Global Economics

Azerbaijan: Key to European Natural Gas


The energy-rich Caspian nation, where oil was first drilled in 1848, is now the locus of Europe's effort to wean itself from dependence on Russian natural gas

A chill wind blows in from the Caspian Sea, bringing with it a faint but distinctive stench of oil. At the front of the brutalist Dom Soviet building, where once a statue of Lenin stood, the Azerbaijan flag ripples in time with each passing gust.

Baku, the capital of Azerbaijan, is booming: gross domestic product growth was more than 9 per cent last year; the hundreds of big, shiny commercial and residential buildings under construction are a result of its oil and gas wealth. Prince Andrew has visited the city often over the past six years, as he tries to promote British business interests in the region.

The capital is also at the centre of one of the most important geopolitical issues of modern times, the security of the European Union's energy supplies. Azerbaijan, with the BP (BP)-led Shah Deniz-2 field, is expected to be the major natural-gas supplier to the Nabucco pipeline, which will run 3,300km from Erzurum, Turkey, to Austria.

Nabucco is strategically vital as it will ease Russia's grip on the supply of natural gas into Europe. More than half of the EU's gas supply comes from Russia, Norway and Algeria. The need for alternative supplies intensified in 2009, when Gazprom (OGZPY), Russia's state energy company, cut off the gas to Ukraine on New Year's Day, following a row over price.

However, the Nabucco project, which is due to start construction next year and deliver gas three years later, is besieged by problems over cost projections, transit issues and even war.

In the Minister's lair

Natiq Aliyev, Azerbaijan's Industry and Energy Minister, stands by his country's flag in his ludicrously vast office in the Dom Soviet, now also known as Government House. He immediately sets out the EU's difficulties: "Europe's reserves of gas and oil in the North Sea especially have declined. Maybe in 10, 20 years if Europe has no more significant discoveries, the current reserves will be over."

The EU wants Nabucco, which has six shareholders including Germany's RWE (RWEOY) and Hungary's Mol (MGYOY), to provide 31bn cubic metres of gas. It is estimated that the Shah Deniz field can only provide about a quarter of this amount.

The success of the pipeline, then, will be based on the participation of other gas-rich countries. "I think in a few years, when the Iran and Iraq situation is more stable politically, we will be able to implement the Nabucco project very speedily," says Aliyev, who is clear that the current timetable cannot be met.

"I don't think construction will be in one or two years. Countries like Iraq, Iran and Turkmenistan need to join this project." The project website admits that it would like to source gas from Iran "at a later point in time", while "it remains to be seen if also gas from Iraq will be linked with the Nabucco pipeline system."

Richard Morningstar, the US State Department's special envoy for Eurasian energy, seemed to rule out Iran's potential involvement last year, the argument over the Middle Eastern state's nuclear programme still too fierce. Iraq's prime minister, Nouri al-Maliki, has expressed interest in supplying gas.

One big hurdle was cleared last year when an intergovernmental agreement was signed in Ankara between Turkey and EU member states. The Turkish parliament recently ratified the document, which provides a legal framework for the construction and operation of the pipeline.

"It was a positive step...not the last step," argues Aliyev. "We don't know yet who the territory [on which the pipeline runs] belongs to – are they government territories, the private sector's?" Aliyev points to the complexity of land negotiations for the shorter Baku-Tbilisi-Ceyhan pipeline. There were more than 1,000 landowners, including farmers and government bodies, involved in Azerbaijan alone.

There have also been disagreements between Azerbaijan and Turkey, some of which are politically motivated. Turkey's relations with Armenia have started to thaw, angering an Azerbaijan that is still formally at war with its neighbour over the disputed (and Armenian controlled) Nagorno-Karabakh region.

More directly, there is still some dispute over how much it will cost Azerbaijan to transit gas through Turkey. Taner Yildiz, Turkey's Energy Minister, did say earlier this month that his government had offered Azerbaijan transit fees at lower than market price, though the government in Baku remains unconvinced.

"How are we going to supply Nabucco if we have no right of transit in Turkey?" asks Aliyev, rhetorically.

Socar to go

Elshad Nassirov, the vice-president of the State Oil Company of Azerbaijan (Socar), is also a senior official of the country's football federation.

He smiles that it was his decision to commission the 3.5 metre bronze statue of Tofik Bakhramov, the Azerbaijani linesman who allowed Geoff Hurst's dubious second goal in the 1966 World Cup final, which now stands outside the national stadium.

The statue was partly a humorous gesture, built when England were drawn in the same 2006 World Cup qualifying group as Azerbaijan. However, this sense of humour has brought Nassirov all sorts of problems.

He joked at a conference last year that Azerbaijan could always send its gas east to China if the EU did not want it. Technically, this would require only a 180km pipeline across the Caspian Sea to Turkmenistan. But Nassirov insists that he was simply teasing his audience and not making a veiled threat. "For us, the priority is the European market," he says. "The very best thing about the European market is that it is a free market price, not dependent on a decision in Brussels."

Nassirov giggles that he didn't expect his joke to "ignite so many furious responses." However, the misinterpretation of his aside only goes to show just how worried European states are about where they get their gas from.

He points out that there are options for the EU besides Nabucco: the 520km Trans Adriatic pipeline, connecting Greece and Italy, and the $2.8bn Turkey-Greece-Italy scheme.

"They are cheaper, that's the positive side," says Nassirov. "The negative side is that they lack the EU support of Nabucco and their markets are not as diverse as Nabucco."

The EU does seem committed to the Nabucco project, but it will have to ensure Azerbaijan's support if it is to be more than a dry, empty pipeline.

Once again, this small country of nine million people finds itself one of the most important places on Earth. Truly the mecca of the energy industry, it was in Baku that the world's first oil well was drilled in 1848.

The second oil boom of the post-Soviet period has already given the country extraordinary wealth, the state oil fund having nearly $11bn of assets.

And now Azerbaijan is gaining political might, Baku's decisions are affecting the energy security of almost an entire continent.


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