A consortium of energy companies led by BP (NYSE:BP), which is developing the Shah Deniz natural gas project in the South Caspian Sea, recently announced the final investment decision for the second phase of development of the Shah Deniz gas field located around 70 kilometers offshore in the Azerbaijan sector of the Caspian Sea. 
The second phase of development of Azerbaijan’s largest gas field will be coupled with huge investments in establishing the pipeline infrastructure to transport 10 billion cubic meters of natural gas per annum (BCMA) to the European markets. These markets are heavily dependent on Russia for their natural gas supply, which gives a lot of political leverage to Russia in the region. Importing gas from the Caspian region is one of the prime alternatives for the European countries to diversify their natural gas supplies away from Russia.
BP is the operator of the Shah Deniz project with a 28.8% stake. Azerbaijan’s state-owned oil and gas company, SOCAR owns 16.7% stake in the project, followed by the Norwegian multinational energy giant, Statoil (NYSE:STO), which owns 15.5% stake. Apart from this, Total (NYSE:TOT), National Iranian Oil Company (NIOC), and the Russian energy giant, Lukoil also own 10% stake in the project each. Turkey’s state-run energy company, TPAO owns 9% stake in the project as well.
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Shah Deniz Phase-I
Discovered in 1999, the Shah Deniz field is one of the world’s largest gas-condensate fields with over 1 trillion cubic meters of gas in place. Phase-I of the development project aimed at tapping this huge reserve started operations in 2006. It has the capacity to produce about 9 BCMA of gas and approximately 50,000 barrels per day (BPD) of condensates. Apart from the gas wells, a platform and an onshore terminal, Phase-I of the project also included the 700-kilometer long South Caucasus Pipeline (SCP), which runs through Azerbaijan and Georgia to the Georgia-Turkey border. The project currently supplies gas to Azerbaijan, Georgia and Turkey.
Shah Deniz Phase-II
The second phase of the Shah Deniz project will add another 16 BCMA of natural gas production capacity to the 9 BCMA being produced currently. Of the additional capacity, 6 BCMA will be supplied to a state-owned crude oil and natural gas pipelines and a trading company in Turkey and 10 BCMA will be sold to nine European utilities and gas trading companies according to the recently signed agreements. 
The total investment required in the project to expand its production, processing and transportation capacity to the Georgia-Turkey border is currently estimated at around $25 billion. The consortium is targeting first gas exports to Turkey in 2018 and to Europe in 2019.
While the consumption of natural gas in the EU has been consistently increasing over the past few decades, production in the region has declined in recent years. As a result, the region’s dependence on imported natural gas from its primary supplier, Russia, has been increasing. Natural gas, unlike oil, is not a global commodity, and thus the predominant regional supplier has a much higher control over the pricing of this commodity.
Moreover, fragile relations between Russia and Ukraine through which most of the natural gas supplies to Europe flow, also increases the susceptibility of these supplies to unwarranted fluctuations. Therefore, the European countries have been looking for alternatives to diversify away from the Russian gas supplies. Currently, Russia accounts for more than 30% of the natural gas imports into EU. 
The Southern Gas Corridor
The transportation of natural gas from the Shah Deniz field in the Caspian Sea across 4,000 kilometers to Europe would require enhancement of some of the existing infrastructure and development of a chain of new pipelines. The southern corridor is a non-Russian and non-Iranian natural gas pipeline system to transport natural gas from the Caspian region and Central Asia to Europe.
The existing SCP will be expanded with a new parallel pipeline across Azerbaijan and Georgia to transport the additional gas that will be produced from the second phase of the project. Once in Turkey, the gas will be transported through a new Trans Anatolian Pipeline (TANAP). In Europe, the Trans Adriatic Pipeline (TAP) will be built to take gas through Greece and Albania to Italy. This chain of pipelines will complete the southern corridor, which will create an alternative route for natural gas supplies to the European countries. Establishing this pipeline infrastructure is expected to cost more than $15 billion.
Prospects For BP
The start-up of the second phase of the Shah Deniz project will boost BP’s natural gas revenues through higher production capacity. At 16 BCMA, the project’s gross capacity is around 25% of what BP’s subsidiaries achieved in 2012.  We therefore expect the project to boost the company’s net natural gas production by 5-6% over 2012 levels in the long run.
Moreover, since the company has been operating in the region for the past 6-7 years, it will also have a much better understanding of geological and other technical challenges that the project can potentially face. Not only this, the company could also leverage some of its existing infrastructure and improve operational efficiency through larger scale. Also, a higher proportion of natural gas sales in the European countries, where prices are much higher compared to those in the U.S., will also enhance the company’s average price realizations for natural gas. We expect these factors to boost the company’s natural gas operating margins in the long run.Notes:
- Shah Deniz Final Investment Decision Paves Way For Souther Corridor Gas Link With Europe, bp.com [↩]
- BP-Led Group Inks Azeri Gas Deals Worth $100 Billion, wsj.com [↩]
- Europe’s Energy Security: Options and Challenges to Natural Gas Supply Diversification, fas.org [↩]
- BP 2012 Annual Report, bp.com [↩]