Paper: Europe Unlikely to Get Substantial Volumes of Azerbaijani Gas by 2030

Azerbaijan is experiencing a ?gas supply squeeze?, due to which it is unlikely that substantial volumes of Azerbaijani gas will be available for Europe by 2030, assessed Simon Pirani, Senior Research Fellow at the Oxford Institute for Energy Studies (OIES), in his new paper entitled 'Azerbaijan's gas supply squeeze and the consequences for the Southern Corridor'. Therefore, for the Southern Gas Corridor to provide substantial supply diversification for Europe during the 2020s, significant volumes would have to be acquired from Iraq, Iran, Turkmenistan (or other Central Asian countries) or East Mediterranean sources, stressed Pirani.

Azerbaijan, whose economy is heavily dependent on oil and gas exports, was particularly seriously affected by the fall in oil prices in 2014-15, and in 2016 the country entered economic recession for the first time in 20 years. The fall in oil prices has forced the State Oil Company of Azerbaijan Republic (SOCAR), along with most other oil producers, to scale back investment plans, and this, according to Pirani, is an element of the problems with gas production.

Azerbaijan has three main sources of gas: (i) the Shah Deniz field, the country’s largest gas resource, where a consortium headed by BP began production in 2007 (current output about 10 bcm/year); (ii) associated gas from the Azeri-Chirag-Guneshli (ACG) oil field (Azerbaijan’s largest oil producing field), which is provided free to SOCAR under the production sharing agreement (PSA) between the government and an international consortium headed by BP (about 3 bcm/year); and (iii) volumes produced by SOCAR from the Shallow Water Guneshli field and other smaller fields (about 6 bcm/year).

The largest consumer of Azerbaijani gas is the domestic market (about 10 bcm/year in recent years). Since the start-up of Shah Deniz production in 2007, Azerbaijan has exported gas to Turkey (under a contract providing for 6.6 bcm/y of sales), Georgia (1-2 bcm/y), and southern Russia. There will be a major expansion of gas production from 2018, when the second phase of the Shah Deniz project is commissioned. When it reaches plateau production in the early 2020s, Shah Deniz II will produce about 16.3 bcm/year of gas. Sales contracts are in place for this gas – 6 bcm/y to Turkey and 10 bcm/y to European buyers – and infrastructure is under construction (the South Caucasus pipeline expansion (SCPx), the Trans Anatolian pipeline (TANAP) and the Trans Adriatic pipeline (TAP)) to bring it to market.

SOCAR in talks with Russia on gas imports

However, growing demand for gas in Turkey, Georgia, and especially in the domestic market, where demand has increased more rapidly than supply, has resulted in Azerbaijan’s gas supply squeeze.

According to Pirani, output from SOCAR’s own gas fields in the Caspian Sea – including the Shallow Water Guneshli field that contributes about 60% of the company’s own production –fell during 2010-15, from 6.4 bcm in 2010 to 5.8 bcm in 2015, notwithstanding slight upward spikes in 2012 and 2014. Pirani assessed that the problem is likely to be exacerbated in 2016 for two reasons - a shortage of investment funds to take output-enhancing measures and develop new fields, and due to a serious accident on platform no. 10, one of three producing platforms at the Shallow Water Guneshli field.

In addition to lower output from SOCAR’s own fields, in 2013-14 the volume of associated gas that SOCAR acquired from the Azeri-Chirag-Guneshli (ACG) oil project fell, from 3.0-3.5 bcm/year in previous years to 2.19 bcm in 2013 and 2.76 bcm in 2014. ?Although the output of associated gas recovered to 3.2 bcm in 2015, it is likely to fall further in the next few years as the whole project goes into natural decline,? said Pirani.

He added that in response to these supply problems, SOCAR has terminated gas exports to Russia and limited them to Georgia. Nevertheless, this has still left Azerbaijan potentially short of gas, and the following supply side measures have been taken in 2015-16: proposed imports from Russia (Rovnag Abullayev, SOCAR CEO, stated that negotiations have commenced with Gazprom about the purchase of 3-5 bcm/year), fuel oil imports, possible future purchases of gas from Turkmenistan, and demand-side measures.

?SOCAR’s focus on the range of actions mentioned – directed at importing gas and fuel oil on the one hand, and seeking demand-side savings on the other – underlines the fact that, while Azerbaijan is richly endowed with gas resources, particularly offshore, these resources cannot be developed rapidly enough to address the gas supply squeeze in the short or medium term. The pace of field development, both on SOCAR’s own offshore fields and those to be worked under existing or proposed PSAs, will be further slowed because SOCAR’s investment funds have been slashed as a result of low oil prices,? stressed Pirani, warning that previous expectations on the availability of Azerbaijani gas were based on mistaken assumptions.

Lower estimates

Pirani therefore thinks that the validity of claims referring to Azerbaijan as ?a major potential source of gas for the European market, and the major source for the Southern Gas Corridor in the 2020s? should be reassessed.

Figure 1: Shah Deniz production estimates; Sources: Stage 1, BP presentation "BP in Azerbaijan. Baku, September 2006", slide 43, "Shah Deniz stage 1 development". Stage 2, Shah Deniz 2 Infrastructure project. Draft Environmental and Socio-Economic Impact Assessment, July 2014, p. 5/6, figure 5.2; author's estimates (stage 1, 2030-33).

In 2010-2013 the International Energy Agency (IEA), Pirani, and Wood Mackenzie, estimated for 2020 output of 36 bcm, 37 bcm and 30 bcm respectively. While Wood Mackenzie’s estimate was lower than the others, because it assumed that Shah Deniz II would still not have reached plateau production by 2020, all three estimates assumed that SOCAR’s own production would reach 10-11 bcm by 2020. However, according to Pirani, this now seems extremely unlikely. ?SOCAR’s old fields, which are in natural decline, may by 2020 be producing only 5 bcm/year or less. Had Shah Deniz II reached plateau production by 2020, that would have implied total Azerbaijani output of 33 bcm. In fact, Shah Deniz II is expected to produce 10 bcm in 2020, as it will still be ramping up, implying total Azerbaijani output of 27 bcm in that year.?

For 2025, the IEA and Wood Mackenzie have estimated 43 bcm of output; SOCAR’s senior managers have estimated 40 bcm. However, according to Pirani (i) insufficient account has been taken of the fact that Shah Deniz I is expected to be in decline by 2025 (a publicly available forecast from BP suggests that by 2025, Shah Deniz I output will have fallen to 6.7 bcm/y; Shah Deniz II is expected to be at plateau production of about 16.3 bcm/y at that time, giving a total of 23 bcm/y from the field), (ii) overly optimistic assumptions have been made about the Absheron field and/or other PSA projects, and (iii) output from SOCAR’s own fields has again been over-estimated.

In a reassessed outlook for the 2020s, Pirani foresees that Azerbaijan’s gas production will comprise:

• production from Shah Deniz stages I and II: the combined output of the field was expected to start falling from 2023-24, due to the decline of the first phase, reaching about 20 bcm in 2030. This has significant implications for export infrastructure planning: by 2024 – 1 bcm/y, and by 2030 – 6 bcm/y, of spare capacity should be available in the pipelines built for Shah Deniz gas;
• production from PSAs and prospective PSAs (Absheron, ACG deep, etc): regarding the Absheron field, Pirani said that the original intention of taking a final investment decision (FID) in 2016, starting drilling in 2019, and producing first gas in 2021, is in doubt. The possibility of first gas from ACG non-associated (deep) gas before 2030 is also receding. Other prospective PSAs, including the Shafag-Asiman project covered by a PSA on exploration and development between the government and BP, are likely to be developed after Absheron and ACG deep gas;
• and production from SOCAR’s own fields (possible ranges of output - 5.17-7.67 bcm in 2020, 5.37-10.87 in 2025).

Pirani assessed that Azerbaijani gas output will amount to 27.2-30.7 bcm in 2020 and 30.7-42.2 in 2025.

Of the gas produced in 2020, up to 18.8 bcm (6.6 bcm to Turkey under its Shah Deniz I contract, 10 bcm to Shah Deniz II counterparties and 2.2 bcm to Georgia) could be under contract for export, leaving 8.4-11.9 bcm for domestic consumption. SOCAR forecasts 11.8 bcm of domestic consumption in 2020, and would presumably have to make up any shortfall (up to 3.4 bcm) with Russian imports, explained Pirani.

The situation will change in 2021, when the Shah Deniz I contract with Turkey comes to an end. ?From that point, contracted sales from Shah Deniz II are 6 bcm to Turkey and 10 bcm to Europe; it may reasonably be assumed that there will be demand in Georgia for 2.2-2.5 bcm of Azerbaijani gas, making an export requirement of 18.2-18.5 bcm. So, in 2025, if no additional gas is being sold to Turkey, after fulfilling that requirement Azerbaijan may have 12.2-24 bcm of gas to meet domestic commitments, which are forecast by SOCAR at 13.1 bcm. On the other hand, if output is at the lower level, 12.2 bcm of domestic demand can be covered, and a little under 1 bcm of Russian imports would be required. Only if output reaches the higher level, which seems unlikely, could domestic demand be covered and a significant volume of gas – 10.9 bcm – be available for additional exports.?

Azerbaijani gas can be competitive in Turkey and potentially in the Balkans

Therefore, Pirani thinks that apart from the volumes committed to Turkey and Europe from Shah Deniz II, and 2.2-2.5 bcm of gas for Georgia, by 2025 Azerbaijan is very unlikely to have 10 bcm/year or more available for export. ?It is indeed more likely that if field development proceeds more slowly at the lower end of the ranges of output, Azerbaijan would have no additional gas to export, and will still require small volumes of Russian imports for its own gas balance. If Azerbaijani output is in the middle of the range, e.g. 35-36 bcm/year, then there would be 3.7-4.7 bcm/year spare to export. Assertions e.g. that “gas volumes [to be transported via the Southern Corridor] are slated to increase to 35 bcm as other gas fields in Azerbaijan come online after 2020” are misleading.?

Pirani also mentioned that Azerbaijani gas is not competitive in Europe at current market prices, and that gas produced from deep-sea deposits and transported over long distances will always struggle to compete in a low-price environment. ?On the other hand, Azerbaijani gas can be competitive in Turkey, and potentially competitive in the small markets of south-eastern Europe, e.g. the Balkan countries. Indeed it may well be that the significant contribution of Azerbaijani gas exports in the 2020s will be first in Turkey and second in south-eastern Europe, rather than in the larger European markets where the volumes likely to be available will not make a major impact.?

Pirani thinks that ?substantial volumes of Azerbaijani gas will not be available for Europe until the commodity cycle has turned, sizeable investment funds are available, more PSAs are signed and fields developed, and SOCAR’s own production increases. It is unlikely that all this will happen by 2030. This in turn means that for the Southern Gas Corridor to provide substantial supply diversification for Europe during the 2020s, significant volumes would have to be acquired from Iraq, Iran, Turkmenistan (or other Central Asian countries) or East Mediterranean sources?.

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