AZERBAIJAN STATOIL EXEC SAYS SD1 AND SD2 WILL BE

C O N F I D E N T I A L SECTION 01 OF 02 BAKU 000630

SIPDIS

E.O. 12958: DECL: 07/01/2018
TAGS: PGOV PREL AJ TU ENRG
SUBJECT: AZERBAIJAN STATOIL EXEC SAYS SD1 AND SD2 WILL BE
SOLVED TOGETHER

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


1. (C) SUMMARY: According to a Baku-based StatoilHydro
executive, issues relating to the new price of Shah Deniz
Phase One gas being sold to Turkey will be solved
contemporaneously with agreement of sales of volumes of Shah
Deniz Phase Two to Turkey. According to him, there are
features of the Shah Deniz Phase One contract that can be
used as incentives for the GOT to come to a deal on the sales
of Shah Deniz Phase Two gas to Turkey, and, by extension, on
providing a fair and transparent transit regime for GOAJ gas
seeking European markets. END SUMMARY.


2. (C) On June 25 EnergyOff met with StatoilHydro Azerbaijan
Vice-President for Gas Jan Heiberg, to discuss the Shah Deniz
Consortium's price negotiations with Botas for Shah Deniz
Phase One gas (SD1) and also marketing issues for Shah Deniz
Phase Two gas (SD2).


3. (C) Heiberg said the SD Consortium and Botas has signed a
Letter of Agreement stipulating April 15, 2008 as the
"trigger date," i.e. the date after which Botas must pay a
new price to the SD Consortium for the SD1 gas that until
that point was being sold at USD 120 per thousand cubic
meters (mcm). Whatever new SD1 price eventually arrived at
will be 'grandfathered' back to the April 15 date. Heiberg
did not know what the eventual new price would be, but
pointed out that Gazprom and Iran are each selling gas to
Turkey at a price between USD 400-450/mcm.


4. (C) The SD Consortium and Botas have had only two meetings
to discuss a new price since signing the letter in April, one
in May and one in June. According to both Heiburg and SOCAR
Vice-President for Marketing Elshad Nassirov, the meetings
have been unproductive, as Botas has rejected both SD
Consortium proposed pricing models while not forwarding any
of their own. (COMMENT: BP Azerbaijan President Bill
Schrader said in a June 30 conversation with the Ambassador
that given rising prices, the longer Botas waits to lock in a
price, the more it will probably pay for its gas). The next
session between the SD Consortium and Botas will be July 16 -
17, at which time the SD Consortium hopes to receive a
counter-proposal from Botas.


5. (C) Heiberg explained that the "new price" for SD1 will
actually consist of both a new starting price ("P-zero"),and
an oil-indexed pricing mechanism. He said that negotiating
the new SD1 price perforce will be influenced by and will
influence the GOT's negotiations to buy SD2 gas, i.e. that
there will have to be "one big solution" for all the gas
issues between Azerbaijan and Turkey. He quoted Azerbaijan
Deputy Speaker of Parliament Valekh Alesgerov, who had told
him that "both issues (SD1 and SD2) will have to be solved at
once."


6. (C) Heiberg said that other than price, there were two
aspects of the SD1 contract that could be used as a
'sweetner' for SD2 negotiations. For SD1, while the first 80
percent of the contracted volumes were "take or pay," the
remaining 20 percent of the SD1 volumes for Turkey were sold
with a substantial rebat. Botas is seeking that this price
rebate for 2 percent of the SD1 volumes remain
non-negotiabl, whereas the SD Consortium has said that this
rbate is also subject to re-negotiation. Additionaly, the
current SD1 contract is set to expire in 021. Given that
"all of Turkey's supply contracts expire
around 2020," the SD Consortium could offer to extend the
sales contract.


7. (C) Heiberg said that the negotiations within the SD
Consortium to create a new Special Purpose Vehicle (SPV) to
market SD2 gas and to implement sales contracts is
deadlocked. (Comment: The SPV for SD1 is the Azerbaijan Gas
Supply Company - AGSC - headed by Statoil.) According to
Heiberg, SOCAR, who is seeking to play the primary role in
marketing SD2 gas, is unwilling to give BP and Statoil the
type of "negative control" (i.e. veto power) that these
companies feel they require to safeguard what will be an
investment of over USD 10 billion.


8. (C) Heiberg said that SD2 production would be
approximately 13 bcm/a. He presumed that approximately three
of it would stay in Azerbaijan or Georgia, so that no more
than four bcm/a could be sold to Turkey while still leaving
enough SD2 gas to sanction one pipeline (i.e. six bcm/a). In

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this regard, he also said that the GOAJ was seeking to have
the SD Consortium write a letter on behalf of President
Aliyev to Prime Minister Erdogan saying that the GOAJ could
not sell more than 4 bcm/a to Turkey.


9. (C) COMMENT: SOCAR says the SD1 price must be fixed
before the SD Consortium will contemplate SD2 sales to
Turkey; Botas says that SD2 sales must come first because
"SD1 negotiations will take a long time." As Heiberg points
out, given that the price of each will determine the price of
the other, it is likely that both SD1 and SD2 bilateral
issues will probably have to be resolved at the same time.
END COMMENT.
DERSE