ACG Contract: Production on New Conditions up to 2050 (Analytics)

Baku / 14.09.17 / Turan: A significant event took place in Azerbaijan today. The State Oil Company of Azerbaijan (SOCAR) and eight foreign companies signed a new PSA type agreement for the Caspian mega project Azeri-Chirag-Guneshli (ACG).

The History of Signing the New Contract

Azerbaijan signed 34 agreements of the PSA type before, but has never re-signed an agreement on one of the existing contracts.

Then what prompted the sides to take such a step? The peak of production in the framework of the ACG project was recorded in 2010, when 40.6 million tons of raw materials were extracted from the contract area. However, the next two years for Azerbaijan were simply shocking - according to the results of 2012, the volume of production fell to 34.9 million tons. In the same year, in October, for the first time the government of Azerbaijan at its meeting with the President of Azerbaijan sharply criticized the activity of the operator of the international consortium, BP. Soon almost all the main top managers of BP-Azerbaijan were replaced. A new team was formed, which began to stabilize the production.

The statistics of the past five-year plan (2013-2017) shows that, in fact, the average annual rate of decline in production volumes was about 900 thousand tons, and this year, slightly more than 28 million tons of oil will be produced at ACG.

During this period, the foreign partners of SOCAR believed that capital-intensive investments in ACG are needed to stabilize oil production: construction of new production platforms, construction of the appropriate underwater infrastructure and modernization of the existing platforms. To fulfill these financial obligations, the foreign companies required to extend the current contract, so that the invested funds could be returned according to the R-factor (rate of return).

The Azerbaijani side was cautious about the proposals of its partners. The matter is that it was a question of multi-billion capital expenditures, not to mention the operational costs of these facilities. Therefore, it was deemed advisable to step-by-step approach to solving this problem. First, a compromise was reached in the modernization of the existing platforms. Then SOCAR offered to sign a new contract of the PSA type on new terms. The partners did not agree with this, as they thought it was better to continue the old contract, while increasing the dividends to the Azerbaijani side. However, in the end the parties found a compromise and decided to continue the "game according to the new rules."

On December 23, 2016, SOCAR and Azerbaijan International Operating Company (AIOC) operated by BP signed a letter of intent for the further development of the Azeri-Chirag-Guneshli oil block located in the Azerbaijani shelf of the Caspian Sea. In February 2017, the parties began the final phase of the commercial negotiations for the ACG-2 contract.

Why Did They Need to Sign a New Contract?

A. Interests of the state

SOCAR as a defender of the interests of the state, first insisted on signing a new contract, instead of extending the old one signed on September 20, 1994.

First, SOCAR believed that, despite the maximum protection of the interests of the state in the previous contract, all the same, it no longer meets the requirements of the modern period. Present-day Azerbaijan with its capabilities and potential is not the country that was formed on the ruins of the former USSR in the early 1990s. In the period when they signed the contract, the companies took into account all the risks of that period in the agreement and they are still in effect.

Secondly, in the country at that time there were practically no specialists who had international certificates. There were no local companies that would simply perform subcontract work, according to the European standards.

Thirdly, Azerbaijan did not have any financial means to finance even a small share of the State Oil Company within the framework of the "early oil production" at ACG since 1995.

Fourthly, even after the signing of the "contract of the century," there were two attempts of an armed coup (October 1994 and March 1995).

Today the situation is completely different: the country"s currency reserves exceed $ 40 billion, the political situation is stable, although the economy has a single way, but work is being carried out to diversify and develop infrastructure, Azerbaijan has influence in the region and increases its business in the neighboring countries.

While in the first contract the interests of the state were concentrated only on the fact that the investments in the project should be paid off as soon as possible and the state would go to the highest profit bar (80%) accumulated in the State Oil Fund of Azerbaijan, now the state"s focus has changed a little.

The matter is that earlier, within the framework of ACG, the production grew intensively and, in addition to this, oil prices also started to grow since 2000. The revenues were quickly paid off (in mid-2008, the state had already reached the profit level of 80%, although 5% of this was sent for dividends to the Baku-Tbilisi-Ceyhan oil pipeline project, so that it could also make a profit ahead of time). Now the main task is to stabilize the annual production volumes by 2030 at the level of 24-25 million tons, starting from 2020. This is not an easy task, but it is feasible, since there will actually be no intensity of development of the strata. Therefore, within the framework of the new contract, the state will increase revenues from SOCAR and state-controlled enterprises that receive large contractual and subcontract work within the framework of ACG.

This is a very important point. In 2010-2019, a very large financial burden lay on the shoulders of SOCAR under the implementation of projects in Azerbaijan, the region and abroad. It accumulated multimillion-dollar credit debts (when the projects start work, they will be covered with profits) and in the implementation of these projects the state also helped it. Increasing its share in the ACG project from 11.6% to 25%, SOCAR will be able to earn much more money than before. And in the end, this will reduce the state"s burden of supporting the locomotive of the domestic economy.

B. Interests of the companies

One can ask a simple question - why did foreign companies agree to such an offer by the Azerbaijani side? After all, they could continue the extraction to the end of the contract period - December 12, 2024, and then leave it or begin negotiations closer to this time; then the situation might have changed.

However, such options do not work for the oil and gas industry. The fact is that the implementation of capital-intensive projects begins much earlier than the project legally loses its force. In addition, if foreign companies did not take the initiative until 2018, from 2019 - 5 years before the end of the contract, in accordance with the terms of the agreement, they would have to create a "liquidation fund" (annually transfer finance from their profits to this fund in order not to leave effects on the local environment by the time of their departure). In addition, if at that time they began to renew the contract, it would have cost them much more: after all, without advance investments in the project, the production volumes would decrease at a high pace and, accordingly, the revenues would decrease. Then they would have to spend a huge amount of money on the restoration.

In reality, it is advantageous for foreign partners of SOCAR to work in Azerbaijan and develop their business than to go "alone" - to try to find new unfamiliar projects. After all, this takes not only time (years), but also finance. First, the company loses its stable income. Secondly, the company will have to take risks on new projects, since it is unknown how the invested capital will justify itself. And here in ACG they have been present since 1994, working since 1995, mining since 1997, and having the knowledge of the contract area from A to Z.

And still, when in 1994 the contract on ACG was signed, the companies believed that the volume of recoverable oil is not more than 511 million tons. According to data by the end of the first half of 2017, ACG already produced 430 million tons of raw materials, and recoverable residual reserves were more than 550 million tons. According to international estimates, this means a mega deposit. Where is it now possible to find such deposits? And the oil is of high quality...

* The ACG project participants are: British BP (35.78% -operator), American Chevron (11.27%) and ExxonMobil (8%), Indian ONGC (2.72%), Azerbaijani SOCAR (11.65%), Japanese Inpex Corp. (10.96%) and Itochu Oil (4.3%), the Norwegian Statoil (8.56%), and the Turkish TPAO (6.75%).

At ACG, there are 6 production platforms, which are connected via pipelines to the Sangachal terminal near Baku. 90% of the oil produced at ACG is exported to the world markets via the Baku-Tbilisi-Ceyhan pipeline, 10% through the Baku-Supsa pipeline, and about 1% by rail to the port of Batumi.

Specially for Turan News Agency and the website

Ilham Shaban

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