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Charles Kennedy

Charles Kennedy

Charles is a writer for Oilprice.com

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Oil Is Key In Russia’s Rapprochement With Azerbaijan

It is oftentimes said that the Middle East is the most complicated region in our world, however the Southern Caucasus would certainly take issue with that assumption. The military developments in and around Nagorno Karabakh have complicated matters even further, expanding the territorial holdings of Azerbaijan and effectively perpetuating them by creating a Russian peacemaking battalion. Political developments have imminently brought about energy-relevant changes and one of the main novelties of the post-2020 world might be a much tighter Russia-Azerbaijan energy link. For the first time in many months, it could be Azerbaijan now that would be actively engaging with the Russian “big brother”.  Retrospectively looking, the Russo-Azerbaijani energy relationship can at best be described as problematic. Although much of Azerbaijan’s current producing portfolio was the result of a joint Soviet effort to tap into the Caspian offshore, the Aliyev administration wasted no time on trying to invite as many Western majors into its flagship project (Azeri-Chirag-Guneshli, aka the “contract of the century”). Russia tried to sneak into the Azerbaijani offshore but the best it could garner was LUKOIL buying its way into the ACG shareholder structure, perhaps aided by the fact that LUKOIL’s main owner and general director is an ethnic Azeri. Transanatolian and Trans Adriatic pipelines (TANAP and TAP) notwithstanding, this year’s Nagorno Karabakh war has changed all that.

Azerbaijan’s military victory, tangibly facilitated by Turkish support, rested upon an international recognition to be finalized. The tripartite agreement between Moscow, Yerevan and Baku has provided just that and Western powers have joined in, providing an extra layer of recognition. Coincidentally, all this is happening with two US majors intent on leaving Azerbaijan, with Chevron already gone and ExxonMobil seeking a suitable buyer for its stake. Should both US majors leave, BP would be the only oil titan remaining, operating the ACG fields and the Baku-Tbilisi-Ceyhan pipeline. Russian companies, especially LUKOIL that virtually controls all of the Russian Caspian and has become the nation’s flagbearer there, buzz with excitement. 

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A couple of recent developments indicate that the energy paths of Russia and Azerbaijan, erstwhile direct competitors, are indeed converging. Perhaps unsurprisingly, it is indeed LUKOIL that got the main part in this. LUKOIL’s CEO Vagit Alekperov is an ethnic Azerbaijani, born in Baku into a family of oilmen, has studied at the Azerbaijani State Oil University and worked as a drilling operator in Azerbaijan’s offshore production (then predominantly shallow water), hence there seems to be a natural proclivity for LUKOIL to gather ground in Azerbaijan. The Russian company’s first try took place in 1997 when LUKOIL managed to clinch a PSA on the Yalama structure (also known as D222). Perhaps due to its relative distance from main Azeri producing assets – Yalama is located on the Azeri-Russian maritime border much to the north of ACG – both exploration wells discovered only non-commercial hydrocarbon volumes. 

In early 2019 the Russian firm announced that it intends to buy 20% of the Absheron offshore field, once touted as the natural successor of Shah Deniz. Absheron was initially developed under French operatorship with Total (40%) and ENGIE (20%) taking a stake in it along with the Azerbaijani state oil company SOCAR. ENGIE was quite quick to withdraw amid first drilling results – Absheron’s targeted sandstone formations are more than 6000m deep (in water depths more than 500m), hence require more sophisticated solutions than the more palatable Shah Deniz. Although Absheron’s initial reserves were assessed at a respectable 12 TCf (350 BCm), the project’s first phase had to be downgraded to a production plateau of 1.5 BCm per year – all of the volumes are assumed to be utilized on the domestic market and only Phase 2 would allow for some pipeline gas exports. 

The next step will be LUKOIL and SOCAR taking up a greenfield project from scratch. In January 2020 the two companies have signed a Memorandum of Understanding on two blocks – one includes the shallow water Goshadash and Precaspian Guba fields to the north of the Absheron peninsula, whilst the other contains the Nakhchivan field. Both Goshadash and Nakhchivan fields were discovered in the 1960s and were already appraised by SOCAR’s international partners, Petronas and ExxonMobil respectively. The Nakhchivan field, to the southwest of Shah Deniz, is of special interest as previous drillings have seemingly confirmed the presence of oil shows but they were deemed geologically too challenging to develop. 

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As blistering as the developments of 2019-2020 might seem, the upcoming months might bring about further Russian moves into Azerbaijani upstream. LUKOIL has expressed interest in joining the Umid/Babek, perhaps the most ambitious project on Azerbaijani books, located 45km to the west of Shah Deniz. The fields are the last untapped mohicans of Soviet offshore exploration, first appraised in the 1950-1960s, and both tilt towards the gas/condensate side – the total assumed reserves of Umid/Babek stand at 20 TCf and almost 1 BBbls of condensate. SOCAR has been spearheading Umid test production, backed by Nobel Upstream (20%), under a 2017 risk service contract, however, has failed to make significant headway and keeps on pushing the commissioning dates backward. The root cause of such tardiness lies in the high costs of production – pay formations in Umid/Babek are at least 6km deep. 

What does this mean for Russian oil interests in Azerbaijan? Russia’s tangible reluctance to take sides in the Armenian-Azerbaijani conflict and Moscow’s guaranteeing of Azerbaijan’s new borders by means of a peacekeeping force has provided material benefits for its main Caspian-focused producer, LUKOIL. Russia’s participation is still revolving around risky projects, but the risk involved is significantly smaller than it used to be with all past frontier assets. Although there is no guarantee that LUKOIL will buy its way into Azerbaijan’s upstream, the political narrative that underlies the evident rapprochement of Moscow and Baku seems to be aiding it greatly. 

By Charles Kennedy for Oilprice.com

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