The Future of Azerbaijani Gas Exports: Is it Worth Worrying?
Threats and barriers
It is said to be the Golden Age of Gas, but definitely not for Europe, at least in the mid-term. As per IEA figures, demand for gas in Europe has been declining since 2011 and is projected to continue weakening in the next 5-6 years due to three basic reasons – (a) decline in power demand growth; (b) gas-to-coal switching and (c) flourishing renewables. Such a picture is expected, however, to change after 2020 in favor of gas over coal and even oil.
The United States, as usual, is going to be the leading player in the global energy game. While shale gas only accounted for 2% of US supply in 2000, it was 37% in 2012. Such acceleration is a clear example of why it is called a revolution, which is now expected to manifest itself in European markets thanks to US exports planned for the next year.
The US has already become the largest gas producer in the world since 2012. This is something that will arguably alter the entire economic and geopolitical picture worldwide, with a particular impact on international oil and gas business.
Noticeably declining LNG imports in Europe in the recent years should not lead to undervaluation of favorable LNG offers in the future. The expectation of LNG share in EU energy mix is 30%, which is not low. Therefore, being less costly and sold on spot basis, American LNG would naturally be more preferable for Europe than having 20 year pipeline contracts with highly oil-indexed prices.
On the other hand, Asian markets will be more attractive for the US due to much higher margins and accelerating demand, though it does not sound realistic that Europe will be excluded from the list of major buyers of North American gas. Furthermore, the US is not the only potential supplier from whom Europe may get LNG deals.
Qatar – the global LNG leader with rapidly growing cheap supply – is another competitor. Low utilization rate of European LNG plants is also a supportive factor. Hence, globalizing LNG trade is going to look like spaghetti and will definitely challenge many potential pipeline projects. In case of LNG pushing pipeline gas prices down, many potential projects will become commercially unfeasible and Azeri projects might not be an exception.
However, even if some European countries opt for substituting pipeline imports with LNG, the initially withdrawn pipeline supplier would be Russia – the most expensive and politically ineffective one, but not non-Russian FSU suppliers.
In fact, it is Russia that would be most challenged by increased LNG imports in Europe, should they happen, although some argue that the price of imported American LNG may even exceed Russian prices primarily due to infrastructural costs.
Furthermore, as Russian supply has already started to significantly decline (including domestic demand), non-Russian Caspian supply to a limited extent might become a kind of replacement for Europe. But for now, this gap is being filled abruptly by a substantial increase from Norway.
Nonetheless, LNG trade still focused on Asian market due to (1) Japanese, Chinese, Korean and other Asian countries’ increased demand; (2) highest prices in the world market; and (3) relatively shorter distance for Asian, African and Australian suppliers; which in turn leaves room for Russia to continue supply dominance in Europe anyway.
Shale Gas
Another threat for future Caspian export is the development of shale gas in Europe, which is not an entirely rejected option, despite continuing regulatory, geological, geographical, social and commercial obstacles forecasted to continue into the next half-decade. Countries such as Poland, UK and Ukraine are now attempting to be the pioneers of a European shale ‘revolution’.
Whatever the current situation is, if our subject is long-term projections, the Azerbaijani government and SOCAR should not ignore European shale gas developments in terms of its potential as a threat to demand security of its future pipeline gas projects.
For instance, Total SA is now planning to withdraw from SCP by selling its shares to BOTAS and at the same time acquire working interests in UK shale gas projects, which itself signals projections of potential developments in the continent. According to initial geological estimations, once the non-geo barriers are removed, Europe might discover self-sufficient amounts of gas that could reshape the picture of the entire global energy economy.
Middle East
One of the most challenging points for Azerbaijan in the mid to long-term is cheap Iraqi (mainly Kurdish) gas that might fill TAP well before the Caspian does. Official estimations say Kurdistan alone possesses more than 2.5 tcm of gas reserves, which is higher than Shah Deniz figures.
One more point here is that resource developments by the Kurdish Regional Government (KRG) will unlikely involve considerable political risks, because operations are being conducted jointly by American and Russian giants such as ExxonMobil and Rosneft, respectively. Plus, the Central Iraqi government has not expressed its concern about independent operations by the KRG neither to Russia, nor to the States, though it did to Turkey.
Other than that, potential increased exports of Iranian gas to Europe as a result of political mitigations should also not be neglected and has to be taken into consideration by Azerbaijan as a highly competing version. Although a long time is required for revitalizing undeveloped Iranian gas reserves, they are huge enough and would be cheaper than Caspian and Russian gas for Europe. A competitor threatening even the major supplier – Russia – should not be ignored.
East Med
Another case with regards to the southern supply rally are recent Eastern Mediterranean discoveries. An underwater pipeline project from Israel’s new and enormous Leviathan field to Turkey and other similar projects proposed for the discovery in Cyprus are being disussed, which can also be treated as a threat to European demand for Azerbaijani gas in the long-term.
Ukraine/Russia
There is now a Ukraine issue that may also have some influence. In case of Western ‘victory’ in Ukraine, it could be thought that Russia will be seeking opportunities to push forward the South Stream project and increase supply through southern regions (with potential discounts), which in turn may also negatively impact future opportunities for Azerbaijan.
Advantages and Opportunities
A positive factor regarding demand in Europe is that Turkey – the largest and most reliable buyer of Azeri gas – is almost the only European country where demand significantly increased and it accounts for 50% of incremental power generation in the continent.
The fact that Azerbaijan is Turkey's closest ally is in favor of the former in terms of partially securing sales of its oil and gas in the long-run, albeit with a discount. However, Turkey’s launched or ‘increased’ gas imports from the KRG, said to cost three times less than Caspian gas, could also to some extent damage Turkish demand security of Azeri gas.
In general, projections saying that gas in Europe will stop lagging behind coal and oil after 2020 can also be referred to as an indirect and implicit positive factor for Caspian gas.
Another minor advantage for Azerbaijan is that several Central and Eastern European countries do not have a convenient geographic location for LNG imports, thereby constraining options pipeline imports. Despite Russian dominance in those regions, Caspian gas is not unattractive. There are still coinciding interests between the region and Azerbaijan, regardless of the TAP selection.
One more noteworthy point is contract terms and conditions. Long-term take or pay contracts are obviously in favor of Azerbaijan and reduces the risks that can occur due to aforementioned factors. Rising liberalization, and thus competition and efficiency in European gas markets, however, will probably shorten contract durations and conditions.
In any event, the Southern Corridor is considered one of the most vital (if not the most) tools for Europe’s energy diversification strategy. This factor can play a significant role in reducing anxiety about the future, though it is not directly or only related to Azerbaijan’s future supplies.
Nevertheless, if Azerbaijan gains ground in filling remaining capacity for TANAP and TAP via planned projects such as Absheron, Shafaq-Asiman, etc., in addition to Shah Deniz 2, it would considerably reduce long-term risks.
Turkmens are naturally more oriented towards the Asian, primarily Chinese markets, rather than joining TANAP via the Trans Caspian Pipeline (TCP), at least due to an already existing and expanding huge pipeline to thirsty China and some $2 of difference between Chinese and European prices, plus remaining political disagreements on Caspian.
Such a factor makes room for Azerbaijani gas and increases chances to fill up the rest of TANAP as well as TAP when possible. TCP, however, is still not a totally ignored project for the future as Turkmenistan possesses enormous gas reserves that strategically might require diversified demand. On the other hand, another ‘pro’ is that Italy – a major buyer of Shah Deniz 2 gas – still has an opposing stance against LNG, an indirect advantage for Azerbaijan.
In reality, LNG is not in absolute competition with pipelines. For example, while Asia shares the most part of the development in LNG trade, interregional pipeline projects have also been developed mostly in the same continent thanks to growing Chinese demand, which means these two types of supply do not severely compete with each other, rather they are selected according to several factors including geographical, commercial and political.
Therefore, whilst LNG can be considered a challenge for Caspian projects, it can simultaneously present some opportunities as well.
With regards to the location being on a ‘landlocked Caspian lake’: My proposal as an option for diversifying demand for (buyers of) Azerbaijani gas and making it more flexible in the future, at least in ‘emergency’ periods, would be to jointly build an LNG plant in Turkish Mediterranean coastlands (preferably in Ceyhan), pump the gas through double-expanded SCP to liquefaction plants and export LNG to the Asian market through the Suez channel or wherever needed. While the cost of building a new LNG plant would be significant, pipelines would have minimal costs in case of SCP’s second expansion, although an additional pipeline construction in Georgia might be required for continuous incremental supply from new Caspian reserves.
Other options might be pumping to already existing plant in Aliaga (Mediterranean) with 6 bcm capacity (if there is space) or to the proposed one in Iskenderun (Eastern Mediterranean) which is closer to Azeri borders. This kind of diversification sounds to be much more promising in the long-term.Additionally, Asian price factors would also markedly contribute to the advantages. So, if LNG seems to be a problem, why not to convert it to an opportunity then? It is time to think about Asia, too, as many exporters already do.
Finally, from the political aspect the country needs to be careful with both gigantic anti-imperialist neighbors and the Western world in order to preserve the balance of non-conflicting relationships with all industry leaders being global and/or regional superpowers at the same time. Politically, for a smaller country with less proven reserves needing to be exported anyway, cooperative strategies would work better than competitive.
Conclusion
Considering that Azerbaijan does not own that huge proven gas reserves in comparison with big players, existing projects in addition to other feasible options suggest that there are no serious reasons to get that worried about the future of its gas exports.
Sooner or later, the Golden Age of Gas will be a valid expression for all continents, which means Azerbaijan will unlikely have any overproduction or oversupply of gas, if not under.
Therefore, the country needs to focus on explorations and extraction of discovered reserves. Pipeline-wise, winning the TAP rally is amajor task for Azerbaijan and the government is required to be hell-bent on this.
Nevertheless, a considerable number of points discussed above suggest that the government should not be easy-tempered on the future of its gas exports. It is indeed worth carefully working on several effective strategic options, anticipating challenges and getting prepared for them within more uncertain and erratic atmosphere of the European gas market.
Elchin Hasan is an oil and gas economics and politics researcher