Azerbaijan’s Necessary Energy Diversification

Oil field in Azerbaijan, April 17, 2008

Oil field in Azerbaijan, April 17, 2008 (Nick Taylor)

The ink dried in 1994 on the “deal of the century” between Azerbaijan, BP and a number of Western oil companies. It paved the way for Azerbaijan to become one of the world’s most pivotal oil and gas exporters under the direction of the State Oil Company of the Azerbaijan Republic (SOCAR).

But in a new century, even hydrocarbon rich Azerbaijan must begin considering ways to diversify its energy portfolio. Furthermore, developing alternative sources of energy within Azerbaijan would leave more natural gas for export and help diversify the Azerbaijani economy.

A Chinese proverb notes, “A partnership is like a marriage; you sleep in the same bed but have different dreams.” Still there is no doubting the significance of the oil deal signed that September 1994. Azerbaijan was recovering from a disastrous war with Armenia in which up to one million Azeris from Armenia and the Karabakh region were displaced and major damage had been sustained to Azerbaijan’s economy. At the time the Caucasus was a forgotten region on the world map, a mere byproduct of the dissolution of the Cold War. But for international oil companies, the region was not without opportunities nor its political risks.

BP aggressively expanded into the post Soviet space, providing a much needed infusion of technology while SOCAR was keen to access these new methods and technologies. Although Azerbaijan saw the world’s first offshore oil platform in the late 1940s, Soviet drilling technologies had failed to keep up with those in the West. Thus, in the 1990s, BP began to invest heavily in the former Soviet Union knowing that there were many opportunities to be had. One of the company’s major goals was to bring natural gas to European markets.

BP discovered the Shah Deniz field in the Caspian Sea south of Baku, a development which put Azerbaijan instead of Turkmenistan as the country best positioned to provide natural gas to European markets in the midterm.

Not only was Shan Deniz one of BP’s largest gas field discoveries in decades; it came at a time when the company’s operations were centered on North America, allowing BP to significantly diversify its portfolio.

BP and other international oil companies made other significant finds which have resulted in a second oil boom and spectacular economic growth for Azerbaijan. In 2006, the nation’s economy grew over 25 percent. In 2007, economic growth even reached 30 percent.

Today, Azerbaijan accounts for roughly 70 percent of economic activity among South Caucasus nations and is geostrategically one of the important countries of the twenty-first century. Further expansion of the Shah Deniz field will come online in 2017, effectively doubling its production. BP invests roughly $1.5 billion in Azerbaijan this year, an increase from $870 million in 2011. Azerbaijan’s total gas reserves are booked at three to five trillion cubic meters.

The gas from the Shah Deniz expansion will need a way to reach markets and for now, the Trans Anatolian Gas Pipeline continues to pick up steam while the competing Nabucco project languishes.

In an apolitical world, Azerbaijan might also consider working to develop connections eastward such as with the proposed Trans Afghanistan Pipeline. In such a world, Azerbaijani gas could have access to both European and South Asian markets.

However, political instability in Afghanistan and South Asia is likely to give SOCAR pause in pursuing a partnership. Secondly, and perhaps more importantly at present, it appears that Azerbaijan does not have the reserves to make an oil or gas pipeline toward South Asia feasible.

According to Ilgar Gurbanov, an energy security analyst at Strategic Outlook, a Turkish based research think tank, “Azerbaijan does not have enough natural gas reserves to turn to both East and West.”

At the present time, Western markets are priorities for [the] Azerbaijani government, since there are already infrastructure and legal basis, notably intensive negotiations in order to transport its natural resources to Western markets.

Pending new discoveries, this is Azerbaijan’s inherent geostrategic reality. Despite having the world’s seventh-largest gas reserves, SOCAR officials have expressed concern about the potential for shale gas discoveries in Central and Eastern Europe cutting into the market share of any future pipeline project.

In order to better capitalize on its position as an energy exporter, Azerbaijan should work on more than just pipelines. It should work to develop alternative energy sources which will allow more energy for export.

Currently, 5.2 megawatts of Azerbaijan’s seven megawatt capacity is produced by fossil fuels with the balance coming from hydroelectric sources, one of the benefits of Azerbaijan’s mountainous terrain. Yet its geography means that it has great potential for a variety of alternative and renewable energy resources. Wind power in the country has the potential to produce eight hundred megawatts per year. The name Baku comes from “Badi Kube” which translates from old Persian as “City of Wind.” Anyone who has ever visited Azerbaijan can testify to the fact that the capital’s title is well deserved.

Solar can also play a role given that Azerbaijan receives 2400 to 3200 hours of sunshine per year. Geothermal has great potential in the seismically active Caucuses region.

In the past, Azerbaijan has also flirted with going nuclear and has signed some research efforts. By waiting so long to pursue nuclear technology, it can benefit from safer fourth generation reactors. Surrounded by states such as Armenia, Iran and Turkey, which are either pursuing or planning to pursue nuclear power, Azerbaijan has been cautious in developing nuclear energy. The state has long enjoyed the moral high ground of bashing the nearby Metsamor nuclear power plant in Armenia as an environmental and safety risk to the region.

This year, the government took steps to deregulate the energy sector and promote alternative energy sources. Baku would like to see alternative energy’s share in domestic consumption to rise to 17 percent in the coming years.

Given that more alternative energy in Azerbaijan would mean more natural gas for export, the European Union has not surprisingly been supportive of the country’s efforts. Seeing the value in a strong Azerbaijani alternative energy sector, Europe has signaled that it will help develop its alternative energy resources.

Few countries have as firm a grip on their energy future as Azerbaijan. With the right portfolio, energy sources and pipeline projects, it can strengthen its hold on a bright future.