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Borut Grgic: â€œAzerbaijanâ€™s gas gambitâ€ - ANALYSIS

Borut Grgic: â€œAzerbaijanâ€™s gas gambitâ€ - <font color=red>ANALYSIS</font>

21 October 2011 13:08 (UTC +04:00)

We present the writing.

After splitting from the Soviet Union to chart its own path, Azerbaijanâ€™s journey to present day energy pivot is sprinkled with moments of extreme humanitarian suffering, war, loss of territory, diplomatic uncertainty, and massive advancements in the energy sector.

A recent discovery at the Absherone offshore field has elevated the estimated total amount of proven natural gas reserves in Azerbaijan to 2.6 billion cubic meters. Where, and how this gas is sold is an extremely relevant question for the Azeri authorities. Natural gas unlike oil offers the potential to build long-lasting strategic partnerships. With all this natural gas at its fingertips, Baku has a real chance to remake itself into an indispensable energy partner for Europe, and a leader in the development of the Caspian energy sector. The two objectives are interlinked and Azerbaijan should pursue them simultaneously.

When international energy companies returned to an independent Azerbaijan in the early 90s, the country was devastated by a war it fought with Armenia over the Nagorno-Karabakh province, which Azerbaijan lost at the time, and which Armenia continues to occupy, together with the seven surrounding territories. This defeat did a lot to knock the self-confidence out of the Azerbaijanis, and Russia was the first to take advantage of this. Russia was omnipotent in the South Caucasus in the â€™90s. Turkey was less strategic and less able to engage, while the West largely sat on the fringes. The internationalization of the oil sector in Azerbaijan under these geopolitical conditions was a difficult task, but skilful diplomacy of the late Azerbaijani President, Heydar Aliyev opened the doors for the construction of the Baku-Tbilisi-Ceyhan (BTC) oil pipeline. The first Azerbaijani oil reached the international oil market via Turkey, and with this began the remaking of Azerbaijan into a pivotal Caspian energy player.

The BTC line set the pretext for the South Caucasus Pipeline, which was built to transport natural gas from Baku to Erzerum in Turkey. Thanks to betting on the West, Azerbaijanâ€™s GDP has grown at a cumulative average rate higher than 10 percent over the last 10 years. Its economy has recovered lost ground, and its energy exports have climbed. Sitting on new cash and with new strategic partners by its side, namely the US and Europe, Azerbaijan today can afford to make calculated choices that will best address its geopolitical and commercial needs.

This is the context for todayâ€™s gas debate between Europe and Azerbaijan.

Three European pipeline projects are competing to bring Azerbaijanâ€™s gas to Europe. All run through Turkey. The Nabucco pipeline, which is the biggest, ends in Baumgarten, a major European natural gas distribution and trading hub. From here Azerbaijanâ€™s gas would be sold across Western and Central Europe. The other two, TGI and TAP, are eyeing the Italian market primarily. While these projects may offer access to attractive markets in the immediate, they do little to secure Azerbaijanâ€™s long-term political and economic needs. For one, the Nabucco pipeline is too cumbersome which makes it cost-inefficient for the suppliers. In this case, the sacrifice on the profit margin is too high for the pleasure of accessing Western markets. In fairness to the TAP project, the team is working to develop a strong Balkan component to its pipeline strategy, which gives Azerbaijan a two-way solution, a plug into the Italian market and access to the Balkans.

Azerbaijanâ€™s first 10 bcm from Shah Deniz, which is expected to come online by 2014, should be sold in Southeast and Central Europe, namely in the former YU countries, Romania, Bulgaria, Hungary and Slovakia. There are two reasons for this. First the infrastructure to get the natural gas from Azerbaijan to these markets is mostly in place. We are talking about building interconnections between existing systems rather than constructing new pipelines, which protects the profit margin significantly.

The second reason is political. Due to history and the geography, southeastern and central European countries are importing most of their natural gas from Russia. Furthermore, their gas infrastructure is designed in such a way that they have little choice in terms of accessing alternative suppliers. Bringing Azerbaijani gas into these markets not only helps to balance the Russian dependency, but more importantly, it takes care of the growing need for new energy as the governments phase out coal and old nuclear technology, and as the economies of these countries expand. By pumping close to 10 bcm of natural gas into Southeast and Central Europe, Azerbaijan would become a major energy partner for these countries, majority of which are also EU member states. Intensive energy cooperation will yield political leverage, which in turn should bring about geopolitical benefits for Azerbaijan. This is even more relevant now that the EU is walking away from its enlargement agenda.

The recently proposed BP pipeline to southeastern Europe, the SEEP project, gives Azerbaijan awesome conditions to enter the southeast, and east European markets. Beyond a pipeline connection to this region, Azerbaijan needs an LNG facility in Georgia to give it the opportunity to sell its gas on the spot market, and to Ukraine. The spot market for natural gas will grow overtime, especially in light of all the new natural gas finds in North America and other parts of Europe. There is also the Turkey factor, which an LNG facility in Georgia would help address. Currently, all of Azerbaijanâ€™s export routes to the west run through Turkey. Ankara has shown its cards in terms of what it wants for itself long-term â€“ to be an energy hub, selling and buying gas on its border. This gives Turkey too much leverage and power to set the gas price, and for no good reason. It also separates Azerbaijan from the end buyers, which undermines the political benefits that Azerbaijan would gain through selling its gas directly to countries like Romania, Bulgaria, Serbia and Slovenia. An LNG facility in Georgia built, owned and operated by Azerbaijan is key to neutralizing Turkeyâ€™s leverage over Azerbaijan.

Clearly, Azerbaijan will be a major energy partner for Europe for decades to come, the only question remains whether Baku can use the energy platform to build a sustainable and even-handed relationship with Europe that will endure over time. Betting on the Southeast European energy pipeline and constructing an LNG facility in Georgia are smart strategic decision, much like the decision to build the BTC pipeline was. Baku can hope to collect handsome political and economic dividends in southeastern Europe, not to be had if most of Azerbaijanâ€™s gas ends up in Italy or in Germany.