassador's question on Iran and its Caspian operations, Woodward noted that the Iranian "Alov" oil rig was finished and could be moved into position in the Caspian as early as the fall. Woodward speculated that the Government of Iran would not move the rig to the disputed Alov field, noting that this would be seen as an aggressive and provocative move. President Aliyev reportedly told Woodward that Azerbaijan would "react strongly," without being specific, if the Iranians moved the platform to the Alov field. Woodward said that the GOAJ is not pushing BP to continue its exploration efforts in the disputed area but that if the Iranians moved to tap the field he felt the GOAJ would most certainly approach the U.S. and U.K. governments, as well as the international community, for support. AMBASSADOR HOSTS ENERGY FORUM -------------- BAKU 00000996 003.2 OF 004 ¶11. (C) On July 6 the Ambassador hosted an energy forum with the major U.S. and international energy companies to discuss the overall operating environment and inquire about individual company activities. BP's executive briefed on BP's efforts to improve its security and good corporate governance initiative. Chevron's lcoal president told the Ambassador that the attitudes and mentality of many key GOAJ energy officials appear to be shifting as Azerbaijan's energy revenues increase. (NOTE: AIOC President David Woodward,in an earlier meeting with the Ambassador, echoed the same sentiment tha the key individuals in the GOAJ appear to be taing a harder line with the international energy companies.) ¶12. (C) The Chevron president added that the GOAJ appeared to be not interested in implementing additional exploration plans, preferring to delay any future projects. Regarding SOCAR, he indicated that the state-owned company lacked "ownership and accountability" over the energy sector and also did not want to move forward on future exploration plans. He also noted that GOAJ lacks the technological capacity to expand and that the GOAJ had more money than it could handle. He indicated that one of the major challenges was keeping GOAJ interested in future endeavors, adding that as projects come to completion, international energy companies would look to move to different regions. ¶13. (C) Representatives of TOTAL, Devon Energy and Statoil also briefed the Ambassador on their respective operations and future plans. The Devon representative indicated that the company was looking to begin additional on-shore exploration projects. The Statoil executive also indicated that the GOAJ was not as interested in accelerating future exploration and investment plans. He noted that Statoil was interesting in maintaining "the plateau of natural gas production" while the GOAJ did not see this as a priority. ¶14. (C) A McDermott company representative explained to the Ambassador that major energy fabrication projects had begun to wind down and that his company would most likely halve its workforce by early 2007. The McDermott representative noted that there could be a lull in energy projects during the next two years. He added that the company was looking for additional projects to retain the employees but the lack of diversity in the Azerbaijani economy and other barriers in the Caspian region made it difficult to use the company's operations in Baku as a platform to work in Kazakhstan. For this reason, McDermott is planning to set up operations in Kazakhstan to meet the growing demand for oil and energy services companies. ¶15. (C) The McDermott representative said that developing a duty free trade zone in Azerbaijan and creating a "Caspian open market" for the region would facilitate the concentration of expertise in one country for use in all the countries of the Caspian. On a positive note, the McDermott representative noted that the GOAJ had taken some positive steps to improve the business-operating climate, such as removing all VAT on export work. He added, however, that corruption and labor issues remain two of the biggest problems for energy services companies operating in Azerbaijan. ¶16. (C) One of the major challenges to this, noted the Chevron President, was the desire of individual countries to demand "local content" in all facets of projects, prohibiting the use of Azerbaijani-made oil platforms for use in other countries. The ExxonMobil representative agreed and noted that it had commissioned a platform built in Azerbaijan and sailed it to Turkmenistan waters only to have Turkmen authorities bar all Azerbaijani employees on the platform and require Turkmen employees, causing massive delays and cost overruns. ¶17. (C) All of the energy participants agreed that Azerbaijan had a nascent oil-services capacity that is hindered by "local content" provisions in other Caspian countries. For example, all of the executives praised Azerbaijan's ability to develop deep water jackets for oil rig platforms, noting that the production was world-class and that it was done with 80 percent Azerbaijani labor. The McDermott executive noted BAKU 00000996 004 OF 004 that Azerbaijani has four energy production fabrication facilities that are most likely some of the best in the world. AIOC BRIEFING -------------- ¶18. (C) At the regular monthly AIOC meeting with the U.S. and U.K. ambassadors on July 7, AIOC President David Woodward briefed on the group's energy operations and the latest GOAJ efforts to increase natural gas exports. Woodward indicated that BTC is pumping 500,000 barrels a day and that there have been already six tanker loadings of Azerbaijani crude at Ceyhan. Woodward said that the pipeline is almost 100 percent complete while Turkish authorities have found five illegal taps on the pipeline. Woodward told the Ambassadors that the east Azeri platform is complete and is set to sail in the near-term with good weather. ¶19. (C) Woodward noted that as the Shah Deniz gas project is nearing completion the GOAJ is reviewing whether to begin negotiations with the Government of Turkey on its gas commitments. Azerbaijan wants Turkey to refuse some of its natural gas commitments, leaving the excess amounts available for domestic consumption or for export to Europe. Woodward was not confident that Turkey would refuse the gas, characterizing Azerbaijan's approach to this issue as "naive." Woodward explained that at a recent cabinet meeting, President Aliyev told his key energy aides to prepare information for meetings with Turkey on the gas contracts. ¶20. (C) Driving this request, according to Woodward, is the feeling within the GOAJ that Gazprom plans to renegotiate its gas contracts with Azerbaijan and increase prices. In addition, the GOAJ apparently fears that Russia could stop natural gas exports to Azerbaijan, leaving it to find additional supplies on short notice. The GOAJ has requested BP provide information on its ability to divert Shah Deniz gas to different locations within Azerbaijan. BP has told the GOAJ that it can divert approximately 50 to 75 percent of production based on current pipeline infrastructure. ¶21. (C) Woodward highlighted a recent problem of profit oil entitlement calculations with the State Oil Company (SOCAR). Woodward explained that in this early stage of the ACG Production Sharing Agreement, the international energy consortium receives 70 percent of the profit oil and SOCAR receives 30 percent. This arrangement will quickly shift to 80 percent for SOCAR and 20 percent for the oil companies as soon as the energy infrastructure costs has been repaid to the energy companies. Woodward stated that due to unexpected circumstances related to the grade of the Azerbaijan crude, the oil companies were entitled to five percent of SOCAR's current 30 percent share of the profit oil. This amount had a net present value of USD 1 billion. Woodward recognized that SOCAR and GOAJ would not immediately accept the "penalty" and had told AIOC that the government wanted to work the issue out without arbitration. DERSE