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About us AKE has over 20 years of experience working with the insurance sector, providing clients with unrivaled political and economic risk consultancy. Our experienced team of analysts provides tailored analysis and strategic forecasting, allowing our clients to better assess risks in challenging environments. Contact us on: +44 (0)20 3816 9970 / [email protected] Or visit: www.akegroup.com / @akegroup
AKE Special Report Political Risks in Azerbaijan
The Energy Sector
The Azeri energy sector is dominated by the State Oil Company
of Azerbaijan (SOCAR). Founded in 1992, SOCAR was created
by a merger of Azerbaijan’s two Soviet-legacy state oil
companies, Azerineft State Concern and Azerneftkimiya
Production Association. The company produces both oil and
natural gas from onshore fields as well as offshore fields in the
Azeri section of the Caspian Sea.
The second more important company in the sector is BP, which
was the first major foreign investor in the country when it
originally entered the market in 1994.
BP and SOCAR’s cooperation has been focused on the Azeri-
Chirag-Deepwater Gunashli (ACG) field and the Shah Deniz
fields. Since 2013 this has also involved investment in the
development of the Shah Deniz 2 Project, which forms the
basis of new natural gas deliveries for ongoing gas pipeline
expansion projects detailed below. This involves connecting
the oil fields of Azerbaijan with European markets through the
Southern Gas Corridor. This new network of pipelines extends
from the existing South Caucasus Pipeline (SCP) that runs from
Baku to Erzurum in eastern Turkey. The set expansions are
ultimately set to deliver gas from Turkey to European markets
via Greece, Albania and Italy. Potential further linkages of
Turkey’s gas network with Balkan states and eventually to
Hungary are under discussion, although the establishment of
these routes remains controversial and discussions will be
drawn-out.
AKE in Azerbaijan
AKE travelled to Azerbaijan in June 2017 to examine key facets of Azerbaijan’s political economy and to meet valuable local sources. This included meetings with government and business representatives, civil society actors, and local analysts. The trip was accompanied by travel to Tbilisi in neighbouring Georgia, home to Azerbaijan’s most active dissidents, and Moscow. The insights in this report are also supplemented by an earlier trip to Yerevan undertaken in the aftermath of the April 2016 clashes between Armenian and Azeri forces. The aim of the trip was to develop a holistic picture of the security, business, economic and political environment in Azerbaijan as well as to challenge prior assumptions and analysis. AKE undertook discussions and met with representatives of government ministries, journalists, opposition supporters and local players. AKE also visited key development sites in Baku, travelled across the country to Ganja and Zaqata, and also visited the city of Sumqayit. The contributions of all the interviewees have been taken into consideration in the below analysis, which intends to assess the risks and opportunities in Azerbaijan
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The Azeri energy sector is also currently undergoing political
and managerial changes, although the impact of these will be
more limited. These were prompted by the 9 June 2017 death
of 69-year-old Azerbaijani Energy Minister Natiq Aliyev. Aliyev
died of natural causes in Turkey; his death is not seen as
suspicious. A replacement has yet to be announced. Aliyev had
served as energy minister since 2006 after 13 years as the head
of SOCAR. The current SOCAR CEO, Rovnag Abduallayev, was
appointed to succeed Aliyev and is expected to remain in the
role for the foreseeable future.
While a shakeup of the sector is unlikely, the Energy Ministry
is amongst the most powerful ministries in the government
and President Ilham Aliyev will hand the role to a close ally.
This process could set off political infighting, particularly given
the February 2017 sacking of Transportation Minister Ziya
Mammadov. The Mammadov family formed arguably the third
most influential family in the government previously, after
President Aliyev’s own family and that of Emergency Services
Minister Kamaladdin Heydarov. That is not to say that major
changes to, or turbulence within, the sector should be
expected, merely that it is in a period of uncertainty that the
government must manage carefully.
2.2 Total Production
Total National Production in the energy sector in 2016 came
to 41m tonnes of oil and 29.4bln cubic metres (bcm) of gas.
Divided into the respective companies that produce oil and
gas and export it form Azerbaijan the proportions were as
follows:
1. State Oil Company of Azerbaijan (SOCAR): 7.5m tons of
oil; 6.3bcm of gas
2. BP: 2.5m tons of oil; 10.7bcm of gas
3. Chevron: Roughly 1.6m tons of oil; 0.124bcm of gas
4. Others (including Devon Energy, Statoil, TPAO,
ExxonMobil, and Inpex) (29.4m tonnes of oil; 12.2bcm of
gas).
Baku Tiblisi Ceyhan (BTC) Pipeline
The Baku Tbilisi Ceyhan (BTC) oil pipeline carries oil from the
Azeri-Chirag-Deepwater Gunashli (ACG) field and condensate
from Shah Deniz across Azerbaijan, Georgia and into Turkey.
Meanwhile, the South Caucasus Pipeline (SCP) starts from the
Sangachal terminal near Baku. It follows the route of the BTC
through Azerbaijan and Georgia into Turkey, where it is linked
to the Turkish gas distribution system.
The 1,768km BTC pipeline became operational in May 2006.
The Baku-Tbilisi-Ceyhan Pipeline Company (BTC Co.) was
established in London in 2002 and construction began in April
2003 and was completed in 2005. The pipeline is 8m wide and
443km of the route runs through Azerbaijan, 249km through
Georgia, and 1076km through Turkey. The Azeri section was
constructed by Consolidated Contractors International (CCIC)
and the Georgian section by Spiecapag and Petrofac
International. Turkey’s state-owned pipeline corporation
BOTAŞ oversaw construction of the Turkish section of the
pipeline.
South Caucasus Pipeline (SCP)
The South Caucasus Pipeline (SCP) is a natural gas pipeline that
runs alongside the BTC until Erzurum, a city in north-eastern
Turkey. The 42-inch wide pipeline has been operational since
late 2006 transporting gas from the Shah Deniz field to
Azerbaijan and Georgia, and starting from July 2007 to Turkey,
running a total of 692km. Of this 443km are in Azerbaijan and
248km are in Georgia. The SCP runs in east-west direction
pumping natural gas for stakeholders in the SCP Company.
These are BP (28.8 per cent) Turkey’s state-owned TPAO (19
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per cent), Azerbaijan’s state-owned SOCAR (10 per cent),
Lukoil (10 per cent), SGC Midstream (6.7 per cent_, Malaysian
state-owned Petronas (15.5 per cent) and Iranian state-owned
Naftiran Intertrade (10 per cent). Initially designed to deliver
5bcm of gas per annum, the current expansion project is
looking to increase this to 25bcm. The SCP is not immune to
geopolitics of international conflict and was in August 2008
shut down for two days amid the Russian-Georgian war
conflict.
South Caucasus Pipeline Expansion (SCPX)
The SCP is currently undergoing an expansion. The SCP
Expansion (SCPX) project involves laying down a new pipeline
across Azerbaijan and constructing two new compressor
stations in Georgia. This expansion will triple gas volumes
exported through the pipeline to over 20bcm per annum. With
steady progress in Q1 2017, SCPX activities continued
successfully and 89 per cent of the construction and
commissioning scope has now been completed. Hydro-testing
of the pipeline is ongoing in both Azerbaijan and Georgia.
Construction has continued in Georgia at the two compressor
stations whereby the first is at 96 per cent and the second at
70 per cent - both are on track for a 2018 start-up. Meanwhile,
metering station construction works are 95 per cent complete
and on track for a 2017 start-up. The SCPX project is part of the
Shah Deniz Full Field Development (FFD) and the capacity
increase will be able to accommodate an additional 16bcm gas
coming from the Shah Deniz Stage 2 project.
The European Union Southern Gas Corridor Programme
The European Union (EU) Southern Gas Corridor (SGC)
programme was initiated by the European Commission to
introduce a connection of the Caspian and Middle Eastern
regions and Europe in terms of natural gas supply. Its aim is to
reduce Europe’s dependency on Russian gas. Its route will
consist of the South Caucasus Pipeline (SCP),the Trans-
Anatolian Pipeline (TANAP) and the Trans-Adriatic Pipeline
(TAP) with the main supply source being the Shah Deniz gas
field. Stretching over seven countries and including over a
dozen major energy companies, the programme is comprised
of several separate energy projects and will cost more than
US$45bln.
These projects include:
• The Shah Deniz 2 development – drilling wells and
producing gas offshore in the Caspian Sea.
• Expansion of the natural gas processing plant at the
Sangchal Terminal in Azerbaijan.
• Three aforementioned pipeline projects: the SCPX,
TANAP, and TAP
• Expansion of the Italian gas transmission network.
• There have been discussions about expanding a new
route from Turkey to Hungary, via Bulgaria and Serbia.
While the relevant governments signed agreements to
seek to build the pipeline in June and July 2017, Russia’s
heavy push for this plan comes amid its own efforts to
build the so-called ‘Turkish Stream’ pipeline will
complicate the issue for some time.
The ultimate aim of the project is for Caspian gas to reach as
many European markets as possible through the SGC. TAP AG,
the company running the construction of the Trans-Adriatic
Pipeline, so far predicts that with their access to the Italian
natural gas grid they will be able to reach Austria, Germany,
France, Switzerland, and Belgium and the Netherlands,
eventually reaching the UK. Financing has been arranged for
TANAP with construction underway since March 2015. Current
estimates expect the pipeline to be completed by Q3 2018.
A major component of EU energy policy, the SGC aims to
decrease reliance on Russia as an exporter of natural gas and
thus decrease the vulnerability of EU energy markets to its
political issues with the Kremlin. Events such as the war in
Ukraine would naturally have less potential to affect EU energy
markets as the SGC offers an alternative. Fewer conflicts in the
region that the SGC covers indicate it has the potential to be a
more stable long-term natural gas route than any previous
one. Meanwhile, talks of extending the SGC to Central Asia and
adding Kazakhstan and Turkmenistan as first suppliers have
seen the SGC dubbed the ‘New Silk Road’. The potential for
diversification trade is enormous as these routes develop,
however, key focus will remain on the initial SGC construction
(see below) as it is set to begin working in late 2018 and
supplying Georgia and Turkey – meanwhile gas deliveries are
expected just over a year after first gas is produced from
offshore Azerbaijan.
Key barriers to a smooth start will be economic pressures as
well as pressure from the Kremlin on the Azeri government. Oil
and gas prices continue to be low and, whilst initially treated
as temporary by Azeri officials, they have already had a
devastating impact on most sectors of the economy, which has
been exacerbated by the state’s mismanagement of funds.
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While the Trans-Anatolian Pipeline is not likely to face
financing changes as it moves towards completion, questions
remain about the ultimate financing for the Trans Adriatic
Pipeline, which still aims to secure more than US$2bln in
additional financing. The European Investment Bank and the
European Bank for Reconstruction and Development are
expected to agree to this funding, although it has been
delayed. However, other sources are also likely to be willing to
provide financing, as demonstrated by the Asian Infrastructure
Investment Bank (AIIB) agreement to loan US$600m towards
the construction of TANAP, which was finalised in February
2017. It should nevertheless be noted that socio-political
issues in Azerbaijan such as poor human rights and social
justice standards make EU involvement in energy trade with
the nation controversial and prompt NGO activity lobbying
against it, although these have not met with success.
Finally, European commitment to the project is also in
question because of the EU’s decrease in gas demand and
Russia’s backing for the rival Turkish Stream project that will
deliver gas from Russia to Turkey. This is in some ways
complimentary and in others a direct competitor, given that
the construction of Turkish Stream, the SCP expansion and
TANAP mean Turkey will have more gas deliveries than it
requires. Ostensibly this should allow it to become a hub for
shipments into Europe, as TAP envisages, along with
competing Moscow-backed plans to deliver gas via Bulgaria
and Serbia to Hungary. However, these contrast with the EU
policy of seeking alternative supplies other than Russian gas,
which are now likely to enter the market via the same route
that Azeri gas will use.
Other Recent Investment
Flows of foreign direct investment (FDI) into Azerbaijan have
increased steadily in recent years to reach US$4.5bln in 2016.
The biggest share of this lies in the oil and gas sector, while the
nation is introducing initiatives to attract foreign investors to
other sectors.
Meanwhile, other investments in Azerbaijan include Technip’s
in the petrochemical sector. The French company has been
awarded by SOCAR a service contract for the ethylene and
cryomax technology licenses respectively for a petrochemical
complex located in Garadagh, Azerbaijan. The scope of work
covers the design of a new gas processing plant with a capacity
of 10bcm per annum and a new petrochemical plant.
Further investments into a Trans-Caspian gas pipeline to
connect Turkmenbashi in Turkmenistan to Baku have been
proposed. The future of such endeavours is unclear. While
support for such a project will likely depend on initial successes
of the Southern Gas Corridor and the consequential optimism
of investors, it cannot go ahead until a final new treaty on the
Caspian Sea has been agreed by all the states in its littoral, a
process that is unlikely to be completed in the foreseeable
future despite ongoing regular summits given its significant
geopolitical implications.
State Oil Fund Of Azerbaijan (SOFAZ)
The State Oil Fund of Azerbaijan (SOFAZ) is an extra-budgetary
sovereign wealth fund, created in 2000 to secure
macroeconomic stability and promote the development of the
non-oil sector. SOFAZ revenues come from oil and gas projects
and agreements. The government also announced that the
fund would increase transparency in spending state reserves,
although this has not proven to be the case. While the fund
remains less opaque than other similar funds in the post-Soviet
space (such as Kazakhstan’s Samruk Kazyna), concerns over
the valuation of some of its assets will continue to emerge
from time to time.
SOFAZ serves a key role in bridging oil and gas revenues with
the rest of the economy, while its activity also significantly
impacts foreign currency transactions given that it is
effectively the domestic supplier of dollar liquidity, due to its
participation in the Central Bank’s dollar auctions. In addition
to questions about the fund’s valuation, however, there
remain correlated concerns over potential corruption, as
elaborated below. The fund is overseen by Azerbaijan’s
president who approves the budget and appoints the board
members, which gives the President exclusive control over the
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fund. Due to the economic downturn, the fund in recent years
has had deficits, which has prompted the government to take
fiscal consolidation measures.
As of 1 July 2017 SOFAZ stated its holdings have amounted to
US$34.79bln. 47.3 per cent of its assets are placed in US
dollars, 35.9 per cent in euros, and 19 per cent in other
currencies, again according to SOFAZ.
Budget support
SOFAZ ran deficits in both 2015 and 2016, with the fund
declining by US$1.1bln and US$3.8bln respectively. According
to the 2017 SOFAZ budget, its deficit is forecast at US$3.5bln.
However, according to independent sources this figure may
increase by as much as US$1bln in the aftermath of the
collapse of the International Bank of Azerbaijan (IBA). The
government insisted this was not the case given that IBA’s non-
trade creditors accepted maturity extensions on their debt.
However, some trade credit loans underwritten by IBA – which
the bank always said it would honour in full – were reportedly
paid out early. An agreement to repay Kazakhstan’s recently
restructured loans to IBA early also cannot be ruled out, which
would also likely be met with funds drawn from SOFAZ. There
have also been reports that SOFAZ will intervene in foreign
exchange markets to boost the manat, although Azeri
government officials downplayed the likelihood of this saying
that that they did not expect the full 7.5bln manat (US$4bn)
authorised in the 2017 budget for such purposes would be fully
utilised.
The slight recovery in global energy prices may help alleviate
the need for large transfers to the state budget witnessed in
2015 and 2016. Transfers reportedly may decrease to
US$1.5bln in 2018 according to local media sources, although
speculation has varied widely.
Corruption allegations
SOFAZ is considered a transparent institution in Azerbaijan, as
one of the reasons of its establishment was to have a
transparent mechanism for oil revenues. Oil production and
revenues are reported and audited according to international
standards. The audits are carried out by an international firm
of auditors. Furthermore, every quarter SOFAZ publishes
reports on the revenues and expenditures. In 2007 SOFAZ
received United Nations Public Service Award for an improving
transparency, and an award from Extractive Industries
Transparency Initiative (EITI) to be the most compliant state.
Several media outlets raised concerns that the fund’s
transparency and auditing standards would decrease as a
result of the 10 May 2017 decision by Baku to withdraw from
the EITI, which promotes transparency in extractive industries.
Baku was previously warned for failing to live up to EITI’s
standards and the move raised concerns that multilateral
lenders could cool on supporting Azerbaijani energy
investment. AKE believes this to be extremely unlikely, a view
held by Azeri officials and local government critics as well.
Nevertheless, it highlights concerns around the use of SOFAZ’s
funds and could decrease the quality of future audits of
government spending.
Despite the international supervision, there are still aspects
that lead to unknown practices. For example, SOFAZ is not
subject to any rules that would limit the amount of money that
is transferred to the budget. SOFAZ funds have been widely
used to reduce the fiscal deficit. Moreover, the state budget
does not disclose how the transferred money is spent. There is
significant evidence for bribery in relation to SOFAZ spending.
The opposition-linked Centre for Economic and Social
Development (CESD) think tank has conducted several
investigations on projects that SOFAZ invests in. An example of
alleged construction related to SOFAZ investment emerges
from CESDS’ investigation into the Baku-Tbilisi-Kars railway
construction project. The initial estimate costs were US$400m,
but has now cost more than US$1.2bln. CESD noted the lack of
an open tender process for most contracts related to the
project, many of which were awarded to close political allies.
SOFAZ spending on such contracts is not subject to any
independent oversight.
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The Financial Sector
32 banks are currently operating in Azerbaijan. However, 11
banks have been shuttered since the collapse of oil prices in
late 2014 and early 2015. Seven banks account for over 55 per
cent of the banking sector’s total assets. These are, by size:
International Bank of Azerbaijan (IBA), Xalq Bank, Kapital Bank,
Bank Standard, Access Bank, Pasha Bank, and Atabank.
The Organised Crime and Corruption Reporting Project
(OCCRP) has established that the family of President Ilham
Aliyev controls Atabank, Xalq Bank and Pasha Bank. It also
holds a 49 per cent stake in Russian bank VTB's local subsidiary
and has been linked with stakes in Expresbank, Azerbaijan
Industrial Bank and likely controls Silk Way Bank as well. The
OCCRP estimated that in 2014 approximately US$3bln in
banking assets were controlled by the first family. Their
dominance of the banking sector is likely to continue, and
could in fact become more significant in the aftermath of the
IBA collapse and the decline of the family that controlled it,
detailed in the subsequent section.
The latest major amendment to Azerbaijan’s banking laws
came into force on 16 April 2017. The main amendments are
concerned with the appointment of temporary administration
and financial assistance to crisis-stricken banks. The changes
included important new legislation on dealing with insolvent
banks. It concerns appointment of a temporary administrator,
to be appointed by the Financial Market Supervisory Authority
(FIMSA) for a period of nine months, with the possibility for a
three-month extension. The law also sets out a process for
dealing with insolvent banks. This calls for the merging of the
afflicted bank with a solvent and stable bank; fully or partially
transferring assets and liabilities of the insolvent bank to a
solvent bank; establishing a bridge bank, which would then be
sold to investors; selling the insolvent bank; debt restructuring
with its creditors. Notably, the law also includes a clause
authorising investigations into the circumstances that led to
the bank’s liquidation. Individuals may be held responsible and
brought before the court. This provision is unlikely to work
independently due to the high corruption level in the state.
However, it may have been included to target those the state
holds responsible for the collapse of the International Bank of
Azerbaijan, which is detailed further in the subsequent section.
The government has heavily intervened in the sector, spending
nearly US$7bln bailing out the country’s largest bank, IBA.
However, in May it allowed IBA to default. The official line from
the government has been that this will allow the banking and
financial sector to begin to recover by drawing a line under the
significant issues it suffered. Poor management, corruption
and failures to hedge currency risk are the defining factors that
led to IBA’s collapse and significant pain across the wider
banking sector. If the economy does not improve, one can
expect further bank closures. The government could promote
another bank at the expense of IBA. Nominal plans to privatise
IBA are unlikely to proceed for quite some time. Further pain
in the sector means banking sector competition may decrease,
which could hamper growth amid already high interest rates.
The government has implemented laws in response to the
crisis for restructuring and managing insolvent banks, but the
fallout with IBA and its unexpected default will dampen
confidence in the sector for some time.
International Bank of Azerbaijan
The International Bank of Azerbaijan’s May 2017 restructuring
struck almost all of its investors and creditors as a major shock.
The government had spent US$5.8bln absorbing bad loans,
and US$1.3bln in new deposits to provide liquidity and
recapitalise the bank in the previous two years. President
Ilham Aliyev had publicly stated his support for the bank as
recently as January.
The process of recapitalising and absorbing the bank’s bad
loans had seen the government’s stake in the bank rise from
50.2 per cent in July 2015 to 91.3 per cent in January 2017.
While the bank had not received explicitly state guarantees, it
was the successor to the old Soviet trade bank (known as VTB,
much like the Russian state-owned bank that still goes by that
name) and had been closely overseen by the government, with
key officials in charge of IBA having close ties to the Azeri
government.
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Fitch also ratified a credit rating for IBA at BB as recently as
November 2016 on the basis of government support, despite
the bank having effectively failed as a stand-alone institution.
This came only six weeks after the State Oil Fund of Azerbaijan
(SOFAZ) injected US$1bln into the bank. Although Fitch
highlighted it had noted additional concerns in January 2016
given the size of losses from unhedged manat positions, it did
not change its rating.
Government officials were extremely hesitant to talk about
the restructuring, claiming that the process was an effort to
draw a line under concerns over the Azeri banking sector that
had been battered by the devaluation of the manat over the
past two years. Local journalists noted that they believed the
restructuring to be related to corruption issues around former
IBA Chairman Jahangir Hajiyev and Hajiyev’s brother-in-law,
former national security minister Eldar Mahmudov.
Mahmudov and Hajiyev have been tied to a series of
individuals arrested and found guilty in connection to fraud
and taking out illegal loans from IBA over the past two years.
However, the family of President Ilham Aliyev and their close
confidantes have long been accused of similarly taking out
preferential loans from banks controlled by their allies or the
family itself.
There has been widespread speculation as to what caused the
fallout between the government and Hajiyev-Mahmudov.
Local journalists who spoke to AKE agreed that it appeared to
be prompted by the fact that Mahmudov was taken down by
other oligarchic government officials, primarily the Aliyev
family and Emergency Services Minister Kamaladdin
Heydarov, after Mahmudov was seen to have concentrated
too much power in his family’s hands and used these to
blatantly steal funds from the state through IBA.
In June 2017 after the restructuring was announced, it was
revealed that Kazakhstan had persuaded IBA to redeem a
US$198m bond issued in September 2013 two years early,
with repayment coming in September 2016, just after SOFAZ
deposited US$1bln in IBA. The repayment reportedly came
following three earlier requests to repay the debt early. The
bond in question had a 7.75 per cent coupon, 212.5 basis
points higher than its comparable five-year bond issued a year
later. Kazakhstan’s state-pension fund (ENPF) did not receive
early repayment on the US$250m 10-year IBA bond it
purchased in October 2014, which carried an 8.25 per cent
coupon. That bond is now included in the restructuring.
AKE was not able to determine the ultimate owner of the
US$100m subordinated loan issued via Ireland-based financing
vehicle Rubrika Finance that faces a 50 per cent haircut under
the restructuring plan. It was a failure to repay the initial on
this note, a 10-year bond issued with an 8.40 per cent coupon
in May 2007, on 10 May that triggered IBA’s initial default.
Kazakh media, which has extensively covered the impact on
ENPF and the Central Bank, has not indicated that the note was
bought by Kazakhstan. The note is listed on the Cayman Islands
stock exchange, which limits the disclosures required to the
Irish Central Bank. Rubrika Finance is formally owned by
Carmel Naughton, the wife of Michael Naughton, one of
Ireland’s richest men. The company has not stated whether it
holds the note itself.
Subsequent section 6.1 details a timeline of IBA’s collapse and
the preceding developments with regards to the
abovementioned Kazakh notes, government statements of
support and dismissals and arrests of relevant figures. Section
6.2 outlines the arrests of individuals tied to the bank in detail.
Given strict controls on reporting and the political nature of
the trials, this list should not be seen as exhaustive.
Looking Ahead
Change comes slowly in Azerbaijan, but the country will
continue to be at the forefront of Europe’s energy
diversification policy and the development of new gas
networks stretching from Baku to Europe, and potentially in
the future over the Caspian to Central Asia as well. Despite the
promise that these opportunities provide, even in the
continued environment of relatively muted energy prices,
significant risks will remain. These are outlined in the following
paragraphs, with a view towards enabling readers to have a
strong understanding of the fundamental concerns they
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should have, as well as the areas of investigation they should
focus on when considering projects in Azerbaijan.
The primary risk faced when doing business in Azerbaijan is
corruption. While such activity is par for the course across
much of Eurasia, navigating the relevant networks in
Azerbaijan can be extremely difficult. The shifting fortunes of
elite power brokers, and their decision-making processes, are
highly murky and poorly understood even by most locals. As
mentioned in this report, two of the most powerful ministers
have lost their jobs in the past two years. Security Minister
Eldar Mahmudov lost his post in 2015, with the falling out likely
playing a direct role in the collapse of IBA. In February 2017
Transportation Minister Ziya Mammadov was sacked
unexpectedly, despite the growing prominence of his own son,
Anar Mammadov, in international pro-Azeri business lobbying
circles. The sacking came less than a month before US media
reported that President Donald Trump had licensed a hotel to
the Mammadov’s that was also invested in by front groups for
Iran’s Revolutionary Guard Corps (IRGC), which has prompted
concerns that businesses linked to the Mamadovs could be
affected, including Azerbaijan Railways. On 15 June Azerbaijan
Railways announced a proposal for a financial advisor for the
'possible refinancing of certain existing liabilities'.
A secondary risk is that of conflict with Armenia over the
Nagorno-Karabakh conflict. The likelihood of this conflict
emerging into a major war remains relatively low, but such an
event would have major ramifications for the Azeri energy
sector and wider economy, as well as for political stability.
President Ilham Aliyev’s father, Heydar Aliyev, rose to the
presidency as a result of the instability emerging from the
initial post-Soviet conflict over the area, despite having
effectively lost his prior influence amid the collapse of the
Soviet Union, given his previous role as a deputy premier of
the USSR. The South Caucasus Pipeline and Baku-Tbilisi-
Ceyhan pipelines run within 40 km of the front line. While
Azerbaijan’s mutual defence pact with Turkey and Armenia’s
mutual defence treaty with Russia provide for significant
deterrent factors, April 2016 witnessed four days of heavy
clashes that left more than 200 dead and saw Azeri forces
retake a number of strategic heights. International efforts to
ensure the conflict does not escalate leave much to be desired.
The primary mediation arrangement, the Minsk Group
overseen by the OSCE, has not made any significant progress
over the past 23 years, with both sides still refusing to take part
in formal peace talks. Violent incidents remain commonplace,
but the risk of escalation is primarily from Azeri forces moving
on Armenian positions rather than the opposite. Nevertheless,
even in the event of such an assault, Armenia retains artillery
capabilities that could likely respond with an attack on Azeri
energy infrastructure, while any potential involvement in the
conflict by Russia would quickly turn the tide against Baku.
While war remains unlikely, the risk must be accounted for
given its potentially critical impact.
Thirdly, while TANAP is expected to meet its construction
targets and it is increasingly likely that the route connecting
Azerbaijan’s Caspian fields with Italy’s gas networks via TAP
will be completed, the significant deepening of Russian-
Turkish ties poses a number of questions for potential further
expansions of the European Union’s planned Southern
Corridor route. EU support for the Southern Corridor is largely
predicated on the fact that it should be an alternative to
Russian gas supplies, which continue to dominate in central
and eastern Europe. Completion of the Turkish Stream gas
pipeline, as well as Russia’s efforts to build – and own – a
pipeline connecting Turkey with Bulgaria, Serbia and Hungary
will complicate these matters. Multiple legal challenges within
the EU can be expected if Russia does announce it will begin to
build such a pipeline. These tend to be drawn-out and
extremely politicised. While opposition to additional Azeri
supplies is non-existent in Turkey and negligible within the EU,
Moscow would also undoubtedly seek to ensure it had
effectively preferential access for its supplies to this new
route. Even a failure by Moscow to secure the route for itself
could dampen the prospects of further expansion of the
Southern Corridor as under EU competition rules it could not
hinder Gazprom from accessing the pipeline if its gas is already
available on the Turkish market. This would therefore
decrease European support for such a route.
Additional factors such as the price of energy supplies and
developments in Iranian-Western and Iranian-Russian
relations will have major impacts on Azerbaijan’s prospects as
well. The ultimate legal status of the Caspian Sea may also
open it one day to serve as a bridge between Europe, the
Caucasus and Central Asia, although hoping for progress on
this front has proven a fool’s errand. Ultimately, local factors
determine the three primary risks – economic in the form of
corruption, geopolitical in relation to Azerbaijan’s export
routes and security-wise in relation to the conflict with
Armenia. The overall trends in these three areas develop
slowly. However, a thorough examination of their nature and
relation to any particular project is vital.