AZERBAIJAN: WHERE WE ARE WITH SHAH DENIZ PHASES

C O N F I D E N T I A L SECTION 01 OF 04 BAKU 001186 SIPDIS E.O. 12958: DECL: 12/17/2018 TAGS: PGOV PREL AJ ENRG TU SUBJECT: AZERBAIJAN: WHERE WE ARE WITH SHAH DENIZ PHASES ONE AND TWO REF: A. A) ANKARA 2123 ¶B. B) BAKU 1126 Classified By: CDA Don Lu, reasons 1.4 (b,d) ¶1. (C) SUMMARY (CONT): As 2008 ends, the 16-month long stasis surrounding the marketing of Shah Deniz Phase Two (SD2) gas continues, as Turkey and Azerbaijan remain unable to agree on a gas marketing mechanism which would allow them to agree on volumes, prices, and transit. Price negotiations for the Shah Deniz Phase One gas currently being delivered to Turkey remain similarly stalled, with the prospect of commercial arbitration becoming increasingly real. This lack of SD2 commercial traction, combined with technical problems relating to optimal SD2 development, has led to revised estimates of SD2 "First Gas" from late 2014 to late 2015. According to a high-level SOCAR executive, during the latest SD2 negotiations on December 5 both Azerbaijan and Turkey seemed to have agreed to a formula whereby the GOAJ would sell eight billion cubic meters annually (bcm/a) to Turkey in exchange for transit of remaining volumes, only to have the agreement fall apart the following day over disagreements over how the price of the gas would be determined and whether SOCAR could market the gas within Turkey in accordance with existing Turkish laws liberalizing gas marketing. This SOCAR executive characterized a December 19 meeting in Turkey between SOCAR President Abdullayev and GOT Prime Minister Erdogan as important for the future of SD2 development. ¶2. (C) SUMMARY (CONT): It remains unclear to Embassy whether this SOCAR willingness to sell eight bmc/a to Turkey using existing Turkish gas market liberalization laws is a tactical switch of emphasis in pursuit of its goal of getting transit to European markets, or whether (less likely) SOCAR now thinks that gas sales past Turkey might be a bridge too far in the short-term. We will explore this question next week with SOCAR when we get a readout of today's Abdullayev-Erdogan meeting. END SUMMARY. ¶3. (U) On December 19 Embassy EnergyOff met with Murat Heydarov, Advisor to SOCAR President Rovnaq Abdullayev, to discuss Shah Deniz Phase One price negotiations and Shah Deniz Phase Two (SD2) developments, to include a readout of the December 5 discussions held in Ankara between GOAJ Energy Minister Aliyev and GOT Energy Minister Guler (Ref A). During this meeting Heydarov allowed EnergyOff to read and take notes on (but not keep) the December 6 GOAJ and GOT draft MOUs alluded to below, as well as the December 15 letter from GOAJ Energy Minister Aliyev to GOT Energy Minister Guler. DECEMBER 5 MTG -------------- ¶4. (C) According to Heydarov, during the December 5 Ankara meeting between GOAJ Energy Minister Aliyev and GOT Energy Minister Guler, both sides reached an agreement in which Azerbaijan would provide eight bcm/a for the domestic Turkish market, in exchange for Turkey granting transit for remaining GOAJ gas volumes consistent with internationally accepted commercial principles. ¶5. (C) In this regard, Heydarov said the current GOAJ priority is to accommodate Turky's desire to meet its energy security needs. Hwever, "Turkish energy security is different tha Botas energy security." As such, SOCAR sought to provide the eight bcm/a to the Turkish domestic market in compliance with Turkey's own existing laws on gas market liberalization. ¶6. (C) To this end, the two sides agreed on December 5 that Azerbaijan could sell its gas to any gas-importing entity in Turkey, consistent with existing gas market liberalization legislation in Turkey (i.e. isn't forced to sell to Botas), through a competitive sales process that resulted in a commercially attractive price benchmarked to domestic market prices. In exchange for Azerbaijan's providing eight bcm/a for the domestic Turkish market, the GOT would provide transit for remaining GOAJ gas volumes consistent with internationally accepted commercial principles. ¶7. (C) EnergyOff asked why the GOAJ would be willing to sell eight bcm/a to Turkey after having said that selling such an amount would make the Southern Corridor non-viable. Heydarov BAKU 00001186 002 OF 004 repeated that the current GOAJ priority is to accommodate Turkey's desire to meet its energy security needs, adding that: - Turkey is the closest major market for SD2 gas, and assuming a competitive market is Azerbaijani's preferred customer, since transportation costs are lowest and resulting netbacks would be the highest; - Ensuring that SD2 gas is marketed within Turkey consistent with existing market liberalization legislation would allow the SD Consortium to avoid a situation where it had to sell to Botas, and the resulting competitive market for SD gas would better allow the SD Consortium to get a market price for its gas within Turkish borders. - Although it did not share this information with the GOT, Azerbaijan expects SD2 production to be 16-17 bcm/a, which, in addition to other Azerbaijani sources of gas, would provide the seven bcm/a of gas for transit through Turkey for whichever pipeline project the SD Consortium ultimately chooses. DECEMBER 6 LETTERS -------------- ¶8. (C) On December 6 at 1300 hours a Draft MOU containing the points agreed to the previous day was sent from GOAJ Energy Minister Aliyev to GOT Energy Minister Guler. Five hours later that same day GOT Energy Guler sent GOAJ Minister Aliyev a revised draft MOU, with two main changes, both of which the GOAJ side found unacceptable: - In Article One, the GOAJ wording referred to the sales price of SD2 gas in Turkey being "competitive to the sales of gas beyond the Republic of Turkey," (i.e. market prices). However the GOT wording of the same clause referred to the price of the gas at Turkish-Georgian border being competitive with the natural gas sales price beyond BOT borders. According to Heydarov, this proposed wording change, innocuous to those non-versed in the details of gas marketing, meant that the price of SD2 gas to Turkey would be the Baumgarten price minus transportation costs to the Turkey-Georgia border. This pricing mechanism is the same one incorporated into the ill-fated Turkey-Greece-Italy Intergovernmental Agreement (TGI IGA),which, according to the GOAJ, would force it to sell gas to Turkey at severely sub-market prices, something it is unwilling to contemplate. - the second proposed GOT change to the MOU stipulated that the GOT would be able to nominate the buyer for Azerbaijani gas, which according to Heydarov meant that SOCAR would be forced to sell to Botas. This change would be contrary to the liberalization of gas market laws in Turkey, which said, inter alia, that any entity could apply for an import license, and that any agent could bring gas to Turkey. DEC 15 LETTER/DEC 19 MTG -------------- ¶9. (C) On December 15, GOAJ Energy Minister Aliyev sent a letter to GOT Energy Minister Guler, pointing out that the two sides have been at the current stalemate for 16 months, and that if Turkey and Azerbaijan cannot agree to SD2 gas marketing conditions in Turkey, the SD Consortium will be forced to either seek alternative routes or delay sanctioning SD2 development. Heydarov said that SOCAR President Abdullayev was in Ankara today (December 19) to meet with PM Erdogan. He termed this meeting "very important" to SD2's fate, and agreed to give EnergyOff a readout the following week. SD2 SANCTIONING DELAY -------------- ¶10. (C) Heydarov confirmed press reports that the planned start of the SD2 "define" phase, during which the SD Consortium begins to spend appreciably larger amounts of money towards actualizing SD2, has been delayed. In summer 2008 the SD Consortium approved a three-month delay to the start of the SD2 sanctioning, to approximately November 2009, due to largely unresolved technical problems on how to best develop SD2. BAKU 00001186 003 OF 004 ¶11. (C) In October, SOCAR and the other SD partners decided not to approve the 2009 budget for the SD2 define phase. The Consortium tasked the Operator (BP) to make amendments to the SD2 development budget based on developments in SD2 sales negotiations, and to submit a revised SD2 development budget in December. Additionally, the SD Consortium at that time approved allocating funds for the Consortium to explore "alternate routes" for SD2 gas outside of Turkey. Although these routes were not explicitly named, Heydarov said that Russia and Iran were the two obvious alternatives. ¶12. (C) Since the October meeting, SD Operator BP has told the partners it will seek an additional minimal six-month delay to SD2 sanctiong, until approximately May-June of 2010, due to the lack of progress on marketing SD2 gas. Such a delay would extend SD2 "First Gas" from the end of 2014 to 3Q 2015 at the earliest, although Heydarov said that this date could only slip. Heydarov said that SD Consortium partner StatoilHydro (which along with BP is SD's largest shareholder) opposed this six-month extension (COMMENT: EnergyOff heard much the same independently from StatoilHydro Azerbaijan VP for Gas earlier in the week. SD1 PRICE NEGOTIATIONS -------------- ¶13. (C) Heydarov said that within the last week the marketing agent for SD1 gas (AGSC - Azerbaijan Gas Supply Company, headed by StatoilHydro) postponed what would have been the eighth meeting between its Price Review Negotiating Team (PRNT) with its Botas counterparts to determine the new price of the SD1 gas currently being sold to Turkey, scheduled for December 17. One reason for the postponement was that there had been "no progress" at a meeting two weeks prior between the SD PRNT and Botas, and one between SOCAR and Botas, to solve the problem of SD1 prices. The Botas proposal was still a twenty percent price increase in SD1 price in 2009 over the existing price,, followed by a subsequent annual ten percent price increase for the following three years. The SD Consortium strongly balked at such a formula, saying that it would result in a price vastly lower than market prices, and instead called for bringing the SD1 price into conformity with market prices (COMMENT: the existing SD1 Sales agreement, struck at a time of very low oil prices, was written such that for the first year of gas delivery there was a ceiling on SD1 gas prices of o/a USD 120/mcm, at a time when market prices were between USD 400-500 mcm. Now that the first year has expired, the current price negotiations are a mechanism within the existing contract by which the price can be re-aligned with existing market realities). ¶14. (C) Heydarov said that during the meeting two weeks prior, SOCAR had told Botas that it could convince AGSC to sell SD1 gas to Turkey at a "competitive discount" to the price at which Turkey was buying gas from Gazprom and Iran, such a discount being anywhere from USD 15 to 50 dollars per thousand cubic meters. Botas refused the offer, sticking to its original proposal. ¶15. (C) Heydarov said another reason for postponing the December 17 negotiations was to see the results of SOCAR President Abdullayev's December 19 meeting with PM Erdogan, plus the results of other bilateral meetings (NOTE: SOCAR President Abdullayev and Marketing VP Elshad Nassirov are currently in Moscow, the second high-level SOCAR visit to Gazprom in less than a month). Additionally, AGSC is developing its case for arbitration, having met earlier this week in London with its lawyers for consultations in this regard. The next negotiations with Botas are scheduled for late January, 2009. ¶16. (C) COMMENT: Given the history of hard bargaining between Turkey and Azerbaijan over SD2, it is not surprising that SOCAR's depiction of the December 5 meeting differs appreciably from the readout provided to our Ankara colleagues (Ref A -for what it is worth, the December 6 GOAJ and GOT draft MOUs, as well as the December 15 letter from GOAJ Energy Minister Aliyev to GOT Energy Minister Guler, seemed to more accord with SOCAR's interpretation of events). On a separate note, it is noteworthy that SOCAR now frames the issue not as one of transit to Europe but rather as one of finding the appropriate gas marketing mechansm within Turkey. The SD Consortium, desperate to proceed with the sanctioning of SD2 with all possible alacrity, seems now to BAKU 00001186 004 OF 004 be focusing on using Turkey's existing gas marketing liberalization laws as a way of getting a market price for its gas within Turkey. ¶17. (C) COMMENT (CONT): It remains unclear to Embassy whether this SOCAR willingness to sell eight bmc/a to Turkey using existing gas market liberalization laws is a tactical shift in emphasis in pursuit of its goal of getting transit to European markets, reflecting an opinion that revised SD2 production estimates might allow both eight bcm/a for Turkey and the seven bcm/a needed to sanction either TGI, TAP or Nabucco. Less likely, it could be a realization that if the GOAJ wants to develop SD2, it will have to sell eight bcm/a to Turkey, leaving perhaps an insufficient amount to sanction either TGI, TAP or Nabucco. In this regard, Heydarov seemed somewhat dismissive of the prospect of Nabucco finding sufficient volumes for sanctioning, and mused that even the seven to eight bcm/a needed for TGI might be a bridge too far. Previously, SOCAR has always insisted that Turkey must grant transit for GOAJ gas before it can make final decisions on SD2 volume allocation. We will explore this question of SOCAR's latest thinking next week when we get a readout of today's Abdullayev-Erdogan meeting. END COMMENT. LU