Regional stability a concern, but Azerbaijan oil hunters press on
Oil company executives see increased U.S. influence as balm to area's volatility

The news this past year for Azerbaijan’s all-important oil and gas sector has been both good and bad. First, the good news.

Oil Pipelines from Azerbaijan.

The Azerbaijan International Operating Company (AIOC), the British Petroleum-led consortium, announced plans to proceed with full field development that could raise oil production from its fields nearly 10 times to one million barrels per day in 2011. Studies on a new pipeline costing nearly $3 billion to carry that oil through to Western markets entered a yearlong “detailed engineering study” phase.

In early October, Georgia completed negotiations with Azerbaijan on gas transit fees. This agreement paves the way for both the development of the world-class Shah Deniz gas field, and construction of a new gas pipeline from Baku to Turkey by 2005.

Other oil companies, however, saw their hopes for equivalent discoveries dashed by wells that came up with no commercially viable quantities of oil, or ran into high-pressure problems that derailed further exploration.

In July, Iran’s confrontational pursuit of its questionable claims to Azerbaijani territorial waters also further clouded exploration hopes in the southern part of the Caspian.

Finally, the political realignment in the region that may follow the current American-led campaign against terrorism has raised serious questions about the long-term future of Caspian oil exploration.

Despite such problems, however, Caspian oil companies remain optimistic. Proven oil reserves in the Azerbaijan sector of the Caspian are estimated at seven billion barrels. And geologists expect more hydrocarbons to be found in the future, with reserves possibly going as high as 20 billion barrels. Similarly, proven gas reserves are believed to be 20 trillion standard cubic feet, but reserves could reach the 100 to 200 trillion standard cubic feet range.

This summer, David K. Woodward, President of AIOC and BP Azerbaijan Associate President, signed contracts confirming AIOC’s intention to complete “Phase I” of its oil production development by 2005. Completion of Phase I is expected to boost production from the current level of 120,000 barrels per day to 375,000 barrels per day in 2005, and to 1 million barrels daily by 2011.

AIOC is a consortium of 10 oil companies that share rights under one of 22 production sharing agreements (PSA) signed in 1994 and after with the government of Azerbaijan. The AIOC, which has chosen BP as sole operator, has exploration and production rights in the PSA encompassing the Azeri, Chirag, and Guneshli (deep water) fields, collectively known as ACG.

Woodward says the preliminary work on the Baku-Tbilisi-Ceyhan (BTC) pipeline is progressing well. Social and environmental impact studies are currently being completed as part of the detailed engineering study. A significant milestone is set for 2002, when a decision must be made as to whether to proceed with pipeline construction, on the basis of the detailed engineering study.

Some oil company consortia operating other PSAs have not been as successful. Chevron Oil has “gone back to review its geological and physical databases,” according to general manager John Connor, after drilling two holes in its Absheron PSA block. The efforts showed the presence of hydrocarbons, but not in commercially viable quantities.

According to the Baku Sun, an English language weekly, Exxon Mobil announced plans in July for its subsidiary, Oguz Operating Company, to abandon plans to drill more exploratory wells in its Oguz field. Instead, the company switched its attention to drilling its first well in the Nakhchevan block. Exxon reportedly began drilling its first Nakhchevan well in September. A second well will follow.

Results are not expected until February 2002. A Japanese consortium, JAOC, has also begun drilling, and is expected to report results from its two wells about the same time.

Geology nightmares
While the euphoria surrounding BP’s find has subsided somewhat because of recent drilling results, other phenomena associated with drilling in the Caspian Sea have reinforced the sober attitude among oilmen.

“Drilling in the Caspian is challenging,” Woodward says. “Sedimentary layers are very young, geologically speaking. Layers are unstable, and some rock sections are very weak.”

Other oil industry experts point to the existence of mud volcanoes and a “gumbo” clay on the sea bottom, a material so viscous that extracting drilling rig legs from it can be a drilling company’s nightmare.

Chevron’s John Connor says that the shifting of sedimentary layers with these characteristics through the eons can result in oil deposits being under such immense pressure that drilling into such deposits is beyond the technology available today. The oil pressure is so high that the drilling equipment would be destroyed.

Moreover, says Woodward, some of the prospects are very deep, some as much as three to four miles below the seabed. “This puts limits on the way wells are drilled,” he explains. “The rigs and pressure controls needed are very costly, and the amount of such equipment available is very limited. It takes about six months to drill a deep well.”

All this means that drilling for oil in the Caspian Sea is much more expensive than drilling elsewhere – a context that makes five dry wells in a row more cogent to oil company executives. Most oil bosses in Baku say that a typical deep-water well drilling operation here costs between $12 and $15 million, and some say total investments for drilling can soar to double that level. By comparison, industry experts say, a similar exploratory well in the Gulf of Mexico might cost only $1 million to $2 million.

As if the geological and economic problems aren’t enough, every oil executive contacted for this report says that regional political stability is currently their most gnawing concern.

All major companies executives, no matter their country of origin, laud President Aliyev for the progress made to date in restoring domestic political and economic stability.

They also have encouraging words for Azerbaijan’s State Oil Company, SOCAR, in particular for Foreign Investment Division General Manager Valekh Aleskerov (“He may be the smartest man I’ve ever met,” says one major company general manager). Aleskerov is praised as a tough negotiator who knows exactly what is in his country’s best interests, and gets it. The executives also praise Azerbaijan’s PSAs as “world class, first rate.”

The one concern that overrides all others is the question of regional stability. Nearly all of the business executives interviewed for this report urge the United States to take a more active role in bringing about a negotiated solution to that conflict.

Russia, Iran compete for influence over region’s oil
A more urgent concern is now Iran. After announcing claims to Azerbaijani portions of the Caspian Sea, the radical fundamentalist Islamic regime on Azerbaijan’s southern border has sent fighter aircraft on dozens of over flights above Azerbaijan cities and installations, according to Western diplomats and businessmen.

On July 23, Teheran sent a naval vessel to challenge an unarmed civilian Azeri research ship under contract to British Petroleum, operating in a section of Azerbaijan’s territorial waters now claimed by Iran. The Azerbaijan government immediately recalled the research ship. Further research in the PSAs in the disputed areas in on indefinite hold until the five nations bordering the Caspian can agree on a solution.

Although Russia and Kazakhstan support Azerbaijan’s position in the Caspian border dispute, Turkmenistan inexplicably has supported the Iranian position. The Turkmen action raises further questions about the Turkmen regime among its neighbors.

But as worrisome as Teheran’s evident intention to back its claims with military force are, in the long term, oil executives are holding their breath to see whether the Russians gain even more influence than they already have regarding the region’s oil and its transport routes. Russia is already a huge oil producer, and has been cutting oil and gas transportation deals from Uzbekistan to Iraq. Having decisions “Made In Moscow” for much of the world’s oil supply is a concern that worries many in the West.

Up to now, American strategy in the area has been to discourage producing counties from transporting their oil through Russia, and prevent it from being transported through Iran. Russian President Vladimir Putin likely stands to gain from his cooperation with the United States in the war on terrorism; the region is watching to see whether that influence will grow in the oil sector as well.

With these concerns, the oil companies almost unanimously raise their voices in urging the Bush Administration to be more active in the area. In particular, the oil firms would like to see the immediate repeal of Section 907 of the Freedom Support Act, which prohibits direct American aid to Azerbaijan as a result of the Nagorno-Karabagh conflict.

Oil industry says, “Repeal 907”
They say that repeal of 907 would automatically increase American influence in Azerbaijan, and encourage faster development of democracy and more extensive economic reform. A settlement of the Nagorno-Karabagh conflict would significantly ease regional tensions, paving the way for real economic development of the entire TransCaucasus and Caspian Seas region.

Some oilmen are quite vocal about this issue. “We are in the position of aligning ourselves with Armenia, an ally of Russia, and turning our backs on Azerbaijan, a country close to NATO,” says the general manager of an oilrig service company.

“These sanctions hurt American companies’ interests in Azerbaijan. I have nothing against Armenia, but our policy should be equal and fair. No other NATO country has sanctions against Azerbaijan.”

“Section 907 is appalling,” says a general manager of an onshore operating company. “Our position is wrong. There is no logic for it. It is very difficult to convince Azerbaijanis that we are their friends when we have this law on the books. Here, relations and respect between people mean everything. President Aliyev has done everything to accommodate American oil companies, yet all he gets are promises, and no action. It is time for action. Azerbaijanis don’t understand our political processes. They see us as hypocrites.”