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Monday, 22 October 2007, 13:49
C O N F I D E N T I A L SECTION 01 OF 04 BAKU 001268 
SIPDIS 
SIPDIS 
DEPARTMENT OF ENERGY PASS TO A/S KAREN HARBERT, DAS ALAN 
HEGBURG, OFFICE OF RUSSIA/EURASIAN AFFAIRS DIRECTOR LANA 
EKIMOFF 
EO 12958 DECL: 09/21/2017 
TAGS PGOV, PREL, ENRG, AJ 
SUBJECT: AZERBAIJAN: SOCAR REFRAINS FROM “GOING KAZAKH” ON 
BP-LED CONSORTIUM
REF: BAKU 1224
Classified By: Ambasador Anne E. Derse, Reasons 1.4 (b,d)
¶1. (C) SUMMARY: During a October 19 steering committee meeting of the Azerbaijan International Oil Consortium (AIOC), the State Oil Company of Azerbaijan (SOCAR), representing the Azerbaijan government, avoided declaring the Consortium in material breach of the Production Sharing Agreement (PSA) as it had been threatening to do, an act which would have worsened the current dispute between the two parties over short-term issues potentially involving billions of dollars. SOCAR did give the Consortium an unrealistic ultimatum to “solve all outstanding issues within a week,” but Consortium partners plan to counter-propose a working group to work on settling the issues of contention. Embassy will continue to monitor events and press for a negotiating environment in which a mutually satisfactory conclusion can be reached. END SUMMARY.
¶2. (C)BACKGROUND: According to BP Azerbaijan, the commercial dispute between the AIOC Consortium (formed as a result of the 1994 Azerbaijan Chirag Guneshli (ACG) Production Sharing Agreement, and consisting of BP, Chevron, Inpex, SOCAR, Statoil, ExxonMobil, TPAO, Devon, Itochu and Hess) and the Government of Azerbaijan, as represented by SOCAR, centers on three main issues, the first two of which influence the percentages of ‘profit oil’ going to each party:
- Calculation of the “Total Transportation Cost” (TTC) - Calculation of the “Rate of Return” (ROR) - SOCAR claim of collusion between the BTC and AIOC Consortiums so that the BTC project was deliberately slowed down in order to influence TTC by driving up transportation costs.
¶3. (C) Part of the dispute stems from the ACG/AIOC PSA not defining some key terms, so that, for example, while the Consortium claims that finance costs should be considered as a type of petroleum cost and hence taken into account when calculating ROR, SOCAR disagrees. BP says SOCAR’s claims stem from the fact that “it doesn’t like the PSA it signed 14 years ago,” and that AIOC has done due diligence on its accounting practices to confirm that the Consortium’s methodologies adhere to the PSA. SOCAR claims, inter alia, that the Consortium itself, by changing the methods used for calculating the ROR, is acting outside the PSA, in a “dishonest” attempt to maximize revenue.
BP: SOCAR THREATENING TO “GO KAZAKH”
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¶4. (C) On October 17, BP Azerbaijan VP-Commercial Dr. Phil Home  commented that on October 2 SOCAR President Rovnaq Abdullayev had summoned BP Azerbaijan President Bill Schrader, to inform him that SOCAR intended to claim that the AIOC Consortium was in material breach of the PSA.
¶5. (C) Home said that SOCAR had called for a convening of the AIOC Steering Committee on October 19, at which time SOCAR might formally claim material breach. Home said that according to the PSA, once SOCAR (on behalf of Azerbaijan) claims material breach, then the AIOC Consortium has 90 days to “respond or rectify.” If after this period the dispute has not been solved, it goes to arbitration. If the arbitration process decides in favor of Azerbaijan, then the AIOC Consortium would have 90 days to rectify the material breach.
¶6. (C) However, Home said that SOCAR has been threatening to take action that is outside the PSA’s dispute resolution mechanism, to include unilaterally shortening the amount of time the Consortium has to respond or rectify once material breach has been declared (perhaps to ten days or even shorter).
¶7. (C) Additionally, Home said that SOCAR has repeatedly warned the Consortium to “look at Kazakhstan,” i.e. explicitly and repeatedly hinted at taking extra-legal actions if the Consortium does not give in on key issues (Comment: SOCAR VP Nasirov has made the same point, saying
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that the Consortium should realize that “no international energy company has ever won a fight against the home country national oil company.”)
SCHRADER TRIED FOR SMUGGLING/STEALING
------------------------------------- 
¶8. (C) More worrisome to the Consortium and to BP, Homesaid that SOCAR President Abdullayev has threatened to unilaterally calculate the split of profit oil, declare any excess amounts being received by the Consortium as contraband, and then have BP Azerbaijan President Schrader charged with smuggling and brought before the National Parliament to be tried for “stealing ten billion dollars worth of Azerbaijani oil.”
SOCAR: BP BROKE PSA
------------------- 
¶9. (C) In an October 18 discussion with the Ambassador, SOCAR President Rovnaq Abdullayev said that the AIOC’s proposed revision of the method of calculating the Rate of Return (ROR) was “against all market rules and regulations.” Although SOCAR had originally agreed to negotiate with AIOC, its “deception” in seeking to “change the PSA” caused Abdullayev to suspend talks on all future projects. Abdullayev said that the unanticipated high oil prices had caused a greedy AIOC consortium to seek to illegally change the ROR - “if oil had stayed at 30-40 dollars per barrel, the final flip in profit splitting would occur in 2012, but with the rise in price, BP claimed mistakes in its previous ROR calculation and changed the methodology, “which it had been using for a decade.” XXXXXXXXXXXX
¶10. (C) SOCAR President Rovnaq Abdullayev also said that the AIOC Consortium was using ACG Associated gas “as a weapon against us,” trying to “blackmail” SOCAR by cutting deliveries from 3 billion cubic meters annually (bcm/a) to 1.4 bcm/a. However, the AIOC’s cutting off of surplus ACG associated gas deliveries would only hurt Georgia, as it meant that Azerbaijan would no longer be able to meet all of Georgia’s winter gas needs, as it intended to do had the AIOC Consortium continued to deliver 8.5 million cubic meters/day (mcm/d), vice the current daily delivery to SOCAR of 4 million mcm. Abdullayev also said that the Consortium’s actions were helping Russia, who was claiming that “Azerbaijan doesn’t even have enough gas to supply Georgia,” which would indeed be the case if and only if the AIOC continued to “punish” Azerbaijan by withholding ACG associated gas. Although GOAJ had planned to meet all of Georgia’s winter gas needs, with the AIOC’s lessening of gas supplies this would no longer be possible - politically, Azerbaijan could not burn mazut that sells for an equivalent of USD 450 per thousand cubic meters to sell gas to Georgia at approximately USD 167/tcm. Abdullayev said SOCAR experts disputed AIOC claims that this gas being withheld from SOCAR was needed for re-injection, saying that re-injection of an additional 4 mcm/d into the ACG field would make “no difference” relative to the approximately 800 thousand barrels a day being extracted.
¶11. (C) Ambassador Derse said that while the USG cannot and does not take any position in the commercial negotiations between the AIOC Consortium and Azerbaijan, Azerbaijan has been exemplary in its devotion to the sanctity of the PSAs it has signed, all of which have the force of law in Azerbaijan.  This commitment to the PSAs has resulted in rapid development of Azerbaijan’s energy sector. As such, regardless of the outcome of the commercial negotiations, the U.S. hoped both sides adhere to the PSA and seek to address all concerns solely by the manners stipulated within the PSA.  XXXXXXXXXXXX
BP - “ACTING W/IN THE PSA”
-------------------------- 
¶12. (C) In an October 19 talk with the Ambassador, BP Azerbaijan President Bill Schrader said that if BP were to
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accede to SOCAR demands in an attempt to solve its dispute, it could be sued by any AIOC partner for acting outside the PSA.
¶13. (C) Schrader said that the Consortium had “19 disputed areas” about which it had asked for guidance from SOCAR, but all it got was either “silence or threats” from Abdullayev, whom he characterized as a “pit bull.” Schrader was convinced that Abdullayev was “doing President Aliyev’s bidding” in seeking to “box it out” with the Consortium for the approximately ten billion dollars at stake. To him, the bottom line was that SOCAR “didn’t like the PSA it signed” in 1994, and was seeking to change its terms. He confirmed what Home had said earlier, i.e., that Abdullayev had threatened to arrest and try Schrader in front of Parliament for being a “criminal smuggler.”
¶14. (C) Schrader said that BP Azerbaijan had already prepared for such an eventuality. If SOCAR went public with charges of malfeasance against BP, BP would keep a “low profile,” repeating the simple message that everything it had done was consistent with the PSA. Schrader argued that the putative “change in methodology in ROR calculation” was not a change at all - before revenue started flowing the methodology being used for pro forma profit calculation runs had a flaw in it, which was corrected when the partners became aware of it and before the revenue stream started.
¶15. (C) Referring to the AIOC Steering Committee meeting to be held later that day, Schrader said he thought it unlikely that Abdullayev would formally claim that the AIOC Consortium was in material breach, as that would start SOCAR down a road that it didn’t want to go, since the overwhelming likelihood of any arbitration would be in favor of the Consortium - “Azerbaijan doesn’t want any experts involved in this matter.” Schrader quoted what Chevron CEO David O’Reilly had heard from President Aliyev when they had recently met, to the effect that Azerbaijan was going to receive approximately USD 200 billion of oil revenue over the next 15 years - it was not going to embarrass itself for an extra ten billion.” BP’s London experts familiar with the GOAJ have similarly told BP Azerbaijan that SOCAR is unlikely to act upon is threats.
¶16. (C) In this regard, BP Vice-President Phil Home said that Moody’s was planning to come to Azerbaijan in two weeks, and had asked to talk with him about Azerbaijan’s investment climate, and he mused aloud as to what he should tell them given the Consortium’s current difficulties.
¶17. (C) XXXXXXXXXXXX
¶18. (C) Schrader said that the AIOC partners were all in agreement as to the correct course of action. He predicted that SOCAR would “set the dogs on us,” i.e., seek to make operations much more difficult for the Consortium. If this were to happen, he would keep record of every penny of additional expense incurred, send it in a monthly letter to SOCAR, and seek to cost-recover it all, in line with the PSA provisions for recovery via allocation of “cost oil.”
¶19. (C) Speaking of the longer-term issues of PSA extension and access to ACG Deep Gas, for political reasons he thought it unlikely that President Aliyev would move on them before being re-elected as President.
SOCAR BACKS DOWN
---------------- 
¶20. (C) After the October 19 AIOC Steering Committee meeting, Schrader said that the meeting itself had turned out to be a “non-event.” SOCAR head Abdullayev read prepared remarks in which he railed against BP and the Consortium, but he did not seek to claim material breech. He did tell the Consortium that they “had a week to resolve all outstanding issues,” but
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did not specify any adverse consequences for not doing so. Schrader said that obviously it would be impossible to meet Abdullayev’s deadline, but that the AIOC partners were going to offer to form a working group to meet with SOCAR to work on these issues. He confirmed that one of SOCAR’s demands was that BP yield operator status of the BTC to SOCAR, to do away with the putative “conflict of interest” due to BP being operator of both ACG and BTC. Schrader said that BP Head of Exploration and Production Andy Inglis would be coming to Azerbaijan on October 29 to meet with President Aliyev.
¶21. (C) SOFAZ head Shahmar Movsumov, who attended the Steering Committee meeting, afterwards told the Ambassador that Abdullayev had laid out the GOAJ’s grievances in a ninety minute recitation, and that Azerbaijan was not going to “just roll over and take BP’s line.” However, he confirmed that Azerbaijan would work to resolve the disputes within the PSA.
¶22. (C) COMMENT: BP President Schrader told the Ambassador that when he got here a year ago, Azerbaijan’s operating environment seemed “benign” compared to his previous assignments, to include Angola. Although BP’s situation is not as “benign” as a year ago, SOCAR’s decision not to escalate its dispute with the Consortium is a promising sign that a mutually satisfactory solution can be reached, thus clearing the way for PSA extension and access to ACG Deep Gas, both prerequisites for the second stage of Azerbaijani energy sector development. Embassy will continue to monitor events and press for a negotiating environment in which a mutually satisfactory conclusion can be reached. DERSE