Azerbaijan rebuilds oil and gas industry

By bne IntelliNews June 17, 2008

Heiner Klemm in Baku -

Perched on the edge of the resource-rich Caspian Sea, Azerbaijan is the birthplace of the global oil industry. In the late 19th century, the Swedish Nobel brothers - those of Nobel-prize fame - started the world's first commercial oil production in Baku. But despite its early start, the oil industry largely lay fallow during the seven decades of Soviet domination. Since the end of communism, the government has set itself the task of rebuilding the sector so that today the country is producing more oil than during its previous peak set in 1941 and has turned from being a gas importer to a gas exporter.

Historians describe locals using oil to heat and light their homes as far back as the 13th century. Traveller Marco Polo passed through at that time and described the abundant oil bubbling up on the shores of the Caspian. "Near the Georgian border there is a spring from which gushes a stream of oil, in such abundance that a hundred ships may load there at once. This oil is not good to eat; but it is good for burning and as a salve for men and camels affected with itch or scab. Men come from a long distance to fetch this oil, and in all the neighbourhood no other oil is burnt but this," Polo wrote in his diaries.

The first industrial production began some 160 years ago when wells were drilled south of Baku, making the country the first industrial producer of oil in the world. During the second half of the 19th century, there was an oil rush to the republic. Leading industrialists like the Nobel brothers from Sweden and the French branch of the Rothschilds rushed to Baku to prospect for oil. The city still bears the marks of these illustrious entrepreneurs whose Baroque-style mansions are dotted around the town behind the ancient city walls. For a while, as oil production boomed, Baku became one of the most famous and chicest capitals in the world.

By the turn of the century, more oil was produced in Azerbaijan than anywhere else in the world, with output of 11.5m tonnes in 1901, compared with 9.1m tonnes produced in the US that year. However, Baku's first glorious oil boom faded as political and economic strife swept the world, ahead of World War I.

Under the Soviet Union, oil production first moved offshore, and in 1949 a well on the "Oil Rocks," some 40 kilometres south east of the Abseron Peninsula, spurted its first black gold. In the 1970s, still under Soviet rule, Azerbaijan was given control of the entire Caspian Sea and began exploring the whole area, including fields that now belong to Iran. Production spread to deeper waters and Azeri-Chirag-Gunashli (ACG), which has since become Azerbaijan's most famous oilfield, was explored. However, production in the deep waters of Gunashli proved technologically challenging, so by the end of the 1980s the first international oil companies were brought in. But before any projects could be implemented, the Soviet Union collapsed and Azerbaijan fell into political and economic freefall.

Contract of the century

Azerbaijan's modern oil industry was born on September 20, 1994, when the country's founding father and then-president, Heydar Aliyev, created the Azerbaijan International Operating Company (AIOC) consortium to develop the ACG field. BP won the operatorship of AIOC in a deal that was later dubbed the "Contract of the Century."

"With the help of foreign companies we were able to produce oil again. The arrival of the foreigners also sent an important message to the rest of the world that Azerbaijan had again become a stable country and was open for business," says Khoshbakht Yusifzade, first vice-president on geology, geophysics and field development issues at Azerbaijan's state-owned oil company Socar. The strategy paid off. Foreign companies flooded in to develop the Caspian region and Socar has since signed a further 26 Production Sharing Agreements (PSA).

ACG lies some 120 km off the coast of Azerbaijan in 120-metre deep waters and, according to BP, contains at least 5.4bn barrels of recoverable oil. Production began with the Chirag Early Oil Project in 1997, based on one platform, and by 2004 production was running at an average of 132,000 barrels per day (b/d). The Central Azeri field began producing in February 2005, while West Azeri came on steam in December of the same year, taking overall production to some 340,000 b/d. Phase two development of West Azeri and East Azeri increased oil production to around 800,000 b/d in 2007, and by 2009, when phase three is completed with the development of deepwater Gunashli, BP expects to be producing around 1m b/d from the fields of ACG.

Overall, Azerbaijan produced some 32m tonnes of oil in 2006, topping its previous Soviet-era production record of 23.5m, set in 1941, when the country's output accounted for 71.4% of the overall oil output of the Soviet Union and played and important role in fuelling the Allies' victory in World War II. Azerbaijan produced some 840,000 b/d, or 41.7m tonnes, of crude oil in 2007, and President Ilham Aliyev said on a recent visit to Poland that output would reach 53m tonnes in 2008. Yusifzade expects production to remain steady at between 50m and 55m tonnes per year for the next five to 10 years.

Pipeline to the West

While the "Contract of the Century" reintroduced Azerbaijan to the world, the completion in 2006 of the Baku-Tbilisi-Ceyhan (BTC) oil pipeline put the country back on the map as a major oil exporter.

Running from Sangachal Terminal near Baku, via the Georgian capital Tbilisi, to the port of Ceyhan on the south-eastern Mediterranean coast of Turkey, the BTC pipeline was a major victory by the US in its attempts to have Caspian oil transported directly into western markets without first having to traverse Russian soil. The 1,800-km, $3.6bn pipeline was inaugurated in each of the three countries with the final ceremony taking place July 13, 2006, in Ceyhan. By 2009, BTC is expected to be operating at full capacity, shifting 1m b/d to Ceyhan, from where it can be shipped all over the world by super-tanker.

Almost 85% of Azerbaijan's oil output in 2007 was exported, with 80% of exports, or some 28.3m tonnes leaving the country via BTC. Two previous, smaller pipelines also operate: the Northern Early Oil Pipeline, which was completed in 1997, and runs to the Russian port of Novorossiyk on the Black Sea; and the Western Early Oil Pipeline which was completed in 1999, and connects to the Georgian port of Supsa, also on the Black Sea.

The completion of BTC marked an important financial turning point for Azerbaijan. "The infrastructure is now in place and has gradually been paid off. Azerbaijan has chalked up some 20m tonnes of profit oil and, as production increases, so will the country's share of profits," Yusifzade comments.

Over the next 15 years, the small country of some 8.5m people is expected to earn as much as $400bn from oil alone and cash is already starting to pile up in the government oil fund, SOFAZ, which was set up in 1999 and stood at nearly $2.5bn at the start of 2008.

Much of Azerbaijan's staggering recent economic growth can be attributed to oil; according to the central bank, the oil sector accounted for nearly two-thirds of the country's GDP of AZN25.2bn in 2007. The government, aware that funds from oil production are likely to tail off within five years and could virtually dry up in less than two decades, is investing heavily to develop the non-oil sector, which has put in a respectable average annual growth of over 11% since 1995. However, gas and Azerbaijan's potential as a strategic transit point for Central Asian gas on route to Europe could prolong Azerbaijan's hydrocarbon boom well into the second half of this century.

Gas balloon

Oil dominates the news and the international political agenda, but Azerbaijan also has huge gas deposits, which are now almost as strategically important as oil.

Last year marked an important turning point, as after four decades of dependence on Russian, Azerbaijan switched from being a gas importer to an exporter. Commercial production at the Shah Deniz gas condensate field, discovered by a BP-led consortium in 1999, was launched in December 2006, and with recoverable gas reserves of some 625bn cubic meters (cm), the field has assumed the lead role in Azerbaijan's gas strategy.

The South Caucasus gas pipeline, which runs some 700 km along the same route as the BTC pipeline to its end point in Erzurum, where it links to the Turkish national gas grid, also began operating at the end of 2006.

These two projects were perfectly timed: when Russian state-owned gas monopoly Gazprom more than doubled its asking price for gas imports from $110 to $230 per 1,000 cubic meters (cm) for 2007, Azerbaijan had become self-sufficient in gas and asserted its independence from its old master.

Azerbaijan went on to produce a record 11bn cm of gas last year, with some 13.5m cm per day going to Turkey and a further 1m cm per day going to its neighbour, Georgia. This year, the country expects to produce 18bn cm of gas and by 2012, as the second stage of development of Shah Deniz kicks in, that figure could double to between 30bn and 40bn cm per year (cm/y).

In total, the country has reserves of some 2 trillion cm of gas, which should be enough to satisfy domestic demand for about 150 years. However, since gas is increasingly in demand as a cleaner energy source for power stations and prices are rocketing in the face of supply worries, Azerbaijan is looking to export to more countries besides Georgia and Turkey, and has already signed memoranda on export of oil and gas with Greece and Italy. "We have plenty of gas and are ready to increase production. We are waiting for customers and are ready to supply Europe, however, the last link in the chain is still missing," says Yusifzade, referring to the lack of a pipeline to transport gas beyond Turkey and onwards to Europe.

The EU, keen to reduce its dependence on Russian, which currently provides about a quarter of Europe's gas imports, is backing the construction of the 3,300-km, €5bn Nabucco Pipeline, which would run from Erzurum to Austria, via Bulgaria, Romania and Hungary. Austria's OMV is leading a consortium that expects to begin construction of the pipeline in 2010, with the completion date scheduled for 2013 and capacity ultimately to reach 31bn cm/y. "Nabucco is absolutely crucial. Oil you can fill into a container and ship, but gas is much more difficult to transport. Unless you turn it into LNG, you need a pipeline," comments Yusifzade.

Besides Nabucco, the final project that would cement Azerbaijan's position as a strategic transit route for hydrocarbons would be the construction of the Trans-Caspian Pipeline between Azerbaijan and Turkmenistan, to tap into Central Asia's huge gas reserves. In March, Azerbaijan settled an old gas debt with Turkmenistan in a clear sign of improving relations between the two. However, the pipeline is unlikely to go ahead until the ongoing dispute over the demarcation of the Caspian Sea is settled. Azerbaijan has already reached an agreement with Russia and Kazakhstan on the sea's division, and Yusifzade claims a deal with Turkmenistan and Iran is on the cards, but international observers doubt Russia will concede to the 30bn cm/y pipeline and cede its current monopoly over Central Asian gas export routes.

In the meantime, Kazakh oil is already being shipped across the Caspian to Azerbaijan and the two countries are considering shipping gas as LNG.

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