Azerbaijan Set to Sell Gas to Ukraine

Ukraine plans to build a liquefied natural gas (LNG) port on the Black Sea for gas that it plans to buy from Azerbaijan. The two countries’ foreign ministers recently met in Baku with a view towards implementing this and other economic and energy agreements reached during Azerbaijani President Ilham Aliyev’s recent visit to Ukraine. The project is part and parcel of Ukraine’s strategy to diversify its sources of energy supply away from Russia, as the Nord Stream pipeline comes on line and Russian gas exports to Europe begin to shift to that corridor.

BACKGROUND: Russia has cut off gas exports to Ukraine three times in the last six years. It will in years to come re-route a significant fraction of its gas exports to Europe, which currently transit Ukraine, via the just-completed Nord Stream pipeline under the Baltic Sea to Germany. Nord Stream’s full capacity is 55 billion cubic meters per year (bcm/y), of which Russia says 20 bcm/y will come from gas currently transited through Ukraine. Ukraine is seeking revision of an industrial agreement obliging it to buy fixed quantities from Russia every year, and also seeks to decrease its gas imports from Russia by diversifying suppliers and developing domestic sources.

As part of that strategy, Kyiv has agreed with Baku to import LNG liquefied on the Georgian coast. A first stage of the project may be limited to a capacity of 5 bcm/y, but subsequent stages foresee a doubling to 10 bcm/y. If achieved, the doubled capacity would represent almost 20 percent of the country’s gas balance. The terminal’s location has not been definitively fixed. There are several possibilities, but the Yuzhnyi port near Odessa is high in the running. It is situated not far from the southeastern terminus of the Odessa-Brody (now also called “Sarmatia”) oil pipeline. Ukraine also signed a Memorandum of Understanding (MOU) with TNK-BP to spend between US$ 1 billion and US$ 2 billion to explore and develop shale gas in the country. The project has the potential to produce up to 5 bcm/y.

An MOU already exists for the Azerbaijan-Georgia-Romania Interconnector (AGRI) project that would export LNG to Romania by constructing a liquefaction plant on the Georgian coast, probably at Kulevi, and a re-gasification plant in Romania at Constanta. Despite the possibility of further connectors taking the gas to Central Europe, the volumes projected are not great – a maximum of 7 bcm/y of which Romania would off-take 2 bcm/y. Also on the drawing boards is a project for compressed natural gas (CNG) to Bulgaria for up to 8 bcm/y.

IMPLICATIONS: None of these trans-Black Sea projects, or any of them together, would be a substitute for high-volume pipelines such as Nabucco and White Stream, and the Azerbaijani leadership knows this. However, official Baku is genuinely sympathetic to the countries that suffered from their dependence on Russian gas transited through Ukraine when Russia cut off that supply twice in mid-winter, and it wishes to alleviate that dependency. In this same line, Azerbaijan signed a significant pact with Georgia in November 2008, guaranteeing to supply Georgia’s natural gas consumption requirements through 2014. Moreover, with the confirmation of volumes in the newer Umid and Absheron strikes this year, it is not out of the question that Azerbaijan will be able to turn all these MOUs into actual supply contracts and to satisfy them, if the CNG and LNG implementation costs are not excessive. This is a significant issue, because the Shah Deniz Two consortium is investing over US$ 20 billion in field development and is not about to subsidize technologies for such purposes.

Another reason why Azerbaijan has been seeking to multiply potential gas export routes is that negotiations with Turkey over transit of larger volumes of Shah Deniz Two gas to Europe (and for domestic Turkish consumption) have dragged on over the past two years. However, the negotiations now seem to be on the road to completion, since the countries’ two presidents met at the end of summer and gave their respective delegations instructions to bring them to conclusion. One problem from the Turkish side at least in the past was that the state company, Botas, was dragging its feet. This is largely because the Ankara government’s privatization and liberalization program in the electricity sector, the growth of which is driven by increasing natural gas imports, disadvantages Botas which is losing its dominant market position and finds itself financially squeezed as a result.

In late October 2010, Azerbaijan’s and Ukraine’s heads of state created a joint working group tasked with drafting a strategic agreement for increasing energy supplies of both oil and gas, from Azerbaijan to Ukraine. The two countries are cooperating in the Euro-Asian Oil Transportation Corridor (EAOTC), which involves reversing the flow of the Odessa-Brody Pipeline (OBP, now also called “Sarmatia”) back to its originally planned southeast-to-northwest direction. A trial shipment was completed last year, arriving in Mozyr, Belarus, which can use the quantities and also transit refined products to Europe. After upgrading, the system should be able to transport about 300,000 barrels per year. The arrangement is signed and contracted to continue through the end of 2013. OBP aside, Aliyev announced that Azerbaijan had supplied over 50 million barrels of oil to Ukraine this year and sought to increase that quantity in the future.

CONCLUSIONS: Azerbaijan and Ukraine have been considering how to re-invigorate the GUAM cooperation process for the last several years, but without much success until now. GUAM is a consultative forum established by Georgia, Ukraine, Azerbaijan, and Moldova in October 1997; Uzbekistan was a member from 1999 to 2005. GUAM never had any significant permanent organization until its headquarters opened in 2009 in Ukraine. The main working body is a collection of coordinators, one from each participating state, tasked by the countries’ respective foreign ministries. There are also a handful of expert working groups in various stages of dormancy. With Vladimir Voronin having recently left the presidency of Moldova, Azerbaijan and Ukraine may now wish to consider using GUAM as a forum to coordinate the four countries’ policy views on and implementation of the projects included in the EU’s “Interstate Oil and Gas Transportation to Europe” program (INOGATE).

For this purpose, Azerbaijan might consider becoming at least an observer, like Georgia, in the European Energy Community, where Ukraine and Moldova are already contracting parties. Such a move would enable Baku to participate more integrally in INOGATE’s project to strengthen its own Technical Secretariat, which like that of GUAM is located in Kyiv. This would make sense since INOGATE has become the secretariat of the 2004 Baku Initiative, which launched strategic cooperation on energy transport between the EU on the one hand, and the wider Black Sea and Caspian Sea region on the other.

Originally published on Central Asia-Caucasus Institute Analyst.