“Structural changes in the international oil and gas industry that came to the foreground in the mid-2000s
In the 2000s, a new configuration began to emerge in the global economy, which led to significant changes in the competitive landscape of the international oil and gas industry.
China’s growing economic power drove up prices for oil, gas and other natural resources, which, after a short-lived decline during the 2008 international financial crisis, swiftly recovered thanks to continued economic growth, monetary easing policies and capital markets’ support for pressing ahead with globalization. Accordingly, the economies of resource-rich countries also grew stronger, and the distribution of power in the oil and gas industry began to shift from the former undisputed dominance of Western majors to their state-owned counterparts in resource-rich states, which gradually acquired the characteristics of full-fledged competitors.
In Russia, where oil production fell by about 50% to 6 mln barrels per day in the 1990s, largely due to a decline in drilling and underinvestment in new wells, and where privatized oil companies underpaid taxes and transferred earnings abroad, a concerted effort was launched to tighten control over the oil and gas sector. Increased collection of tax revenues and reinvestment of profits domestically strengthened public finances. In 2007, crude oil production increased to 9 mln barrels per day, and in 2019 it exceeded 11 mln barrels per day, on par with the Soviet peak production level and again being largely under state control.
In Kazakhstan, this period was characterized by China’s growing presence in the oil and gas sector – which manifested itself in the construction of an oil pipeline connecting Kazakhstan with China, the acquisition of oil production assets, and the modernization of refineries – in line with the expansion of Beijing’s influence in Central Asia. The rise in state revenues and the diversification of foreign ties coincided with a new round of negotiations with Western oil majors, leading to an increase in the state’s equity participation in mega-projects created in the 1990s.
In Azerbaijan, cooperation with Western majors remained the basis for the development of the oil and gas sector. The strengthening of the local economy led SOCAR to invest in foreign assets, primarily in Türkiye and other countries whose support was crucial to its foreign policy.
Redistribution of investment flows, supply and demand trends in the natural gas sector
Against the backdrop of increased competition from state-owned companies in oil and gas producing countries, the US oil and gas industry placed a major emphasis on developing new breakthrough technologies in the exploration and production of unconventional oil and gas reserves domestically.
In the mid-2000s, a breakthrough was achieved in reducing the cost of producing unconventional reserves, unleashing a rapid growth in production. In 2007, total energy imports in the US peaked and subsequently declined in nearly every year since then. In 2020, for the first time since the 1950s, the US became a net total energy exporter. US LNG exports began in 2016 and exceeded 100 bln cubic meters per year by 2022.
The development of domestic reserves had profound implications for US foreign policy and the international order. The energy security of the United States – the world’s largest hard power security provider and a leading member of NATO – ceased to depend on access to reserves in oil- and gas-rich states around the world. The US companies’ interest in oil and gas reserves located in geopolitically unstable regions such as the Middle East, the Caspian region and Russia correspondingly declined.
Meanwhile, in Europe, demand for natural gas continued to grow, while domestic production declined. A significant increase in imports was required to cover the growing gap between demand and supply of natural gas. The lower-cost supplies that could address this issue could come from Russia, the Middle East and the Caspian region. The US pivot to investing in domestic production meant that the burden of securing access to new gas supplies shifted to European players.
Over the same period, demand for natural gas in China also grew rapidly, driven by robust economic growth and a policy campaign to reduce coal consumption to address air quality concerns. In 2006, China began importing gas for the first time. Initially carried out in the form of LNG, imports subsequently grew steadily in the form of both LNG and pipeline gas.
Thus, the issue of ensuring natural gas supplies came to the forefront of the interests of European and Chinese governments and companies in relations with Russia, Azerbaijan and Central Asia.
Distinct characteristics of the natural gas export supply chain in the post-Soviet space
The history of natural gas exports from the USSR was closely linked to trade cooperation with Europe, a large market that was in need of overland supplies of this form of energy.
Shortly after the start of Soviet gas supplies to Warsaw Pact countries in 1967, the USSR concluded its first contract for the export of gas outside the socialist block with Austria’s OMV in 1968. The overall framework of this initiative, which enabled large-scale economic cooperation between former World War II adversaries, was as follows: the USSR developed its vast gas reserves in Siberia and Yamal, while Austria, Italy, Finland, West Germany and other European states (France in the 1980s), as well as the US, provided gas turbine and pipeline manufacturing technologies for the construction of export pipelines. The entire project was dubbed “gas for pipelines”.
As trade volumes expanded in the 1970s and 1980s, in keeping with the logic of the Cold War, the project encountered opposition from various factions in the West, but not only that: it also caused significant tensions with some of the Warsaw Pact member states, which issue already then demonstrated the risks of political instability in transit states located along the pipeline routes.
After the dissolution of the USSR, the former Warsaw Pact countries made rapid progress toward joining NATO and the EU. The once unified, centrally managed Soviet gas pipeline system was divided among the newly independent post-Soviet states according to the territorial location of the pipelines. Newly independent Ukraine, Moldova, and Belarus now acted as transit states for hydrocarbon supplies from Russia to Europe, including 80-90 bln cubic meters of gas per year supplied through Ukraine and Moldova.
Russia was not the only gas exporter in the post-Soviet space. Turkmenistan, Kazakhstan and Uzbekistan retained state control over their countries’ gas sectors, which fully met their domestic needs and exported up to 60 bln cubic meters of gas via Russia – based on intergovernmental agreements with Gazprom or private trading companies – to markets in Ukraine, Belarus, the Baltic states, the South Caucasus and the former Warsaw Pact countries. In the 1990s, the flows of discounted Russian and Central Asian gas were crucial to maintaining basic incomes, employment and the functioning of the vast socialist block industrial base in both Central Asia and Eastern Europe.
In the gas sector of Azerbaijan, the situation was the exact opposite to that in Russia and Central Asia: throughout the 1990s, the country imported gas from Russia, Turkmenistan (via Russia), and Iran. This situation began to change radically after the giant Shah Deniz field was discovered on Azerbaijan’s continental shelf in 1999.
The “Great Gas Game“ on the Eurasian continent
Interested in meeting Europe’s growing gas demand, Russia already in 1993-2003 adopted a two-pronged approach to this issue: it laid the foundation for diversifying gas export routes by preparing the launch of new pipeline projects through Belarus, Türkiye and the Nord Stream project, while continuing to rely heavily on gas exports through Ukraine and Moldova.
In 2004-2005, following the Orange Revolution, Ukraine announced a likely departure from its “multi-vector” foreign policy. The ensuing disagreements over gas supply contracts led to a temporary halt in Russian gas supplies to Ukraine and transit of Russian gas to Europe. The events set in motion a chain reaction of redistribution of gas flows, which had direct consequences for Central Asia.
In 2006, gas supplies from Turkmenistan to Ukraine, with an estimated volume of 25-35 bln cubic meters per year, were stopped due to a price dispute, Ukraine’s growing debt to Turkmenistan, and the latter’s demands to switch from barter deals to full cash payments for gas. The loss of a key market turned Turkmenistan, whose economy relied heavily on gas exports, into a potential major new supplier to Europe or China. At the same time, Turkmenistan announced the discovery of the super-giant Galkynysh field, which brought the country’s natural gas reserves to fourth place in the world.
The bottom line for Europe was: 1. the benefits of increasing Russian gas imports were accompanied by a growing risk to the transit of this gas through Ukraine 2. the commercialization of unconventional reserves in the US was still in its early stages 3. China was poised to become a major competitor and buyer of LNG and pipeline gas. The solutions found included continuing to expand gas trade with Russia in the hope of stabilizing the situation with transit, while intensifying efforts to secure new supplies in the Middle East and the Caspian region.
With Iran under international sanctions and Iraq politically unstable, Turkmenistan remained the only major potential source of new non-LNG pipeline supplies.
An important obstacle here, however, was that Western oil and gas majors, despite the support of US and EU governments, considered it too risky to invest in the construction of a gas pipeline from Turkmenistan to markets in Europe. Since the overland route through Iran was not feasible for political reasons and due to Iran having its own abundant gas reserves needing exports, the only other option was the Trans-Caspian Pipeline (TCP) that would connect Turkmenistan with Azerbaijan across the Caspian Sea and then transport the gas across Georgia and Türkiye to Europe. Predictably, the project faced opposition from Russia and Iran, as well as the tacit reluctance of Azerbaijan, which prioritized the commercialization of its own (more modest) gas reserves.
China’s competing proposal to build the export pipeline and provide long-term loans to finance the Turkmen government’s share of the field development costs sealed the fate of the TCP. China made similar offers to Kazakhstan and Uzbekistan. China’s proposal, which the Central Asian states accepted, was similar in character and scale to the partnership that once linked them for decades with Russia, and before that with the USSR. In 2007, CNPC began construction of the Central Asia-China gas pipeline system, the total throughput capacity of which reached 55 bln cubic meters per year by 2015, making China the principal buyer of Central Asian gas.
The Southern Gas Corridor and Azerbaijan’s unique position in the European gas market
The ambivalent relationship between Russia and Europe on the gas chessboard continued in the subsequent years: as supplies exceeded 150 bln cubic meters and additional export pipelines were built, transit risks continued to grow. The gravity of this problem became apparent with the outbreak of military conflict between Russia and Ukraine in 2014.
Amid growing uncertainty, European energy companies continued to expand gas trade with Russia, while the EU and the US government backed the Nabucco project. Promoted by Austria’s OMV, Hungary’s MOL and Germany’s RWE, the project aimed to supply 31 bln cubic meters of gas annually through the Balkan region to Austria, aggregating supplies from Iran, Iraq, Azerbaijan and Turkmenistan.
However, continued instability in the Middle East, including the Arab Spring and the suppression of the Iranian Green Movement protests in 2009-2011, the civil war in Syria and the rise of ISIS in Iraq in 2011-2013, and the Shia Crescent policy in Iran, rendered the possibility of gas supplies needed for the Nabucco pipeline impossible.
This brought to the fore its smaller rival, the Trans Adriatic Pipeline (TAP) project, which had a 10 bln cubic meter throughput capacity and relied entirely on the resource base of Azerbaijan’s Shah Deniz field.
Upon the discovery of the Shah Deniz field in 1999, Azerbaijan embarked on the same path in gas exports as it had previously in oil exports. BP became the operator in an international consortium, this time led by European companies and the Turkish state-owned TPAO. In 2001, agreements were signed with Georgia and Türkiye to construct the export pipeline and sell the gas to these markets.
The launch of the Shah Deniz production in 2006-2007 turned Azerbaijan from an importer of Russian gas into an exporter of its own gas. The 2008 war between Russia and Georgia resulted in Russia recognizing the independence of Georgia’s breakaway regions, and Georgia switching to importing and transiting gas from Azerbaijan, bypassing Russia.
This drive to the West was tempered by the fact that Russia’s private Lukoil and Iran’s state-owned NICO received a combined 20% stake in the Shah Deniz project. The move reflected regional realities, namely Iran’s role as an important gas supplier to Türkiye and the Azerbaijani exclave of Nakhchivan, and Azerbaijan’s desire to avoid Russian opposition to the project.
After the consortium member companies from France, Norway and Germany withdrew from the Shah Deniz project and the TAP pipeline by 2014, BP and Turkish state-owned TPAO and BOTAS remained the only Western participants in Shah Deniz and pipelines running through Türkiye. Azerbaijan’s supplies to Italy and other EU customers commenced in 2020.
Conclusions
Azerbaijan, by choosing to rely on its own supply base and involve neighboring powers in the project, rather than place a bet on the aggregation of larger supplies in the Caspian and Middle East regions, implemented a carefully thought-out strategy that allowed it to avoid risks to its security and successfully complete the Southern Gas Corridor initiative, expanding its reach in Türkiye and Europe.
[4 – continues. The previous chapters are here:
Energy, Transport and Infrastructure Alliances in the Caspian Region. Part 1
Azerbaijan and the Great Power Politics in the post-Cold War international system – Part 2
The oil and gas sector in Azerbaijan and Central Asia in the post-Soviet period – Part 3 ]
Photo: dragonoil, attribution
