10.2 How Far We've Come - Evaluating the Progress of Azerbaijan's Oil Industry

Summer 2002 (10.2)
Pages 72-74

How Far We've Come
Evaluating the Progress of Azerbaijan's Oil Industry

by Valeh Alasgarov

Valeh Alasgarov, General Manager of the Foreign Investment Division of the State Oil Company of Azerbaijan Republic (SOCAR), has been involved with Azerbaijan's oil contracts with international companies since SOCAR was established in 1993.

This article is an expanded version of the speech that he gave at the USACC's Fifth Annual Conference in Washington, D.C. on March 8, 2002. Here Alasgarov responds to what he sees is a tendency for foreigners to weigh Azerbaijan, Russia and Kazakhstan against each other in terms of their economic growth and progress toward democracy. This is like comparing apples and oranges, he says. Considering all of the crises that Azerbaijan has had to deal with in these past 10 years - war with Armenia, nearly a million refugees and early widespread political unrest, Alasgarov is convinced that the country has made incredible strides forward.

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We didn't start from zero. We started from a collapsed system. We had no country, no ruling power, no government. We had to put those pieces together, rebuild the country and try to regain the people's trust. When we talk today of what we have attained, we have to remember how it all started.
-Valeh Alasgarov

Above: Roughly 1 out of every 8 Azerbaijanis was made a refugee from the war with Armenians over the territory of Karabakh. Still they have not been able to return to their homes nine years later. The responsibility of trying to provide even meager support for nearly 1 million homeless people has placed a serious strain on Azerbaijan and its development. Photo: Oleg Litvin, 1993.

A decade has passed since Azerbaijan gained its independence and we began to move towards democracy and a market economy. It's important that we not forget the many obstacles that have obstructed our path. Perhaps the most significant is the fact that 1/8th of Azerbaijan's population are refugees and IDPs (internally displaced persons). Nearly 1 million people in Azerbaijan were forced to flee their homes because of the war in Nagorno-Karabakh with Armenia. This massive displacement of civilians creates a tremendous burden on our society because these people have to be helped and cared for. So many of our refugees still don't have work.

Imagine if 12 percent of the population of the United States were refugees. In a population of 285 million people, that would mean 22.8 million people would be displaced from their homes and communities - about twice the population of New York City. Consider the appalling economic, political and social consequences of such a disaster. For any country, this would be a catastrophe.

In any evaluation of Azerbaijan's development this past decade, it's a mistake not to factor in these historical and social conditions that we have been dealing with. To speak about issues like macro-economic indices, democracy and human rights doesn't make sense to the refugees right now. How can you talk about human rights when the most basic of their rights as human beings - the right to live on their own land-has been violated?

Their concerns are more basic. They are absorbed with issues like: Where can I get something to eat today? Where can I find shelter? How do I care for my children or my grandparents who lie ill?

Certainly Russia has had to deal with its share of refugees as well. Russian newspapers indicate that there are 1.6 million Russian nationals who came from Tajikistan and other newly independent countries of the former Soviet Union. However, unlike Azerbaijani refugees who had to flee for their lives, these people simply decided that it would be more feasible for them to live in Russia after the collapse of the Soviet Union.

But still such a large number of refugees (roughly 1 percent of the population) is considered to be a major economic burden for Russia because these people need homes, jobs and social support. Now, if this situation creates such a huge problem for a country with an estimated population of 144 million, imagine what it does to us, a country of only 8 million when 12 percent of our people have to cope with such life-shattering circumstances. For such a small country like ours to deal with this problem is an enormous undertaking in itself. Despite all these difficulties, it's obvious that Azerbaijan is developing and moving forward.

Even families that have not been displaced are affected by it. When my daughter sees refugee children, she is psychologically affected by it. It causes her to lose faith in justice, in honesty and the basic decency of people. She asks, "Dad, doesn't the whole world see what's going on?"

It doesn't matter who is right or who is wrong when it comes to politics. The fact is that these people have lost their homes, their past lives, their whole sense of belonging. It's also a tragedy that this little person of 10 years old loses faith and belief in what she considers to be fair in life.

Once she was watching TV where they were discussing human rights and democracy. Suddenly she stood up in anger and rebuked the TV: "I'd like to know what you would say about human rights if you came and saw how our refugees live in the camps." Imagine such a young child being so deeply affected. Everybody is affected one way or another by the tragedy of our refugees.

Educating the Public
Another difficulty in building a democracy and a market economy has been in preparing the Azerbaijani public for sweeping economic and political changes. It's one thing to pass laws and legislation, but these new rules must be understood and put into practice by the entire population.

Let's not forget that an economy is not based only on formulas, programs and laws, but on the people's sense of community as well. In other words, not just the President of a country or his ministers. If the general public is not ready for certain economic or political changes, then it becomes very difficult to implement them.

We've had wonderful help from experts from the United States and Europe who have come over to assist us in building a democracy. But in advising us, they should also keep in mind the history of their own countries. It's not reasonable to expect us to achieve in a mere 10 years what it took them 200 to 300 years to do.

A few years ago at a conference in Washington, D.C., I challenged the Americans there to consider how long it had taken for some of their democratic institutions to be fully realized. For example, even though the Constitution had been adopted in 1787, women were not granted the right to vote for more than a century. It took more than 133 years for something as basic as women's suffrage to be enacted.

And what about blacks? When did they get the right to ride in the front of the buses with whites, or to eat in the same restaurants? Not until the 1960s. For 215 years, the United States has had a democratic Constitution that outlines basic human rights. Those declarations haven't changed, but in reality these basic human rights have not always been fulfilled. Why? Because the people were not ready to accept the laws.

New Mentality
We Azerbaijanis have had to totally rethink our political system. Today's young people don't have the Soviet mentality that we grew up with, but naturally they still carry the remnants of the past because their parents and grandparents grew up under that system. It will take a long time, even several generations for that Soviet mindset to be replaced with new ideas.

I often think about why Moses wandered in the desert with his people for 40 years? If you look at a map of the area, you see that it should have only taken them about 20 or 30 days to walk from Egypt to Israel - not 40 years.

Moses knew what he was doing. He knew it would have been impossible to build up a new society with people who had grown up knowing only slavery. He wanted his people the Israelites to emerge with a new mentality when they reached the Promised Land. You can't build a new society with people who have the mentality of slaves.

In the desert they had to work hard for their own survival in order to organize a new nation. First they had to get used to freedom. Then they had to understand that their survival depended on their own initiative. Just like them, we Azerbaijanis are building a new society - a new state. And we need time.

Early Negotiations
Some readers may recall the situation in Azerbaijan between 1990 and 1993. Three years of negotiations with international oil companies had failed to produce a single page of agreement. The main problem at that time was a lack of mutual understanding. The two sides simply did not understand each other.

For one thing, Azerbaijanis didn't understand the value of money. During the Soviet era, our factories and official departments received money according to decisions made by the top decision makers in Moscow. Azerbaijanis could only follow orders; they were not given the responsibility to care if a business was effective or ineffective, profitable or unprofitable. Some of the money from the Central government was dispersed to the oil industry, some to agriculture, some to engineering. So when we gained our freedom, we weren't used to making financial decisions. So the Azerbaijani side lacked a basic understanding about money.

On the other hand, the international companies didn't understand the mentality of our country at first. They thought that everyone here would understand complex economic terms like "internal rate of return" and "net present value". But we Azerbaijanis were used to thinking with a different set of categories. Basic financial terminology had different meanings for each side - it didn't matter if we were speaking to each other in Russian or English.

Political Instability
Another major obstacle was the political and economic instability that existed in Azerbaijan at the time. At the end of the Soviet period, in 1990 and 1991, it was impossible to even think about our future because we didn't know what was going to happen to our country. How could we make plans to implement a 20- to 30-year oil project when we didn't know what would happen tomorrow? There was no faith in the future.

After Azerbaijan became independent, the situation worsened as various leaders jockeyed for power. At that time, the people who were fighting for power were using terms like democracy, market economy and human rights. Those were pleasant words spoken by individuals who weren't necessarily intent on building a new country. In reality, they were interested in controlling the stream of goods, money and oil.

I remember in June 1993, there was hardly a single foreigner left in Azerbaijan because a civil war had broken out. Some people now refer to those days as a "military coup", but that wasn't the reality. People who weren't here at the time can say those things. But we were here. We lived through it. It was civil war. There was curfew and tanks in the street. The country was on the verge of collapse.

One colonel was in control of the western part of Azerbaijan; another, the east; another, the north, and in Baku there was no one. Each political party had its own armed force. The foreigners had all left Baku because they didn't believe that anything could be done. The country was literally falling apart.

Azerbaijanis wondered who was ruling the country and where it was heading? Would Azerbaijan survive, or would it be divided into several regions and fall under the protectorate of other countries?

Aliyev Returns
In the midst of this chaos and impending collapse, the people who were in power decided to go to Nakhchivan where Heydar Aliyev was living at the time and invite him to come to Baku. The leaders who call themselves "opposition" today were actually among the ones who invited him at the time. It took a lot of persuasion, but when Aliyev realized that the country was on the verge of collapse, he agreed to come.

People tend to forget that Aliyev took big risks in doing so: no one could guarantee his safety. There could easily have been an attempt made on his life. Likewise, when Aliyev went to Ganja to meet with Surat Huseynov, who was trying to take control of the entire country, no one could vouch for Aliyev's security.

About a week later, Azerbaijan's President, Elchibey, ran away from the situation [June 1993]. He just got on a plane and disappeared, without telling anyone. He left for his mountain village in Nakhchivan without informing anyone. What was the country to do? What was Heydar Aliyev supposed to do? Sit and wait until he came back? The country was disintegrating.

Things got worse. One of the colonels, now referred to by some as a "political prisoner", declared himself as president of a Talish-Mughan republic. He pulled his troops away from the Front in Nagorno-Karabakh, leaving our territory exposed, and he headed down to Lankaran, the center of the Talish-Mughan region.

After two assassination attempts - in October 1994 and in March 1995 - what did Aliyev do? He went out into the streets at midnight and addressed the people. Hundreds of thousands of people turned out to support him - the young, the old, women and children. It was the people who protected the President, not the armed soldiers. No one could guarantee that there weren't people in that crowd who would try to kill him. But he went out anyway to rally the nation that had come to protect him.

We didn't start from zero. We started from a collapsed system. We had no country, no ruling power, no government. We had to put all those pieces together, rebuild the country and try to regain the people's trust. When we talk today of what we have attained, we have to remember where it all started. These are the events that took place only seven or eight years ago.

New Oil Contracts
Nevertheless, by late 1993, we were already putting together a negotiation team - including Natig Aliyev, Ilham Aliyev, Khoshbakht Yusifzade and myself - to begin serious talks about contracts with international oil companies.

But before we signed agreements like the "Contract of the Century" (September 1994, for the development of Azeri, Chirag and Gunashli), we had to establish a system that would encourage and protect foreign investment. We had to give serious consideration how to carry this out on a legal level.

After studying the oil contracts and legislation of 61 different countries, we realized that there were two ways to proceed. We could follow the model set forth by Norway, England, the United States and Canada - that is, to prepare a comprehensive set of regulations. But according to my calculations, we would have needed to create at least 1,380 regulations related to issues such as taxation, customs and insurance. This process would have taken several years. Unfortunately, we didn't have such luxury of time. We had to forge ahead and try to attract foreign investment as quickly as possible.

That's why we adopted a law, which in my opinion was very good, despite the fact that we still receive criticism today about it. Each oil contract has to be ratified by the Milli Majlis (Parliament), and only then can it be deemed binding as a legal document according to the laws of the Azerbaijan Republic. In this way, we sped up the process in a way that allows investors to trust this country.

It would have been impossible to attract large companies and major investors here any other way because those companies already had experience in other post-Soviet countries - for example, in Russia. And they saw that every day the government there was adopting new laws, a new taxation system and new regulations related to import and export taxes. We had to reassure the international companies that we weren't going to change their contracts. They would be valid for 25 to 30 years, and nobody would be able to change them, even if new laws were adopted in Azerbaijan. Any changes relative to their contracts would have to be carried out with the consent of both sides.

In these past seven years, since the signing of that first major contract, we haven't had any complaints that Azerbaijan isn't following the rules. These companies come to Azerbaijan because they believe that they can trust their billions of dollars to work for them.

This trust between the two parties, in my opinion, is critical. If an investor doesn't have faith in a country - no matter how much oil it has - he will never invest his money there. This is not the money and investment of a single person: this is the money of an entire company and its shareholders. In my opinion, we've succeeded in gaining the trust of these companies.

Each contract that we signed protects not only investors and oil companies, but also the other companies that work for them, including subcontractors, service companies and suppliers. This is why the service industry has dared to come to Azerbaijan.

For example, when Transocean Sedco Forex built a drilling rig in Azerbaijan, 25 percent of the costs were covered by the oil companies, but the other 75 percent was undertaken by the service company. This shows that service companies are not afraid to invest their money in the development of Azerbaijani infrastructure.

In a short period of time, we've signed 21 PSAs [Profit Sharing Agreements] - a significant achievement for Azerbaijan. If we compare Azerbaijan to neighboring countries that have many more confirmed oil deposits, they haven't been nearly as active. It's because their legislation doesn't recognize the basic needs of their investors and they end up changing the rules too often. But in Azerbaijan, we continue to work in the same mode and attract new investors to the oil and gas sector.

Hits and Misses
I would also like to say a few words about the wells that have turned out to be empty. Of course, it's very disappointing to hear that such wells were not deemed profitable enough to develop, but this is only natural. According to international statistics, if two or three wells out of 10 turn out to have significant oil and gas deposits, it's considered to be very successful.

Let's take Saudi Arabia, for example, which signed its first oil contract back in 1922. Their second major contract wasn't signed until ten years later, in 1932. But consider, when was the first major deposit discovered? In 1949. And when did they first start exporting oil? In 1951. At present, Saudi's Ghawar oil deposit is considered to be the largest oil reserve in the world, with more than 11 billion tons of oil. But they had to deal with many empty wells before they discovered it.

Or consider the discoveries found in the North Sea. In the 1950s, who would have thought that there would be so much oil there? Many books and articles at the time insisted that there could be no oil or gas in the North Sea. Even though small gas deposits had appeared on the shores of England in the 1920s, analysts insisted there could be nothing more than that. In 1959, the massive Groningen gas field was discovered in the Netherlands, but still the experts said that there could be nothing more.

Of course, the companies that are drilling the wells have to pay for them, so it's only natural for them to be deeply concerned. But there's no use to speculate about whether there will be this much oil or that much oil in a given well. There will only be as much oil as God has put there.

Progress on Pipelines
Exploration and exploitation of the oil or gas deposits is really the easiest part of our job here. The main difficulty is figuring out how to transport this oil out to the world market. In this area, Azerbaijan has again made what I consider to be wise decisions.

Back in 1997, in the First Stage of Early Oil with ACG, we started building the Northern pipeline from Baku to Novorossiysk (Russia). Despite harsh criticism, we also decided to build a second pipeline. And today I can say that most of the companies who are currently using the Western pipeline route between Baku-Supsa (Georgia) were against the idea at that time. There were complaining: "Why do we need a second pipeline if we already have Baku-Novorossiysk? If something happens in Russia tomorrow, we'll sue them."

But the Azerbaijani side and primarily President Aliyev insisted on constructing the second pipeline. Experience now shows that we made the right decision. The Baku-Supsa pipeline is not having any problems in getting the Azerbaijani oil to the world market. The same can't be said about the first pipeline that we built to Novorossiysk.

But the Baku-Supsa pipeline is still not an adequate solution. Perhaps it's enough for our needs today, but we must plan for the future. Actually, we started thinking about this shortly after signing the first oil contract in 1994. Today, when some people criticize us and say that the pipeline route of Baku-Tbilisi-Ceyhan [pronounced Jeyhan] is merely a political decision, I can say that it's not true. Believe me, I've been in this business since the very beginning. It took us three years - 1995, 1996, 1997 - to consider the various options: going through the Black Sea, the Persian Gulf and numerous other alternatives. We calculated everything and reached the decision about Baku-Ceyhan, without being pushed by anybody.

I always say that Azerbaijan is not such a rich country that we can construct a pipeline wherever we want. We have to know the value of every single dollar and every single manat. And that's how the decision about Baku-Ceyhan was reached. It's clearly the best option from an economic point of view.

Fewer and fewer people are speaking about using the Bosphorus [which connects the Black Sea to the Mediterranean Sea] these days, but some still continue to insist: "Why are you building a pipeline to the southern coast of Turkey on the Mediterranean? Use the Bosphorus. You can transport 100-200 million tons a year through the Bosphorus." But it's not true. It's impossible to transport that much oil through those narrow straits.
Not so long ago while delivering a speech in Istanbul, I said: "This nation [Turkey] will wake up someday. God forbid that some tanker explodes in the Bosphorus. All the disasters that have happened there so far, fortunately, have not been catastrophic. But if a major disaster does take place, not a single tanker will be allowed to pass through the Bosphorus for years."

According to my calculations, the Bosphorus can handle about 75-80 million tons a year. The figure is already close to 60 million tons. In a few years, it will reach 70-80. And then what will happen?

When we consider other possible routes through Bulgaria, Greece, Romania and Croatia, it's necessary to take into account the fact that we wouldn't receive the reasonable rates that we can get with Baku-Ceyhan. Let's take the Azeri-Chirag-Gunashli oil deposit, for instance, which has an estimated 600 million tons of oil. If we were to spend an extra $2.50 to $4 on each barrel, the additional cost would be $15-24 billion. Who would agree to such a decision? That's why we're convinced of the feasibility of the Baku-Ceyhan route.

The Detailed Engineering Phase of the Baku-Ceyhan project is now coming to an end. This June, we plan to sign contracts regarding the main equipment purchase. By the end of 2004, Baku-Ceyhan should be completed and already beginning to operate.

As for the gas pipeline, after the discovery of the Shah Deniz gas condensate deposit, we had to start thinking about how to export gas as well. As a result of negotiations with Turkey and Georgia, we have signed several contracts: a Gas Sale and Purchase Agreement with Turkey, another with Azerbaijan, and now we are going to sign one with Georgia.

The gas pipeline construction is supposed to be finished by the end of 2004. And beginning in 2005, we are going to start transporting Shah Deniz gas to the Azerbaijani and Georgian markets, and onward to the Turkish market. Someday we anticipate that this pipeline will not only transport Azerbaijani gas, but that of other Caspian countries as well.

Non-Oil Sectors
Non-oil sectors are also a very important topic for Azerbaijan. What good is it if we export oil but then have to spend our money on importing apples from Argentina? It's hard to believe, but today Azerbaijani marketplaces sell apples from Argentina, milk from Germany and chicken from somewhere else. That's why it's crucial for Azerbaijan to develop its non-oil sectors.

Azerbaijani is beginning to sell its products to the world market as well. Ten years ago, had anybody in America heard of place called Masalli? No. But today, a company working in Masalli is exhibiting its produce in the United States. And I believe that in the nearest future, the non-oil sectors in Azerbaijan will develop tremendously as well.

In my opinion, the Oil Fund that we have just established will help develop these other sectors. But they in return must bring a profit to themselves as well as back to the Oil Fund.

Some people think that we were forced to establish the Oil Fund. No, we did it on our own accord. Azerbaijan managed to establish the Oil Fund in a very short time, with a transparent accounting of its revenues and expenditures. Each year, all of the Oil Fund's revenues and expenditures are checked by an independent auditing company and then published. If there is anything more that we can do for transparency, we are ready to do that.

During the Soviet era, we used to spend everything we earned and, consequently, we went bankrupt. Now that we're independent, it's critically important that we make wise decisions so that our children and grandchildren can benefit from what we are doing today.

Valeh Alasgarov was interviewed by Azerbaijan International's Editor, Betty Blair, to expand his initial speech given in Washington, D.C.

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