25 Years After the “Contract of the Century”: The Implications for Caspian Energy
When the agreement between Azerbaijan and an international oil consortium was signed on September 24, 1994, it launched the development of the Azeri-Chirag-Guneshli (ACG) oil fields in the deep-water Caspian Sea and, at the same, time signaled the region’s return as a serious oil supplier to world markets. Dubbed “The Contract of the Century” by Azerbaijan’s then-president Heydar Aliyev, the document had implications that went beyond just arrangements with a government for companies to drill for, produce, and sell oil. The $7.4 billion agreement originally had 11 international energy companies (AMOCO, BP, McDermott, UNOCAL, SOCAR, Lukoil, Statoil, TPAO, Pennzoil, Ramco, and Delta) from seven different countries (Azerbaijan, Norway, Russia, Saudi Arabia, Turkey, UK, and the United States).
The investment flows and income resulting from the contract had tremendous positive benefits that boosted the income and helped strengthen the independence of Georgia as well as Azerbaijan. The agreement also demonstrated clear international, especially U.S. and western European, interest in the region’s newly independent countries as they worked to find their way forward after the Soviet Union’s collapse. It signaled Azerbaijan wanted to be a place in which international companies could do business and invest. The restart of the Caspian region’s energy sector would provide an on-going means for those countries to earn revenues that would foster growth and stability, particularly important for those such as Azerbaijan that was in armed conflict with its neighbor Armenia over Nagorno-Karabakh. Finally, it would become the model for future deals and projects, e.g., the Southern Gas Corridor, that would further boost Europe’s and the world’s energy security.
Over the past twenty five years, there have been significant changes in world energy markets, especially in the ability to tap previously inaccessible oil and gas through directional drilling and fracking. Still, the Caspian Basin remains an important oil and gas supplier. Kazakhstan’s Tengiz oil field might be the sixth largest in the world and is the focus of a $36.8 billion upgrade that is expected to boost production by 260,000 b/d to 860,000 b/d by 2022. Bordering Iran and Russia and an oil and gas source for Asian as well as Western markets, the region’s geopolitics remains complex. And while there might be questions about the likelihood of future international mega-energy projects on the scale of the $40+ billion Southern Gas Corridor, the Caspian region has the potential to contribute further to regional and global energy security through smaller projects. Such projects could include a gas pipeline though the Balkans to enhance that region’s energy security and a connection to Turkmenistan to move its gas west.
A Confluence of Oil, International Security, and Politics
The world’s oldest hydrocarbon province — the first modern oil well was drilled near Baku in 1846, some years ahead of Drake’s 1859 well in Titusville in the United States — oil production in Azerbaijan and the Caspian had languished in the post-World War II Soviet Union. Azerbaijan was one of the world’s top oil sources before World War I and an important strategic objective for Hitler in invading the Soviet Union in World War II. After the War, however, the Soviets looked to develop oil deposits elsewhere in the USSR at the expense of Azerbaijan, despite the significance of its hydrocarbon resources. Estimates today put Caspian Basin reserve levels (excluding Iran) at around 48 billion barrels of oil and 292 trillion cubic feet (8.3 trillion cubic meters) of natural gas. New studies and recovery technologies, however, could mean greater levels of oil and gas recovery, just as they have in other established provinces.
By September 2017 when the ACG contract was renewed for another 25 years, some 3.2 billion barrels of oil had been produced in the ACG fields as a result of $33 billion in investments. As important as the geology is in terms of hydrocarbon recovery, it is instructive to look at the above-the-ground aspects and their relationship to the 1994 contract’s impact.
Perhaps the most essential above-the-ground principle the Contract set out is the idea Azerbaijan — and again, by extension, others in the region — recognized that they must be responsive to the concerns of private enterprise, of international corporations, in order to tap, market, and profit from their resources. The contract followed over three years of negotiations with the private-sector partners in which they made clear the legal and other conditions needed for work to proceed. Conditions laid down included the private-sector partners’ right to move capital freely into and out of Azerbaijan. The contract’s provisions, as Azerbaijan’s leadership has frequently and proudly remarked since, were ratified by the country’s parliament in a way that they are enshrined as constitutional law. Thus, the Azerbaijani government used the contract to send a strong signal in 1994 — a time when most of the former Soviet Union was rather chaotic in terms of the conditions for doing business — that it would take the steps needed to attract and keep foreign investors.
A second principle established as a collateral result of the contract was recognition that the countries in the region need to work together. The contract called for building an export pipeline within 54 months. Moving the oil out of Azerbaijan would mean crossing neighboring countries’ territories. Initially, there was an effort to use this necessity to lower Armenian-Azerbaijani animosities by building a pipeline to carry the Azerbaijani crude west to world markets cross Armenia. But Armenia’s government refused. This move, unfortunately, furthered Armenia’s economic isolation in addition to scrapping a measure that could have helped build a needed degree of confidence between Baku and Yerevan.
At the same time, however, cooperation between Azerbaijan and Georgia (as well as Turkey) flourished, given a desire for pipelines that could move the oil west in a way that avoided crossing Iran or Russia. The strong level of cooperation and connectivity that resulted would yield benefits for more than just those two countries. The new pipelines across the Southern Caucasus, dubbed the East-West Energy Corridor, included the Baku-Tbilisi-Ceyhan oil pipeline and the complementary South Caucasus Gas Pipeline that would serve as a model for the Southern Gas Corridor, a U.S. and EU-supported project that will supply natural gas from the Caspian to Europe and lessen European reliance on Russian gas. The corridor also became the path for the Baku-Tbilisi-Kars railroad, which opened in 2017 and provides a new overland link between Europe and the South Caucasus and South Asia, offering a faster surface-transportation route — 10 to 14 days as opposed to as long as 45 days — between Shanghai and Hamburg. Thus the contract sparked a model that would help re-establish trans-Eurasian transport and trade links and help foster greater connectivity within the region that in turn could lead to greater economic growth in the South Caucasus and Central Asia.
A third above-the-ground benefit was the increased revenue Azerbaijan received. In 1994, Armenia had seized the disputed territory of Nagorno-Karabakh as well as seven surrounding Azerbaijani districts; hundreds of thousands became refugees or were otherwise displaced. Domestic political disputes had so plagued Azerbaijan since independence that some worried it could become a failed state. This was a period of domestic unrest in other countries of the region as well, including, for example, the armed conflict in Chechnya. With the contract, Azerbaijan would receive substantial revenues from increased oil production, income that would help stabilize the state budget and stimulate the country’s economy, raising Azerbaijanis’ prosperity and standard of living.
Energy income would provide the means for economic growth and for boosting the standard of living in Kazakhstan as well. The Tengiz, with up to 11 billion barrels of recoverable oil, and the neighboring Korolev field, reportedly provide as much as a quarter of Kazakhstan’s national revenues. Tengizchevoil, which operates the Tengiz and Korolev fields and is a joint venture of Chevron (50%), Exxon Mobil (25%), KazMunayGas (20%), and LukOil (5%), has a workforce that is 85% Kazakhstani. In Baku, BP officials note around 95% of the workforce is Azerbaijani.
Finally, a factor that helped bring about the Contract of the Century was the political and diplomatic engagement and the support of the West, especially of the United States and the United Kingdom. These governments supported their countries’ energy companies as the contract was developed, but they were also certainly interested in the stability, independence, and success of post-Soviet states. Thus, their ambassadors were present at the contract’s signing in Baku, as were the UK Energy Minister and the U.S. Deputy Energy Secretary. Strong U.S., British, and later EU engagement would continue in supporting Azerbaijani and Caspian oil and gas production, including in developing and realizing the Southern Gas Corridor Project. This engagement would also pay off in terms of affording NATO access to Afghanistan via the Northern Distribution Network as well as in helping countries in the region stand up to aggressive neighbors and pursue independent foreign policies.
Anniversaries should be occasions to take stock and think about what’s next, not just for remembering or celebrating past achievements.
Looking forward then, it is essential to recognize how significantly energy markets have changed since 1994. Talk of peak oil supplies is obsolete given the development of fracking and other new technologies that have made oil — and natural gas — deposits, previously thought unable to be commercially tapped, commercially productive. The United States’ switch from a net importer to net exporter due to the application of these technologies is a core aspect of this development. Moreover, while the industrialized west will continue to rely on oil and natural gas for the foreseeable future, demand from this traditional group of consumers seems to have plateaued, especially in Western Europe, and in some cases is slowly declining. At the same time, demand in other parts of the world, especially in China but also in India, continues to rise, and signs are these economies, and to a lesser extent those in Africa, will demand increasing oil and gas supplies even as they look to develop more renewables and employ more energy-saving technologies. While peak oil demand is a current focus for analysts, policymakers, and corporate planners, while many suggest global oil demand might top out by 2040 or somewhat later, few expect a precipitous drop in in the world’s oil consumption. Rather, they expect a gradual decline in its use of oil. Natural-gas demand, too, could peak and then gradually decline but with it continuing to be in demand for power generation and as a key petrochemical feedstock.
With a continued need for oil and natural gas, governments will need to continue thinking about secure supplies, about energy security as a component of their countries’ and populations’ well-being.
So while circumstances are no longer what they were in 1994 or in the opening years of this century, Caspian oil and gas remain important. Signature of a 25-year ACG contract extension in 2017 between Azerbaijan’s SOCAR and its international partners shows continued energy-company interest in the region. Turkey sees its role in the transport and export of Caspian oil and natural gas as a key aspect of its ambitions to be an energy hub. Bulgaria and other countries in the Balkans seek to obtain natural gas from Azerbaijan and the Caspian to provide an alternative to Russian gas supplies and so improve their energy and foreign-policy security. Construction of the Greece-Bulgaria Interconnector pipeline now underway is a key component to advancing this policy. Turkmenistan, considered to have the fourth-largest natural gas deposits in the world, is now primarily dependent on one customer: China. Proceeding with some sort of pipeline or connector to Azerbaijan and ideally to markets further west would give Ashgabat a more secure customer base and additional income as well as contribute further to global energy security. The United States, the EU, and other governments continue to engage to foster access to energy sources in the region, as in other areas of the world, out of national-security concerns.
The bottom line, then, is the process begun with the 1994 contract continues to play in world markets and global energy security as well as in the stability of the Caspian region.