Azerbaijan: Racing To Develop Natural Gas Potential

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EurasiaNet Commentary

Back in 1994, when the so-called “Contract of the Century” was signed, forming an international partnership to develop the giant Azeri-Chirag-Guneshli (ACG) oil field, lots of experts believed that Azerbaijan would not have to worry about money for a long time.


But just 23 years later, Azerbaijan’s government finds itself wrestling with revenue dilemmas. Today, Azerbaijan still holds roughly 7 billion barrels of proven oil reserves and produces 841,000 barrels on a daily basis. Yet that volume represents a significant drop from peak output of 1.1 million barrels a day in 2010. Lower yields, rising concerns about the depletion of reserves and falling world oil prices have sent Azerbaijan searching for alternative sources of revenue.

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Baku’s chief hope is to develop its natural gas potential.

According to conservative estimates, Azerbaijan sits atop 1.3 trillion cubic meters of gas and condensate, most of it in the offshore Shah Deniz field, which is believed to be among the largest in the world.

Production there began in 2006, and is expected to increase significantly during the second development phase, currently underway. Azerbaijan’s ambition is to supply natural gas through Turkey, Greece, and Albania to Italy and the rest of Europe – via the planned Trans-Anatolian (TANAP) and Trans-Adriatic (TAP) pipelines that will form the Southern Gas Corridor.

Deliveries are scheduled to begin in 2018, with around 4 billion cubic meters (bcm) per year slated for the Georgian and Turkish markets. The plan is to then expand this volume to 12 bcm a year in 2019, and finally to a full capacity of 16 billion cubic meters a year in 2020, 10 bcm of it headed for Europe.

But even the boost from Shah Deniz exports is not projected to be enough to place Baku on sound financial ground. The ultimate success of Azerbaijan’s effort to emerge as a global natural gas power rests with new offshore exploration.

One recent discovery, announced in 2010, is the Umid gas field in the south Caspian Sea, estimated to contain 200 billion cubic meters of gas and 40 million tons of condensate; the country’s state energy company, SOCAR, has been producing gas there since 2012, and has recently finished drilling the third well.

Also of great promise is the adjacent Babak field, yet to be developed, with potential gas reserves of 400 billion cubic meters, plus 80 million tons of condensate. Further off the coast, the Shafag-Asiman field holds an additional 300 billion cubic meters of gas, which Azerbaijan plans to extract in an equal-share partnership with BP. (This field may contain oil too, according to a seismic survey.) And another offshore deposit, Nakhichevan, is being jointly explored with the German company RWE.

The difference-maker for Azerbaijan’s ambitions as a gas exporter is the Absheron field, discovered in 2011. This field’s development, currently in its first phase, could greatly boost potential supplies (its reserves are estimated at 350 billion cubic meters of gas and 45 million tons of condensate) capable of filling Europe-bound pipelines of the Southern Corridor. This could bolster Europe-bound flows from the Shah Deniz field, and ease concerns that the European Union might have over future supplies. All in all, according to SOCAR’s strategy document, these steps could expand Azerbaijan’s gas export volumes to a massive 40 bcm per year.

The problem is that this will not happen until 2025 at the earliest, and in the meantime, Azerbaijan has several challenges to overcome.

More importantly, it will be at least five years before Azerbaijan begins to see its anticipated windfall from natural gas. The Absheron field will not start producing until late 2021 or early 2022, and the first gas deliveries from Shah Deniz will not reach Europe until 2020 or later.

For Baku, it may be a race against time. At present, Azerbaijan faces a gas shortage. It needs 12 billion cubic meters to satisfy its own domestic demand, and in 2016, it was forced to import around one-tenth of it from abroad. In fact, in the first five months of that year, SOCAR’s gas production had actually decreased by 5.4 percent compared to the same period in 2015. The fall triggered new discussions with Gazprom over potential gas imports from Russia, on the order of 3 bcm to 5 bcm per year, with Baku asking Moscow for a discount.

Combined with low oil prices, this shortfall translates into a pressing cash flow problem. Azerbaijan has already had to borrow money – around $5 billion – from international financial institutions to fund its share of Southern Corridor construction costs. It has also sold $1 billion worth of Eurobonds, and is preparing to sell more, in addition to securing a $400 million loan from the World Bank. When it comes to the TAP project, where Azerbaijan is responsible for 20 percent of the costs, the EBRD has confirmed talks to provide about $550 million in direct financing and to attract another $1.1 billion from commercial banks.

Azerbaijan’s high construction expenses are somewhat offset by the falling world price of steel, which is needed for pipelines; Baku has saved $2 billion on TANAP alone. But its budget is still strained, forcing it to prioritize some energy development projects over others. This will likely leave it focused on the Shah Deniz field and the Southern Gas Corridor initiative, while other projects that have no foreign partners –including the Umid and Babak gas fields – risk falling behind. Absheron will probably stay on track, thanks to the involvement of France’s Total.

This set of problems might soon have repercussions for Azerbaijan’s domestic politics. The country’s sovereign wealth fund SOFAZ – long a cornerstone of its energy development efforts – is being rapidly depleted. It stood at a modest $64 million in 2016, a big drop from $323 million in 2015 and $523 million in 2014. This trend is likely to continue as Azerbaijan pursues its natural gas ambitions, and it might not be long before its people feel the effects on their livelihoods. Baku can only hope that its natural gas reaches Europe before then.

Editor’s note: Marika Karayianni is a Caspian energy expert based in Athens, Greece.

Article by Marika Karayianni, EurasiaNet

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