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 BAKU 00000494 001.2 OF 003 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 BAKU 00000494 002.2 OF 003 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 BAKU 00000494 003.2 OF 003 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