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[alpha] INSIGHT - AZ/RUSSIA/TURKEY/IRAN - the energy soap opera - AZ is in trouble

Released on 2012-03-02 18:00 GMT

Email-ID 157151
Date 2011-10-25 15:03:16
Met with the adviser to SOCAR president. The president is currently in
Ankara trying to finalize negotiations with Turkey for gas transit. The
adviser I met with is going to Brussels tomorrow to meet with NATO (will
explain why further below.)

The adviser is Western-educated, obviously knows how to handle himself in
a negotiation, but opened up quite a bit in the discussion.

The first step AZ is focusing on is to get this agreement with Turkey,
which he gives a a 50/50 chance of being finalized tomorrow (Wednesday) in
Ankara. The basic premise of the deal is Turkey guarantees purchase of 6
bcm for its domestic market. Turkey then has to guarantee 10 bcm for
TRANSPORT (not necessarily purchase for itself) for Az's buyers in Europe.
He couldn't disclose the price that they're currently negotiating over 6
bcm, but said the Turkish press has been claiming some prices favorable of
course to Turkish interests. He said though that the price was very much
competitive in comparison to the high price TUrkey pays to Russia for its
natural gas, and AZ understands that it needs to keep that price
competitive to get this deal through. He said that Turkey and AZ have
agreed on a price and that the remaining issues being negotiated right now
have to do with technical details on quality of gas, regulations, etc.
These are all 25 year contracts. AZ's main priority right now is simply
to guarantee somehow, some way that it will have a market for 16 bcm by
2017. The Azerbaijanis don't really care which route it takes (of course
they're looking out for their financial interests,) but the main thing is
to just make sure they are able to sell this amount of gas no matter what.
(keep this in mind when it comes to Russia..)

After AZ makes this agreement with Turkey, then it will decide which
transport route is most feasible/favorable to their interests. Contrary
to what the press is saying, I don't get the impression at all that AZ is
close to picking the transport route yet. He explained all 8 main
criteria that AZ uses to compare the different routes (ITGI, TAP, Nabucco,
the most recent SEEP) - price of gas, tariff, transport, regulation,
political feasibility, project feasibility, etc. He avoided saying if any
one of these projects is more favorable than the others, but pointed out
that there are issues with each. Nabucco of course is very ambitious and
the funding for the project is unclear. (He referred to the fact that only
Az is committed to supply.) For TAP he said it may be more technically
feasible, then he said there were 'political problems' there. I asked
whether he meant between Turkey and Greece and he said no, but if you look
at the map it would go through Greece, Albania and Turkey, and 2 out of
those 3 countries have issues with each other. (Didn't realize that the
Greece-Albania/Macedonia factor was that big a deal in this, but
apparently it is.) He also didn't seem too thrilled with ITGI, either,
mainly blaming it on problems with Greek regulations and bureaucracy and
being consumed with its own financial turmoil. He seemed most interested
in the South Eastern European Project, the most recent one that BP is
involved in. The problem he said is that SEEP is not that mature yet in
all the feasibility studies and what-not, but what's most attractive about
it is that it requires far less construction and thus is less costly than
the other 3 options. There is no plan yet for sponsorship on SEEP. SOCAR
would need a significant stake in any of these projects as a major
shareholder, but they haven't really advanced negotiations yet on this
proposal with the energy firms expected to be involved from Hungary,
Bulgaria, Romania.

What is most interesting in all this is the Russian factor. The source
would continue to emphasize how good and personal a relationship Aliyev
has with Putin on these matters (as well as with top-management of
Gazprom), but he would visibly become uncomfortable and shift in his seat
whenever I brought up Russia. AZ understands completely that it has to
pull off a very clever balancing act with the Russians if it intends to
see any of these projects go through. The Russians are completely playing
it cool. He said that the last major meeting Russia had with the
Azerbaijanis on this was back in August. They're just watching and
waiting. I get the impression that the Russians are quite confident in
the levers they have to further stall any of these alternate transit
plans. He confirmed what I heard from another Azerbaijani diplomatic
source earlier in the day about how in 2008 Azerbaijan made an offer to
Russia to supply around 50 percent or so of its natural gas to the South
Stream pipeline. This was AZ's way of making a concession to Russia to
balance against its other energy projects that circumvent Russia. Russia
didn't bite, though. The Russians gave them every excuse in the book,
saying it wasn't technically or logistically feasible. Instead, the
Russians said that if you want to deal, then make sure that all of AZ's 16
bcm go through Russia, and Russia only -- not to Turkey/Europe. I asked if
the Russians are still sticking to the same core demand today, and he said
yes. The Azerbaijanis are also trying to soften Russia by giving them all
these rights on trans-Caspian route with Turkmenistan, but that's not
working either. The AZ diplomatic source earlier in the day said that
Russia has all these levers with Georgia already (they got the hint in
2008 and knew Russia could have bombed BTC if it wanted to. The Russians
also have a close relationship with Germany, which the Azerbaijanis have
taken note of. What I'm getting from all this is that Azerbaijan is quite
concerned that Russia may have what it takes to block these projects and
throw off the timeline again for Shah Deniz II. SOCAR source said that
Russia should know better than to use 'uncivilized' tactics in pursuing
its energy interests (haha.)

I asked both of these guys individually (the diplomatic source and the
SOCAR source) whether that means AZ envisions having to eventually just
give in and sell the bulk of its gas to Russia. Both reacted very
similarly. They would look down, sigh and admit yes. Of course, AZ really,
really does not want to do this. They don't want to become dependent on
the Russians and know that the Russians would manipulate the hell out of
those contracts. They're trying to convince Turkey that being so dependent
on Russian gas is a very bad idea. It all comes down to Turkey. AZ
absolutely needs Turkey to guarantee transit of this gas no matter what.
If Turkey doesn't do this, AZ will have to turn back to Russia.

What the diplomatic source stressed heavily is that the US simply isnt
there the way it was in the 1990s when BTC was being negotiated. Back
then, US was ready to drive that project home and force feed it to Russia.
The Europeans don't even come close to that attitude. AZ doesn't have the
political backing they need of an external power to see through these
projects, in my opinion.

I asked the SOCAR source what the plans are for expanding AZ energy
transit to Russia. Right now AZ is exporting 1.5 bcm to Russia. He says
that AZ wants to expand that to 2 bcm next year and then possibly expand
to 3 bcm, but is worried that Russia will be pissed off and not agree if
AZ and Turkey come to a deal. The currnet line to Russia is old and would
need upgrades if they tried to reach capacity of around 7 bcm. Gazprom is
happy to do these upgrades and more -- as long as AZ transports all 16 bcm
to Russia first. They aren't budging on that demand.

I asked SOCAR source if he says any shift out of Turkmenistan on
trans-Caspian. He had an interesting reply on this -- basically, AZ's
whole strategy on Turkmenistan is to steer clear and play nice with the
Russians. AZ's firm policy on Turkmenistan is 'you guys sort out your
political issues with Europe AND with Russia, get the financing, build the
pipeline, and we guarantee you'll be able to transit gas through
Azerbaijan." In other words, AZ does not want to get entangled in any
Turkmenistan political issue with Russia. They are being extremely careful
on that front. Don't expect any movement on this end any time soon.

Then, I brought up the Iran factor, which I find the most fascinating in
all this. What I heard from the Israeli ambassador a few days ago was
that there is another big issue cropping up with Shah Deniz II concerning
Iran. As part of AZ's geopolitical balancing act, it made sure Iran had a
10% stake in the Shah Deniz consortium. Now, the US congress and sanctions
lobby is ratcheting up the pressure saying that this makes the whole
project sanctionable. The Israeli amb said that BP is now saying they may
not be able to go through with the project unless AZ resolves this Iran
issue. (What is ironic is that the SOCAR guy said they will work very
closely with the Israeli lobby in DC to convince the congress that Iran is
not a major problem). The guy also said that Iran is not a problem because
1) they don't have the right of decision-making 2) SD phase II's revenue
will go to a bank in Europe, in which Iran's money will be frozen. Source
claims that Iranians basically agreed to participate in SD2 without
getting an immediate interest. The SOCAR source said that BP hasn't put it
in that blunt terms, but he admitted this is becoming a big issue. He
described how impossible it's going to be for AZ to deal with this because
the legislation already dictates that AZ can't simply 'kick out' a member
of the consortium. The consortium shareholder must also agree to leave.
Plus, AZ really does not want to piss off the Iranians right now. The
securitiy tensions are seriously increasing between AZ and Iran (will
explain in more detail later), and the Israeli cooperation with AZ isn't
really helping alleviate those tensions, either. Instead, AZ is trying to
convince NATO (This is why SOCAR source is going to Brussels tomorrow as
he later admitted,) and the US that the cost of trying to exclude Iran is
not worth it. THey are trying to assure US, BP, NATO, etc. that Iran
'can't profit' off the SHah Deniz project anyway because all the money
they get from it is going to European banks where their assets are frozen
(not a very convincing argument, if you ask me.) More importantly,
they're saying that if the US tries to make Shah Deniz II contingent on
kicking Iran out, then the whole southeastern corridor project is doomed.
In fact, AZ could just send 10 bcm to Iran instead at a very favorable
price. He went on to say, 'better yet, we could give 5 bcm to Russia and 5
bcm to Iran'." Then let's see what US says.

This is a really tough negotiation that AZ is getting into right now. In
December, AZ is sending a high-level delegation to the US to try to
convince them to not screw this up over Iran. The source joked at the end
that our conversation (which got pretty intense) was a good rehearsal for
his meeting at NATO HQ in Brussels, where he basically has to give the
argument that i just outlined. I think it's going to be very difficult for
AZ to make this case, though. Should have more perspective on this issue
from the Israelis after a dinner meeting tonight.

Trying to make AZ into a Dubai - transit hub for flights, searching for
niche in non-oil sector - cheaper for refueling for asia flights to stop
in Baku, expand Elat port