Caspian contagion risks
A banking crisis is a short-term risk in a region bursting with energy developments
A banking crisis in Azerbaijan and Kazakhstan has put a renewed onus on the oil and gas sector as both Caspian economies struggle to deal with the fallout from a slowdown in neighbouring Russia and China.
Analysts fear the banking problems of the two economies—still reeling from a decline in commodity prices and currency devaluations—may spread, affecting big capital-spending plans aimed at arresting declining oil production.
A default by the International Bank of Azerbaijan (IBA) in May sent shockwaves across the Caspian after the country's largest lender said it was seeking a write-down as part of a $3.3bn restructuring. Kazakhstan, which is undertaking yet another painful restructuring of its biggest banks, has exposure to IBA with its state pension fund facing losses of at least $250m from bonds bought in late 2014. Investors are now speculating that Kazkommertsbank, the biggest Kazakh lender by assets, could be the next big domino to topple amid its $7.5bn state bailout.
"Azerbaijan is a higher-beta oil-rich country, with more risks to its sovereign financial strength than just the ubiquitous oil-price unpredictability," says Petr Grishin, head of macro research at VTB Capital. "It is this thinking that informs our view of the need to restructure the IBA debt."
Anything that might impact Azerbaijan's sovereign rating or sovereign debt is a concern to investors, according to Ashley Sherman, senior Caspian analyst at Wood Mackenzie, who highlighted the importance to the Caspian of the $40bn Southern Gas Corridor (SGC) project.
The pipeline will bring Caspian natural gas from Azerbaijan to European markets for the first time, bypassing the region's biggest supplier, Russia. External financing of $5bn has already been secured via a range of international financing institutions (IFIs), but more financing deals remain to be done.
"If we focus on the SGC project, Azerbaijan has been highly successful in the past two years in raising debt to finance its share," Sherman, who was in Baku in late May, told Petroleum Economist. "The Eurobonds of Azerbaijan's SGC vehicle have a full sovereign guarantee and there is no concern about the financing arrangements for the key energy project ongoing in the country."
0.58m b/d - Oil output from the Azeri-Chirag-Guneshli project in Azerbaijan
International financing for Trans-Anatolian Natural Gas Pipeline (usually known as Tanap), which goes from Azerbaijan through Georgia and Turkey to Europe, is almost complete, while the Greece-Italy Trans-Adriatic Pipeline (or Tap) is also looking fairly secure.
While the IBA default may not affect immediate financing needs, it is causing extensive reputational damage to a country struggling to emerge from a two-year recession. The danger for Azerbaijan is that the crisis could lead to further depreciation of the national currency and trigger a deposit run in the other remaining banks.
All this is happening as the International Crisis Group reported on June 1 that Azerbaijan and Armenia are closer to war over Nagorno-Karabakh than at any point since 1994. Following the deadly three-day flare-up which left over 200 casualties in April 2016, Baku and Yerevan have failed to make any headway in peace negotiations. In Kazakhstan, ratings agency S&P said in May that the Central Bank is using a liquidity line to repay Kazkommertsbank's senior unsecured bond. Moody's Investors Service forecasts the government will run a deficit of about 7.6% of GDP this year as a result of "one-off measures related to the recapitalisation" of banks.
These macro-economic problems have brought the Opec deal to cut production into sharper focus for both countries.
Azerbaijan, which committed to hold back 35,000 barrels a day, appears to be fully compliant, according to data covering January to May. The BP-led Azeri-Chirag-Guneshli (ACG) field represents about 75% of the country's output. First-quarter production slid to 0.58m b/d compared with 0.63m b/d during 2016, but is attributable to the field's terminal decline rather than the Opec pact. A decline is also expected by analysts at fields belong to the state oil company, Socar.
"ACG was expected to reach a plateau of 1m b/d, but has never managed to achieve this level," said Dmitry Loukashov, an oil and gas analyst with VTB Capital. "Peak output was 0.82m b/d in 2010, and has since fallen to 0.63m in 2016 and 0.58m in the first quarter this year, although the latter number reflects planned maintenance shutdown."
BP is expected to shortly sign a contract extending its production sharing-agreement covering Azerbaijan's largest oilfields until 2050—a deal which would unlock new capital investments.
Kashagan keeps pumps primed
Kazakhstan's compliance with the Opec deal remains more of a challenge due to growth from Kashagan. Data from the first five months indicate that the country's output grew on an annual basis.
Kashagan has been pumping 180,000-200,000 b/d over the past few months. Later in the summer, the field will start gas re-injection which should let it increase capacity. The latest target calls for output of 360,000 b/d by 2018.
Analysts at Wood Mackenzie also expect production from Kazakhstan's other two big projects, Tengizchevroil and Karachaganak, to be in line with 2016 or slightly higher. With the country facing fiscal challenges, it's a surprise to many it continued with the cut, on the same terms, at 20,000 b/d.
But Tengizchevroil's output could also be much higher in 2017 after reaching a record level of just over 0.6m b/d. Operations at the oilfield were suspended in late May after a toxic substance was released, while workers were evacuated.
"Kazakh compliance will definitely come under scrutiny because of Kashagan," says Sherman. "With every passing month, it may become ever more challenging for Kazakhstan to fulfil its commitment, particularly as we head into the latter part of 2017."
Despite some speculation ahead of the May Opec-non-Opec meeting, Turkmenistan didn't participate in the deal. Analysts predict its output of 265,000 b/d will be stable this year, with some growth potential from Dragon Oil's oil-producing Cheleken Contract Area, which is close to its targeted level of 100,000 b/d.
The Turkmen state oil company issued a tender earlier in the year for help developing a shallow-water extension of its biggest onshore oil field. In the medium term, that could be another source of growth for Turkmenistan. South Korean and Japanese companies are already involved in the downstream, holding stakes in petrochemicals, gasoline and fertiliser plants.
But Turkmenistan's main focus remains gas—and where to send it. Russia no longer buys it and a dispute over the terms allowing for export to Iran has hindered that export route too.
Kazakhstan's compliance with the Opec deal remains more of a challenge due to growth from Kashagan
"So, there is an ever-stronger reliance on China," says Sherman. "Volumes to China are big and will continue to grow, but at a more sluggish pace than hoped."
Vladimir Osakovskiy, an economist at Bank of America Merrill Lynch, believes China's One Belt One Road (Obor) trade initiative could "support robust foreign direct investment" to the region and especially to Kazakhstan and Azerbaijan.
The plan, which is valued at more than $1 trillion, involves China underwriting billions of dollars of infrastructure investment in countries along the old Silk Road linking it with Europe. China is spending roughly $150bn a year in the 68 countries that have signed up to the scheme.
"Railway operators in Russia and Kazakhstan could benefit the most from the programme, which could support their foreign exchange revenues and help to finance large investment projects," says Osakovskiy. "Azerbaijan could benefit the most at the macro level through relatively large FDI inflows, new transit flows and better connectivity to global markets."
Due to an expansion of capacity on the region's main oil network, the Caspian Pipeline Consortium (CPC)—now also being fed by Kashagan—record volumes of CPC blend are being delivered to the Mediterranean. As for gas, Russian export giant Gazprom continues to buy gas from Kazakhstan, some of which ends up in Europe.
"For both gas and oil those flows are here to stay," says Sherman. "But, for Central Asia, the growth story remains China—mainly on the gas side, but there are also plans to boost Kazakh oil exports to China.
Persian Gulf countries are starting to flex their financial muscle in the region too. UAE-based Arabtec has a $1bn contract to build the Abu Dhabi Plaza project in the Kazakh capital Astana, while Dubai-owned Dragon Oil is expanding the Cheleken concession in Turkmenistan. Dubai's Topaz Energy and Marine also recently won a $350m contract to supply vessels to transport oil extracted by Chevron from Kazakhstan's part of the Caspian.
Meanwhile, new liberalisation efforts in Kazakhstan are also underway. As Expo 2017 kicks off in the capital of Astana, the government is finally pushing ahead with its much-delayed $70bn privatisation programme in a bid to revive growth. Dual listings are planned for most of the assets, with London the preferred international location as deals come on stream next year.
State-controlled KazMunaiGas, which accounts for about a third of the country's oil production, is offloading assets and trimming its capital spending ahead of a planned listing.
"They are clearly serious about those plans, but they need to accelerate from this year onwards," says Sherman. "The pinnacle would be the proposed IPO of KazMunaiGas in a few years' time but a lot needs to be done before then, including the internal transformation of some of these state companies into fully commercial operators, as well as the successful listing of other state entities beforehand."