Relaunch of Russian gas supplies to Azerbaijan raises questions about Baku-Brussels deal

Relaunch of Russian gas supplies to Azerbaijan raises questions about Baku-Brussels deal
Renewed Russian gas sales to Azerbaijan are making the job of preventing Moscow's gas exports that much harder. / bne IntelliNews
By bne IntelliNews November 22, 2022

Russia’s Gazprom announced on November 18 it would deliver up to 1bn cubic metres of natural gas to Azerbaijan between now and March under a new contract with the latter country’s state-owned oil firm SOCAR.

Gazprom was a supplier of gas to Azerbaijan between 2000 and 2006, but then the country rapidly expanded its own gas production at the BP-operated Shah Deniz field, allowing it not to only cover its own gas needs but export supplies to Georgia and Turkey. With much of its gas contracted to foreign buyers, Azerbaijan then turned back to Russian supplies in 2017-2018, only to cease purchases again after the second stage of Shah Deniz’s development flowed its first gas in 2019.

Azerbaijan has long prioritised the sale of its gas overseas over home needs, in order to maximise export revenues, and this has led to it contending with a domestic gas squeeze. The deal with Gazprom comes as Azerbaijan braces for mid-winter peak demand. However, the resumption of Russian gas imports now also raises additional questions, considering that Azerbaijan has recently committed to pumping more gas to Europe, in order to offset the loss of its own Russian supply.

In a statement to Azeri news agency APA, SOCAR said it had a long history of co-operation with Gazprom, and that the two companies “are trying to optimise their infrastructure by organising the mutual exchange of gas flows.”

Azeri gas supplies to Europe via the Southern Gas Corridor (SGC) had been set to reach the contractually agreed 10 bcm per year this year. And under a memorandum of understanding (MoU) signed between Baku and Brussels in July, the Azeri side has pledged to ramp up exports to 12 bcm in 2022.

Both Brussels and Baku praised the new deal as an expansion of the energy relationship between the EU and Azerbaijan. The European Commission touted the agreement as a victory in its efforts to diversify EU gas supply. But it was never specified whether the extra supply would be sourced.

According to Eurasianet, citing a source close to the Shah Deniz consortium, which is responsible for all Azeri gas exports, no additional export deals have been agreed to sell gas from the field, beyond the 10 bcm per year already contractually agreed. This raises the question of whether the Russian gas will be resold to fulfil the EU deal.

The resumption of Russian gas supply to Azerbaijan may simply indicate that Baku is once again concerned about the domestic supply squeeze. And indeed, the Azeri-EU deal is only a memorandum, and therefore non-binding. But the timing raises suspicion, and suggests that Brussels is continuing to support the Russian war effort in Ukraine, even if indirectly, as Azerbaijan could be able to use Russian gas to cover its domestic supply in order to free up volumes for export to Europe.

Azerbaijan is, of course, free to import as much gas as it wants. But if it is using Russian gas to send more supply to Europe, this would obviously undermine the spirit of the Baku-Brussels agreement. It would also serve as another example of how difficult Europe is finding it to secure alternatives to Russian gas in the near term.


Long-term prospects

Under the July deal, the EU is ultimately looking to expand Azeri gas purchases to 20 bcm per year by 2027. In the long term, Azerbaijan could have the potential to fulfil this goal, without having to resort to significant amounts of Russian gas. The country has a number of undeveloped discoveries that could be assigned to the task. 

Among the undeveloped finds in the Azeri Caspian, the Absheron, Umid and Garabagh fields are proven. Shah Deniz Stage 3, comprising gas reserves located beneath those that are already in production, are not proven, and neither are deeper gas layers at the Azeri-Chirag-Guneshli (ACG) oil project. Neither have resources been proven at the Babek prospect.

Karabagh, which is being developed by Azerbaijan’s SOCAR and Norway’s Equinor under a risk service agreement, could supply 2 bcm per year at plateau, based on its reserves and statements by the Azeri government. This extra volume would only be ready by 2025-26, however.

Absheron, developed by a joint venture between SOCAR and France’s TotalEnergies, could flow 5 bcm per year, but not until after 2027. The existing Umid field is currently producing 1.7 bcm per year and this could be ramped up to 3 bcm. Meanwhile Babek, located adjacent to the field, could produce 3-4 bcm per year, according to Azeri state estimates, but likewise not for a few more years.

At Shah Deniz Stage 3 and ACG Deep Gas, the drilling of new wells is due to start this year, and results from the boreholes will help define resource volumes and production potential. But in any case, it would seem that Azerbaijan has the potential to provide Europe with the gas that it wants. However, at all of these projects, foreign investment, technology and know-how will be needed to drive development. This is particularly true at Umid and Babek, which are both geologically complex fields that currently lack any Western participation. 

Investment may also be harder to secure, as many Western majors have announced plans to scale back capital expenditure in oil and gas over the coming years in favour of renewables and other low-carbon technologies. This includes BP, the biggest investor in Azerbaijan’s oil sector, whose present strategy calls for a 40% cut in oil and gas production over the next decade. 

Western financiers, likewise, have made commitments to phase out some or all of their fossil fuel investments, including the European Investment Bank (EIB), which played an integral role in getting the SGC pipeline project that connects Azerbaijan with the European gas market started.

On the other hand, SGC succeeded at a time when spot gas prices in Europe were generally low. Thanks to political support from the EU and nation states receiving Azeri gas, long-term contracts were agreed even though prices under them did not always compete with Russian supply, or LNG spot cargoes.

Now the situation is very different. Spot prices are now exceptionally high, and Russian supply is unreliable now, and is set to be eliminated under EU plans anyway in the coming years. This gives extra Azeri gas, priced under long-term contracts, a competitive edge. Even if there is less political support from Brussels for new fossil fuel projects, it may be that market conditions drive the case for increased supply.