Friday, 28 June 2013

Russia and Azerbaijan Terminate Baku-Novorossiysk Agreement

Published in Field Reports

by Mina Muradova (06/26/2013 issue of the CACI Analyst)

Russia and Azerbaijan have recently terminated two strategic agreements. In May, the Russian government terminated a 1996 deal to transport oil from Azerbaijan through its pipeline system. The agreement on transporting Azerbaijani  oil via the Baku-Novorossiysk pipeline envisaged the transit of at least five million metric tons of oil a year, with a tariff of about US$ 15.70 per metric ton.

However, the State Oil Company of Azerbaijan Republic (SOCAR) has pumped only about two million metric tons of oil in the past two years, and planned to further reduce that quantity to 1.6 million metric tons this year. Russia’s state-run oil pipeline operator Transneft said it had lost about US$ 50 million a year because the pipeline was operating at half capacity. Russian and Azerbaijani companies have started talks on introducing a new pricing system for next year, but the current tariff will remain in force for the remainder of this year.

The Deputy Head of Azerbaijan’s Presidential Administration, Novruz Mammadov, told local media that “the transportation of oil at the moment is simply not profitable to both parties in terms of economic and commercial viability.” He noted “we accept the decision of the Russian Federation as perfectly normal.” Earlier this year, official Moscow announced the termination of another agreement regarding the lease of the early warning radar station “Darial” in Gabala region, Azerbaijan. Russia leased the radar station since the collapse of Soviet Union and the last agreement expired in December 2012 after 10 years. Media reported that the sides failed to agree on a rent fee.

Recent developments in bilateral relations between Russia and Azerbaijan led to assumptions that tensions are rising between the two countries, but Russian Foreign Minister stressed that “there are no political tensions between us” and that the issue of the Baku-Novorossiysk pipeline was purely a business decision. “Any deterioration in relations between the two countries is out of the question,” Lavrov said. “The situation over the Gabala radar station is known – we failed to agree on the price. Other claims are speculation and we are not engaged in speculation.” Lavrov stressed the lack of sufficient oil coming through the pipeline as the main reason for the decision, not anger over the Gabala radar station, reported. “As to the contract on the Baku-Novorossiysk pipeline signed in 1996, originally the sides aimed to fill up the pipe and the rate was calculated inappropriately … In fact, the pipeline was not fully filled up, which caused problems for the Russian side. So, this is a purely economic matter. Possibly, tariffs will be reconsidered.”

At the same time, Azerbaijan has long complained about losing money on the pipeline due to Transneft’s tariff of US$ 15.70 per ton of oil transported through Russian territory to the Black Sea port of Novorossiysk, though it has since developed cheaper pipeline and railroad routes to neighboring Georgia. Analysts say that the prices Baku can obtain for the oil are further limited because Russia mixes the high-quality Azeri Light product with its own heavy sour Urals brand at Novorossiysk, thus selling it at a discount to the benchmark Brent crude.

SOCAR stated that the decision of the Russian government to terminate the agreement will have “no negative impact on the supply of Azerbaijani oil to the world markets,” due to the fact that Azerbaijan has established a reliable and diverse system of oil and gas pipelines. “Achieving an agreement between the parties requires consideration of a number of commercial issues. First of all, supply of the necessary amount of oil requires the establishment of an oil quality bank,” SOCAR’s President Rovnag Abdullayev told journalists. He confirmed that Azerbaijan also sustained losses during the transportation of oil through Russian territory because Azerbaijani  Light oil is exported from Novorossiysk under the Urals brand. “The company will continue oil deliveries [via Baku-Novorossiysk] in terms of the economic suitability of new [contract] conditions for SOCAR … Otherwise, deliveries won't be implemented,” Abdullayev said. Abdullayev also claimed that SOCAR is ready to discuss other options with Russia, in particular the possibility of oil shipments from third countries and other oil transportation schemes. “There will be no problems with oil exports. We have the Baku-Tbilisi-Ceyhan route, Baku-Supsa and a railway,” Abdullayev said, referring to existing pipelines to Turkish and Georgian ports on the Black Sea.

Transneft also said it might offer a new contract to Azerbaijan based on a “pump or pay” principle. A new contract would have to set a tariff, and under the principle of pump or pay Azerbaijan would pay even if it does not use the designated amount of capacity, and has been refused by Azerbaijani high-ranking officials. “It is up to Russia. If they do not like these conditions, for us there is no problem. We have nothing to lose,” Azerbaijan’s Energy Minister Natik Aliyev told reporters on the sidelines of a conference in Vienna. According to Aliyev, “We do not have enough oil [to pump the Russian pipeline] … the most important is to fill our own pipelines, not to go to Novorossiysk."

SOCAR made a counteroffer by suggesting that Russia uses the Baku-Novorossiysk pipeline in reverse mode. “The option of reverse use will be discussed in talks between SOCAR and Transneft. The pipeline will transport Russian oil to Azerbaijan. This oil can be refined in the future at a new petrochemical complex to be constructed by SOCAR, or exported in other directions,” Abdullayev said.

Russian oil is now considered for the oil refinery that SOCAR is planning to build in Tokmak, Kyrgyzstan. Supplies from Russia are possible without additional infrastructure, as Russia is currently the main oil supplier to Kyrgyzstan.

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