Socar feels the squeeze

Socar feels the squeeze
Socar Tower in Baku.
By bne IntelliNews June 20, 2016

Socar was not a company many Europeans were familiar with until the Euro 2016 football championships, when the Azerbaijani state-owned energy company’s banner was beamed into millions of households around the continent as the tournament’s lead sponsor. Earlier in June, Socar moved into its new headquarters – a futuristic skyscraper on the outskirts of the capital Baku, which is believed to have cost over €300mn and took six years to build. But while its new home and rising international profile speaks of a company on the up, Socar is tightening its belt.

A Socar official revealed on May 25 that it has employed the services of consultancy Ernst & Young to help the oil and gas company save some AZN400mn (€241mn) in operating costs over the next three years, according to Reuters.

The first signs that Socar, which reported revenues worth half the country’s entire GDP in 2015, is serious about its austerity programme are beginning to show. In May, the company closed down representative offices in Germany, Belgium and Switzerland, while scrapping plans for non-essential projects like a $120mn oil refinery and a urea plant in Georgia, as well as a €500mn luxury resort in Montenegro.

It is also cutting back on transport costs, conferences and its previously vast sponsorship programmes. This is a far cry from the normally generous sponsor of costly events like the 2012 Eurovision Song Contest, which Azerbaijan hosted, and the first European Games held in Baku in June 2015. That its name appeared so prominently on European TV screens is a legacy of better times; Socar agreed to sponsor the Euro 2016 tournament three years ago, when oil prices were still sky-high. 

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Socar’s revenues declined by almost 40% year on year to $31.5bn in 2015. But the company’s bottom line last year was cushioned by a 50% devaluation of the Azerbaijani manat. Because its revenues are in dollars and expenses in manats, thanks to an exchange rate gain of some AZN1bn (€600mn) Socar managed to finish 2015 with zero profits, its vice president, Suleyman Gasimov, told APA news agency in April.

Gone are the days when oil was $100 per barrel, and when Socar mustered billions in profits despite the generous disbursements it was making to the state budget, sovereign wealth fund, the alleged murky deals, and the vast array of unrelated expenses it was incurring.

But relying on foreign exchange volatility to stay in the black is no strategy. The manat appears to have stabilised thanks to the central bank’s interventions on foreign exchange markets, and another devaluation is unlikely in 2016. As such, reining in unnecessary costs will have to become Socar’s new modus operandi if it wants to stay profitable at the new low oil prices.

In parallel to cutting costs, the company appears to be seeking higher revenues from existing contracts, the largest of which is the production sharing agreement (PSA) that it signed with BP, Chevron, Statoil and ExxonMobil in 1994 to develop the Azeri-Chirag-Guneshli (ACG) block of offshore oil fields. On May 26, Socar’s president, Rovnag Abdullayev, appeared to say in a fairly flimsy report by Azernews that the state company had submitted proposals for new contract terms to its international partners in the PSA and that “now, the ball is in their court”. He did not elaborate on the ambiguous statement. 

If an attempt is made to renegotiate the PSA terms, the consequences could be severe; the PSA in question is the foundation on which Azerbaijan’s entire oil and gas industry was built, as it covers the terms under which three-quarters of the country’s oil production is extracted. It was dubbed “the contract of the century” and has not been altered since it was signed over 20 years ago.

“If Socar were trying to change the existing contract, that would certainly be a sign of desperation and financial dire straits on the government’s part,” Andrew Neff, principal analyst at consultancy IHS, tells bne IntelliNews. “But I am not sure that this will happen, as the report appears to be poorly written.”

Indeed, Socar denies to bne IntelliNews the PSA is being redrawn for economic reasons, instead clarifying that, “due to the characteristics of the oil fields and framework conditions, it makes sense to renegotiate the cooperation conditions between partners every decade or two. Like all agreements, the PSA for ACG has an expiry date, which is 2024. But the fields are not depleted, and can be exploited at least until 2050 or 2060… At the moment, all options are on the table.”

New prospects

While cutting operating costs and non-core projects, Socar’s answer to low oil and gas prices has been to embark on a flurry of agreements for new downstream, midstream and upstream projects. In its email to bne IntelliNews, Socar claims that the streamlining of its operational costs merely coincides with the slump in oil prices, and was not caused by it. In addition to the projects that it has scrapped, the company is also “reshaping the masterplan for the OGPC [petrochemical complex in Azerbaijan] in order to adjust it to new market conditions”.

But it has also identified new areas of opportunity in the shape of petrochemicals in Turkey, gas exploration in Azerbaijan and global oil trading. Already one of the largest investors in Turkey, where it is building a container port Petlim and $5bn refinery in the Izmir region on the Aegean coast, Socar will continue to invest in the projects that it considers “our success stories in the making”. According to an independent analysis by investment consultancy Ak Yatirim, “the earnings before interest (EBIT) for the Petkim refinery will grow by 10% annually between 2016 and 2019,” the company writes. “We are not just redirecting non-essential investments, we are reshaping the projects in our portfolio to reflect changing market conditions.”

Global oil trade appears to be an area that Socar is seeking to tap. Its trading arm, Socar Trading, already operates four global offices in Geneva, Dubai, London and Singapore, and is now seeking to open two new ones in Calgary, Canada and Houston, the US. “It is difficult to expand when everyone is growing. In a situation when there are more opportunities left as others have scaled back... the trading companies that can manage risk are stepping in,” Socar Trading CEO Arzu Azimov told Reuters on June 14. “It was not the original intention, but we’re moving towards becoming a merchant trading house.”

In Azerbaijan, the company is working on multiple downstream projects – renovating an older oil refinery, building the OPGC petrochemical complex –  and has recently embarked on a flurry of upstream agreements. And gas rather than oil is where it is placing its bets: the company already produces some 6bn cubic metres (cm) of gas, and is a shareholder in the EU’s ambitious Southern Gas Corridor (SGC) project, which will deliver 16bn cm/y of gas from the Shah Deniz II gas field to Turkey and Europe starting in 2019.

Developing the second phase of the giant Shah Deniz gas field is both Socar’s and the government’s number one priority at the moment, according to Neff. Some 75% of the offshore construction at the field has been completed since work began two years ago. But Azerbaijan remains $8bn short of financing the project, and has been tapping capital markets and international financial institutions for funding. The higher Socar’s revenues, the less the country will have to borrow to complete its landmark project.

Beyond Shah Deniz II, Socar’s head of investments, Vagif Aliyev, told Natural Gas Europe on June 1 that Socar is looking to develop two new offshore gas fields – Umid, which has reserves of over 200bn cm, and Babek, starting in late 2016. A week earlier, the company said it had signed an agreement with BP to develop a new block in the Caspian Sea, D230.

Socar also holds a 40% share in the Absheron gas field, which is operated by France’s Total and is estimated to contain some 350bn cm of gas. The French oil major has been waiting patiently for Shah Deniz II to come on stream to proceed with the joint exploration of its own field, but has recently expressed concerns over its access to transport infrastructure, asking the Azerbaijani government for support, according to Natural Gas Europe.

Since Total will likely be unable to market the gas from the Absheron field itself, because it is not a shareholder in the gas pipelines connecting Azerbaijan with Europe, it will have to make concessions to its partner Socar, Neff explains, which would bring in additional revenues from gas marketing to the state company.

The flurry of new E&P projects at a time of low gas demand in Europe is unusual, but Neff believes that there is no reason for concern yet; exploring new prospects is a signal to the markets that there is still gas to be found in Azerbaijan, and that the country’s production remains resilient despite low demand and prices. Besides, “Socar’s agreement with BP on sector D230 appears to be a lukewarm commitment to drill one well, invest a certain amount of money, and see where that takes them. The contract hasn’t even been signed yet,” he says.

While E&P could prove lucrative in the long run, Socar’s more immediate need to cut costs would be better served if the company addressed the chronic waste that pervades the company.

Over the years, numerous investigations – most notably Global Witness’ “Azerbaijan Anonymous” – have revealed how dire the misuse of funds at Socar has been. As recently as January, revelations about corruption in its ranks made the headlines and prompted an internal investigation. On June 16, it emerged that nine members of the US Congress were forced to hand over jade earrings, tea sets, silk scarves, woven rugs and other gifts to the US government after a watchdog report deemed a trip they had made to Azerbaijan and Turkey, secretly financed by Socar, improper.

The highlighting of concerns over a company where corruption appears entrenched – and which is so closely related to the country’s ruling elites – is arguably too little too late. But a quiet cleanup would go a long way toward making the Azerbaijani state leviathan more profitable. That is, of course, if Socar is genuine about cleaning up its act, now that its name is going global.