AZERBAIJAN-IRAN COOPERATE ON NATURAL GAS, CONSIDER

C O N F I D E N T I A L SECTION 01 OF 02 BAKU 000757

SIPDIS

EUR/CRAC FOR JOHN CLOONEY; EEB FOR ESC/IEC/EPC

E.O. 12958: DECL: 08/10/2018
TAGS: AJ IR ENRG PREL PGOV
SUBJECT: AZERBAIJAN-IRAN COOPERATE ON NATURAL GAS, CONSIDER
EXPANSION

REF: NONE

Classified By: Acting DCM Rob Garverick


1. (C) SUMMARY: The Azerbaijan-Iran natural gas
relationship is expanding and will continue to be
strategically important to both countries. This opinion was
conveyed to polecon officer in separate meetings with
Azerigaz Vice-Chairman, Nazim Sadmed-zadeh; State oil Company
of Azerbaijan Vice President Elshad Nassirov; and long-time
energy analyst for Azerbaijani TURAN news, Ilham Shaban.
According to these observers, the energy relationship meets
critical needs of both nations. Azerbaijan is reliant on
Iran,s gas for the isolated autonomous region of Nakhchevan,
while Iran counts on southern Azerbaijan to supply gas to its
northern territories. The relationship is based on a swap
agreement, a practice increasingly used in the region to meet
energy needs. All agreed the swap practice is particularly
beneficial when dealing with Iran as it minimizes political
and commercial risk for the Government of Azerbaijan. Since
GOAJ is not investing in the Iranian gas sector and no
monetary exchange or profit is being made by either
government, GOAJ is confident it will not face international
criticism nor violate any international sanctions.

Background to the Natural Gas Swap Relationship
-------------- --


2. (C) Azerbaijan-Iran cooperation in natural gas is
primarily limited to a swap agreement that involves an
Iranian gas supply to Nakhchevan and an Azerbaijani gas
supply via its southern border to Astara, Iran. The exchange
officially commenced in 2004 and is based on acute supply
deficiencies in both countries. The closure of land borders
between Armenia and Nakhchevan as a result of the
Nargoro-Kharabakh conflict has severely limited Azerbaijan,s
options for supplying gas and other necessities to the
enclave. According to the GOAJ, Iran--with the sole land
border open for entry to the Nakchevan--is the only practical
gas supplier for Nakhchevan. In terms of Iranian needs, the
most efficient way to provide gas to northern Iran is via
Azerbaijan as Iran,s major gas fields are in the south of
the country. Iran also relies on Azerbaijani gas because of
the growing demand in its northern territories and its lack
of adequate investment in domestic production and
infrastructure.

Why a Swap Program
--------------


3. (C) All three interviewees said energy swaps are a growing
practice in the region because they limit financial and
political risks to each government. Under such arrangements,
including the Azerbaijan-Iran gas exchange, each government
is responsible for building and maintaining the necessary
infrastructure and ensuring gas transit to the other country.
If one side disrupts service, the other party can follow
suit. As Azerigaz official Sadmed-zadeh said 'we sink or
swim together in this scenario.' According to TURAN energy
analyst, swaps with Iran are particularly popular, not only
because of the two nations, geographical-based needs but
because the government of Azerbaijan feels less exposed to
international criticism and possible sanctions. By engaging
in swaps the GOAJ avoids making investments in Iranian gas
sector and neither side realizes a monetary profit. In fact,
according to the agreement, no money changes hands between
the two parties. Shaban also surmised the GOAJ prefers swaps
with Iran because the negotiations do not get bogged down in
cost issues which seem to hamper all other such deal-making
with the Iranian Government. Shaban said Iran is "always
trying to broker a deal where it gets everything for free"
from the other party.

Increasing volumes exchanged
--------------


4. (C) According to Sadmed-zadeh the swap volume exchanged
between Azerbaijan and Iran has increased by 50 million cubic
meters each year since 2004. In 2004, 50 million cubic
meters were exchanged and by 2007, 200 mcm were swapped. In
the first quarter of 2008, 122 mcm have been exchanged.
Nazim said the pipeline capacity is not functioning at
capacity and could swap more than 300 mcm without a problem.
The gas exchange is not balanced as Azerbaijan provides an
additional 15 percent of total gas exchanged to Iran annually
to cover transit costs from Iran.


5. (C) Shaban and Nassirov both projected that gas
cooperation with Iran would continue to expand. According to

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Nassirov, Iran has already proposed to Azerbaijan that it
purchase all the natural gas from Phase II of Shah Deniz when
in becomes operational in 2012. While Nassirov did not say
the proposal was likely, he also would not rule out some
degree of additional gas sales to Iran in the future. (NOTE:
Iran has about a ten percent ownership stake in the Shah
Deniz project, varying slightly between the field itself and
the associated pipeline.)


6. (C) COMMENT: Despite tension between the two
governments--particularly over Caspian delimitation and
Iran,s perceived alliance with Armenia--Azerbaijan and Iran,
as evidenced by energy cooperation, have pursued a strategic
relationship to advance their immediate interests. It seems
feasible that if the geopolitical situation does not
drastically change in the region, the Azerbaijan-Iran
bilateral relationship, particularly in the energy sector,
could continue to expand. Without resolution to the
Nagorno-Karabakh situation, Azerbaijan will continue to rely
on Iran to meet the energy needs of Nakhchevan. If Turkey
continues to frustrate Azerbaijan,s pipeline transit
proposals, Azerbaijan may seek out neighbors, like Iran or
Russia who would be willing to work together on energy
projects. (NOTE: In the past two years Iran has made several
high level visits to Azerbaijan which include submission of
proposals to increase cooperation in electricity, oil, and
gas.) While we accept Iran as the only practical gas
supplier for Nakhchevan at this time, Post will continue to
discourage Azerbaijan from expanding its energy relationship
with Iran beyond this exchange or increasing its ties with
Iran in other sectors.
LU