Gubad Ibadoghlu: Why EU plans to increase gas imports from Azerbaijan are unrealistic

The EU’s vision of replacing Russian gas with Azerbaijani gas is a pipe dream.

Cross-posted from the LSE EUROPP blog

Picture by shankar s.

In July last year, the EU signed an Energy Memorandum with Azerbaijan. While this was described as a potential step toward using Azerbaijani gas as an alternative to Russian energy, the document itself was simply a statement of intent and served a largely political purpose.

A major limitation of the agreement is that it was signed without conducting political and financial risk assessments or resource and stakeholder analyses. It also only considered the interests of the buyer and the seller. This is important as realising such projects also depends on the interests of transit countries, joint-stock companies managing gas fields and pipelines, and investors. When the interests of these stakeholders are properly assessed, it becomes clear that using Azerbaijani gas as an alternative to Russian energy remains unrealistic.

Delayed production and growing demand

The task of increasing and diversifying Europe’s energy supply by bringing gas resources from the Caspian Sea is being implemented within the framework of the Southern Gas Corridor project. This includes the operation of the Shah Deniz natural gas condensate field with an investment value of approximately 40 billion US dollars and three separate pipelines.

Shah Deniz’s natural gas-condensate field is operated in two stages. Stage 1 covers about 10 billion cubic metres of gas per year. Output in the Shah Deniz-1 field is on a downward trend, but the Shah Deniz Stage 2 field has the potential to produce 16 billion cubic metres of gas. In addition to the Shah Deniz gas field, the largest in Azerbaijan, there are three other gas fields that hold particular importance, namely the Absheron, Shafaq-Asiman, and Umid-Babek gas fields.

Due to the size of its reserves, the extraction of the first gas from the Absheron field is considered a key step in increasing gas production in Azerbaijan. According to the data, the reserves of the Absheron field have proven to be lower than initially expected and exploration is proving difficult. The first gas extraction under the Absheron-1 project was initially scheduled for the first quarter of 2019, but this has been delayed to 2021 and then to 2023. The Absheron-2 project’s first gas production is expected in 2027.

The geological exploration of the Shafaq-Asiman gas field has not yielded positive results yet. There is also a need for geologists who have reached a high level of professionalism to start exploitation work and increase the volume of production in the Umid-Babek area, which is considered difficult from a technical point of view. All of this requires additional time and financial resources.

Alongside this delayed production, there is also growing gas demand from Azerbaijan’s population and the country’s growing economy. Launching new production capacities in the industry creates excess demand for additional gas volumes. Population growth and the expansion of the country’s territory also increases the demand for gas. At present, Azerbaijan’s domestic consumption is approximately 12-13 billion cubic metres per year, and the government is obliged to consider this when making export plans.

Current trends suggest domestic consumption will hit 14 billion cubic metres in 2023 and 15 billion cubic metres in 2026. Meanwhile, forecasting models indicate that gas production in Azerbaijan will be around 47.8 billion cubic metres in 2023, 49.2 billion cubic metres in 2024, and 49.7 billion cubic metres in 2025. Considering domestic consumption, exports can be increased by an additional 2.5 billion cubic metres by 2026. This means that Azerbaijan’s exports to the EU can be increased to only 14-15 billion cubic metres by 2026.

Management challenges

To increase the gas supply to Europe, there will need to be investment in improving the current transmission capacity of the South Caucasus (SCP), Trans-Anatolian (TANAP) and Trans Adriatic (TAP) pipelines. Of these, only the Trans Adriatic pipeline is largely under the control of EU companies.

Currently, 19.9 per cent of the South Caucasus pipeline is owned by the Russian oil company Lukoil, while 10 per cent is owned by the National Iranian Oil Company (NIOC). This creates obvious political difficulties for the EU when it comes to making financial and management decisions. Both companies could work together to create obstacles for increasing the gas supply to Europe.

The pipelines from Azerbaijan pass through Turkey and Georgia. Both countries are buyers of Azerbaijani gas. To increase the gas supply to Europe, it will be necessary to establish transit agreements with the Turkish state and Turkish companies to meet the growing needs of both European and Turkish consumers. Azerbaijan’s President, Ilham Aliyev, recently noted that “negotiations are taking longer than we expected. We hope that we will reach this agreement. Because if we do not reach this agreement for certain reasons, then all our plans to supply additional gas to Turkey and Europe will be in jeopardy.”

Finally, there are significant financial challenges associated with increasing the gas supply from Azerbaijan to Europe. The level of investment required to extend the transmission capacities of pipelines is estimated at several billion US dollars. This creates financial difficulties from the point of view of investors, companies, and buyers.

Unrealistic expectations

In sum, plans to increase the gas supply to Europe are likely to be undermined by Azerbaijan’s growing domestic demand and slow gas production. Indeed, at present the only viable way for the country to fulfil its obligations to Europe by 2027 would be to purchase additional gas from Russia and Turkmenistan. This would be entirely counterproductive given the political rationale of the EU-Azerbaijan energy memorandum.

Whether tangible results can be achieved will depend not only on the decisions made by the Azerbaijani government but also on the positions taken by transit countries and the companies that own the associated gas fields and pipelines. Reconciling these competing interests will require considerable time and financial resources. All of this is likely to make the goal of substituting Russian gas imports with gas from Azerbaijan something of a pipe dream in the near term.

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