AZERBAIJAN SCENESETTER FOR SPECIAL ENVOY FOR

C O N F I D E N T I A L SECTION 01 OF 03 BAKU 000494

SIPDIS

E.O. 12958: DECL: 05/25/2018
TAGS: AJ PGOV PREL ENRG
SUBJECT: AZERBAIJAN SCENESETTER FOR SPECIAL ENVOY FOR
EURASIAN ENERGY AMBASSADOR C. BOYDEN GRAY


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Classified By: Ambassador Anne E. Derse, reasons 1.4 (b,d)


1. (C) SUMMARY: Building on the success of the BTC and SCP
pipelines, Azerbaijan could become a still more important
producer and transit country for Caspian energy reserves.
Several key issues must be resolved. Azerbaijan is working
quietly with Turkmenistan to improve their relationship,
setting the stage for possible new bilateral Caspian energy
development. Turkish gas transit issues, and increasingly
difficult negotiations with IOCs over developing new gas
production, must be resolved in order to realize Azerbaijan's
potential as a gas producer. Although Azerbaijan and
Kazakhstan have signed agreements to transit Kazakh oil
through Azerbaijan, The two countries' rent-seeking
activities could harm the commercial viability of the
'Southern Corridor' for overland transportation of Kazakh
oil. During your visit to Baku for the June 3-6 Caspian Oil
and Gas Exhibition and Conference (COGS),your Azerbaijani
Government interlocutors will also be eager to hear your
views on European Union perspectives on Caspian Energy. END
SUMMARY

GOAJ COMES INTO MONEY
--------------


2. (C) The catalyst for Azerbaijan's economic "great leap
forward" since 2007 is the flood of revenue from the offshore
Azeri-Chiraq-Gunashli (ACG) oil field, developed by the
Azerbaijan International Oil Consortium (AIOC ) nine
international oil companies plus the State Oil Company of
Azerbaijan - SOCAR). As of April of this year, Azerbaijan
is receiving approximately 80 percent of the profit oil from
this field, which finds its way to market through the
Baku-Tbilisi-Ceyhan (BTC) pipeline, itself owned by a
Consortium with many of the same members of the AIOC. Like
many countries with a sudden infusion of mineral-based
revenues, Azerbaijan is undergoing sweeping changes, much of
which can be seen in the Baku construction boom. In the
energy sector, the state energy company SOCAR, flush with a
success it did relatively little to bring about, is seeking
to increase its proximity to its final consumers downstream,
for example purchasing a terminal in Georgia and a refinery
in Turkey. It is also seeking to in essence "renegotiate"
existing Production Sharing Agreements (PSAs),originally
penned at a time when its negotiating position was far weaker
than now.

ENERGY - OIL
--------------


3. (C) The AIOC operator BP has been engaged in a long and
acrimonious dispute with the GOAJ over respective shares of
AIOC profit oil. Extending the current AIOC PSA would
increase recoverable reserves and allow greater revenues (and
allow the U.S. companies to book these additional reserves
now). However, SOCAR is unwilling to discuss PSA extension
until not just the revenue split issues are resolved, but
also issues surrounding ownership of the BTC pipeline after
the PSA ends, ownership of the Baku-Supsa oil pipeline
(currently owned by the AIOC but coveted by SOCAR),and
allocation of the associated gas from the ACG field. The
GOAJ is also dragging its feet on expanding BTC capacity as
it seeks to optimize future revenue streams by in essence
trying to renegotiate the terms of the current PSAs. You
should encourage the GOAJ to work out its issues
expeditiously with the AIOC Consortium so that PSA extension
can go forward.

GAS: PROVE UP/DEVELOP RESERVES
--------------


4. (C) Azerbaijan became a gas exporter in 2007, with
production starting for the offshore Shah Deniz (SD)
mega-field, and currently exports gas to Georgia and Turkey,
and a very small amount to Greece, via the South Caucasus
Pipeline (SCP). The field is being developed by the Shah
Deniz Consortium (six international energy companies and
SOCAR). When the second phase of SD production comes online
in late 2014 (SD2),in addition to Turkey and Georgia,
Azerbaijani gas volumes can be sold to European customers,
either via the Turkey-Greece-Italy (TGI),Nabucco, or
Trans-Adriatic Pipeline project (TAP).


5. (C) President Aliyev has said that he intends for
Azerbaijan's domestic gas needs to be met by SOCAR's gas

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production (approximately 7 billion cubic meters annually -
bcm/a),with the approximately 13 bcm/a of SD2 production
being exported. Flush with oil revenues, Azerbaijan sees its
gas exports as a way to increase its geopolitical connections
with a Europe that for reasons of security is seeking to
increase its non-Gazprom gas supplies.


6. (C) President Aliyev has stated that Azerbaijan seeks to
"export as much gas to Europe as possible as quickly as
possible." But Azerbaijan has yet to take the aggressive
steps necessary to prove up and develop its reserves. The
next significant gas field to be developed is "ACG Deep Gas,"
the non-associated gas that lies under the
Azeri-Chiraq-Gunashli (ACG) oil field currently being
developed by the AIOC. ACG Deep Gas reserves are estimated
at approximately seven trillion cubic feet (tcf),about
one-third of the Shah Deniz mega-field's, making this field
the logical choice for development.


7. (C) While the AIOC Consortium is eager to develop this
gas, the GOAJ and SOCAR are holding ACG Deep Gas development
hostage to resolving other issues revolving around revenue
allocation between the AIOC and the GOAJ. Given the long
timelines involved with developing gas and the shortage of
Caspian construction assets, even if the GOAJ decided today
to develop ACG Deep Gas expeditiously, production from this
field would not begin until 2014-2015 at the earliest,
according to Baku-based energy executives. Unless the GOAJ
can persuade the AIOC Consortium to part with some of the 11
bcm/a of associated ACG gas currently being re-injected, it
is unclear whether Azerbaijan will have significant new
sources of gas to export after SD2 comes online o/a 2015,
until at the earliest 2018-2020. You should encourage the
GOAJ to systematically prove up its gas reserves and to work
with IOCs to develop ACG Deep Gas and other gas fields as
expeditiously as possible, in order to fulfill its strategic
goal of being a significant gas exporter to Europe.

GAS -TURKISH TRANSIT
--------------


8. (C) SD2 cannot move to the next phase of its development,
scheduled for the first quarter of 2009 and at which point
significant sums begin to be spent, until preliminary sales
and purchase contracts are signed between European gas
consumers and the Shah Deniz Consortium. SOCAR will be the
lead for SD2 gas marketing, but SOCAR is unwilling to sign
any agreements until Turkey provides a fair and transparent
tariff on which SOCAR can calculate its negotiations with
downstream customers. Turkey, by signing a June 2007
Intergovernmental Agreement (IGA) with Greece and Italy,
sought to lock in the right to buy a percentage of all GOAJ
gas transiting Turkey at what SOCAR took to be sub-market
prices. Since the IGA signing there had been little progress
in resolving the "Turkish gas transit issue;" the sides are
now talking nd it seems that the answer may lie in
Azerbaija selling additional volumes of SD2 gas to Turkey.
Turkish Energy Minister Hilmi Guler will be coming prior to
the June 3-6 Caspian Oil and Gas Show (COGS),and indications
are that he will be seeking to resolve the issue with his
GOAJ interlocutors prior to a June 4 meeting between
President Aliyev and Prime Minister Erdogan on June 4 in
Nakhchivan.

TURKMENISTAN
--------------


9. (C) Azerbaijan seeks to draw Turkmen gas volumes from
offshore fields through Azerbaijan to Europe, to increase its
own strategic importance. Azerbaijan is to be commended for
its efforts to strengthen the bilateral relationship with
Turkmenistan since Turkmanbashi's death. The May 19-20 visit
to Baku of Turkmen President Berdimuhamedov, made possible by
President Aliyev's previous settlement of the bilateral debt
issue to the benefit of Ashgabat, was an important step in
this regard. It is not yet clear how much progress was made
during this visit on the bilateral development of Caspian
energy deposits, although initial indications are positive.
The GOTX position prior to this visit focused on its
long-standing claims to the ACG and the Sardar-Kapaz fields.
The GOAJ had been unwilling to discuss GOTX claims on ACG,
although they indicated they might be willing to cede
majority ownership of Serdar-Kapaz to the GOTX if the two
could jointly develop the field. In theory, the two sides
have been willing to discuss cooperation in Caspian energy

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development absent an overarching five-part delimitation
agreement among the littoral countries. The GOAJ is to be
commended for its outreach to Turkmenistan and encouraged to
continue cooperation on bilateral offshore energy
development, even absent an overarching delimitation
agreement.

KAZAKH OIL TRANSIT
--------------


10. (C) Even if the recently announced doubling of Caspian
Pipeline Consortium (CPC) capacity occurs, Kazakh oil volumes
from Tengiz and Kashagan fields will need to transit
Azerbaijan via a "Southern Corridor" consisting of ship, rail
and pipeline. Although the corridor is technically ready to
transit TengizChevroil (TCO) volumes, the inability of the
Azerbaijani freight forwarding company (controlled by SOCAR)
to reach agreement with TCO has prevented this corridor from
being used for TCO volumes. Azerbaijan should be encouraged
to ensure the commercial viability of this corridor and to
focus on setting up the infrastructure to handle increasing
volumes of Kazakh oil.

EU
--


11. (C) Partially in response to the claims of various
European countries that Azerbaijan is not being sufficiently
aggressive in seeking markets for its gas, various GOAJ
energy interlocutors to include President Aliyev has
countered that many European countries "are not serious" in
their desire for Azerbaijani gas, preferring instead to make
'secret and not so secret deals with Russia and Gazprom. Your
GOAJ interlocutors will be very interested in hearing your
insights on EU energy policy and how it relates to the real
motives of the various European countries professing a desire
for Caspian gas.--
DERSE