ake special report special report political risks in azerbaijan the energy sector the azeri energy...

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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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AKE Special Report – Political Risks in Azerbaijan Example Monthly Report Tit le

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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.

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