AZERBAIJAN: MOTION ON SHAH DENIZ PHASE TWO TURKEY

C O N F I D E N T I A L SECTION 01 OF 04 BAKU 000031

SIPDIS

ANKARA FOR DAS BRYZA

E.O. 12958: DECL: 01/14/2019
TAGS: PGOV PREL AJ TK ENRG
SUBJECT: AZERBAIJAN: MOTION ON SHAH DENIZ PHASE TWO TURKEY
TALKS

REF: A) BAKU 1126 (2008) B) BAKU 1186 (2008) C)
ANKARA 56 D) BAKU 30

Classified By: CDA Don Lu, Reasons 1.4 (b,d)


1. (C) SUMMARY. According to Shah Deniz Consortium members
SOCAR, StatoilHydro and BP Azerbaijan, there has been no
progress in talks with Turkey on either the price of Shah
Deniz Phase One gas currently being delivered to Turkey or on
the marketing and transit of Shah Deniz Phase Two gas to and
through Turkey. However, SOCAR President Rovnaq Abdullayev
is scheduled to meet on January 16 with Turkish
Parliamentarian Taner Yildez, whom Prime Minister Erdogan has
authorized to represent him in discussions with SOCAR, and
SOCAR officials are hopeful that this new channel can
expedite progress. If Azerbaijan and Turkey cannot reach
agreement, StatoilHydro officials say that the Shah Deniz
Consortium is increasingly contemplating the possibility of
selling at least some Shah Deniz Phase Two volumes to
Gazprom, possibly as part of a swap deal, although SOCAR has
previously assured the USG that it would never sell
appreciable SD2 volumes to Russia. EU Commissioner Benita
Ferrero-Waldner will be visiting Baku on January 21 to
discuss, inter alia, energy issues. END SUMMARY.

2. (C) On January 15, EnergyOff met separately with Murad
Heydarov, advisor to SOCAR President Rovnaq Abdullayev; Olav
Skalmeros, StatoilHydro Vice-President for Marketing; and,
Richard Ruddiman, BP Azerbaijan's Shah Deniz gas commercial
manager, to discuss the status of Shah Deniz Phase one (SD1)
and Shah Deniz Phase Two (SD2).
FERRERO-WALDNER VISIT

3. (C) SOCAR Presidential Advisor Murat Heydarov said that EU
Commissioner Benita Ferrero-Waldner would be visiting Baku on
January 21 to discuss (inter alia) energy issues, and that he
was traveling to Vienna on January 18 to meet with EU staff
to help prepare for the meeting. This Ferrrero-Waldner visit
grew out of discussions with European Commission Energy
Commissioner Piebalgs during his visit to the November 13-14
Baku Energy Summit, during which he and GOAJ officials agreed
to intensify EU-GOAJ energy cooperation. Since the recent
Ukraine-Russia gas dispute, Heydarov said he senses far
greater enthusiasm for Nabucco from his EU interlocutors.
SD1 ) OFFICIAL NEGOTIATIONS

4. (C) Heydarov denied that Botas has made any upwards
revision in the price it was offering for SD1 gas (see reftel
C). Explaining, he said that there are two fora for
discussing SD1 price. The major and official forum is the
negotiations between Botas (buyer) and the Azerbaijan Gas
Supply Company (AGSC ) the gas marketing company for Shah
Deniz Phase One gas, headed by StatoilHydro). The last
meeting of this forum was in October 2008, with a subsequent
meeting in December cancelled. In this forum Botas has
continued to adhere to its long-standing proposal of raising
the SD1 gas price cap (i.e. maximum allowable price) the
first year by 20 percent, followed by 10 percent raises in
the second and third years. Heydarov explained that what this
would mean is that for the first year the price of SD1 would
be at most USD 144 per thousand cubic meters (tcm),and in
the third year the price would be approximately USD 180/tcm.
At that point, this price would have to remain for four
successive quarters before price renegotiations could resume,
which means that for all intents and purposes, the pricing
mechanism arrived at during this phase of negotiations would
last for (at least) four years. Since Botas's proposal
results in a price that is severely sub-market, the AGSC
Consortium refuses to consider it (COMMENT: StatoilHydro Gas
Marketing VP Olav Skalmeros explained to EnergyOff that even
with the current low oil prices, the resulting SD1 gas price
using the current pricing formula would exceed USD 180/tcm.)
The next meeting of this forum is scheduled for January 27.
SD1 & SD2 ) UNOFFICIAL NEGOTIATIONS

5. (C) Heydarov explained that outside this formal
negotiating forum, there is a parallel, supplementary forum
in which government and energy officials from both countries
meet to discuss possible solutions for SD1 and SD2. On the
GOAJ side, this group's regular and revolving participants
include Energy Minister Natiq Aliyev, SOCAR President Rovnaq
Abdullayev, and SOCAR Marketing Vice-President Elshad
Nasirov; on the GOT side, Energy Minister Guler and Botas
President Duzyol. This group met during this November 13-14

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Baku Energy Summit, during which, according to SOCAR
President Abdullayev, Energy Minister Guler was about to sign
an Energy MOU with Azerbaijan but "backed out at the last
minute"(ref A).
SOCAR WILLING TO GIVE 4 BCM TO TURKEY

6. (C) In late November, Energy Minister Aliyev, SOCAR
President Abdullayev and VP Nasirov traveled to Ankara at
Energy Minister Guler's invitation to meet with him to
discuss SD and SD2 issues. Their already unfavorable
opinin of Guler was worsened when he kept them waiting ive
hours, as he was "out of the capitol." In tis late November
meeting SOCAR's proposal to Bots was that it would sell a
minimum of four billin cubic meters annually (bcm/a) to
Turkey, with the possibility of more volumes, in exchange for
the right to transit seven bcm/a to Europe. Turkey refused
this offer, insisting on eight bcm/a for its own energy
needs.
THEN 8 BCM

7. (C) In a December 5 meeting (reftel b) SOCARlatest
proposal was that it would accede to GOT demands to sell
eight billion cubic meters annually (bcm/a) to Turkey.
Heydarov explained that previously SOCAR was reluctant to
commit eight bcm/a of SD2 to the Turkish market, since it
needed a minimum of seven bcm/a for transit to Europe in
order to sanction one of the competing pipeline projects
(Nabucco, TAP, TGI) (COMMENT: SD2 production is anticipated
to be between 13-16 bcm/a, three of which would be needed for
the Azerbaijani and Georgian markets. Of this remaining
10-13 bcm/a, if seven were for European markets, only three
to six bcm/a would be left for Turkey. END COMMENT).
However, in order to meet Turkey's demand for eight bcm/a,
while still having seven bcm/a for Europe and three for
Georgia/Azerbaijan, Heydarov said that SOCAR would try to get
increased gas production from existing SOCAR fields
(shallow-water Gunashli),the 'Bahar' field, or from ACG
associated gas.

8. (C) However, in exchange for providing eight bcm/a, SOCAR
insisted that it be allowed to sell SD2 gas consistent with
existing GOT gas market liberalization laws, which would
allow it to sell gas to any licensed buyer, i.e. not being
forced to sell to BOTAS. In this way, SOCAR felt it could
get a fair market price for SD2 gas within Turkey. As
Heydarov explained it to EnergyOff, "although SOCAR willing
to meet Turkey's energy security needs, that doesn't mean it
is willing to meet Botas's energy security needs." However,
Heydarov said that GOT and Botas refused this proposal also,
insisting that SD2 gas be sold to Botas and only Botas.

9. (C) As for SD1 gas, Heydarov said that even though the
two countries' respective presidents in their recent
bilateral meetings have agreed that the price of Azerbaijani
gas being sold to Turkey is too low, there has still be no
hint of an agreement about a new, more realistic price, in
either the formal or informal forum. In the latter, Heydarov
said that Botas has implied that it would be willing to raise
price caps to allow a price of USD 250-270 at oil prices of
USD 100 per barrel, but has made no concrete proposals.
Heydarov explained that while the GOT would like to separate
the issues of SD1 and SD2, for the GOAJ that is not feasible,
as it sees GOT unwillingness to pay anything close to market
price for SD1 as an indication of bad faith that weakens GOT
assertions that it is willing to pay 'market price' for SD2
gas.

10. (C) Referring to the SD1 price formula, Heydarov said
international best practices for gas marketing are for a
price formula that is 100 percent 'oil weighted,' i.e. where
the gas price is a direct function of the oil price.
However, the current PSA-stipulated SD1 pricing formula is
only 60 percent 'oil weighted,' and has a price cap. The
final gas price is arrived at by adding a fixed element (USD
100 per thousand cubic meters) to a variable. SOCAR and SD
Consortium want to revise the price formula to abolish price
caps and to raise the fixed element upwards from USD 100, but
Botas (understandably) likes the current formula.

11. (C) Heydarov said that on December 23 SOCAR President
Abdullayev met with GOT Prime Minister Erdogan to brief him
on SD1 and SD2 developments, mainly because SOCAR felt that
the Prime Minister was not getting an accurate assessment of
the situation from Energy Minister Guler. Erdogan was
"attentive," "promised to look into the matter deeply," and
As a result of this meeting Erdogan authorized his energy

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advisor (and Parliamentarian) Taner Yildez as his point of
contact for SOCAR President Abdullayev. Heydarov said the
assignment of Yildez as POC pleased SOCAR, as now it feels it
is less dependent on Energy Minister Guler and Botas
President Duzyol, both of whom it considers unreliable and
not empowered to make the necessary decisions.

12. (C) Heydarov said that SOCAR President Abdullayev and VP
Nasirov are scheduled to meet Yildez in Ankara on January 16.
At that time they hope to get feedback to the December 15
letter from GOAJ Energy Minister Aliyev outlining the latest
GOAJ SD2 proposal, which offered eight bcm/a of gas for
Turkey (but not necessarily Botas) in exchange for the right
to transit seven bcm/a to European markets.

13. (C) In discussing the price of SD2 gas to Turkey with
EnergyOff, Heydarov admitted that it is unlikely that the
final price would be equal to a "pure market price," as
political considerations would also be taken into account.
As such, it was likely any final SD2 price would be
discounted below the Gazprom and Iranian prices into Turkey.
He said that the GOAJ argument to Turkey has been (inter
alia) that it can glean significant additional revenues from
being a transit country, given that (for example) it could
charge o/a three Euros per thousand cubic meters per
kilometers, which could mean significant revenues given
Turkey's size and possible transit volumes of up to 50 bcm/a.
Given that there are only three possible transit countries
for eastern gas seeking European markets (Ukraine, Belarus
and Turkey) and especially given the recent Russia-Ukraine
problems, Heydarov said it would seem to be in Turkey's
interest to exploit its transit potential.

14. (C) As for plans for SD2 development, Heydarov confirmed
that full field development start-up has been delayed, and
that consequently SD2 development budget has been revised
downwards. The latest estimate for SD2 "first gas" is third
quarter 2015 at the earliest.
BP/STATOILHYDRO ) NO PROGRESS

15. (C) In a subsequent meeting with StatoilHydro
Vice-President for Marketing Olav Skalmeros and BP
Azerbaijan's Shah Deniz gas commercial manager Richard
Ruddiman, both said that there had been no progress in SD1
price negotiations with Botas, with the latest offer still
being the one that would result in a price over three years
of approximately USD 180/tcm. Skalmeros said that the SD
Consortium was increasingly moving towards at least starting
arbitration, since "no one in Turkey except the Prime
Minister is able to make any decision." SOCAR is relatively
reluctant to begin arbitration due to reasons of Turkic
solidarity. As for SD2, he confirmed development delays,
saying that although third quarter 2015 is now the earliest
start date of 'first gas,' the SD Consortium is not excluding
the possibility of first gas in 2016 or 2017.

16. (C) Referring to SOCAR's latest proposal to be allowed to
sell SD2 gas to any licensed buyer in Turkey, Skalmeros said
the idea was a non-starter, since although any licensed
entity could sell gas in Turkey, only Botas could import it.
Given that Botas's desire was to maintain its gas monopoly
within Turkey, it would never allow another SOCAR's proposal.
GAZPROM LOOKING GOOD FOR SD2?

17. (C) Commenting on the many recent trips of SOCAR to
Moscow, Skalmeros said that the Shah Deniz Consortium looks
favorably upon Gazprom and "would have no problem" selling
SD2 gas to Gazprom, who is willing to pay market prices for
it. Negotiations in this regard are relatively advanced, and
the SD Consortium to include SOCAR are even paying increased
attention to the possibility of doing a swap deal with
Gazprom with SD2 gas, where the SD Consortium sells an amount
to Russia, then receives an equivalent amount from Russia in
Europe. According to Skalmeros, "building 120 kilometers of
pipeline in the Caspian sand" is a lot easier and cheaper"
than building Nabucco.

18. (C) COMMENT: SOCAR is encouraged by the separate
channel it has set up with the Prime Minister's office and
with Taner Yildez, as it feels that it is only the President
or Prime Minister who will ultimately be able to make a deal
on gas for the Turkish government. Separately, information
gleaned from SOCAR, StatoilHydro and BP Azerbaijan conflicts
with the Ref C, with the three stating there has been no real
movement in Botas's proffered price in either the official
forum or in unofficial discussions. Although the Embassy
believes that StatoilHydro's laudatory comments about Gazprom

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and the SD Consortium's willingness to sell to it were
intended to persuade as well as to communicate, there is no
doubt that any continued inability to reach agreement with
Turkey on either SD1 or SD2 would increasingly push the SD
Consortium to consider its other marketing options. It
should be kept in mind that SOCAR has previously assured
Embassy interlocutors that despite commercial negotiating
activity with Gazprom, it would never sell appreciable
amounts of SD2 gas to Russia. Embassy will get a readout of
the January 16 Yildez-SOCAR meeting as soon as possible. END
COMMENT
LU