Baku BP (BP.L) will have to invest billions of dollars more than previously planned if it is to slow falling output at an Azeri oil project that is also that country's biggest cash cow, oil executives and diplomats say.
The investments required to cut the decline at the Azeri-Chirag-Gunashli (ACG) fields are so large that it may not even be commercially viable for the companies to spend the money unless they receive sweeteners from the government, the sources told Reuters.
The problems at ACG will affect international oil supplies and come as BP faces the possibility of paying out $17 billion more in fines related to the Gulf of Mexico oil spill than it has budgeted for, after the U.S. Department of Justice accused the company of gross negligence earlier this month.
ACG was supposed to produce more than 1 million barrels per day (bpd), after a third phase was completed in 2008. The prospect of so much non-OPEC crude ensured considerable western diplomatic support for the project and industry kudos for BP.
ACG is so critical to Azerbaijan that the day of the signing of the Production Sharing Agreement (PSA) covering the fields -- September 20 -- has been designated as "Oil Workers Day" and each year, public celebrations are held in Baku on this date.
However, ACG has not lived up to expectations. After hitting 823,000 bpd in 2010, output has fallen.
Production averaged 684,000 bpd in the first half of this year and oil executives and diplomats said the challenge is now to keep output to around the 700,000 bpd mark.
Officials at BP and state oil company Socar say the geology of the field has fallen short of original expectations, but have cited maintenance when explaining the falls of the past 18 months.
Industry and Energy Minister Natik Aliyev denied last week that "natural circumstances in the oil field" were to blame and cited a desire to preserve production into the future.
Speaking at the sidelines of an International Press Institute conference in Baku last week, he told Reuters that, after routine repair work was completed, the field could pump at more than 800,000 bpd for years to come.
ACG is due to receive a boost of 100,000 bpd when the Chirag Oil Project, or 'COP', platform, which lies almost completed in a yard south of Baku, comes online late in 2013.
Socar deputy vice-president Vitaliy Baylarbayov told reporters on the sidelines of the same conference that this would "allow to keep stable oil output until the end of the contract (field exploitation agreement) in 2024" but declined to say what the output level would be.
Three people with knowledge of the situation said that production will have declined further by the time COP starts up and that there was no question of hitting 800,000 bpd again, or holding that level.
Executives at two of the companies involved said the primary problem was falling pressure in the reservoir.
"ACG is in decline. And that is normal. All oil and gas fields will be in decline at some stage in their lifetime," said Lars Troen Sorensen, Azerbaijan Country Manager for Norway's Statoil, which is also a shareholder in ACG.
However, two sources in Baku, not directly involved in the project but who had been briefed on it, said they believed the original design had also contributed to the sharp decline, and the need for expensive upgrades.
These sources both noted the project was designed when oil was around $10/barrel and industry margins tight, giving an incentive for the consortium to engineer the platform to be as cheap as possible.
One BP insider dismissed the suggestion the company had cut corners but accepted the economic realities of the 1990s meant the project could not be over-engineered and that this made subsequent upgrades more expensive than might otherwise be the case.
Capital investment at ACG is already running at $2 billion a year but three people familiar with the project said the investments needed to stem the decline rate from over 10 percent per year to "mid single digits" would require the partners to spend more.
The investments are so large that it was unlikely the consortium, which also includes U.S. oil groups Chevron (CVX.N) and ExxonMobil (XOM.N), would be able to recoup its expenditure within the time period left on the contract. The two companies did not comment.
It will take 2-3 years at least to built the platform extensions and other facilities required to stem ACG's decline, these sources said, leaving under a decade of enhanced output.
One source close to the matter said one way to allow the necessary work to be conducted would be for Socar or the government to cover the cost. But the source admitted this was unlikely.
More likely is that the ACG contract -- under which the government gets most of the profits and the companies are paid for all their outlays -- will be extended beyond 2024. Three people familiar with the situation said talks are already ongoing.
"An extension is needed," one diplomatic source said, adding the partners couldn't afford to wait for years to agree it.
A BP spokesman declined to give output projections or to confirm talks on contract extension. He also did not comment on the claimed need for enormous amounts of extra work on the field that cannot be done under existing contract terms. But he said there could be further cuts in output goals.
"As part of our normal continuous operations optimization activities we are reviewing our field management plans and forecasts for ACG," he said.
Azeri officials say the country has also the potential to keep oil production up through additional new finds. But executives and diplomats said the remaining unexplored structures in the Caspian were more likely to contain gas reserves than oil.
The country is also touting its potential as an increasingly important gas producer but here as well, executives and diplomats say the country may be being too bullish.
Aliyev said this week that output at the $25 billion Shah Deniz 2 project could be 50 percent higher than the 16 billion cubic meters (bcm) a year scale BP and its partners had planned.
Baylarbayov also said that the Shah Deniz project could be expanded in further phases.
BP said the project could be expanded if necessary but that it was only planning a 16 bcm project. People close to the project said such increases would require additional gas discoveries, which may or may not exist.
"No state has an interest to be pessimistic about its resources .. It is a matter of prestige," one executive said of the comments on ACG and Shah Deniz.
The Industry and Energy Ministry was not available for comment. Socar declined to comment on the outlook for production or the need for significant work to avoid continued sharp output declines.
(Additional reporting by Dmitri Zhdannikov in Moscow; Editing by Giles Elgood)