Does Declining Oil Revenue Equal Less Security for Azerbaijan?
By Eric Eissler for ISN
March 25, 2014
[Summary: Declining oil revenues and a changing energy marketplace are
placing Azerbaijan’s social and economic development under strain.
Worse still, observes Eric Eissler, the lost income might curtail the
country’s defense spending at a time when Baku needs it most.]
To say that Azerbaijan lives in a unique but troubled geopolitical
location is perhaps an understatement. Flanked by assertive regional
powers and embroiled in a `frozen’ conflict with neighboring Armenia
(which still occupies 20% of Azerbaijani territory), Baku’s diplomatic
relations are undoubtedly complex. Nevertheless, this former Soviet
republic has been able to utilize its hydrocarbon wealth to balance
its regional ties and safeguard its overall security. But the veneer
might be slowly starting to slip.
Rising from the Ashes
Upon gaining independence, Azerbaijan inherited a massive quantity of
hydrocarbon reserves, estimated in 2012 to stand at 7 billion barrels
of oil and 0.9 tcm of natural gas Put another way, the country was
effectively born with a ready-made source of income that could boost
its social and economic development during a period of great
uncertainty. In order to better capitalize upon this, Baku established
the State Oil Fund of Azerbaijan Republic (SOFAZ) in December 2000.
Since then, the revenues that it has pumped into Azerbaijan have
formed the backbone of the country’s development.
Indeed, the amount of hydrocarbons-based revenue that SOFAZ has
injected into the country increased dramatically between 2000 and
2013. In 2007, for example, the fund invested $686 million back into
the country. By 2012, however, this figure increased to $11.64
billion. In total, Azerbaijan has allocated an estimated $49.73
billion for economic development and regeneration.
A major benefactor of this investment has been Azerbaijan’s armed
forces. In an address to a military parade in June 2013, President
Ilham Aliev laid bare the extent of his country’s defense expenditure
when he declared:
`In 2003, our military budget was $163 million. Last year [2012] this
figure was $3.6 billion, this year [2013] it has reached $3.7 billion.
This in itself shows that military buildup is the top priority, great
funds are allocated from our budget for military buildup.’
Increased defense expenditure has allowed Azerbaijan to gain the
military upper hand against Russian-backed Armenia. Baku has invested
heavily in purchases of combat and transport helicopters, combat
aircraft and air defenses that can be deployed along the `line of
contact’. Moreover, by possessing the strongest armed forces among the
South Caucasus states Azerbaijan has been able to keep Russia out of
its domestic politics. This, in turn, has enabled Baku to develop
close ties with the likes of Israel and the United States, thereby
boosting its international profile in the process. In marked contrast,
the only recent `positive’ in Russo-Azerbaijani relations was Vladimir
Putin’s visit to Baku in 2013 ` the first official Russian delegation
in seven years .
Trouble Ahead?
But the good times are possibly coming to an end, at least for
Azerbaijan’s elite, pro-government forces and the country’s military.
On December 3 2013, Baku gave the country’s Tariff Council the green
light to raise gas and petrol prices. As a result, petrol prices
increased by up to 33% and natural gas prices almost doubled. This was
effectively the beginning of the end of cheap gas and petrol prices
for Azerbaijan’s citizens.
Skyrocketing domestic fuel prices were quickly followed by an
announcement that SOFAZ will reduce its transfers of oil revenues to
state coffers in 2014. It has been estimated that SOFAZ’s actions will
lead to a 17-18% reduction in government spending. This, in turn,
helps to explain why the government has dramatically hiked up the
price of domestic fuel. Dr. Vugar Bayramov, the Chairman of the Board
form the Center for Economic and Social Development (CESD) told the
ISN:
`The government is attempting to compensate the budget with revenues
from the non-oil sector. One of the main reasons for increasing the
petrol tax rate was to compensate for this deficit.’
But why has Azerbaijan taken such drastic measures? The answer to this
question lies in declining oil production. Estimates suggest that
Azerbaijan produced on average 872,000 barrels per day in 2012. By
contrast, production stood at 1.02 million barrels per day in 2010.
And while Azerbaijan is increasingly developing its natural gas
exploration and production capabilities, gas alone will not be able to
offset declining oil production. That’s due in part to a decline in
gas production from 17.24 bcm per annum in 2010 to 15.6 bcm per annum
in 2013.
In addition, Azerbaijan’s gas sector also faces a number of additional
challenges. These include the United States’ and the West’s growing
exploitation of unconventional resources such as shale oil and gas, as
well as the vagaries of the oil and gas markets. While oil is sold on
the global marketplace, gas tends to be traded regionally and is only
sold on a global level as Liquefied Natural Gas (LNG). As a result,
gas sales are not as consistent as oil purchases. Gas prices remain
very much subject to current regional requirements and their
respective markets.
Currently, Azerbaijan’s economy is not yet diversified enough to cope
with such a dramatic fall in oil revenues. This is also reflected by
the fact that many Azerbaijanis continue to live below the breadline.
While relative poverty has fallen in recent years, and Gross Domestic
Product (GDP) per capita has risen from $1,908 in 2002 to $6,220 in
2012, many citizens living outside of the capital continue to struggle
making a living. It’s also difficult to see how Baku can make
much-needed investment in education and further training against a
backdrop of declining oil revenues.
Around the Neighborhood
Worse still, declining oil revenues casts further doubt over the
sustainability of Azerbaijan’s defense expenditure at a time when it
arguably needs it most. Like many other former Soviet states,
Azerbaijan is undoubtedly viewing the events unfolding in Ukraine with
a sense of unease. The region as a whole is also likely to be unnerved
by popular demands in Russia for Putin to go after other `lost’
territories, such as Belarus and Kazakhstan. Yet, while there is no
suggestion that Azerbaijan is under immediate threat, the fact Moscow
has Russian troops based in neighboring Armenia might become too close
for comfort for Baku in the coming years.
Yet it could have been so different for Azerbaijan and its citizens.
While SOFAZ did a good job in terms of transferring the country’s oil
revenues, it has done little in the way of improving economic
conditions for the generations to come. In 2012, for example, SOFAZ
made significant purchases of gold, only for the price of gold to fall
dramatically after the purchase. The same can also be said of its
investments in Turkish Lira, especially given that this currency
plummeted to all-time lows against the Dollar and the Euro in the
opening weeks of 2014.
Consequently, if Baku wants to continue lavishing its military with
substantial defense expenditure and improve social and economic
conditions for the majority of the population, it needs to keep a
tight rein on long-term planning and asset management. As it currently
stands, Azerbaijan is unable to meet both requirements. Bearing in
mind the neighborhood and times that it finds itself in, these are
lessons that the country needs to learn ` fast.