VZCZCXRO0545
RR RUEHDBU
DE RUEHKB #0249/01 0480601
ZNY CCCCC ZZH
R 170601Z FEB 06
FM AMEMBASSY BAKU
TO RUEHC/SECSTATE WASHDC 9639
INFO RUCNCIS/CIS COLLECTIVE
RUEHAK/AMEMBASSY ANKARA 1482
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEBAAA/DEPT OF ENERGY WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUEAIIA/CIA WASHINGTON DC

C O N F I D E N T I A L SECTION 01 OF 03 BAKU 000249 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: DECL: 02/16/2016 
TAGS: ECON EPET PGOV PREL AJ
SUBJECT: AZERBAIJAN IN 2006 LOOKS TO SOLIDIFY ITSELF AS 
REGIONAL ENERGY PLAYER 
 
REF: (A) BAKU 152 (B) 05 BAKU 1918 (C) BAKU 197 
 
Classified By: Ambassador Reno L. Harnish III, Reasons 1.4(b) and (d). 
 
¶1. (C) SUMMARY:  With the completion of the 
Baku-Tbilisi-Ceyhan oil pipeline scheduled for late May and 
the South Caucasus Pipeline scheduled for October, Azerbaijan 
in 2006 looks to solidify itself as a regional energy hub and 
energy provider to foreign markets, including Europe.  Over 
the next decade, Azerbaijan oil and gas capabilities will 
expand and flourish and it has the potential to become a 
major hub for oil and gas.  Many internal factors, however, 
will influence whether Azerbaijan can take full advantage of 
this opportunity.  Domestic politics, internal bickering and 
political vision, will ultimately affect Azerbaijan,s 
ability to stay at the forefront of energy exploitation and 
distribution to international markets, including diversifying 
European gas supplies away from reliance on Russia.  These 
goals also serve U.S. strategic interests and Azerbaijan 
should be encouraged to pursue them. END SUMMARY. 
 
Azerbaijan as International Source of Energy 
-------------------------------------------- 
 
¶2. (C) With BTC finally nearing completion after significant 
delays (REF A) and oil scheduled to reach Ceyhan in late 
spring, Azerbaijan's energy clout and economic resources will 
quickly increase.  On the heels of BTC, the South Caucasus 
Pipeline (SCP), also known as the Baku-Tbilisi-Erzurum gas 
pipeline, is scheduled to come online in late October 2006 
and Shah Deniz gas, at least eight billion cubic meters of 
gas, will begin flowing to Turkey.  By Phase II, Shah Deniz 
will send approximately 16 billion cubic meters of gas a year 
to Turkey, and possibly beyond.  Both BTC and SCP raise 
Azerbaijan's international geopolitical profile and highlight 
its role in providing Western energy markets with diverse 
supplies (i.e. non-Russian or non-Iranian). 
 
¶3. (C) Presidential Energy Advisor Ali Asadov told PolEcon 
Couns that the Shah Deniz gas field may hold as much as two 
trillion meters of gas and that he could envision Azerbaijan 
building a second pipeline parallel to SCP to send additional 
gas to Europe.  Asadov indicated that Azerbaijan needed to 
double its potential production to 30 to 40 bcm per year. 
Asadov's comments were not the first time that we have heard 
such unproven high estimates for Shah Deniz gas reserves (REF 
B).  Asadov also noted that with future Azerbaijani gas 
demands reaching 15 to 20 billion cubic meters a year, there 
will plenty of additional gas to send to European markets 
(assuming Azerbaijan can produce and send 35-40 bcm per 
year).  Asadov argued that it was in Europe's interest to buy 
Azerbaijani gas in order to lessen GAZPROM and Russia's 
monopoly over gas supplies to Europe. 
 
¶4. (C) Both BP and Statoil executives in Baku openly discuss 
the possibility of a second pipeline to further tap the Shah 
Deniz reservoir.  Without another way to exploit Shah Deniz, 
after Phase II development the gas field will end up 
primarily serving the domestic needs of Azerbaijan and 
Georgia, with a small amount for export.  But with a second 
pipeline, Azerbaijan could both meet projected domestic 
demand and still be a major exporter to Europe.  Recent 
Russian behavior and Iranian rhetoric have created a window 
of opportunity in Europe that Azerbaijan could exploit. 
 
¶5. (C) Azerbaijan has already begun to play an emerging role 
in international energy politics.  During the January energy 
crisis in Georgia, Azerbaijan quickly came to its Caucasus 
neighbor's aid and supplied 2.4 million cubic meters of gas a 
day.  Newly appointed Minister of Energy and Industry and 
former SOCAR president, Natiq Aliyev, played a critical role 
in organizing the GOAJ,s response to the crisis and also 
coordinating multiple ministries and agencies.  In addition, 
Azerbaijan facilitated Iranian gas transiting to Georgia 
during the crisis.  Allowing Iran to send gas to Georgia, a 
natural market for Azerbaijani gas, shows one facet of the 
GOAJ's delicate balance with its regional rivals - Iran and 
Russia. 
 
¶6. (C) Being situated between Russia and Iran, the GOAJ is 
keenly aware of the importance of balancing its relationship 
with Russia.  In 2005, Azerbaijan agreed to buy Russian gas 
at higher prices over the next coming years even though 
Azerbaijan may not need the gas with the start of Shah Deniz. 
 Azerbaijan also allowed Georgia and Iran to sign an 
agreement to send gas through Azerbaijan to Georgia.  Asadov 
 
BAKU 00000249  002 OF 003 
 
 
downplayed the benefits of the deal to Azerbaijan, noting 
that Iran provided Georgia with only 3.65 million cubic 
meters of natural gas that transited Azerbaijan and  the GOAJ 
had levied only USD 10 per thousand meters as transit fees 
(REF C).  Many GOAJ energy officials openly note that, 
compared to Russia and Iran, Azerbaijan's energy and 
political resources are limited and so it must be a "good 
neighbor" in order to stay out of trouble. 
 
Kazahkstan Oil, BTC and the Inter-Government Agreement 
--------------------------------------------- --------- 
 
¶7. (C) A key part of Azerbaijan's growing regional energy 
role is the long-discussed project to ship Kazahkstan's oil 
and gas to Western markets through BTC and SCP.  The 
inter-governmental agreement which would facilitate this, 
however, remains stalled.  American and international energy 
executives told Ambassador Harnish that international 
pressure from abroad (i.e. the U.S.) is required to break the 
impasse and to sign the deal.  The same contacts noted, 
however, that Azerbaijan reportedly wants to renegotiate the 
IGA, potentially stalling the agreement even further.  Former 
SOCAR executive, now Deputy Speaker, Valekh Alasgarov, 
reportedly is pushing this renegotiation.  He is allegedly 
taking his cues directly from President Aliyev.  In terms of 
other regional projects, there is talk about bringing Central 
Asian gas into SCP.  Generally, Kazakhstan is mentioned as 
the likely partner rather than Turkmenistan.  Many in the 
international energy community in Baku still see Turkmenistan 
in terms of the failed TCP project of some years ago, and are 
skeptical that a new project would proceed any differently. 
 
¶8. (C) Reportedly, President Aliyev thinks Azerbaijan 
deserves a better deal due to its emerging role as a vital 
transit country.  He also is reportedly still irritated with 
Kazakhstan President Nazarbayev for the latter's last-minute 
refusal to sign an IGA in May at the BTC First Oil 
ceremonies.  Previously, international companies did not seem 
worried about the slow progress of the IGA.  Now, as the date 
when their Kashagan production will require an outlet comes 
closer and closer, some are beginning to express concern.  It 
is unclear how progress on the IGA will affect the 
smaller-scale project to bring Kazakhstan's Tengiz oil into 
BTC, which is expected to start as early as 2007. 
 
Will the Lack of Energy Coordination Hurt the GOAJ? 
--------------------------------------------- ------ 
 
¶9. (C) Azerbaijan,s ambitious plans to expand its regional 
goals clash with the GOAJ,s recent reorganization of SOCAR, 
the Energy and Industry Ministry and the move of energy-guru 
Valeh Alasgarov to Parliament.  At a meeting with Ambassador 
Harnish, U.S. and international energy executives 
characterized the move of Natik Aliyev from SOCAR to Minister 
of Energy and Industry as a lateral promotion.  Aliyev was 
reportedly upset at his appointment and complained that the 
GOAJ did not appreciate his work.  In addition, most energy 
observers had initially expected Aliyev to play a more active 
role in Azerbaijan,s energy affairs, even corralling all of 
the energy players, including SOCAR, into the Energy 
Ministry.  This scenario, however, appears to have not played 
out and Aliyev has openly said that he devote more of his 
time to the industry part of his portfolio. 
 
¶10. (C) SOCAR,s new President, Rovnaq Abdullayev, arrived 
with plans to reorganize and restructure the state-owned 
company.  He quickly created several new vice president 
positions and appointed several confidants in key positions. 
Several of his deputies are politically connected and 
influential.  Energy executives remark that Abdullayev would 
like to remake SOCAR into an internationally competitive 
firm, such as StatOil of Norway.  SOCAR's new management, 
however, appears paralyzed and unable to make decisions. 
This paralysis may be short-term and some energy executives 
note that SOCAR will probably increase its influence and 
power in energy decision-making.  Abdullayev's efforts to 
reorganize SOCAR into an internationally competitive company 
would be a positive step forward and could lead to greater 
transparency at the company. 
 
¶11. (C)  The one wild card in Azerbaijan,s energy politics 
is the role of Valekh Alasgarov, formerly the foreign 
investments chief of SOCAR and now one of parliament's three 
deputy speakers.  It appears that Alasgarov,s move to 
Parliament has not meant his removal from energy politics -- 
indeed, he chairs parliament's energy committee.   Several 
 
BAKU 00000249  003 OF 003 
 
 
energy executives believe that Alasgarov will play an ad hoc 
role in energy policy, and his apparent role in the IGA 
process on behalf of President Aliyev bears this out.  With 
the relationships undefined among these three powerful 
individuals -- Natik Aliyev, Alasgarov and Abdullayev -- 
there is a void in Azerbaijan,s energy affairs.  Until a new 
division of responsibilities is agreed upon, Azerbaijan's 
energy policy will likely emerge from a process of trade-offs 
and impromptu decisions. 
 
Projects End & Int'l Companies Think of Future 
--------------------------------------------- - 
 
¶12. (C) The lack of coordinated GOAJ energy policy, much like 
general economic decision making in the government, has put 
at risk Azerbaijan,s regional energy hub role and its 
competitive advantage.  American and international oil 
executives noted to Ambassador Harnish that with BTC and Shah 
Deniz projects in Azerbaijan nearing completion and the GOAJ 
unable to focus on future projects, many companies will move 
on to other countries and new projects.  In addition, the 
domestic core of trained professional Azerbaijanis are 
leaving for other countries, such as Russia, to work in the 
petroleum sector.  This double negative on the Azerbaijani 
energy sector could have a tremendous effect on the country's 
ability to exploit future energy resources and retain the 
necessary technical capacity.  One executive noted that 
Azerbaijan needed to create duty free zones for international 
companies to spur greater investment.  He cited Azerbaijan,s 
export tax as a penalty and one of the impediments to 
competition. 
 
¶13. (C) Despite the recent internal GOAJ upheavals, 
Azerbaijan in 2006 will solidify its regional and 
international role as an energy hub and supplier.  Its 
long-term success, however, depends on whether it can focus 
on long-term goals and projects.  The completion of the BTC 
and SCP projects may have moved Azerbaijan's focus from 
future exploitation projects to reaping the economic benefits 
now.  The country has already begun to feel the effects of 
its oil wealth without preparing its financial and economic 
systems.  If the GOAJ loses focus on energy transit issues, 
Azerbaijan's role as a regional energy hub may come to a 
close over the next ten to fifteen years.  The ACG oil field 
will be exhausted, and Shah Deniz will be meeting primarily 
the domestic needs of Azerbaijan and Georgia, with a small 
amount left for export.  If the GOAJ focuses on bringing 
Central Asian oil and gas into its pipelines, and also 
exploits the full potential of Shah Deniz, Azerbaijan can 
look at being an energy hub well towards the middle of the 
century.  Given that this would contribute to economic 
stability in the south Caucasus, diversify world oil supplies 
and diversify European gas supplies away from relying on 
Russia and/or Iran, the United States should support 
Azerbaijan's efforts to play this role. 
HARNISH