Two Sides of the Same Sea: the Caspian Region Presents Lucrative but Different Visions for Oil and Gas Investment

SPECIAL REPORT: Prepared by Global Business Reports CASPIAN REGION for E&P . More information can be found at gbreports.com Aker Solutions, through its Drilling Technologies division, supplied, installed and commissioned a drilling derrick & equipment package to AIOC (operated by BP). Two sides of the same sea: The Caspian region presents lucrative but different visions for oil and gas investment Eugene Yukin , Joseph Hincks , Katie Bromley , Katya Koryakovtseva , and Saskia Coplans , Global Business Reports The Caspian Sea, the largest inland body of water on earth, 2010, compared to just 870,000 b/d in 1995. While no separates what are undoubtedly the two oil giants of the region, doubt a remarkable achievement, the bulk of potential Azerbaijan and Kazakhstan. The Caspian region has become a remains largely untapped . central focal point for untapped oil and natural gas resources Further development faces significant challenges. The two and contains an estimated 10% of the earth’s potential oil oil giants, with vastly different economies, legal structures, and reserves. The major projects that have contributed to this envi - political environments, are addressing very similar issues sur - able position have been Tengiz and Karachaganak in Kaza - rounding the production and transportation of oil and gas in khstan and Azerbaijan’s Azeri, Chirag, and Guneshli fields. the region but in very different ways. This report by E&P Natural gas reserves in the Caspian region are proven at and Global Business Reports explores the directions more than 236 Tcf, and the region’s total oil reserves are each country is taking. The success of these respective paths reported to constitute more than 60 Bbbl of oil, with some has implications for Azerbaijan and Kazakhstan and will estimates as high as 200 Bbbl. With the aid of substantial no doubt hold important lessons for neighboring countries foreign investment, the region produced 4.5 MMb/d in Uzbekistan and Turkmenistan. rom the time of Zoroastrian and Hindu pilgrims, who Azerbaijan: Ftraveled from India to worship at Ateshgah of Baku where a vent from a subterranean gas field once fed a continuously burning flame; throughout the Second World War, when Land of fire almost 80% of the Soviets’ oil was produced in Azerbaijan; to the December 1994 ratification of Heydar Aliyev’s first produc - “Near the Georgian border there is a spring from which gushes tion-sharing agreement (PSA), the “Contract of the Century,” a stream of oil, in such abundance that a hundred ships may which would propel the country toward being the world’s load there at once,” so says the account of Marco Polo in refer - fastest-growing economy in 2006; the history of Azerbaijan ence to Baku oil. is interwoven with the development of its oil and gas industry. May 2012 | EPmag.com SPECIAL REPORT: CASPIAN REGION There are 57 oil deposits in Azerbaijan. Eighteen of Parties to Azerbaijan’s PSA agreements are the gov - them are in the Azeri sector of the Caspian Sea, and the ernment of Azerbaijan represented by SOCAR and rest are on land. According to the State Oil Company of contractors represented by various foreign oil and gas Azerbaijan (SOCAR), the Caspian basin has deposits of companies. The tax system consists of two alternative 30 billion tons of oil and 18 Tcm to 20 Tcm of gas. “Oil regimes: the statutory regime governed by the Tax has always been part of the life of the people in Azerbai - Code, and the tax regime established by existing PSAs. jan,” said Adil Mammadov, president of Azpromo, Azer - Contractors under PSAs pay a prenegotiated profit tax baijan’s national body for the promotion of foreign but enjoy various favorable conditions such as exemp - investment. tion from VAT and customs duties on imports. Azerbaijan is arguably the most experienced oil and More broadly, the legal regime for foreign investors is gas producing nation in the world. The first industrial as favorable as the one created for local investors, and production of oil in Azerbaijan took place in 1846, a Azerbaijani law protects foreign investors’ interests from decade before the Americans sank their first oil well in future adverse changes in the legislation for the next 10 Pennsylvania. The world’s first oil pipeline was laid from years, although this does not apply to changes in legisla - Baku to Supsa on the coast of the Black Sea, and the tion concerning defense, national security and public world’s first oil tanker was built in Azerbaijan. In 2012, order, environmental protection, credit and finance, the country must draw on its exceptional heritage as it and public morale and health. prepares to undertake some of the most ambitious The success of Azerbaijan’s PSAs, and their continued hydrocarbon plays in the world. stability, has been key to attracting foreign investment into the country. Salans, the largest international law firm The contract of the century operating in Azerbaijan, played a major role in fostering and the rise of the PSAs agreements for the ACG field in Azerbaijan as well as Despite Azerbaijan’s heritage as an oil and gas produc - the Karachaganak and Kashagan fields in Kazakhstan. ing nation, after regaining independence from the “The other Caspian states with major oil production Soviet Union the country was desperately in need of succumbed to a great extent to impulses of resource foreign investment and technology to reinvigorate its nationalism, particularly in Kazakhstan,” said James hydrocarbons sector and bolster its nascent economy. Hogan, managing partner at the Baku office of Salans. The Azeri, Chirag, and deepwater Guneshli Contract The Kazakhstan approach entailed periodic demands No. 1, a 2004 agreement signed between then President to renegotiate contract terms, which held up projects, Heydar Aliyev and the Azerbaijan International Operat - and in some cases such changes rendered the original ing Company (AIOC), is commonly referred to in Azer - contract somewhat meaningless. Azerbaijan was differ - baijan as the Contract of the Century. Azerbaijan’s first ent. “There has not been a single case of a PSA having PSA laid out special provisions for the shareholders who to be renegotiated,” said Hogan. “It is a system that has would develop the field and was to change the economy, worked well for both the contracting oil companies and political standing, and standard of living in Azerbaijan the state, and both parties concentrate on getting the for decades to come. The job done.” Azeri-Chirag-Guneshli (ACG) The scope of Azerbaijan’s PSAs goes beyond the basics deal was not only a massive of extraction to include provisions for various sector- financial coup for the govern - related subcontractors. Customs regulations in Azerbai - ment – ACG has estimated oil jan, for example, are regarded as problematic, subject reserves in excess of 5.4 Bbbl, to complex bureaucracy and vulnerable to corruption; and conservative predictions however, logistics companies who deal directly with the when the field came onstream oil and gas sector have a somewhat easier experience in 2006 had it that the con - thanks to the PSAs. tract would bring in up to US “The energy sector for the most part falls under the $170 billion in revenues for PSA and as such clients benefit from preferential tax ben - the country before 2025 – but efits to encourage trade in Azerbaijan,” said John Quinn, also set the framework for operations director at ACE Forwarding Caspian, whose George Taggart, regional future extraction of oil and company has a 15-year history of offering freight forward - manager, Caspian, gas in the country. Since 2004, ing and dangerous goods management services to inter - Drilling Technologies more than 20 PSAs have been national oil and gas companies operating in Azerbaijan. at Aker Solutions signed in Azerbaijan. “If you look at the region – Russia, Kazakhstan, Azerbai - May 2012 | EPmag.com SPECIAL REPORT: CASPIAN REGION jan, Turkmenistan, Georgia – a lot of the legislation fol - relationships in Azerbaijan are, in some cases, providing lows suit, and all have similar requirements ... (but) there the parameters for activities elsewhere in the world. are differences in the PSA agreements; we find that the Aker Solutions Drilling Lifecycle Services, a division of PSA in Azerbaijan will currently allow you to bring in Aker Solutions, has four rigs operating in the ACG fields goods with greater flexibility than in Kazakhstan.” and has maintained a long-term operational service agreement (OSA) with BP. “BP is considering using One egg, one basket the Caspian contract template model in other areas The Azeri, Chirag, and deepwater Guneshli Contract No. of the world. Aker Solutions is a Norwegian company, 1 was not only central to Azerbaijan’s oil and gas evolu - and the fact that the Caspian region is leading the rela - tion, it also served to cement the place of BP as the coun - tionship is hugely significant for us,” George Taggart, try’s most prominent international oil company (IOC). regional manager of Drilling Lifecycle Services at Aker BP, which established an office in Baku in 1992, has a Solutions, said. dominant stake in the majority of the country’s large projects. In addition to being the operator of the ACG Shah Deniz Phase 2 field, BP has heavily invested in the giant gas field Shah The Caspian region was BP’s largest operation globally Deniz and will lead the field into its second phase of at the time of writing and particularly in the wake of development. Other projects in which BP has a signifi - BP losing out to ExxonMobil in the Arctic. The com - cant interest include the Baku–Tbilisi–Ceyhan (BTC) pany’s handling of Shah Deniz as it enters its stage pipeline, which transports crude oil from offshore fields two development will be keenly watched by investors in the Caspian Sea to the Turkish coast of the Mediter - looking for assurance that BP can still deliver on world- ranean for further shipping into Europe; the South Cau - class projects.

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