Development trends in the Azerbaijan oil and gas sector: Achievements and challenges

doi:10.1016/j.enpol.2011.10.002

Energy Policy

Volume 40, January 2012, Pages 282-292

https://doi.org/10.1016/j.enpol.2011.10.002 Get rights and content

Abstract

This article is study of Azerbaijan oil and gas industry. It illustrates the business climate, the impact of this sector on Azerbaijan's economy including role of SOFAZ and highlights recent developments in the energy production and the main concepts of Azeri PSAs (2009). Meanwhile, the article establishes the government policy by indentifying several factors that influenced to attract foreign investment to oil and gas sector and examines significant challenges that still remain for further development of the country's oil industry.

Highlights

► In this study, we review the oil and gas sector in Azerbaijan and describe the main government policies for attracting foreign investment to the sector. ► We showed that providing a predictable legislative and regulatory framework and attractive conditions for oil contracting encourages foreign investment inflows to the country. ► Issues such as the lack of independent regulatory institutions, rehabilitation of oil refineries and resolution of the legal status of the Caspian Sea remain major challenges for further development of the oil and gas industries.

Introduction

The Republic of Azerbaijan is located in the south east of the Caucasus, and borders on Russia, Georgia, Turkey, Iran and Armenia. Throughout history, oil has been used as a leading mechanism in its political and economic life. Since Azerbaijan's independence, oil has become the main political and economic factor for solving several national problems such as strengthening the country's independence, defending its territorial integrity and especially providing economic development by attracting huge amounts of foreign investment.

Following the collapse of the Soviet Union in 1991, Azerbaijan experienced an economic recession, resulting in a decline in GDP by about 63% during 1989–1994. However, since 1994 a successful oil and gas strategy implemented by the government led to an extraordinary amount of international investment flowing into the oil and gas sector. Azerbaijan has received $60 billion in foreign investment in its oil and gas sector over the past 16 years (Azernews, 2010). As Azerbaijan started to seriously recoup the huge revenues from its oil and gas sector, GDP growth averaged 16% a year during 2001–2009. Oil revenues even increased more than predicted due to the spike in oil prices on world markets leading the country's currency reserves to reach 18 billion USD by the end of 2008. The country's oil and gas revenues are expected to reach $200 billion by 2024. Despite, the success of Azeri government in attracting foreign investment into the oil and gas sector, building a solid framework to manage energy revenues, to decrease the excessive dependence of the economy on this sector remains as a major challenge for the country.

This paper provides a complete overview of Azerbaijan's oil and gas strategy with policy discussions on achievement and challenges ahead. The paper covers the period after the oil contracts were signed in 1994. However, the discussion focuses mainly on years 2001 to 2009, when government started to recoup the oil revenues and the most of the policy interventions happened, especially how these decisions can affect the near future. We primarily focus on the type of regulatory framework that has been implemented to foster investments sustainable development of the sector and policy interventions to favor redistribution of income.

The paper is structured as follows. Section 2 analyzes business climate focusing on the significant obstacles to both domestic and foreign investment in the country. Section 3 describes an impact of oil and gas sector on the country's economy including in overall growth, overall investment and poverty reduction and the role of State Oil Fund, SOFAZ's in public investment. Section 4 summarizes the country's prospects for energy production focusing on oil and gas production and consumption trends, as well as country's energy transport infrastructure. Section 5 discusses issues relating to exploration and production contracts of hydrocarbons, mostly Production-Sharing Agreements (PSAs). Section 6 outlines several factors that stand behind of government's achievements to attract foreign investors in the oil industry, and challenges related sector. Section 7 sets out some conclusions.

Section snippets

Business climate

Azerbaijan declared its independence from the former Soviet Union in 1991. The country is confronting both significant prospects and challenges in its transition to a free market economy. In recent years, Azerbaijan has implemented a successful strategy of developing its oil and gas sector as the main driver of the economy. Despite development of the oil sector, the non oil sector of the economy remains undeveloped and very fragile with significant obstacles to both domestic and foreign

Impact of oil and gas sector on economy

The switch from a state-run to a capitalist economy and the Nagorno–Karabakh conflict led to a collapse in trade and a decline in economic output of more than 60% between 1989 and 1995. Trade among the former Soviet countries failed and led to a decline in GDP and to high inflation. The country's GDP fell by almost 60%; agriculture by about 43% and industrial output by about 60% from 1989 to 1994 (International Monetary Fund, 1994). However, since political stability was regained, thanks to oil

Energy production

As a state on the shore of the Caspian Sea, Azerbaijan is endowed with rich oil and gas resources and is currently experiencing an oil boom. Azerbaijan's total energy production has increased almost three-fold from 27.9 million to 74.9 million oil equivalent mainly due to oil and gas production. The country's total energy consumption in 2009 was about 15.7 million tons, which means that a significant part of its production is exported (See Fig. 1). Crude oil and oil products make up over 70% of

Production by type of contract: PSAs

In practice, there are four basic types of contractual arrangements commonly used for oil and gas exploration and development: concessions, production sharing agreements, service contracts and joint ventures. The differences between them usually lie in the level of control given to foreign contractors over operations and production, the share-out of revenue between foreign contractors and the government and the level of government involvement (Al-Emadi, 2010).

For the development of the oil

Government policy and challenges

Azerbaijan is probably the best example of a Caspian country affected by the oil boom. Foreign investors in the oil industry prefer countries, which can offer political stability and an attractive business environment with a predictable legislative and regulatory framework. They usually fear high political risks, administrative intervention and unpredictable laws and regulations. PSA contracts require a regulatory, financial, legal relationship between foreign contractors and the host

Conclusion

As a moderate, western-oriented, secular Muslim state, Azerbaijan is an important country for the energy security of the European Union and plays the role of a transport corridor between Europe and Central Asia.

The creation of a stable legal framework in the energy sector and the provision of a predictable legislative and regulatory framework in oil contracts have been the biggest achievements of the Azerbaijani government in its strategy for attracting foreign investment to develop the oil and

Acknowledgement

We would like to express our gratitude to all those who gave us the useful comments and suggestions especially, Dr. Elnur Soltanov at the ADA Fifth PhD Workshop-2011 held on June 10-11, 2011 and Elmeddin Hasanov from BP and Khagani Guliyev from European Parliament. In addition, we thank to MICINN(SEJ2006-06309 and ECO2009-09120), GobiernoVasco (DEUI, IT-313-07) and Okrestra for their financial support.

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^☆: We thank MICINN (SEJ2006-06309 and ECO2009-09120), Gobierno Vasco (DEUI, IT-313-07) and Okrestra for their financial support. Finally, we are very grateful to Elnur Soltanov from ADA, Elmeddin Hasanov from BP and Khagani Guliyev from European Parliament for their useful comments and suggestions.

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Development trends in the Azerbaijan oil and gas sector: Achievements and challenges☆