Task Forces


The Southern Gas Corridor – a back-up plan for Europe or a new chance for diversification

By Gulmira Rzayeva, EWB member

Despite the recent low oil price environment and challenges facing those looking to secure major oil and gas investment, work has continued on the $40bn-plus Southern Gas Corridor (SGC) project, which is now more than 50% complete. The SGC initiative will carry 6bn cm/y of gas from the giant Shah Deniz field in Azerbaijan to Turkey, starting in 2018, and about 10bn cm/y to Europe from 2020. Paradoxically, the low price environment has created favourable conditions for investors in the various projects which comprise the SGC programme, as capital expenditure (capex) has reduced and payback could be higher if gas prices recover.

Natural gas from the second phase of development of the Shah Deniz field is principally sold under long-term sales contracts, creating more predictable margins. Moreover, transportation tariffs will be set on a long-term basis. As a result, the revenue base structure of the consortia developing the SGC – an expanded South Caucasus Pipeline through Azerbaijan and Georgia, the Trans-Anatolian Pipeline (TANAP) through Turkey, and the Trans-Adriatic Pipeline (TAP) through Greece, Albania and Italy – reduces exposure to fluctuations in international

In an unprecedented move, the companies comprising the Azerbaijan Gas Supply Company (AGSC) that will sell Shakh Deniz gas have signed long-term gas sales and purchase agreements (GSPAs) with European customers for up to 25 years. This contrasts with the traditional market preference for short and mid-term contracts to ensure flexibility and freedom to diversify supply sources. As a result, AGSC has secured a stake in the Greek, Bulgarian and Italian markets for more than two decades, amid rising competition from traditional pipeline suppliers to Europe and new players such as the LNG sector.

Project financing

Azerbaijan is providing some $12bn to the SGC, of which about $6.5bn has been invested as of December 2017. Despite the low price environment and uncertainties in both the Turkish and European markets (in terms of supply/demand dynamics as well as price volatility, pricing mechanisms, competition etc), it seems that attracting long-term loans and credits for the various aspects of project’s value chain has not been a major problem.

The Southern Gas Corridor Company – created by the Azeri government to manage, consolidate and finance the state oil company SOCAR’s share of funding – successfully placed an inaugural Eurobond to the value of $1bn in March 2016, with an interest rate of 7%. More recently, in March this year, the company sold another $1bn Eurobond, this time with an interest rate of 5.75%. The placings were successful not only due to the SGC’s expected profitability, but also because the Republic of Azerbaijan, acting through its Ministry of Finance, is backing the debt financing by providing an explicit sovereign guarantee.

 The SGC initiative has secured finance from a mix of investors, including the State, international finance institutions (IFIs), commercial banks and debt capital markets. As of end-2016, three main vehicles have provided finance for the project – the issuance of $2.5bn worth of bonds by SGC to the State Oil Fund of Azerbaijan (SOFAZ); equity injections from the Ministry of Economy and SOCAR to the value of $2.4bn to date; and the placement of Eurobonds. SOCAR has also secured $0.6bn (as of end-2016) of revenue from share sales in TANAP (42%) in 2015. The remaining share of SOCAR investment – some $5.5bn of debt – is expected to be raised through long-term loans by 2019.

European market

While the planned supply of 10bn cm/y of Shakh Deniz 2 gas via the SGC is just a drop in the ocean compared to Europe’s total annual demand of 514bn cm in 2017 (up 6% from a year earlier), it will help lessen the region’s dependence on major suppliers such as Russia. It brings gas from new sources, diversifying and ensuring security of supply to Greece, Bulgaria and Italy. Longer-term, it may well be able to do this for the wider regional markets of the Balkans and south-eastern Europe.

To put this in some context, in 2016 Gazprom supplied 21bn cm of gas to Italy. Once the SCG is commissioned, Italy will import 8bn cm/y of Azeri gas – 38% of Gazprom’s share, helping to diversify the market. Meanwhile, Greece, which imported 2.5bn cm of gas from Gazprom in 2016, has contracted for 1bn cm of Azeri gas – equivalent to 40% of Gazprom’s share. In Bulgaria this figure is 36%. Moreover, the long-term care pipeline agreement between Gazprom and DEPA (the public natural gas supply corporation of Greece) expires in 2026, and that with Bulgargaz in 2022.

If these companies have an alternative gas supply source available and the political will, they too may want to reduce imports from Gazprom and dependence on a single supplier. Turkish market Turkey’s natural gas market seems to be the most commercially viable market for Azeri gas, given its geographic proximity and relatively higher prices. However, despite forecasts of rapid domestic gas demand growth from the Turkish state-owned crude oil and natural gas pipeline and trading company Botas and market analysts, demand has actually fallen from May 2014 –with an overall decline of 4% in 2016 to 46.3bn cm/y, according to EMRA (Energy Market Regulation Authority of Turkey). Demand remained at this level in 2017 following the government’s privatisation of Turkey’s electricity production sector and incentives provided for renewable energies and other domestic resources, including coal and lignite.

Looking longer term, Turkey’s gas demand is projected to reach 60–62bn cm by 2030. Such sluggish demand growth means it would be challenging for a decision to be made to bring additional volumes of gas to the market beyond those currently contracted from Shakh Deniz 2. However, Botas’ long-term contracts with its pipeline suppliers are due to expire in the 2020s – Azerbaijan in 2022, Iran in 2026 and Russia in 2021 – and private companies’ contracts with Gazprom in 2021, affecting around 36bn cm/y of gas.

As a result, Turkey may face a gas supply shortage depending on the volumes agreed under long-term contracts. Such a gas shortage could not only put Turkey’s energy security at risk, but also affect the internal political situation. Gas from Shah Deniz 2 will replace some of these volumes.

Azerbaijani domestic market

Over the last two to three years, Azerbaijan has been facing a domestic gas shortage due to ongoing delays in the start-up of the Shah Deniz project. However, the issue will be partly resolved when the project is commissioned next year. Domestic gas production will also increase once the Total-operated Absheron field comes onstream in 2019. Production from the high-pressure field will be around 35,000 boe/d, including a significant volume of condenstate.

The gas will supply Azerbaijan’s domestic market. According to Total, this first phase of production will also enable a dynamic appraisal of the field for future phases of development. Volumes will be further bolstered once the recently discovered Umid/ Babek structure is put into production. Azeri gas demand is expected to grow at a slow pace to reach around 13–14bn cm/y by 2025, up from the current 11bn cm/y. The biggest gas consumer in the country is the state electricity production utility Azerenergy. Demand from gas-fired power plants is forecast to grow slowly, as a result of government energy policy aimed at reducing gas use in the power sector and replacing it with other domestically produced fuels. It is unlikely that demand will grow significantly from the household sector as 92% of the country has already been gasified, while demand growth from new housing is expected to be modest. Meanwhile, a number of gas-intensive projects such as SOCAR’s carbamide plant, polyethylene plant, oil and gas processing and petrochemical complex (OGPC) project and oil refinery modernisation programme will boost demand in the industry sector. However, this is not expected to happen until the second half of the 2020s when the new projects are planned to come onstream. Evidently, when it comes to major investments like the SGC it helps to be forward looking and optimistic.

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