Vol. 4, No. 13 (July 01, 2011)

Azerbaijan, Turkey, and energy markets: The evolution of a complex relationship

Samuel Lussac
Centre Emile Durkheim
Sciences Po Bordeaux

Over the last 20 years, Azerbaijan and Turkey have experienced a complex evolution of their relationship in the energy sector, with now one and now the other taking the leading and with shifts sometimes coming because of changes in each of their capitals but more often happening because of pressure from third countries.  The very complexity in this sector helps to provide texture to the overarching spirit of cooperation between the two Turkic states.

After Azerbaijan emerged as an independent country, Turkey was among the very first outside powers to get involved with Azerbaijan’s energy sector.  In early 1993, the Turkish state company BOTAS produced a map of potential export routes for Azerbaijani oil and gas and argued that the one with the greatest potential was between Baku and the Turkish port on the Mediterranean, Ceyhan.  At the same time, the other Turkish state oil company was part of the international consortium negotiating for the production of the Azeri-Chirag-Guneshli fields.  

At that time, Turkey believed that it could benefit from the pro-Turkey and pro-Western foreign policy of President Abulfaz Elchibey, but his replacement by Heydar Aliyev in June 1993 changed the situation.  President Aliyev insisted on a more balanced foreign policy, especially in the area of energy; and Azerbaijan thus stopped viewing Ankara as its only strategic partner.  As a result, TPAO obtained less than a two percent share in the consortium of AIOC, a blow for Ankara’s policies and one which many felt pointed to the direction Azerbaijan’s foreign policy was likely to take (Hemming 1998).

Turkish leaders were especially resentful that President Aliyev planned to allocate five percent of AIOC to the Iranian oil company NIOC, a share more than twice the size of the one Turkey was being given.  As a result, Ankara decided that its best hope for the future was to focus on transport routes, and in early 1995, it became a leading advocate of exporting Azerbaijani early oil through Georgia, an approach that Turkish officials believed would lead to the ultimate implementation of the Baku-Ceyhan project.  

Baku’s original AIOC plan collapsed because of pressure from the US government and the threat of US-based companies to pull out of AIOC if an Iranian firm were to be part of it.  As a result, in early 1995, SOCAR sold half of its share in AIOC, with TPAO buying half of it, thus raising its AIOC share to 6.75 percent.  But that still left open the question of the pipeline route that would carry the oil to foreign markets.

The founding president of AIOC, Terry Adams, favored using both the Baku-Supsa and Baku-Novorossiysk pipelines, even though after February 1995 the institution had to argue in public for the Russian option (Adams 2009). And after almost a year of tense discussions, President Heydar Aliyev opted for such a compromise and asked that early oil be sent both north and west.  That constituted a major victory for Turkey; indeed, one could describe this decision as the high point of their energy involvement in Azerbaijan.  Building on that success, Ankara succeeded in obtaining a nine percent share for TPAO in the giant gas field of Shah Deniz in June 1996.

As a result of these maneuvers and of Azerbaijan’s growing income, Turkey became more an energy partner with Azerbaijan than an energy investor in that country.  In November 1999, Azerbaijan, Georgia and Turkey signed an Intergovernmental Agreement on the construction of the Baku-Tbilisi-Ceyhan oil pipeline.  Construction began in 2004 and was completed in June 2006.  In the meantime, this new relationship opened the door for a gas line—the South Caucasus Pipeline (SCP)—thus paving the way for a new Silk Road. 

While this East-West Energy Corridor reinforces political and economic cooperation between Ankara and Baku, it has not led to increasing Turkish investments in Azerbaijan.  Turkey has been purchasing up to 6.6 billion cubic meters of Azerbaijani gas a year, but Turkish companies play a largely passive role in Azerbaijan.  Having the smallest share in Shah Deniz, TPAO never had a large voice on strategic matters.  The situation has deteriorated since Ankara and Baku started to renegotiate the 2001 gas contract.  Because TPAO is a state-owned company, other members of the operating consortium—led by BP—asked it to stay away from the discussions.  As a result, within TPAO, no one is specifically in charge of Azerbaijani gas transportation issues anymore.

In the last few years, Turkish investments in the Azerbaijani energy sector have been quite limited.  The two largest state-owned companies—BOTAS and TPAO—are not investing at all.  Frustrated with the outcomes of Azerbaijani oil prospects, these companies are now looking at Iraq.  BP and Statoil respectively own 25.5% of the Shah Deniz field, while the Iranian NICO and the Russian Lukoil have a 10% share each in it.  According to this contract, it was planned that Azerbaijan and Turkey would renegotiate the purchasing price of Azerbaijani gas a year after the delivery began.  This process thus started in April 2008. 

Because of dry holes in Azerbaijan in the last decade, many of the majors have left the exploration area.  Turkish companies have followed such a trend and rather focused on other components of Azerbaijan’s energy sector.  TEKFEN Construction, for example, has been regularly awarded contracts for the building or rehabilitation of energy infrastructures in Azerbaijan.  It most notably built the gas export terminal of the SCP in Sangachal in 2007.  A transportation company—IKRA—also acquired AzTransRail in 2006 (Lussac 2010).  This Azerbaijani firm manages the transport of oil through the Baku-Batumi railroad.  Despite this and despite increasing cooperation between Baku and Ankara, new Turkish investments in the Azerbaijani energy sector have remained relatively small during the last few years.

There are two main reasons for this outcome.  On the one hand, only upstream gas is still attractive in Azerbaijan, and no Turkish company has the technological capacity or financial resources to produce gas in the challenging Caspian environment.  And on the other hand, Turkey’s other neighbors have become more attractive investment areas, with Iraq having become a major site of Turkish investment given its huge gas potential.

Turkey’s limited investment in Azerbaijan has followed limited Azerbaijani investment in Turkey for the first decade of their relations.  Until about 2005, Azerbaijan was unable to invest in Turkey, especially in the energy sector.  Until 2000, most of the oil payment bonuses were allocated to compensate state budget deficits (Bagirov 2007).  And after the State Oil Fund of Azerbaijan began functioning, some oil revenues were used to support the Azerbaijani economy.  But, becoming the largest contributor to the state budget, SOCAR used its increasing net profits to expand beyond Azerbaijan’s borders.

SOCAR first started to invest in Georgia, but in the last several years, it has been investing more often in Turkey.  In late 2006, for example, it formed a strategic partnership with Turcas Petrol, which is deeply involved into the Turkish petroleum distribution market.  The two companies then set up a joint-venture called STEAS (SOCAR Turcas Enerji AS) in order to pursue opportunities in Turkey.  The first of these came in July 2008 when the Turkish government decided to privatize half of the petrochemical company PETKIM.  A consortium consisting of SOCAR, Turcas and the Saudi company Injaz sought to purchase a 51% share, but its bid of $2.04 billion fell short.  Subsequently, however, the Turkish Privatization Administration (OIB) decided to reverse its decision and gave this consortium the victory, even if Injaz left the project.

PETKIM is supposed to become the cornerstone of Azerbaijani investments in Turkey.  STEAS has launched an ambitious business plan for the company for the next decade, including the construction of a new refinery in Aliaga, with a capacity up to 200,000 barrels a day.  This four billion US dollar plant should enter service in 2014.  PETKIM will also diversify its petrochemical production in the hopes of earning the largest market share in Turkey.  STEAS fits into a larger strategy aiming at making SOCAR the leader in petrochemicals in the Black Sea region.  In April 2010, President Aliyev issued a decree incorporating the state-owned petrochemical company Azerkimya into SOCAR. 

Azerbaijan thus hopes to improve the efficiency of its company.  In this perspective, it appointed Mukhtar Babayev, former vice-president of SOCAR in charge of ecology, as the new president of Azerkimya.  By 2020, this company should closely cooperate with PETKIM, thereby optimizing the cost and production of petrochemicals in the region.  In the meantime, SOCAR Trading, established in December 2007 in Switzerland, is in charge of purchasing naphtha for both firms.  In this way, PETKIM stands in the middle of an ambitious SOCAR strategy for the petrochemical market in the Black Sea.  Thanks to its partnership with STEAS, SOCAR may play an even stronger role in the Turkish energy market in the out years. 

In December 2010, the Turkish Energy Market Regulatory Authority (EPDK) granted a 30-year gas marketing license to STEAS.  This is the logical outcome of the memorandum of understanding signed between SOCAR and BOTAS in early June 2010.  It then stated that the Azerbaijani company would be allowed to deliver up to 1.2 bcm of gas a year to PETKIM and the Turkish domestic consumers.  The remainder will then be sold by STEAS to Turkish consumers.  This is a rare privilege for a foreign company while local Turkish companies and state monopoly still dominate the Turkish gas distribution market and is a reflection of the difficulties in negotiations about Azerbaijani gas supplies to Turkey and Europe.  Azerbaijan would have linked low purchasing gas prices to Turkey and the right to directly sell gas to Turkish and European consumers.  It obtained both according to the memorandum.  Therefore, Azerbaijan is experiencing a new dawn in Turkey.  After settling down in Georgia, SOCAR is likely to hold an increasingly active role with the Turkish energy markets, either in the refining sector, the petrochemical one or even the gas one (Roberts 2010).

The shift in the investment practices in both Azerbaijan and Turkey reflects the new economic position of these countries.  After failing to economically establish in the post-Soviet space, Turkey has progressively limited its energy investments in this region, favoring cooperation with the hydrocarbons-producing states.  In the meantime, recovering from economic and political meltdown, Azerbaijan has begun to invest in the energy sector beyond its borders, including in Turkey.  From a Turkish investments recipient, Azerbaijan has been transformed into an investment-maker in Turkey.  Such a trend falls into the framework of the rising regional economic leadership held by Baku in the Black Sea region.  It also lays the basis for a new relationship based on energy partnering.

With the completion of the BTC pipeline in 2006, Azerbaijan and Turkey became energy partners.  Subsequently, the SCP pipeline helped them to reach a new level of cooperation with SOCAR being allowed to sell 1.2 bcm a year to Turkish consumers through its STEAS and 2 bcm a year to either Bulgaria or Syria.  The next step will be the implementation of the Baku-Tbilisi-Kars railroad and the Southern Gas Corridor.  The former is scheduled to be completed by late 2012.  It aims at linking Azerbaijan, Georgia and Turkey and, more broadly, Central Asia and Europe.  Mostly funded by Azerbaijan, this project will reinforce the energy partnership between Ankara and Baku. 

At present, three major projects—the Interconnection Turkey-Greece-Italy, the Nabucco project and the Trans-Adriatic Pipeline—are underway that will further link Azerbaijan and Turkey in the energy sector.  All of them require an expansion of the capacity of the SCP pipeline to at more than 20 bcm a year, and that too will increase the energy partnership between Azerbaijan and Turkey.  In this situation, while it may be unlikely that Turkey will be a major investor in the Azerbaijani energy market anytime soon, Baku almost certainly will continue to play an active role in that market in Turkey. 


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