Via Stratfor (subscription required & recommended), interesting analysis of the deal signed between Russia and Azerbaijan on June 29, under which Russia will pay Azerbaijan $350 per thousand cubic meters of natural gas — the highest price Russia has paid for natural gas from the Caucasus or Central Asia. As the article notes, Moscow hopes the deal will choke off other potential export routes for Azerbaijani natural gas, as control over energy exports to Europe is one of Russia’s most powerful political levers:

“…Russia will pay Azerbaijan $350 per thousand cubic meters (tcm) of natural gas starting Jan. 1, 2010, according to a deal signed June 29 during Russian President Dmitri Medvedev’s visit to Baku. Under the deal, struck between Russian state-owned natural gas behemoth Gazprom and the State Oil Company of Azerbaijan (SOCAR), Azerbaijan will sell Russia 0.5 billion cubic meters (bcm) of natural gas annually, with potential increases to 1.5 bcm in the future. The price is the most Moscow has been willing to pay for natural gas from Central Asia or the Caucasus; Uzbek and Turkmen gas costs Russia $300 per tcm.

The agreement between Russia and Azerbaijan is largely symbolic, but it sets the stage for future cooperation that Moscow hopes will see Baku’s natural gas exports travel through Russian territory, thus thwarting Europe’s plans to transport Azerbaijan’s natural gas via Turkey (or anywhere but Russia). For Russia, control of natural gas exports is a key political lever on Europe. The Kremlin does not care much where the natural gas comes from — its own fields or those of its Central Asian vassal states — as long as it controls the spigot at the end of the line. Being able to shut off Europe’s gas in the middle of a winter affords Russia great political control.

Russia produced 602 bcm of natural gas and exported 154 bcm to Europe and Turkey in 2008, which makes the deal for 0.5 bcm minuscule in comparison. However, Russia’s willingness to pay top dollar to lock in the deal shows a determination yet unseen from the Kremlin to open its pockets to lock in supplies from its periphery.

Azerbaijan, a major oil exporter, has been a natural gas importer for most of its recent history, with production (10.3 bcm) overtaking internal demand (8.3 bcm) only in 2007. However, Baku’s massive Shah Deniz projects are set to propel Azerbaijan into a major producer. Shah Deniz I produced 8.6 bcm in 2008 and is estimated to produce approximately 9 bcm per year from 2009 onward, while Shah Deniz II is expected to produce around 10-12 bcm annually when it comes online sometime in 2014 or 2015.

Europe hoped that the planned projects at the Shah Deniz fields, developed by a consortium whose majority stake is owned by European firms BP (25.5 percent) and StatoilHydro (25.5 percent), would play a key role in reducing Europe’s demand for Russian natural gas. The planned Nabucco pipeline, it was hoped, would transport Azerbaijan’s gas through Turkey to Europe. However, the consortium developing Shah Deniz does not have control over how Baku chooses to transport the gas, which makes it possible — and important — for Moscow to lure away Azerbaijan’s gas for transport through Russian pipelines.

Russia has already illustrated very vividly to Azerbaijan the power it commands in the Caucasus with the August 2008 intervention in Georgia. With Georgian energy transport infrastructure now threatened by renewed geopolitical tensions between Moscow and Tbilisi (as proved by the disruption of the Baku-Tbilisi-Ceyhan pipeline during the conflict), Azerbaijan’s only other real option for energy transport is to ship oil and natural gas via Russia. But the deal that Gazprom and SOCAR signed is not based purely on threats; after all, the $350 per tcm Moscow is willing to pay Baku is more than Russia receives from its European customers (in 2009 the price Russia charges the Europeans is expected to average just above $280 per tcm, though that could double in 2010, when Azerbaijan’s natural gas is set to flow to Russia).

However, the Kremlin is willing to incur a financial loss today so that it can lock in Azerbaijan’s natural gas exports for the future. The price for natural gas that Gazprom will be able to charge Europe, once the severe recession is over and demand returns, will definitely rise (at one point in 2008, Gazprom hoped to charge Europe more than $700 per tcm, though it peaked at just over $400 per tcm that year). Moscow will have to invest some financial resources to expand its current natural gas transportation infrastructure to handle the increased exports from Azerbaijan. The current Baku-Novo Filya gas pipeline between Baku and Dagestan — recently reversed since it originally transported Russian natural gas to Azerbaijan to meet Baku’s domestic demand — has a capacity of 8 bcm. But another pipeline, with roughly 10 bcm capacity, may need to be constructed if Moscow wishes to beat Europe to Azerbaijan’s exports once Shah Deniz’s 10-12 bcm of natural gas comes online.

Ultimately, the deal between Gazprom and SOCAR also illustrates a shift in Baku’s thinking. STRATFOR sources in Baku confirm that the Azerbaijanis see Russia as a logical transportation partner since infrastructure is already in place and since Moscow does not take years to conclude deals, as Europeans do. Baku is also wary of giving Ankara any levers in their relationship at this time, due to Turkey’s negotiations with Armenia and the recent politicizing of energy deals that could affect Azerbaijan’s interests in the region.”