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Why -Turkey Gas Agreement are Welcomed by All Sides?

© Center for Economic and Social Development (CESD) Shirin Mirzeyev 76 "a"/33, , Az1002, AZERBAIJAN

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November, 2011

Why Azerbaijan-Turkey Gas Agreement are Welcomed by All Sides?

Last week Azerbaijan and Turkey signed a number of export agreements that allow Turkey to buy gas from Azerbaijan and transport it through neighboring countries to Europe. According to a statement posted on the official website of the State Oil Company of Azerbaijan (SOCAR), the signed package of documents includes:

- An intergovernmental agreement between the governments of Azerbaijan and Turkey; - An agreement to sell natural gas between SOCAR and Botas International Ltd (BIL); - A gas supply agreement between the Azerbaijani company (AKPG) and Botas; - An agreement on gas transit between SOCAR and Botas; - Framework Agreement stipulating the terms and conditions of transit of Azerbaijani gas through Turkey.

According to the IGU and FA the transit of gas via Turkey can be achieved through the existing pipeline system Botas (subject to modernization) or by building a new gas pipe. The signing ceremony was attended by Azerbaijan's President Ilham and Turkish Prime Minister Recep Tayyip Erdogan. The documents were signed by the Minister of Industry and Energy of Azerbaijan Natig Aliyev and Minister of Energy and Natural Resources of Turkey Taner Yildiz and SOCAR president Rovnag Abdullaev, regional president of BP Azerbaijan, Georgia and Turkey, the operator of Shah Deniz" Rashid Javanshir and CEO Director of Botas Fazil Shenel.

"Agreements provide a legal framework for managing the sale of gas from Shah Deniz to Turkey and its transportation to European markets via Turkey", SOCAR reports. "We are pleased to complete the signing of important agreements between Azerbaijan and Turkey, which will give rise to full-scale development of Shah Deniz and, the supply of gas produced in the second stage of this giant field in Azerbaijan on the Caspian Sea to Turkey and to European markets”, Rovnag Abdullayev said “This is an important step that has been achieved by the two governments with the support of all stakeholders, including the Shah Deniz consortium. We believe that this success lies in the close partnership between the three main parties - the government of Azerbaijan, the Turkish government and Shah Deniz consortium. This partnership is a key element of what has been done so far, and will remain the driving force that will allow safe and reliable supply of Azerbaijani gas to Turkey and Europe."

Elshad Nasirov, vice-president of state oil company SOCAR, said that under one agreement signed last week Turkey will purchase 6.6bn cubic metres of gas from Azerbaijan per annum, while under a framework agreement on gas transit 10bn cubic metres of Azerbaijani gas will be transported to Europe via Turkey, The final investment decision on the second stage of development of the Shah Deniz gas condensate field will be made in 2013, Elshad Nasirov said. He confirmed that the first gas from Shah Deniz II would be produced in 2017.

He told a conference in Baku on Wednesday on “The State Oil Fund’s Role in the National Oil Strategy of Azerbaijan" that $23bn was needed to take gas production in Azerbaijan to 26bn cubic metres per year. Earlier cost estimates for Shah Deniz II did not exceed $22bn. As part of Shah Deniz II, 16bn cu.m of gas are to be produced per annum. As part of Shah Deniz I, 10bn cu.m are to be produced, although this figure has not been achieved yet. Elshad Nasirov reminded journalists today that at present Azerbaijan exports 6.6bn cu.m of gas to Turkey, 1.5bn to Georgia, 400m to Iran and 750m to Greece. Azerbaijan exports gas to Russia too.

US welcome Azerbaijan, Turkey gas deals

Secretary of State Hillary Clinton has praised recent agreements on the purchase, sale and transit of Azerbaijani gas through Turkey. She made the comments as part of a wide-ranging speech at the 2011 Annual Conference on US-Turkish Relations, held at the Ritz Carlton in Washington. "I would applaud the recent signing by Prime Minister Erdogan and President Aliyev of Azerbaijan of a very important energy agreement," Clinton said. "The Obama Administration also puts a premium on reaching beyond traditional diplomacy to engage directly with the private sector, civil society, and diaspora communities. We believe that these partnerships can help us leverage new energy, innovation, and resources," she continued.

EU welcome Azerbaijan, Turkey gas deals

EU Commissioner for Energy Gunther Oettinger mentioned that it is good for Europe, as gas from Azerbaijan will arrive on the European Union’s border and be distributed within Europe throughout the EU internal market. But it is not sufficient, and it does not change our focus:

'We want to see sufficient dedicated pipeline capacity that links Azerbaijan to Europe. And this pipeline capacity needs to be operated within a strong legal framework compatible with international law. This is also the preference of the which he set out in a joint Commission-Azerbaijan declaration signed in January 2011 together with President Barroso', he said.

Russia welcome Azerbaijan, Turkey gas deals

Azerbaijan and Turkey have signed a deal on supply and transit of natural gas to the delight of Gazprom shareholders and the Russian tax payers. It says in an article “Azerbaijani gas goes out of Russian control” by East European Gas Analysis CEO Mikhail Korchemkin published on RBK.

The article says that the sides reached a deal on how Turkey will receive up to 6bn cubic meters of Azerbaijani gas by 2017 to meet domestic consumption and serve as transit for 10bn cubic meters of natural gas to Europe. “I hope that Azerbaijani gas will be delivered both to Turkey and Europe via Turkey in even greater volumes once the documents signed here today are implemented,” the author quotes Azerbaijani President as saying at the end of the talks.

"This is really good news for Gazprom shareholders because the gas monopoly will no longer need to purchase expensive Azerbaijani gas," the article says.

“Gazprom’s export portfolio is limited to the contracts signed (the guaranteed volume of exports to foreign countries is 158bn cubic meters between 2020 and 2025). Foreign gas purchased at European prices is too expensive for Russian consumers, and it can only be re-exported. Thus, each cubic meters of foreign gas displaces each cubic meter of gas produced in Russia from export portfolio while the export of Russian gas is the most profitable operation for Gazprom and a major source to fill the state budget of the Russian Federation."

The expert noted that at current prices purchase and re-export of 16bn cubic meters of Azerbaijani has instead of an export gas produced in Russia would reduce Gazprom revenue by $3-$3.2bn a year.

"Foreign gas is re-exported free of duty, so that annual revenues will shrink by $2.2-$2.4 billion and the state will have to get money from other taxpayers. Of course, following unilateral termination of the contract with Turkmenistan, it is difficult to take seriously Gazprom statements about import of Azerbaijani gas "with no restrictions on the volume of purchases in the long run." So, the Russian monopoly would bear short losses in any case," the article reads.

“It is clear that not everybody in Russia benefited from the Azerbaijan-Turkey deal. The authors of “Russia's Energy Strategy for till 2030”, who believed that Russia should not simply sell gas, but also control the flow of fuel between Asia and Europe, can be considered losers.

“As interesting as it may seem, the Russian media describes the direct route from Baku to Turkey and Europe as roundabout, while from a geographical standpoint it is a route through Russia which is a roundabout. For example, the distance from Shah Deniz to the Turkish border via Russia and Blue Stream is about 1750 km, while it is 1,000 km less via Georgia,” the author notes.

BP welcomes Azerbaijan, Turkey gas deals

Speaking on behalf of the consortium, regional president of BP-Azerbaijan Rashid Javanshir said: "We welcome the successful signing of agreements for the sale and transit of gas from Shah-Deniz, as well as the intergovernmental agreement between Azerbaijan and Turkey, and we believe that they will help to open South gas corridor Europe, linking Azerbaijan and Turkey with another strategic partnership. In addition, the agreements will support the further development of the project Shah Deniz-2 in the direction of the final investment decision and the development of Turkey as an energy hub for Europe. The signing of these agreements will allow Shah Deniz to continue the selection process of the European route of the pipeline and to confirm the agreement of sale with potential buyers. On behalf of the partners we congratulate Azerbaijan and Turkey, with the signing of these critical agreements."

CESD Brief Analysis; Why do all Sides Welcome the Gas Deal?

CESD sources confirms that gas agreement signed between Azerbaijan and Turkey does not fully match Azerbaijan’s interests particularly market interests. In fact, terms of the agreements directly determined by Turkish side, Azerbaijani delegation was able to have slight revising, only. First, price of gas exporting to Turkey is 35 % less than market price. Second, there is still dispute how difference between market and real price will be compensated. Turkey imported 6 billion cubic meters (bcm) of gas from Shah Deniz-I, paying $120/thousand cubic meter (tcm), well below the current market prices by previous agreement. Turkey has continued to import natural gas from Azerbaijan although the gas supply agreement expired in April 2008. Considering that Turkey is currently paying to Russian gas $300/tcm, Azerbaijan has instead the same price, too. Azerbaijan asked Turkey to pay around $1.5 to $2 billion to compensate for price differences. CESD sources confirm that Turkey will pay around $ 1,0 billion compensation instead of $ 2 billion Azerbaijan asked. Third, Azerbaijan has targeted normalizing of relations with Turkey by accepting Turkish offers on gas export. Azerbaijani side hopes that gas agreement will give “warm wind” to relations with Turkey which is very important for official Baku from both strategic and political aspects.

Another important point is that all interested sides welcome gas agreement between Azerbaijan and Turkey. The West sees new agreement as complement the Nabucco intergovernmental agreement signed in 2009. EC considers the agreement set out the terms for the Nabucco pipeline and believes further steps will be taken to reach Nabucco agreement. The gas agreement settles on how much gas will be exported to Turkey from Shahdeniz Phase 2 which is around 4 billion cm. Considering that quarrel on ownership of Nabucco gas was one of main impediments for reaching agreement of distribution of Shahdeniz Phase 2 gas last gas agreement has importance for the West to give green light for further negotiations. In fact, EU considers the last agreement as taking important step for Nabucco project.

Meanwhile, Russia does not consider last agreement as main step for Nabucco negotiations, but official Moscow believe that Azerbaijan will compromise with Russia, too. Russia persists increasing of amount of gas export from Azerbaijan. Moscow hopes for 4 billion cm annual gas export from Azerbaijan in the near future and reach 6 billion cm by 2018. Since Turkey will export 10 billion cm gas from Azerbaijan it means official Ankara most probably will address to Russian market in the near future to cover domestic gas consumption. In this case, Russia will be able to keep monopoly position in the region. It is expected that Moscow will increase pressure to Azerbaijan not taking part in Nabucco project.

Azerbaijan is not in easy position to make decision related to regional projects even after gas agreement with Turkey. In fact, Nabucco promises strategic benefits to Azerbaijan as well. Azerbaijan has to select a route for the supply of gas to be produced during the second stage of developing Shahdaniz, the country’s largest gas field in the Caspian Sea. According to projections, production will be brought up to 25 billion cubic meters per year under the second stage of Shahdaniz development, which is expected to produce first gas in 2017. The Shahdaniz field holds estimated reserves of 1.2 trillion cubic meters of gas. Existing pipelines cannot fully transport Azerbaijan’s increasing gas to the world market.

Las agreement gives proof that building of new pipeline will be on the agenda in near future. Azerbaijan exports 2 billion m3 gas to Russia and the maximum power of this pipe is 6 billion m3. Azerbaijan exports 1 billion m3 gas to Iran and is not going to increase this number as a result of technical and political grounds. The Baku-Tbilisi-Arzurum pipeline has a capacity of transporting 8.8 billion m3, and it it possible that in the coming years this amount will reach up to 20 billion m3. Even in the best case scenario Azerbaijan still needs a new pipeline to transport its additional gas.

Appendixes

Table 1. Petroleum Production in Azerbaijan, thousand ton

Petroleum including Years Production On-shore Off-shore

1990 12 513 2 566 9 947

1991 11 742 2 238 9 504

1992 11 084 2 000 9 084

1993 10 295 1 974 8 321

1994 9 563 1 785 7 778

1995 9 161 1 624 7 537

1996 9 100 1 575 7 525

1997 9 071 1 563 7 509

1998 11 424 1 578 9 846

1999 13 807 1 526 12 282 2000 14 017 1 511 12 506

2001 14 909 1 596 13 313

2002 15 334 1 561 13 773

2003 15 381 1 630 13 751

2004 15 549 1 707 13 842

2005 22 214 1 755 20 459

2006 32 268 1 782 30 486

2007 42598 1767 40831

2008 44 514 1 799 42 715

2009 50 416 1 781 48 635

2010 51 000 1800 49 200.

Source : State Statistic Committee of Azerbaijan Republic, 2011

Table 2. Export of energy resources in Azerbaijan

Name 2006 2007 2008 2009 2010 Volume Value, Volum Value, Volum Value, USD Volume Value, Volum Value, USD e USD e USD e USD Crude oil 3848498 6313,7 3214193, 78085. 44170910,6 27829,5 11989737 31916, 18489553 thousand 9215.4 ,5 7 7 ,7 8 ,8 ton Gas, min 867726. 1 569 ton 1611.1 8 1455.5 865509.9 1650.7 1249254.6 1577.4 705963.0 .4 944129.8

Gasoline, 264370. min ton 925.2 9 926.3 344302.8 534.3 273699.8 183.4 36361.3 184.3 34796.4

Supportin 82700. 16132 119877. 389 g oil 61362.8 3681.8 4 4962.0 2.4 9675.5 9 3182.5 880,0 13214.2 products, ton Oil 28582. 28799. 13979. bitumen, 17845.9 3723.6 6 7360.3 5 8117.3 13511.6 4053.5 1 4193.7 ton Electricity , mln. 1174.1 18973.8 443.3 9666.6 808.8 27357.0 710.4 27939.0 392.0 15263.7 kVt.houre

Source : State Statistic Committee of Azerbaijan Republic, 2011

Table. 3. Import of Energy Resources in Azerbaijan

Name 2006 2007 2008 2009 2010 Volume Value, Volume Value, Volume Value, Volume Value, Volume Value, USD USD USD USD USD Gasoline, 26956.6 11868.2 11105.2 6534.8 39324.9 33276.5 8208.5 4793.3 120.4 202.4 thousand ton Gasoline, 103740.2 56932.1 39879.7 29724.5 4 177,0 9994.1 1 392,0 3663.4 215.5 604.9 thousand ton Disel, ton 23 16308.7 14670.8 634,0 20643.8 28463.5 37123.7 25491.4 25857.5 26450.9 28855.7

Natural gas, 4431.2 465123.8 470.1 51706.9 ------mln. cm Electricity, 23 mln. 2010.1 56121.1 773.7 409,0 266.5 10520.7 133.9 5126.3 83.9 3 684,0 kVt/hours

Source : State Statistic Committee of Azerbaijan Republic, 2011