Azerbaijan International

Winter 1995 (3.4)
Page 39

Challenges of the Present
Promises of the Future
The First Year

by Terry D. Adams

AIOC's President, Terry Adams, addressed the Conference, "Investment Window for Azerbaijan" organized by the Adam Smith Institute in London on November 30th. More than 200 foreign business representatives were present as was President Heydar Aliyev and other high-ranking Azerbaijan officials.

Adams elaborated on AIOC's vision for Azerbaijan and about the lessons that the company had learned during its first year of operation.

Oil in Azerbaijan is a very mature industry. In fact, Azerbaijan has the oldest petroleum industry in the world. By 1870, 4 billion barrels of oil had already been discovered. Now 120 years later, the actual proven reserve of the Southern Caspian basin is 17.5 billion barrels.

To put this in perspective, this basin is equivalent to currently proven reserves in the North Sea. Furthermore, there is still much more potential which has yet to be tested. The basin geology is relatively uncomplicated. There are deep structures, large traps, and clean deltaic sandstone reservoirs containing high quality oil.

The possibility of existing reserves actually being doubled is quite realistic. This basin promises a substantial future potential which will bring new oil into world markets at a time when there will be a significant gap between supply and demand.

Dr. Tom Hamilton, President of Pennzoil, once remarked, "When the politics are complex, keep your geology simple". The geology of the South Caspian is simple. The technical risks are low and the conventional technology that is currently available can be used to develop these resources quickly. It's a straightforward technical challenge in the context of a very complex political and commercial environment.

Among which is the running of a company like AIOC which has its own unique complex diversity. We have 11 participating companies which represent six national interests (US, UK, Norway, Turkey, Russia, and Saudi Arabia), each of which introduces a new dimension and particular challenge for management.

On the other hand, this mix of companies brings geo-political strength. We are looking at first-class companies which have achieved international and global reputations. Naturally, they jealously guard their reputations and intend to keep them.

Their collective commitment to this project brings a high degree of investment confidence to Azerbaijan both now and for the future. The full cooperation of SOCAR (State Oil Company of Azerbaijan Republic) has ensured that AIOC can move forward quickly.

Super Giant Field
AIOC is developing three fields, Chirag, Azeri and the deep water portion of Gunashli. (The northern end of the structure, Gunashli shallow water, is already under production by SOCAR). It's worth remembering that the world's first offshore technology was developed in Baku in the 60s. The West expanded upon this foundation and advanced it. So AIOC has entered an operating area where oil industry traditions are strong. Azerbaijanis have their own ways of doing things; and, likewise, we do, too. Nevertheless, I truly believe that both approaches can be brought together for the benefit of the whole to create new strength as we move into the future.

The Azeri-Chirag-Gunashli structure itself is long and narrow and quite significantly compartmentalized; but it is geologically relatively simple. Currently, it has a proven reserve believed to be 3. 8 billion barrels. This is clearly a super giant oil field by any world standard. And at this point of time, with the maturity of the oil industry at large, for us to gain access to such a prodigious field is quite a unique investment opportunity. That's what drives this project forward.

There are some technological challenges: the sea bed is complex and the geotechnical risk high. Mud volcanoes, high seismic activity, and shallow gas are present. But again, with modern technology, we can overcome these problems and develop these fields in a very straight forward manner, under a carefully phased development plan. This is the vision that was created for AIOC in the beginning and it is the business plan we are following.

The "Minimum Obligatory Work Program" will take us up to 1997. In 95-96, AIOC will spend some $220 million in today's dollars to appraise the field size through seismic and appraisal drilling, and to ascertain current "bankroll reserves" so we can be highly confident before embarking on "full field development". The program also lets us begin working in Azerbaijan and start building up a critical infrastructure with SOCAR, before "full field development". Environmental base line surveys are also included in this program.

The Goal of "Early Oil"
Perhaps, one of the most attractive options that we were given when we signed the PSA (Profit Sharing Agreement) last year, was the possibility of doing an "early oil" project. Although the project is really quite small, it still involves an investment of some $600-$700 million and will produce between 80,000 to 100,000 barrels a day. In global terms, it won't have much impact. But what it does for AIOC is two things. First of all, it teaches us how to work in what is a very new operating environment, giving us a chance to really get to know our partners in SOCAR. We'll have the chance to cope with real problems before we have to confront the big issues in "full field development" when there are expenditures up to $8 billion.

Secondly, "early oil" is a model by which AIOC can demonstrate to the business community at large that such projects can work in Azerbaijan, and that we are capable of exporting high quality oil quickly to the Western markets. Our project is based on bringing existing infrastructures up to Western insurable standards.

Major oil
The next phase following "early oil" will be "full field development". This is when the major expenditures will increase as major technologies are introduced. The timing of the front end of "full field development" will be dictated entirely by access to a new regional pipeline. If the pipeline can be selected and constructed early, we have the flexibility to accelerate investment. Should it be delayed, we can also defer our investment. Of course, there is a very strong commercial and political motivation to complete "full field development" as early as possible.

The commitment coming from both the governments in the region, as well as the governments of the shareholders involved, clearly reflects the importance that is being placed on finding a major pipeline solution to export oil from Azerbaijan.

Looking Back on 1995
What have we achieved so far this first year? I think we've proven that we can work successfully in Azerbaijan and with our partner, SOCAR.

We are using conventional technology for a conventional project. We have an $8 billion investment planned for this project. This is the challenge and opportunity for new business that such a flagship project will attract. A reasonable "rule of thumb" suggests that for every dollar AIOC puts into the local economy, there will be another $3 invested in the community chasing that $1 to build up the general infrastructure and services. This will surely bring prosperity and success to this rather remarkable and very unique country.

Azerbaijan Production Profile
Azerbaijan Production Profile (Exhibit 1) shows the existing production of some 180 thousand barrels a day which is now in decline. The "early oil" development wedge will provide the necessary stop gap on that production profile until AIOC gets involved with "full field development". AIOC will be able to produce 700-800 thousand barrels a day at peak. Likewise, production from other oil projects will follow. Conservatively speaking, we can say that in the first decade of the next century, if the regional infrastructure gets built, Azerbaijan should be producing 1-1.5 million barrels a day. This all depends on when the major pipeline is introduced to take main oil out of the region to the West. If it is built earlier, this will benefit everyone.

The Supply Gap
A conventional global "supply demand" forecast has been developed. Though not attributable to any one source, it is based on a variety of predictions from various Think Tanks, such as CERA (Cambridge Energy Research Associates). The forecast shows that the current period of both global demand and global supply is 68 million barrels a day.

Currently, because there is excessive capacity, the prices are being kept down; but as time passes and we get closer to the later years of this decade, a supply gap is expected to develop. By 2000 this gap is expected to become quite significant. At that time, mature fields in the North Sea and Gulf of Mexico are expected to begin to decline. That's when Azeri oil should kick in. So both the timing and the demand for AIOC production on a global scale is particularly well positioned.

But this picture is not without unknowns. Caspian oil will have its own competitors. OPEC (Organization of Petroleum Exporting Countries) could start re-investing in its own tremendous potential. Nevertheless, in terms of new investment, you can see why this Consortium came together, and why there is accelerating interest in offshore Azerbaijan.

Export Pipeline Options-Where?
None of this works, however, unless we solve the critical question of export. That's what motivated AIOC to explore "early oil". AIOC is not producing "early oil" just to sell in local markets. "Early oil" is meant to prove that we can actually reactivate an export system to Western markets via the Black Sea.

There has been tremendous speculation about what our company is doing. Frankly speaking, I find it rather entertaining because much of what I read is far from reality. When we originally looked at the offshore project, Chirag 1, we began examining two existing potential export infrastructures to the north (Russia) and to the west (Georgia). For the first six months of our operation, we studied whether either of these two routes was technically feasible and commercially viable or not. A phenomenal amount of technical work went into assessing both routes.

Choosing Two Routes
On October 9th, AIOC's management met in Baku and announced their decision which has been described by "Time Magazine" as a "judgment of Solomon" since we elected to use both routes simultaneously. Working within the complex geopolitical environment in the Caucasus, we decided that having two viable export solutions was clearly the most effective way of press forward.

This week (November 27) AIOC's lawyers are in Moscow, finalizing agreements on the northern route. Tomorrow, the government of Turkey together with SOCAR , AIOC, and the newly formed Georgia International Oil Corporation (which was set up in Tbilisi a month ago) will meet in London to discuss the western route.

Major Pipeline
But the long term solution for exporting oil must be actively investigated over the next 18 months. Our vision is for a pipeline system to be constructed as an over-sized modern pipeline system with all its technological benefits. It needs to be a low risk operation, capable of transporting high volume at low tariffs to a deep water port so we can achieve the most effective netback prices.

Two key issues have to be recognized in any export solution. The first relates to the congestion in the Bosphorus. With 17.5 million people living in Istanbul, the environmental risks arising from a catastrophic accident is not just political posturing, it is a real agenda in Turkey and it must be recognized. The second issue concerns trans-shipment in the Black Sea. Cost, efficiency and increased environmental risks are inherently involved.

There are numerous options for the major route. What does AIOC prefer? There has been considerable speculation in the press. In the long term, we need access to a deep water port in the Mediterranean. To bring major oil into the Aegean introduces other environmental complexities for this delicate area.

AIOC has 18 months to determine what should be done. The press will continue to speculate, but our commitment under our PSA is to find the optimum solution which meets all technical risk requirements, that is commercially viable, and in the best commercial interests of our shareholders. Most importantly , the solution must meet the geo-political aspirations of all the countries in which we work and through which the oil must transit.

But there is one critical point which must always be recognized. In any solution, Baku is the controlling node. And the interests of the Government of Azerbaijan are paramount in any regional decision that is to be taken.

Lessons Learned
What have we learned this past year working in Baku? We've learned alot. And I've personally learned a lot. We have become very close partners working with SOCAR. I think we're beginning to understand each other. You've already heard a lot at this Conference about the problems that Azerbaijan is facing. But the problems have to be put in their historical and geographical context.

Azerbaijan is a small country with a population of only 7 million people. It has an oil reserve potential comparable to the North Sea. Given peace and prosperity, the probability for success is high. The opportunities are tremendous. We are dealing with a highly educated and very cultured society. There seems to be an infinite supply of musicians and artists in Baku that perform at levels directly comparable to the best in the West. Baku is really quite a remarkable environment in which to work and live. Educational levels are high; intellectual levels are strong. We must be sensitive to these extraordinary achievements and to the sense of pride they bring.

The real challenge is to develop a new business paradigm. We're introducing a Western paradigm into an entrenched Soviet system. Hopefully, (but not just hopefully, because we already seeing it develop) a new paradigm will emerge whereby we'll be able to work together and work together well.

Language is important. But not just language, a deep understanding is needed. It's very easy to misinterpret ideas and to be misunderstood ourselves. The possibilities for confusion are legion. What we take for granted in Western business is quite new in Baku. But attitudes are changing as many young people are becoming highly proficient in translation and interpreting.

When you work in this environment, you soon learn that patience is truly a virtue. Understanding, listening and waiting. That's what you have to do to succeed. Nor is waiting such a bad policy when you don't fully understand what is going on around you.

Azerbaijan is going through a period of phenomenal change. When AIOC got started last year (January 2, 1995), there were only four of us sitting in this office in Baku. Today we employ a staff of 300. We've already invested some $100 million. An incredible amount of technical and commercial work is being done both in AIOC and SOCAR and through external support from a wide variety of organizations which have already established themselves here in Baku.

I think this first year has shown that Westerners can work successfully in Azerbaijan. AIOC and its owners are confident in the future. The moment that first barrel of "early oil" reaches a Black Sea terminal, our confidence in this country's future will be assured.

From Azerbaijan International (3.4) Winter 1995.
© Azerbaijan International 1995. All rights reserved.

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