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Azerbaijan hopes for gas sector to boost economy

As oil output falls, the country wants its gas sector to play a bigger part in the economy

Oil has long been the cornerstone of Azerbaijan’s economy. So as production declines, the government is betting that increased gas production from mega-projects such as Shah Deniz phase 2 will compensate. But rising costs, long lead times and a lack of drilling rigs could make this ambition difficult to achieve. In the short to medium  term, heavy investment in gas production and export infrastructure is set to reinforce Azerbaijan’s increasingly important role as an energy supplier to Europe.

Azeri officials say production from new wells will boost gas output to just under 30 billion cubic metres a year (cm/y) by 2017 from 2014’s expected 28.5bn cm/y. The bedrock of this supply will be the BP-operated Shah Deniz gasfield in the Caspian Sea, which produced 9.8bn cm of gas from estimated proven reserves of 1.2 trillion cm in 2013, as well as producing 2.48m tonnes of condensates. The real prize, however, will be successful completion of the second phase of Shah Deniz, now under development. That should bring 6bn cm/y on stream by around 2019, which will go to Turkey, followed by production of a further 10bn cm/y by 2021, destined for European markets. The official timetable for the project foresees first gas in 2018, though this will probably be delayed. 

Europe’s search for fresh non-Russian sources of gas, in the wake of the Ukraine crisis, means there is plenty of incentive to get Shah Deniz 2 up and running, but concerns over profitability continue to dog this huge project. BP says around $28bn in capital investment will be required to produce Shah Deniz gas and transport it to the Georgia-Turkey border. That figure rises to $45bn if the cost of the entire southern gas corridor transport infrastructure, involving the Trans-Anatolian Pipeline and the Trans-Adriatic Pipeline (Tap), is included.

Broader moves

Both Norway’s Statoil and France’s Total have left the Shah Deniz project this year, in part due to concerns over its cost and the likely returns on gas sales in Europe, given cheaper supplies from Russia and Norway. For both firms, the move was also part of a broader move to divest less profitable parts of their portfolios. Total sold its stake to Turkish state oil company TPAO in May, saying it wanted to focus on projects around the world where it had operatorship. TPAO’s investment reflects Turkey’s role as a major recipient of gas from Shah Deniz – the firm already has a 9% stake in the project. Statoil, meanwhile, announced in mid-October that it was selling its remaining 15.5% stake in Shah Deniz and associated infrastructure – as well as its 12.4% share in the Azerbaijan Gas Supply Company (AGSC) – to Malaysia’s Petronas in a deal worth $2.25bn. Statoil sold a 10% stake in the project to BP and Socar, Azerbaijan’s state firm, in December 2013. 

Neither company’s departure from Shah Deniz represents a pull out from Azerbaijan as a whole. Statoil still retains sizeable assets in the country, including an 8.56% stake in the Azeri-Chirag-Guneshli (ACG) oilfield, and is retaining its 20% stake in Tap, which will take gas from Azerbaijan to Europe. Total is operator of the planned Absheron gas project. Meanwhile, BP and its partners continue with development work for Shah Deniz 2. BP said at the end of October that it had awarded $9.6bn worth of contracts for the project and that total spending in 2014 alone was expected to be around $4.5bn. Gordon Birrell, who heads the project for BP said drilling of the fifth production well had just been completed. In total, over 20 offshore wells are due to be drilled, served by two platforms. When the Statoil and Total stake sales are completed the operating consortium will be: BP (28.8%), Petronas (15.5%), Naftiran Intertrade Company (10%), TPAO (19%), Lukoil (10%), and Socar (16.7%). Even allowing for a ramp-up in gas production when Shah Deniz 2 comes on stream, the longer-term outlook for Azeri gas production remains uncertain, despite bullish comments from Socar highlighting the sector’s potential. “It’s a surprise that the government isn’t pushing harder to reach exploration agreements with oil and gas companies, given its stated view that gas can make up for lost income from falling oil production. The current shortage of rigs is another factor holding up exploration. There is one under construction, but it’s not enough,” says Simon Pirani, a research fellow at the Oxford Institute for Energy Studies.

The one rig Socar has under construction is capable of drilling in 1,000 metres water depth and to a total depth of 8,000 metres, but more will be needed for serious new exploration to take place in the Caspian. Total is reportedly considering using that rig for Absheron, the country’s next large gas project, where it is operator, if it doesn’t decide to build its own rig. Absheron, which is expected to cost up to $7bn to develop, is now scheduled to start producing in 2021, a year later than originally planned. That timetable could yet slip further given the complexity of bringing projects to fruition in Azerbaijan.

Total and Socar each hold 40% stakes, while GDF Suez holds the other 20%. Earlier this year, it was reported that Russia’s Rosneft may be interested in taking a stake in the project. Exploration drilling at Absheron suggests it holds resources of 150bn-300bn cm, according to Total. “With the lack of rig availability in the Caspian, it is very difficult to explore. This also generates long timeframes between field discovery and first production,” said Samuel Lussac, head of the Caspian upstream team at Wood Mackenzie. He added that at least a decade will separate the discovery of Absheron in 2011 and first production. The consultancy estimates that Azeri gas production will total more than 27bn cm/y in 2020, when Shah Deniz 2 comes on stream, rising to 40bn cm/y in the mid-2020s when 5bn cm/y or so of gas from Absheron has been added. Absheron’s output should reach a plateau of 10bn cm/y in 2031.

The oil sector is feeling the impact of limited exploration opportunities more acutely than gas, given declining production volumes from the ACG oilfields in the Caspian. Wood Mackenzie predicts Azeri crude and condensate production will drop from around 880,000 b/d in 2013 to a plateau of around 600,000 b/d in the mid-2020s, before declining further. In the shorter term, operator BP has warned that planned maintenance at ACG could cause a slight drop in output there in 2014. “What is worrying is that there are no really substantial oil projects beyond ACG at the moment, so the country is relying on the condensate produced at gasfields,” says Lussac.

The Azeri government has said it wants to intensify the search for oil onshore and also to look at unconventionals. But that strategy is only likely to bear fruit in the longer term. ConocoPhillips signed an onshore exploration agreement with Socar in 2011, has already carried out some seismic surveys and plans to drill a well next year, but it will take years to develop a project should commercial oil quantities be found. 

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