Russia's Energy Interests in Azerbaijan

RUSSIA’S ENERGY INTERESTS IN AZERBAIJAN: A comparative study of the 1990s and the 2000s

Fariz Ismailzade Series editor: Dr Kevin Rosner

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Publisher’s note Every possible effort has been made to ensure that the information contained in this publication is accurate at the time of going to press and neither the publishers nor any of the authors, editors, contributors or sponsors can accept responsibility for any errors or omissions, however caused. No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the material in this publication can be accepted by the editors, authors, the publisher or any of the contributors or sponsors. Users and readers of this publication may copy or download portions of the material herein for personal use, and may include portions of this material in internal reports and/or reports to customers, and on an occasional and infrequent basis individual articles from the material, provided that such articles (or portions of articles) are attributed to this publication by name, the individual contributor of the portion used and GMB Publishing Ltd. Users and readers of this publication shall not reproduce, distribute, display, sell, publish, broadcast, repurpose, or circulate the material to any third party, or create new collective works for resale or for redistribution to servers or lists, or reuse any copyrighted component of this work in other works, without the prior written permission of GMB Publishing Ltd. GMB Publishing Ltd. 120 Pentonville Road London N1 9JN United Kingdom www.globalmarketbriefings.com This edition first published 2006 by GMB Publishing Ltd. © Fariz Ismailzade Hardcopy ISBN 1-905050-42-9

E-report ISBN 1-905050-87-9

British Library Cataloguing in Publication Data A CIP record for this book is available from the British Library

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Contents About the Author

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Executive Summary

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PART ONE:

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The 1990s and LUKoil

1.1 Military defeats energy: Russian foreign policy in Azerbaijan in the early 1990s 1.2 The beginning of Russian energy policy in Azerbaijan 1.3 Energy cooperation takes a priority: LUKoil’s expansion in Azerbaijan and the change of the Russian government’s attitude

PART TWO:

The 2000s and Putin’s ‘liberal empire’

2.1 Putin’s election: the start of a new economic strategy towards Azerbaijan. 2.2 Putin’s first visit to Baku and the expansion of LUKoil in Azerbaijan. 2.3 LUKoil slows down: Itera, Gazprom and RAO-UES step in

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PART THREE: Russian energy policy in Azerbaijan: what next?

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Notes and references

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About the series: Russian foreign energy policy reports

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About the author Fariz Ismailzade is political analyst based in Baku, Azerbaijan. His work focuses primarily on the geopolitics of the Caucasus region and CIS (Commonwealth of Independent States) affairs. He writes regularly for publications such as Transitions on Line, Jamestown Daily Monitor and Central Asia-Caucasus Analyst, and has presented at international conferences, including the Middle Eastern Studies Association (MESA), NATO Advance Research Workshop in Kyiv, Ukraine and the Association for Studies of Nationalities (ASN). Mr. Ismailzade currently works with the Cornell Caspian Consulting in Baku and is also a part-time lecturer at the department of political science at the Western University in Baku. He holds an MA in Social and Economic Development from Washington University in St. Louis, and a BA in Political Science from Western University in Baku.

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Executive Summary In May 2004, the head of Russia’s electricity monopoly RAO-UES, Anatoly Chubais, visited Baku for the first time and met with the leadership of Azerenergy, the Azerbaijani state electricity monopoly, as well as with President Ilham Aliyev. Local analysts immediately labeled the visit as the signal that Russia was taking over Azerbaijan’s electricity assets as had already happened in Georgia and Armenia. The move would have completed the energy and economic dominance of Russia over Azerbaijan. Yet the Azerbaijani leadership seemed unwilling to take that step. It would not only risk the country’s economic independence, but would also limit its geo-strategic and political independence and harm relations with the US. Thus the Russian-Azeri energy relationship in 2004 is decidedly different than the dynamics of the relationship in 1994 when the Azeri president, Heydar Aliyev, welcomed LUKoil into the country in order to please Russia and ensure the smooth implementation of oil contracts with the Western energy companies. It is clear that the character and penetration of Russian energy companies into Azerbaijan in the last few years has been on a different track than in the mid-1990s. Ever since the Russian empire took over the Caucasus in the early 19th century, it has always been interested in maintaining its dominance over the region. The discovery of oil and gas reserves in the Caspian Sea further strengthened these aspirations. Yet the collapse of the Soviet Union and the decrease in the power of Moscow made Russia’s Caucasus

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policy chaotic, uncoordinated and weak. At the beginning of 1990s, the Kremlin did not find a means to control the Caucasus other than by supporting ethnic separatist conflicts in Nagorno-Karabakh, Abkhazia and South Ossetia. At the same time, the military-industrial sector of Russia was interested in these conflicts for its own benefits through selling weapons to all warring sides. Thus it was clear that the weakening Russia state was trying to hold on to the Caucasus, but with a dwindling number of tools at its disposal. By the mid-1990s, Azerbaijan had begun developing extensive economic ties with Western companies for energy project development in the Caspian Sea (according to the data from the US Congressional Research Service, the Caspian region holds oil reserves of 18bn–34bn barrels1). This further angered Russian policymakers, who were unable or unwilling to comprehend the consequences of the collapse of the Soviet empire and the loss of control over republics such as Azerbaijan. From the view point of the Kremlin, cooperation between the Azerbaijani government and Western energy companies was a zero-sum game. The increasing presence of the West in the Caspian region meant a corresponding decrease in Russian influence. Thus Russia actively opposed these projects and protested against the ‘Contract of the Century’ signed by the Azerbaijani government and a group of Western oil companies in 1994, as well as the idea of BakuTbilisi-Ceyhan (BTC) pipeline. The Kremlin has used the unresolved status of the Caspian Sea as the main tool

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to pressure and prevent the realization of these projects. Yet LUKoil, a Russian oil giant with close ties to Azerbaijani political circles, became a pioneer in building economic ties between Azerbaijan and Russia by taking a risk and by daring to participate in the Contract of the Century. Although LUKoil acted in contradiction to general Russian foreign policy, Azerbaijani officials welcomed its participation in oil projects in hopes of pleasing Russia’s political elite. At the same time, LUKoil’s participation legitimized these projects in the eyes of Russian policy-makers. It is undoubtedly true that Azerbaijan needed a Russian presence in these energy projects in order to ensure their successful launch. The first shift in the minds and actions of Russian policy-makers happened in 1997 with the rise of young technocrats like Boris Nemtsov and Anatoly Chubais. Their presence in the Russian government signaled that economic and energy cooperation with the former Soviet republics would be preferred to the use of military force or pressure as a means of influence. Thus Russia softened its objections to the Contract of the Century, it agreed on the division of the Caspian Sea’s bed on the principles of a ‘middle line’ (long advocated by Azerbaijan and Kazakhstan), and finally it did not seem to mind the construction of a new pipeline from Baku to Supsa, the Georgian port on the Black Sea. These technocrat-politicians strongly believed that only through economic cooperation could Russia restore its dominance over the Caucasus region and it was during this period that LUKoil expanded its presence in Azerbaijan. The second, and most important, shift in Russian policy towards Azerbaijan followed the election of Vladimir Putin to the Russian presidency in 2000. Eager to restore

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Russia’s diminished influence over the former Soviet Union (FSU), Putin has actively used energy companies as a tool to promote ‘liberal empire’. For this purpose, energy giants such as RAO-UES, Gazprom, Rosneft and Transneft – controlled by the Kremlin – became the harbingers of a new Russian policy in the Caucasus. This policy has consisted of obtaining as many local energy assets as possible across the FSU, thus placing the Caucasus republics into a position of economic, and thus political, dependence on Russia. In Armenia and Georgia this policy has been more effective than it has been in Azerbaijan. Azerbaijani policymakers treat proposals from Kremlincontrolled Russian energy companies gingerly, knowing that they threaten the economic and political independence of the country. Still Gazprom, RAO-UES and others have found opportunities to penetrate the Azerbaijani market. Azerbaijani-Russian relations have been on the rise since 2000 when Putin came to power. The ailing Azerbaijani president, Heydar Aliyev, who groomed his son Ilham as his successor, recognized that he needed the support and blessing of President Putin for the inevitable transfer of power to his son’s reign. As a result of an increase in bilateral meetings between President Putin and Heydar before his death and now Ilham as president, the level and frequency of political and economic cooperation between Azerbaijan and Russia has intensified. This has led to more Russian energy companies working in Azerbaijan, so generating a more pronounced Azerbaijani dependence on Russia. The persistent desire and attempts of the Russian energy giants, Gazprom, RAO-UES and others, to enter Azerbaijan should be seen from the perspective of general regional

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politics. Azerbaijan, after the fall of the Armenian and Georgian energy sectors into the hands of the Russians, remains the only free link in the Caucasus. That is why Russian energy giants are so eager to take over the generation and distribution of electricity, and gas and oil pipelines, to ensure the full integration of the Caucasus republics’ energy systems into the Russian network. If this happens, the political tools available to Russia for leverage over Azerbaijan would increase dramatically. So far, Azerbaijan has refrained from transferring its energy strategic assets into the hands of Russia’s energy giants. Again, this is due primarily to the realization by Azerbaijan’s political leadership of the inherent risks in doing so. At the same time, the

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availability of its own oil and gas reserves makes Azerbaijan less vulnerable to Russian pressures. Azerbaijan, which presently buys gas and electricity from Russia, feels confident that its own increasing oil and gas output will soon make it free from energy dependence on the Russian Federation. There is therefore the perception that cooperation with Russian energy companies carries only a temporary danger for Azerbaijani economic and political security. Finally, the tendency of Russian attempts to take over strategic assets in former Soviet republics, so deepening the dependence of FSU states on the Russian Federation, is going to continue. These attempts, however, are doomed to failure in Azerbaijan.

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PART ONE: The 1990s and LUKoil

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1.1 Military defeats energy: Russian foreign policy in Azerbaijan in the early 1990s

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he collapse of the Soviet Union and the emergence of the newly independent states in the postSoviet space was a painful process for Russia. Although there were some in Russia’s political and economic leadership that favored the establishment of normal, balanced relations with these newly independent states (these were mostly the young, westernoriented and technocratic politicians), they were clearly in minority. The majority of the political and military establishment felt hurt by the collapse of the mighty Soviet empire and by the loss of pride that goes along with being a superpower. This majority felt, and continues to feel, the necessity of maintaining dominance over the former Soviet republics. Russian politicians were particularly irritated at the attempts of former Soviet republics to develop independent political and economic ties with the West. In the case of the Caspian region, Azerbaijan, Kazakhstan and Turkmenistan sought to build new economic relations with Western companies, leading to an open Russian objection to this policy trajectory2. Russia is especially unhappy that the resources of the Caspian Sea are being explored by the littoral states without the agreement of the Kremlin. Russia claims that the Caspian Sea is an inland lake and thus all projects must be

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approved by all littoral states. But this policy slowly began to change after Azerbaijan and Kazakhstan signed consortium agreements with the Western oil and gas companies. Kremlin circles were forced to confront this bitter reality. Therefore in 1997 the Russian foreign ministry proposed that each littoral state should maintain an exclusive 45-mile zone of its own leaving the centre of the sea for common use. This position was further modified in 1998, when Russia agreed to the sectoral division of the seabed, but not of its waters3. This was done so that Russia could oppose any possibility of trans-Caspian pipelines. In any case, the shift in the Russian position was a major victory for the newly independent states and the region’s energy players. Secondly, Russia objected to the efforts of Azerbaijan to export its oil through non-Russian territory. It demanded that Azeri oil exports should be directed through the existing pipeline to Novorossiysk. This pipeline was used for the export of ‘early oil’ in 1997, but was found unacceptable to Azerbaijani policy-makers for the export of ‘major oil’. This was due to the fact that the ‘northern pipeline’ was small and that it passed through turbulent Chechnya. Azerbaijani policymakers sought to build a new pipeline through Georgia to the Turkish port

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of Ceyhan on the Mediterranean. A Baku-Tbilisi-Ceyhan (BTC) pipeline would mean not only the loss of economic profit from the transit fees by the Russians, but also a decrease in the political influence of Moscow in the region.

Nagorno-Karabakh In the beginning, Russian dominance in the Caucasus, and in Azerbaijan particularly, was implemented primarily through military methods. The conflict between Azerbaijan and Armenia over the Nagorno-Karabakh province of Azerbaijan was transformed into a full-scale war by 1992, so becoming a major and convenient tool for Russia’s political and military establishment to influence, if not control, these two republics. At the beginning of the NagornoKarabakh conflict, Russia actively supplied weapons, military and technical assistance to both Armenia and Azerbaijan in order to deepen each state’s dependence on Russia. Assistance was provided either free of charge or at cost. The military assistance was provided at the state level and through corrupt local military officers. Although Moscow was interested in weakening both states, its primary objective was to maintain its military presence in the region. This was driven by the fact that Russia’s military defence system was built around the former Soviet Union’s borders and not around Russia’s borders. Therefore after the collapse of the Soviet Union, it was deemed too expensive for Russia to build a new defensive perimeter around Russia, so it sought to maintain its military-political presence in the Caucasus based on whatever strategy worked. In May 1992, Azerbaijan experienced a political coup and the proMoscow regime of Ayaz Mutallibov,

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the former first secretary of the Communist party of Azerbaijan SSR, was overthrown. Power was captured by the Popular Front movement of Azerbaijan, a pan-Turkic nationalist movement that was created at the end of the 1980s to confront the Communist regime and to oppose Armenian plans for the annexation of the Nagorno-Karabakh province of Azerbaijan. Its leader, Abulfaz Elchibey, was a Soviet-era dissident who served several years in prison in the 1970s for anti-Communist propaganda. Thus the assumption of power by the Popular Front movement in Azerbaijan severely worsened bilateral RussianAzerbaijani relations. President Elchibey did not tolerate Russian imperialism and within a year managed to expel all Russian military bases and border guard troops from the country. He also developed very close economic, military and political ties with Turkey and hoped to integrate Azerbaijan into the Euro-Atlantic space. Russia responded by providing significant assistance to Armenian military formations, which resulted in the Armenian occupation of the whole of Nagorno-Karabakh province, as well as the key strategic Azeri towns of Shusha, Lachin and Kelbejar. In February 1992, Armenian military formations with the help of Russia’s 366th motorized infantry brigade, stationed in Nagorno-Karabakh, captured the town of Hojali and massacred more than 630 civilians. The story and the participation of the Russian soldiers in the massacre were widely reported. By 1993, most of Nagorno-Karabakh was in the hands of Armenians and a land corridor with Armenia proper was secured.

President Heydar Aliyev These defeats in turn led to the collapse of the Popular Front regime in

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Baku and the arrival of Heydar Aliyev to power in the summer of 1993. Aliyev, former first secretary of the Soviet Azerbaijan Communist Party and a member of the politburo, was an accomplished politician. He also feared Russia’s presence in the country and correspondingly prevented the establishment of Russian military bases in Azerbaijan. Yet he managed this process cleverly by trying to appease Russia’s political hunger taking Azerbaijan into the Commonwealth of Independent States (CIS) and allowing Russia to use the Gabala radar station for its anti-missile defence system. This allowed Azerbaijan to secure Moscow’s support for a May 1994 ceasefire, which effectively halted all

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military activities in NagornoKarabakh. By that time, Armenia had captured not only almost all of the Nagorno-Karabakh province, but also seven surrounding regions, pushing more than a million refugees and displaced persons into Azerbaijan. Due to his past service in the politburo, Aliyev was regarded as proRussian. In reality he proved to be much more skilled and independent than people thought. He managed to lift Azerbaijani-Russian relations to a new, completely fresh and qualitatively manageable level. He continued to integrate Azerbaijan into the West, but did it in such a way that did not anger Moscow too much.

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1.2 The beginning of Russian energy policy in Azerbaijan The Contract of the Century

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n 20 September 1994, Azerbaijan’s leadership signed a crucial oil contract with leading Western energy firms (BP, Exxon, Amoco, Penzoil, Statoil, Unocal, Ramco and several others). Termed the ‘Contract of the Century’, this agreement brought significant Western interest to the small Caucasian country and has tied Azerbaijan to the strategic interests of the US and EU. Subsequently, a consortium, named Azerbaijan International Operation Company (AIOC) and composed of the above mentioned companies, was formed to execute the contract. Later BP, as the largest foreign shareholder, assumed full responsibility for the execution of the contract in order to minimize the costs of the consortium. The contract for the development of the Azeri-Chiraq-Guneshli (ACG) oil field on the Azerbaijani section of the Caspian Sea was the first production sharing agreement (PSA) signed by the Azerbaijani government and Western energy firms, thus paving the way for more PSAs in the future. It was a dangerous precedent from the perspective of Russian and Iranian policy-makers and politicians, who aggressively opposed any contract of any kind that extended Western influence in the Caspian region. It was not a coincidence that the Russian foreign ministry immediately

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denounced the agreement by saying that the unresolved legal status of the Caspian Sea made it impossible for any of the littoral states to sign any legal contracts with Western companies and start exploration. This was followed by threats of sanctions against Azerbaijan4. The Russian officials also argued that the existing oil and gas fields in the Caspian were discovered during Soviet times and should be considered as resources of the Russian Federation5. It was clear to Azerbaijani policy-makers that the protest from Russian diplomats was aimed at preventing the implementation of the Contract of the Century, thereby preventing Western penetration into the Caspian region. In short, the geopolitical card played a more important role than the legal card. Although largely pro-Western and a purveyor of doveish policies in the past, the Russian foreign minister, Andrei Kozyrev, was pressured by the ultra-nationalist Duma to oppose vigorously any kind of cooperation between the US and former Soviet republics in Russia’s backyard. Interestingly enough, Russia’s ministry of energy and fuel did not oppose the Contract of the Century. In many ways Russian foreign policy during this period demonstrated a lack of coordination within the government towards the Caucasus, reflecting the presence of competing players with often opposing policy goals and visions. Indeed, at the beginning of the

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1990s, the ministries of energy, defence and foreign affairs often advocated opposing policies in the Caucasus with the former lobbying for economic and energy cooperation on equal levels and the latter two promoting neo-imperialistic policies. When the Contract of the Century was signed, the then prime minister of Russia, Viktor Chernomyrdin, reportedly assured President Heydar Aliyev that Russia would not object to the deal, but that Azerbaijan would need to coordinate policy with Russia regarding ecological issues and fishing6. Chernomyrdin, who used to work as the head of Gazprom, as well as serving in the capacity of energy minister, before becoming the prime minister, strongly supported oil and gas developments in the Caspian and was one of those policy-makers in Moscow that put economic and energy interests above geopolitical interests. It was due to pressure from the oil and gas lobby that the then foreign minister, Andrei Kozyrev, reassured President Aliyev that no sanctions would be imposed against Baku7. Despite these assurances, however, both Aliyev and his Georgian counterpart, Eduard Shevardnadze, would later become targets of several terror and assassination attempts linked to the Russian special services.

LUKoil’s concession In order to pacify Russian fears and concerns, the Azerbaijani government made a major concession and diplomatic sacrifice towards Moscow. President Aliyev ordered that a 10 per cent share in the Contract of the Century from the holdings of SOCAR (the State Oil Company of the Azerbaijan Republic, the national oil company and major oil monopoly in the region) should be granted to the Russian oil giant LUKoil.

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LUKoil was known in Baku as having close links with the Russian government, especially with Viktor Chernomyrdin, the then prime minister, who was said to have personally lobbied for the participation of LUKoil in the consortium8. Moreover, what made the Azerbaijani government feel comfortable with LUKoil was that the president of the Russian company was an ethnic Azerbaijani, Vagit Alekperov, and one of the richest oligarchs in Russia. Alekperov was born and raised in Baku, graduated from the State Oil Academy in the Azerbaijani capital and then moved to Russia to build his career in the oil and gas sector. LUKoil’s entry into Azerbaijan was seen by many as an increase of the Russian influence in the Caucasus. After all, 14 per cent of LUKoil’s shares are government owned and LUKoil boasts broad-based government political support, even these days, when the relationship between the Kremlin and oligarchs is not as smooth as it was during Boris Yeltsin’s presidency. For instance, when LUKoil ran into problems with Vladimir Butov, the regional governor of the Nenets autonomous district where the company wanted to expand its holdings by building a deepwater export facility at Murmansk, President Putin had a face-to-face meeting with the governor, who later gave a ‘green light’ to LUKoil’s plans. Subsequently, LUKoil has been able to establish joint ventures there with TotalFinaElf and ConocoPhillips9. Further proof of LUKoil’s close links with the Russian government can be seen from the special licence granted to the company by the government for the exclusive right until 2015 of geological exploration and oil production in Caspian waters close to Russian territory10. In reality, however, LUKoil’s participation in the exploration in the ACG

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fields runs completely counter to Russia’s foreign policy and has caused major tensions between the oil company and the Russian government. While the energy ministry and the prime minister, Viktor Chernomyrdin, supported LUKoil’s profit-making plans, the foreign ministry condemned its actions. Thus one can conclude that whereas Azerbaijan’s decision to grant 10 per cent of the Contract of the Century to the Russian major was a symbolic gesture to please the Kremlin – and was indeed regarded by many as the compensation to the Russians – in reality it was not welcomed by some in the Russian government. Nevertheless, the Contract of the Century was finalized. It should be noted that despite the Russian company LUKoil’s participation, Russian policy-makers have continued for the most part to oppose the

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project and have even used military tactics to sabotage it. In 1997, a scandal related to the illegal transfer of military weapons and hardware from Russia to Armenia rocked the Russian Duma when the chairman of the Duma’s defence committee, Lev Rokhlin, uncovered the deal. The transfer was said to be worth more than $1bn and significantly hurt bilateral relations between Russia and Azerbaijan. Although Baku’s official position demanded an investigation of the case, the subsequent death of Rokhlin and the unwillingness of Moscow officials to correct the mistake led to the gradual shelving of the problem. It was clear, however, that by transferring so much military hardware to Armenia, Russia wanted to threaten energy development in Azerbaijan.

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1.3 Energy cooperation takes priority: LUKoil’s expansion in Azerbaijan and the change of the Russian government’s attitude

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fter LUKoil became the partner of the ACG field, its presence in Azerbaijani oil and gas projects began to increase. By 1997, Russian political power became concentrated in the hands of young technocrats and oligarchs. Politicians like Boris Nemtsov and Anatoly Chubais were appointed by Yeltsin as deputy prime ministers of the Russian government and the oligarch Boris Berezovsky was appointed as the deputy director of the Russian Security Council. These people strongly advocated the expansion of Russian foreign policy in the near abroad through economic means and thus lobbied for more active participation by Russian energy companies in projects in Azerbaijan and other republics of the FSU. It was Nemtsov and Berezovsky who paid a visit to Baku in 1997 and met with President Heydar Aliyev to discuss bilateral relations and projects in the energy sector. As the two Russian policy-makers left the Azerbaijani capital, the negotiations were reported to have been positive.

More stakes for LUKoil In 1996, LUKoil also obtained 10 per cent of the shares of the Shakh-

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Deniz gas field and 60 per cent of the shares in the Yalama (D-222) oil field in 199711. The Yalama field has the potential for 0.5bn tons of oil at a cost estimated by LUKoil of $2bn. SOCAR had initially reached an agreement to develop the field together with LUKoil and another Russian company Rosneft, but later only signed the agreement with LUKoil12. Initially LUKoil obtained 60 per cent of the shares in the contract, but on 4 April 2003 SOCAR sold another 20 per cent of the shares to LUKoil for $30m with the funds being transferred to State Oil Fund of Azerbaijan.13 The contract on the development of Yalama field was signed on 4 July 1997 during an official visit of President Heydar Aliyev to Moscow. This was a grandiose visit aimed at starting new relations between the two nations. The relations between President Yeltsin and Aliyev were tense in the early 1990s, with the former considering the latter as one of the conservative hawks in the Soviet government, opposing reforms and openness. This personal coldness has also affected the bilateral relations between Russia and Azerbaijan. So by visiting Moscow and signing oil contracts, President Aliyev wanted to make goodwill gestures to the Kremlin and try to buy Russian

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support on such issues as the Nagorno-Karabakh conflict, and prevent Russia’s military assistance to Azerbaijan’s arch-rival Armenia14. During the same visit, the Azerbaijani government signed a contract with LUKoil and Rosneft for the development of the Kyapaz oil field, but later the Turkmen government objected to the contract and progress on this project was frozen15. The fact that the agreement was signed in the Kremlin in the presence of the energy giants LUKoil and Rosneft demonstrated that Moscow had begun to use oil companies as policy tools in Azerbaijan. It also demonstrated that it was the oil companies during the latter half of the 1990s that lobbied for the improvement of Azerbaijani-Russian relations16.

The northern pipeline Heydar Aliyev’s trip to Moscow in July 1997 also brought certainty to the export route of ‘early’ Azeri oil. The fact was that Azerbaijan, a landlocked country and too distant from major oil consumers in Europe, did not have any other alternative export routes but the northern pipeline, which runs from Baku to Novorossiysk. From the beginning of the Contract of the Century in 1994, Azerbaijan only used this. The Chechen conflict in the mid-1990s put a temporary stop to its use, but the export of the oil through it resumed on 25 October 1997. This was the second time that Russian energy policy coincided with that of Azerbaijan. The decision was not easy for Azerbaijani politicians, because they feared Russia’s monopoly over regional pipelines. But the quickly developing oil sector in Azerbaijan urgently needed an outlet to export its oil, and the Baku-Novorossiysk pipeline was the only existing pipeline at that time.

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It should also be noted that prior to the Azerbaijani decision to use the northern pipeline, Russia’s future prime minister, Yevgeny Primakov, visited Baku and discussed economic issues with the Azerbaijani leadership. It was indeed due to the pressures from Primakov and other Russian politicians that Azerbaijan was convinced to use the Russian route. A month later on 13 November 1997, the first deputy prime minister of Russia, Boris Nemtsov, said that Azerbaijan should in future use both Russian and Turkish pipelines for exporting its oil. This was a direct message to Baku officials insisting that, even if the BTC was built, Azerbaijan should not abandon the northern pipeline. At the same time, a more detailed look at the decision of Azerbaijani authorities to use the northern pipeline shows that both Russia and Azerbaijan benefited from the decision at the expense of the Chechen authorities. In many ways, one can conclude that Aliyev and the Russian government aligned to deceive the Chechens in return for Russia’s promise to help resolve the Nagorno-Karabakh conflict. The fact of the matter was that the Chechen administration, which gained de facto independence in 1996, wanted to sign a tri-party agreement governing the use of the BakuGrozny-Novorossiysk pipeline. However, Azerbaijani authorities would have never agreed to this, because it would have set a dangerous precedent for the legitimization of ‘secessionist regimes’. The Kremlin stated that it would agree to such an agreement, should Baku officials also agree, but the visit of Chechnya’s President Aslan Maskhadov to Baku and his meeting with President Aliyev brought no change in policy. Thus one can conclude that the Kremlin tipped off Baku about the goals of the Chechen president resulting in both sides hav-

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ing agreed to unify their positions against the Chechen administration17. Later, in 2000, under instructions from President Putin, a bypass was built through Dagestan completely avoiding the Chechen territory. Transneft spent $150m on the development of this project18.

The Baku-Supsa pipeline On April 1999, Azerbaijan broke Russia’s monopoly over regional pipelines by officially launching a pipeline from Baku to Supsa, a Georgian port on the Black Sea, with a capacity of 150,000 b/d (barrels per day). ACG partners shifted almost all of their export to this new pipeline19. It should be noted that the deputy prime

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minister of Russia, Boris Nemtsov, along with the presidents of Azerbaijan, Georgia and Ukraine, took part in the inauguration of the pipeline, once again showing a shift in Moscow’s attitude towards regional energy issues. The Kremlin did not seem to be disturbed by this new pipeline and instead wanted to demonstrate how the economics of such projects meant more wealth for all sides, including Russia. LUKoil kept expanding its presence in Azerbaijan by opening an office in 1999. In the same year, during one of his visits to Baku, LUKoil’s president, Vagit Alekperov, agreed with Azerbaijani officials to start using LUKoil’s new liquid gas technology to replace the fuel sold from petrol stations20.

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PART TWO: The 2000s and Putin’s ‘liberal empire’

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2.1 Putin’s election: the start of a new economic strategy towards Azerbaijan.

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t the end of 19th century, Tsar Alexander III liked to say that the Romanov Empire had only two trustworthy allies: the Russian army and its navy. Similarly at the beginning of the 21st century, Russia seems to rely only on one trustworthy ally: Russian energy. Under its influence, Russia has begun to increase its influence in the post-Soviet space, including Azerbaijan. Russian leaders have long sought to increase their economic leverage in the FSU states in a belief that stronger commercial ties will increase the Kremlin’s political influence21. In the 1990s, lack of finance made this process very difficult for Moscow. Yet rising petroleum prices on world markets have fuelled Russian companies with much needed cash to begin this offensive22.

Putin and the FSU Vladimir Putin was elected to the Russian presidency in 2000. It was the beginning of a new, more coordinated policy towards the FSU states. Unlike Boris Yeltsin, who often did not control what was going on in his cabinet and carried the reputation of being more of an alcoholic than a pragmatic politician, Putin was more of a nationalist politician, who used his

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fist-handed policies to consolidate the federal government, strengthen the central apparatus and to pursue more coherent policies towards the former Soviet republics. Putin also intended to reverse the consequences of the economic chaos of the 1990s23. Putin did not completely dispense with techniques such as ethnic conflicts, separatism and military assistance to control Azerbaijan. Yet he also favoured Russian dominance over the region by building strong economic ties, purchasing and privatizing local energy infrastructure and thus making the former Soviet republics dependent on Russia, not only politically but also economically in energy terms.

Economic cooperation After his election, Putin put the Caspian region with its rich energy resources high on the agenda of Russia’s strategic interests. On 21 April 2000, the Caspian region was one of the two issues discussed at a session of Russia’s Security Council. At that meeting, Putin appointed a new special representative on Caspian affairs. Viktor Kaluzhny, the former energy minister, was set the task of increasing Russia’s presence in the region. At the same meeting, Putin described the

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reasons why the UK and the US were active in the Caspian region. ‘This is because we are not active…. We have to understand that nothing will fall into our lap out of the blue, like manna from heaven. This is a matter of competition and we must be competitive’, said Putin24. In the summer of the same year, a new Russian foreign policy concept was published, which specifically mentioned the Caspian region25: Serious emphasis will be made on the development of economic cooperation, including the creation of a free-trade zone and implementation of programmes for joint, rational use of natural resources. Specifically, Russia will work for such a zone in the Caspian Sea, enabling the littoral states to develop mutually advantageous cooperation. Caspian states would use the region’s resources on a fair basis by taking into account the legitimate interests of one another.26

The concept also said that: Russia intends to steer a purposeful course for turning the Caspian into a zone of peace, stability and good neighbourliness, something that will help advance Russian economic interests, including in the matter of the choice of routes for important energy flows.27

Kaluzhny later traveled to each littoral state and promoted the idea of creating a Centre for Strategic Economic Planning for the Caspian to facilitate joint exploitation of the sea’s energy resources28. By doing so, Russia again wanted to return to the idea of joint exploration of the oil fields by all littoral states. All littoral states rejected the idea of the creation of a centre though.

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Strategic challenges The reason why Putin focused so heavily on the Caspian region is twofold. Foremost, Putin came to power on the tide of the second Chechen war that started in 1999. For Putin, Russian dominance over the Caucasus was particularly important. Secondly, the geopolitical situation for Russia in 1999 was not very favorable, as NATO had officially expanded to include Poland, the Czech Republic and Hungary, as well as showing its power in the Kosovo conflict, a major humiliation for Moscow. Besides, the US president, Bill Clinton, and the presidents of Azerbaijan, Kazakhstan, Georgia and Turkey had signed the Istanbul declaration in November 1999 on the sidelines of the summit of the Organization for Security and Cooperation in Europe (OSCE). The declaration paved the way for the construction of the BTC pipeline, another major defeat for Russia in the region’s geopolitics. As stated by the Russian ambassador, Andrei Urnov, who as the head of the Russian foreign ministry’s Caspian working group: ‘certain outside forces are trying to weaken Russian position in the Caspian basin by driving a wedge between Moscow and the new littoral states.’29 Russia wanted Azerbaijani oil to be exported through Russian territory the same way that Kazakh oil was exported. In 1997, Kazakhstan created the Caspian Pipeline Consortium and with it a major export route from the vast Tengiz field to Novorossiysk. The Russian government owned 24 per cent of the consortium with an additional 20 per cent going to LUKoil and Rosneft. Thus Russia wanted to apply the same model for Azerbaijan and create a similar consortium, which would be partly or largely owned by

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Moscow and ensure that Azerbaijani oil flows through Russian territory30. At the same time, the US administration was actively lobbying for the proposal to export Turkmen and Azeri gas via Turkey to European markets, which would have limited the monopoly that the Russian company Gazprom enjoyed in this field. So Putin was determined to prevent this and to restore Russia’s overall great power status in the region.

State capitalism One of the tactics that Putin has sought to utilize in order to control the former Soviet republics was to restore the power of Russian state capital. Russia is the only country among the top ten oil exporters whose production is not directly state controlled. Instead, the transition period of the 1990s saw the Russian oil industry switching from being under complete state ownership to the emergence of 13 vertically integrated oil companies. These companies were privatized with state ownership in them ranging from 17 to 51 per cent. What the new policy meant was increased control by the Kremlin over private companies, transformation of these energy giants into the loyal subjects of the political elite and subsequently using them for the political and economic dominance of Russia over the FSU space. Speaking at the Security Council in April 2000, Putin said: ‘We must realize that the efforts of the state alone will not be enough for implanting Russian companies there [Caspian region].’31 It was clear that Putin’s message meant bringing the Russian energy giants into the geopolitical game.

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End of the oligarchs Putin’s administration has effectively got rid of independent oligarchs such as Boris Berezovsky and Vladimir Gusinsky, and has arrested and imprisoned the Yukos chief, Mikhail Khodorkovsky. The state has managed to increase its influence over such giants as RAO-UES, Gazprom (90 per cent of gas production and distribution) and Rosneft (which used to control 7 per cent of Russian oil production but has turned into a giant in the oil sector overnight after ‘purchasing’ Yuganskneftgaz, Yukos’s prime asset, with the help of loans from the state-owned Vneshekonombank32). The state has also helped itself by appointing loyal persons to the boards of these companies. Alexey Miller, Putin’s close friend from St. Petersburg, replaced Rem Vyakhirev as Gazprom’s chief executive and Dmitri Medvedev, Putin’s chief of staff and very close associate, joined the company’s board of directors. Meanwhile Rosneft’s board is headed by Medvedev’s deputy, Igor Sechin. Putin also attempted, unsuccessfully, to merge Gazprom and stateowned Rosneft in order to increase the state’s shares in the former from 38.37 per cent to 50 per cent. By strengthening the state’s position in Gazprom and Rosneft, the Kremlin seeks to ensure that the oil and gas industries are developed as they see fit33.

Dominance of the near abroad As the policy of creating a new statecapitalist economy was getting more and more complete, Putin began using these companies to increase Russia’s economic and political dominance over the FSU, particularly the Caucasus. In July 2000, a new company, composed of LUKoil, Gazprom

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and Yukos was created to develop resources in the Caspian Sea. This was indicative of Putin’s intentions to reassert the Kremlin’s influence over the Caspian region and bring coherence to the Russian foreign policy in the ‘near abroad’34. LUKoil’s first vice-president, Ravil Maganov, while speaking at the press conference to announce the new company, stated that it ‘would help Russia to strengthen its stand in the region’35. Under Putin, Russian economic relations with other FSU countries were not conducted within any welldeveloped free trade area arrangements, let alone within anything approaching a single market. Instead, they became heavily influenced by political objectives36.

Controlling assets High international oil and gas prices since 2000 have given Russian energy companies extra cash to purchase valuable assets in the post-Soviet space. These companies, aligned with Russia’s expanding banking sector, have developed new strategies for winning control over the energy and transportation assets of the former

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Soviet republics with the aim of advancing Russia’s strategic interests. The Kremlin, in turn, helped these new initiatives by providing state-held equity and state-guaranteed loans, as well as encouraging debt-for-equity swaps37. The increase of Russian companies’ controlling interests in Azerbaijan would also give an excuse for the Kremlin to expand its military presence in the future, if needed38. At the same time, effective governance in the Caucasus depended heavily on the privatization of stateowned energy enterprises. Due to the high risks, Western companies showed virtually no interest in purchasing these facilities, whereas Russian energy giants jumped at the opportunity to expand Russia’s political and economic influence in the region. Dominance over the energy infrastructure of the Caucasus will enable Russia to exert more political influence in the region. There are clear precedents for this: from the Baltics in 1992 when Latvia, Lithuania and Estonia demanded the withdrawal of Russian troops, and the case of Ukraine; and Georgia in 2000–01 when Moscow demanded support for the war in Chechnya39.

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2.2 Putin’s first visit to Baku and the expansion of LUKoil in Azerbaijan.

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n 9–10 January 2001, Vladimir Putin visited Baku on an official state visit. It was a major event in bilateral relations. His predecessor, Boris Yeltsin, had never paid a visit to Baku and had given his Azerbaijani counterpart, Heydar Aliyev, the cold shoulder. Putin, on the other hand, has chosen a policy of engagement with President Aliyev. With KGB backgrounds, both presidents found similarities in their personalities and quickly established a common language, which smoothed the cooperation between them.

Curbing independence Putin, prior to his visit, used a carrot and stick approach towards policy with Azerbaijan, in order to bring it back into the Russian orbit. During the last few years of Yeltsin’s presidency, Azerbaijan, together with Georgia and Moldova, showed bold signs of independence from Moscow. The leaders of these nations refused to attend CIS summits. Instead, they actively cooperated with NATO on the issue of Kosovo and with the US on the issue of the development of the BTC pipeline. Moreover, Azerbaijan had showed some tolerance toward Chechen dissidents based in Baku, who were conducting an anti-Russian propaganda campaign and extending logistical support to the fighters in Chechnya.

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Thus President Putin, in order to stop these trends, threatened Azerbaijan and Georgia with the imposition of visa regimes and stricter border controls should they choose not to stop supporting the Chechen separatists. For Azerbaijan, this new policy would have had disastrous consequences, as more than two million Azerbaijani citizens live and work in Russia, mostly illegally, and send money to their families in rural areas of the country. Imposition of a visa regime would have led to large-scale deportations of Azeris from Russia, exacerbating already difficult social-economic conditions. Additionally, the imposition of stricter border controls would have erected barriers for Azerbaijani farmers to sell their agricultural goods in Russia. There was another major factor, which pushed Azerbaijan to normalize its relations with Russia and to submit to Putin’s demands. President Heydar Aliyev was ageing and beginning to sicken, which prompted serious consideration of the succession issue in Azerbaijani domestic politics. President Aliyev groomed his son Ilham for the position of president, but knowing the role that Russia had always played in the domestic politics of the country, this succession issue would require the eventual approval and blessing of the Russian president. Due to these factors the Azerbaijani leadership eventually caved into Russian demands. Soon, the cultural

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centres of the Chechens in Baku were closed and the Azerbaijani government started cracking down on Chechen refugees. Some of them were even handed over to the Russian security services. At the same time, the Aliyev administration reversed its sharp pro-Western course towards Russia and began to pursue a more balanced foreign policy.

LUKoil and the Hovsany-Zykh field Under these circumstances, the visit of Putin to Baku was significant for lifting Russian-Azeri bilateral relations to a new level. During the visit, LUKoil expanded its presence in the country by signing another PSA with SOCAR on the exploration and development of the onshore Hovsany-Zykh oil field (20m tons of crude oil, which could be expanded to 33m tons by using LUKoil’s modern technology)40. The two companies divided the shares of the contract on a 50/50 basis. The agreement was signed for a period of 25 years and was worth $215m (with $250m investment needed). LUKoil planned to orient the oil from this field to the domestic market by refining the oil at Baku and selling the products through its chain of 19 filling stations in Azerbaijan. The field had already been producing oil for 50 years and did not carry much strategic significance for either the Russian government or for LUKoil itself. Yet its political significance was evident, as the Azerbaijani authorities wanted to make it clear to the Russian president that Baku was ready for economic cooperation with the Kremlin and in many ways did not want to anger Russia by eliminating Russian economic influence and presence from Azerbaijan. Azerbaijan’s foreign minister, Vilayet Guliyev, said

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that the agreement on Hovsany-Zykh oil field was a ‘step forward’ for both countries41. The parliamentary ratification of the Hovsany-Zykh pipeline was not a smooth one for the Azerbaijani government, as many opposition members lambasted SOCAR officials for signing the contract. At the time, Jamil Hasanli, a deputy from the opposition Popular Front party, charged: ‘The Azerbaijani government has gotten used to making oil gifts for political aims’. His colleague Asim Mollazadeh said that SOCAR was capable of developing small oil deposits independently. Although the final voting was in favor of the contract, the debates bore out the political motives behind the project42. In 2001, LUKoil opened an office for its overseas holding company in Baku with the aim of coordinating four oil projects that the company had in Azerbaijan, as well as serving as a one-stop shop information centre43. In the same year, LUKoil expressed an interest in developing deep water oil fields in the south of the Caspian such as D-9, D-10 and D-1144 and held talks with SOCAR on the participation of the company in the Araz-Alov-Sharg offshore project. In this, it sought to acquire 10-15 per cent of SOCAR’s shares in the project. The Azeri reaction was supportive. Experts believed that Azerbaijan’s leadership was willing to allow the Russian company to operate in this field in exchange for Russian political support against the Iranians, who also claimed the field. However, LUKoil itself had doubts about the final decision, due to the political risks associated with Azerbaijan’s dispute with Iran over the field’s ownership45. There were also those who believed that the Russian company’s participation in Araz-Alov-Sharg project would dampen any Iranian threats to the project. Reportedly, LUKoil tied its participation in this

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project to its future plans regarding the BTC pipeline46.

BTC objections Although Russia opposed the construction of the BTC pipeline from the moment the idea was born, some speculation about Russia joining the project still loomed in the air in the late 1990s and early 2000s. Experts believed that the participation of Russian companies in the BTC project would strengthen Azerbaijan’s position and would be considered as Russia’s support for Azerbaijan in the project47. LUKoil’s leadership indicated in 2001 that the company was inclined towards joining BTC and, if it did so, it was willing to hold a 7.5 per cent stake48. Yet in the words of Vagit Alekperov: ‘LUKoil will take into account all of its shareholders, among which the government of the Russian Federation is one of the largest.’49 This statement shows that LUKoil did not dare to join BTC without the approval from within Russian political circles. After intense and protracted negotiations with SOCAR, LUKoil announced, as expected, on 16 April 2002 that it had decided that it would not participate in the BTC project and instead would use the Baku-Supsa and Baku-Novorossiysk pipelines to export its oil. While the company clearly had political motives for not supporting the pipeline, it is believed that it had economic reasons for doing so. At 1,750 km long and $3bn in value, the BTC pipeline was perceived as a direct threat to the Russian political and economic monopoly in the region. Not only does it tie Azerbaijan and Georgia to NATO member Turkey and open the door for Azeri oil to the European markets, it also ruined Russia’s monopoly of pipelines

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in the region. The fact that the US administrations under both presidents Clinton and Bush actively supported the idea shows that it was indeed aimed at promoting US strategic interests in the region at the expense of Russia. As the late President Heydar Aliyev said: ‘BTC would pump the oil in one direction and politics in the other.’50 Russia attempted to sabotage the BTC pipeline by any and all means. Foremost, it actively utilized and provoked various environmental NGOs and human rights groups to lobby against the construction of the pipeline. These groups staged numerous demonstrations in foreign countries and tried to draw the attention of donor agencies to human rights abuses and environmental insecurities reportedly associated with the pipeline. A massive letter-writing campaign to Western policy-makers was also part of this strategy. When Russia saw that this strategy had failed, it switched its focus from human rights to corruption. NGOs accused BP of bribing the Azerbaijani government: accusations which have proven unfounded.51. Russia has always lobbied for the use of the Baku-Novorossiysk pipeline as an export route for Azeri oil. Meeting with President Aliyev in 2002, President Putin said that Russia wanted Azerbaijan to boost its crude exports through this pipeline up to 100,000 barrels per day. In 2002, Azerbaijan shipped 50,000 b/d of crude oil through Russian territory and both sides were looking for similar volumes in 2003. Azerbaijan continues using the Baku-Novorossiysk pipeline for shipping approximately 2.5m tons of oil per year. SOCAR and Transneft have jointly agreed to continue these operations through 2006 as well52.

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LUKoil’s expansion In 2004, LUKoil purchased an 8 per cent interest in the Azerbaijan Gas Supply Company and a 10 per cent interest in the South Caspian Pipeline Company53. LUKoil has become increasingly involved not only in the oil sector (upstream, midstream and downstream), but also in non-oil sectors such as telecommunications, insurance, trading and freight forwarding through subsidiaries and joint ventures, such as AzEuroTel, LUKoil-Inform, LUKoil Neftegazstroy and LUKoil-Inter-Cart among others54. The company has established a network of filling stations and fuel storage depots throughout Azerbaijan55. By 2002 LUKoil had 19 filling stations in the country with the plans to purchase several additional ones56. Taking advantage of the difficult situation that the private company ISR found itself in due to their problems with the Azerbaijani leadership and their subsequent departure from the country, LUKoil purchased some of their filling stations as well57. In 1996, LUKoil, together with SOCAR, established a major insurance company in Azerbaijan, called Ateshgah. The heads of SOCAR and LUKoil, Natig Aliyev and Vagit Alekperov, participated in the opening ceremony. The company, which is aimed at providing services for oil businesses in the country, is eligible to work with 19 out of 42 types of insurance. The company’s stock was established at $220,000. In 2002, LUKoil together with a Russian financial corporation, NIKOIL, established the first investment and commercial bank in Azerbaijan, NIKOIL Bank, that is fully owned by Russians (40 per cent of the shares are held by LUKoil and 60 per cent by NIKOIL)58.

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Overall, during the period of 19932001, LUKoil invested over $500m in Azerbaijan, of which $294m was invested in the Azeri-Chiraq-Guneshli field59. With the start of ACG’s second phase, LUKoil has pledged another $520m until 200760. By 2001, LUKoil was producing 550,000 tons of oil in Azerbaijan61. By 2010, the output of LUKoil is expected to reach 4m tons. By 2020, the output from this field will reach one third of LUKoil’s total output, 500m barrels per year62.

A special relationship The expansion of LUKoil in Azerbaijan, while seen as a mechanism for increasing Russia’s presence in the country, also satisfies the company’s corporate interests. As for the Azerbaijani government, it quickly developed informal friendships and in many ways kinship relations with the LUKoil president, Vagit Alekperov. President Heydar Aliyev, and his son Ilham Aliyev (the first vice-president of SOCAR) got well along with their Azerbaijani ‘ethnic brother’ Alekperov, even though the parties effectively represented the interests of two competing countries. The comfort and friendship in bilateral relations has been so high, that it has passed well beyond the business sector into family relations. In October 2001, while celebrating LUKoil’s ten year anniversary in Baku, President Heydar Aliyev awarded Alekperov with Azerbaijan’s state award, Shohrat (‘Glory’), for his contribution to development of economic relations between Russia and Azerbaijan63. Alekperov brought a monument of Pushkin to be erected in Baku, which was a personal gift from President Putin, which indeed demonstrates the special role that LUKoil and its president have played

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in the relations between Russia and Azerbaijan64. Moreover, in August 2002, Azerbaijan held a national referendum on constitutional amendments and one of these amendments was to make the prime minister the second highest ranking official after the president. Rumours circulated in Baku that Vagit Alekperov was being groomed for that position, which, although untrue, showed the level of friendship and trust which existed between the LUKoil president and the Aliyev family. Thus, one can conclude, that in providing LUKoil with energy contracts, the official leadership of Azerbaijan perceived little threat or mistrust emanating from Moscow due to the unique friendship which had been developed with LUKoil’s ethnic Azerbaijani president. Concurrently LUKoil, due to the Azerbaijani heritage of its president, has felt very much at home in Azerbaijan. The special relationship between LUKoil and Baku has been demonstrated on numerous occasions, such as in March 2001 when LUKoil held in Baku its first ever board of directors meeting outside Russia65.

Improving bilateral relations Russian-Azerbaijan bilateral relations have continued to expand. In 2001, another Russian oil company, Yukos, expressed interest in a project to rehabilitate, explore and develop the shallow-water section of the Gyunashli

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field66. Yukos also planned to open an office in Baku in 2002. SOCAR responded that it would consider the offer but it had its own capacity for independently developing the field. Considering the fact that a large amount of investment was needed for the project ($500m–$1bn), it was unlikely that SOCAR could manage the project on its own. Residual reserves in the shallow section of Gyunashli field amount to about 100m tons of oil and France’s TotalFinaElf and American Conoco also expressed interests in this project67. The project, however, never materialized due to Yukos’ bankruptcy. Meanwhile, President Heydar Aliyev paid several visits to Moscow during 2001–02. These efforts culminated in an agreement signed in September 2002 on the division of the bottom of the Caspian Sea, which signaled Azeri support for Moscow’s formula on its division. Additionally, an agreement was signed with President Putin on the lease of the Gabala radar station in Azerbaijan to the Russian defence ministry for a period of 25 years. Over the 1990s, these two issues were major problems in bilateral Azeri-Russian relations. In many ways, their resolution was partly possible due to the softening of Russia’s position, but mostly thanks to concessions on the part of Azerbaijani leadership. The latter was eager to deepen the relationship with President Putin for a breakthrough in the NagornoKarabakh conflict, as well as for garnering his support on the Azeri succession issue.

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2.3 LUKoil slows down: Itera, Gazprom and RAO-UES step in

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s Russian-Azerbaijani relations started to normalize from 2000 onwards, the participation of Russian energy companies in Azerbaijan also started to expand. Yet, the overall strategy of Russia’s ‘liberal empire’ now included other energy giants, such as Gazprom, RAO-UES and others. From this perspective, LUKoil lost its role as the sole carrier of Russian business interests in Azerbaijan. In fact, starting in 2000, LUKoil started slowing down its operations in the country. However, this was not at all regarded as a departure by LUKoil or Russia from Azerbaijan.

Withdrawal from Contract of the Century While rumors spread in the local media that LUKoil was planning to sell its 10 per cent stake in the ACG oil field, it was perceived as ‘thunder in the midst of a sunny day’. Few analysts could believe, yet alone understand, why LUKoil would be willing to depart from such a lucrative deal. For Russian companies constantly striving to expand their presence in the near abroad, it would be a rather unusual act. Rumours were followed by further speculation and denial. On several occasions, LUKoil executives announced that they did not plan to sell ACG shares. A press release from the

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company vaguely stated at the time that: ‘from time to time, LUKoil engages in discussion with other oil and gas companies regarding its strategic options. None of these potential options has reached the stage that justifies further comment at this time.’68 Yet it all came true on 15 November 2002, when LUKoil officials announced that the company planned to sell its ACG stake to an unnamed Japanese firm for $1.25bn69. Analysts and experts from the oil industry termed the decision unwise. Robert Ebel, director of the energy and national security programme at the Centre for Strategic and International Studies in Washington, said: ‘I am totally surprised. If I were in Moscow, I would want LUKoil involved in Azerbaijan over the years.’70 By the time of the sale, ACG was already producing oil and was indeed a profitable venture. LUKoil’s declining growth at that time would seem to have pushed the company towards holding on to this project. Some speculated that LUKoil’s action was motivated by the Russian foreign ministry’s decision to placate Japanese demands on the return of the Kuril Islands. This hypothesis seems unlikely. Although LUKoil is known for its close relations with the Russian government, it would not trade off its strategic interests to Japanese firms in order to satisfy the Kremlin’s political agenda.

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The Azerbaijani government was shocked by the announcement. SOCAR head, Natig Aliyev, stated in response to the decision that he would demand a serious explanation from LUKoil’s management for the action. ‘I do not know if any of this is true, but if it is, then LUKoil should not count on doing anything in Azerbaijan in the future,’ Aliyev reportedly said71. In order for the sale to be complete, the approval of SOCAR and the other consortium participants was needed. President Heydar Aliyev said that before the sale was approved, LUKoil had to meet ‘certain conditions’ that it had taken before joining the project72. Azerbaijani politicians were upset by the news because it ran contrary to the two years spent trying to normalize Russian-Azerbaijani relations73. LUKoil’s decision meant that Azerbaijan had lost an important ally for its interests in Kremlin circles, despite the fact that the company itself did not completely leave the country74. LUKoil’s move was also seen in Baku as a desire in Moscow to stall the ACG and the related BTC pipeline projects, which were about to be agreed with Western partners. Vafa Guluzadeh, a former presidential advisor on foreign policy, said that LUKoil’s decision was connected to Russian opposition to BTC. ‘This is a pressure on Baku with the goal of slowing down the pipeline project,’ Guluzadeh said75. LUKoil indeed said that it would not join the BTC consortium and would not use the pipeline once it was built. Speaking to Dow Jones Newswires on 21 December 2000, Ravil Maganov, first vice-president of LUKoil, said: ‘LUKoil will find its own export routes for oil volumes it has now without BCT.’76 Yet some analysts believed that LUKoil’s pull-out from the Contract of the Century was not connected to the pipeline. Former president of SOCAR, Sabit Bagirov, said that the

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LUKoil pull-out was connected with the financial difficulties that the company was experiencing and due to a lack of available cash needed to invest $1.5bn in the ACG project. He further denied that the decision of the company was in any way ordered or connected to some criminal groups in Russia that at the time had kidnapped the relatives of LUKoil’s high-ranking officials prior to the deal77. In order to satisfy angry questions rising in Azerbaijani political circles, LUKoil’s president, Vagit Alekperov, personally flew down to Baku on 25 December in order to explain the reasons for the sale. He attempted to convince the Azerbaijani leadership that the sale was not driven to undermine Azerbaijan’s energy plans and that they were driven purely from LUKoil’s internal strategic need to focus on its Arctic oil fields (TimanPechora), on new developments in the northern Caspian, on the development of crude export facilities at the port of Murmansk (alone costing $2.5bn), and by other projects in Eastern Europe and the Baltic states. LUKoil was also worried that secondranked Yukos with a 20 per cent jump in production, compared to only a 3 per cent growth in production by LUKoil, would gradually take over the first position in the Russian energy market78. ‘We intend to focus on Azeri projects where we have operator’s rights,’ Alekperov said to reporters in Baku79. ‘The company remains committed to the development of the Caspian Sea region and in particular to our close relationship with Azerbaijan.’ Alekperov added this final point in an effort to calm the Azerbaijani leadership80. Local analysts believed that LUKoil’s decision to expand its shares in the Yalama project from 60 per cent to 80 per cent in April 2003 was further aimed at calming residual Azerbaijani anger over the decision.

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The sale to the Inpex Southwest Caspian Sea Limited Corporation, an affiliate of Inpex Corporation and Japan’s national oil corporation, began on 20 December 2002 and was completed on 28 April 2003 for $1.4bn in cash, subject to certain postclosing adjustments81. After the sale was completed, it became increasingly evident that LUKoil’s action was not ‘forced’ at the Kremlin level. On the contrary, one can argue that LUKoil’s pull-out from the ACG project ran against the policies of the Russian government. The decision was prompted by LUKoil’s management seeking a heavy influx of cash to purchase 75 per cent of the shares of Russia’s eighth-largest oil company Slavneft. This acquisition would streng then LUKoil’s position within Russia itself as the largest oil company, something that company executives were strategically moving towards82. An insider commented at the time that ‘sometimes [a] commercial decision . . . take[s] preference over a political one’83.

Cold spell in relations After LUKoil’s pull-out from the ACG project, its relations with the Azerbaijani government went through a cold spell. Despite the LUKoil chief’s attempts to smooth out relations with the Azeri political leadership, the latter decided to put forward demands for the payment of 15 per cent in capital gains tax on the sale of its 10 per cent stake on the ACG project. The Azerbaijani government insisted that LUKoil owed it about $250m84. Azerbaijan’s tax minister, Fazil Mammadov, said on 9 June 2003: ‘tax issues with LUKoil have not been solved. We still want to get profit tax from the LUKoil-Inpex transaction, which the law sets at 25 per cent. It will be a big success if we manage to

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solve the problem before the end of 2003’85. On 11 May 2005, Mammadov informed the media and public that the ministry was looking for an international audit to sort out the issue86. Two weeks later, his deputy, Namik Aliyev, stated that LUKoil had not transferred $52m to the Azerbaijan national budget and that the ministry planned to sue LUKoil in the international court87. LUKoil denied the accusations of tax evasion and refused to pay the required sum into the budget of Azerbaijan. On 30 March 2003, a LUKoil spokesman, Grigory Volchek, stated that the company had not received any official claims from the Azerbaijani tax ministry and that the financial examination of the activities of LUKoil Overseas (a subsidiary company established for the development of ACG field) was underway88. LUKoil’s official in Baku declared that the demand ran counter to the terms of the PSA agreement and that the stake was owned by an off-shore LUKoil subsidiary meaning that there was no tax liability in either Azerbaijan or in any other jurisdiction89. After informal negotiations between Alekperov and SOCAR officials, it was reported that the Azerbaijani government would drop its demands for a payment by LUKoil for capital gains on the sale of its ACG share in return for LUKoil’s agreement to increase its investment in the Yalama project from 60 per cent to 80 per cent and by $156m over the lifetime of the project, whatever the results90. LUKoil also agreed to pay $40m out of this $156m in advance for exploration services91. Experts in Baku claimed that LUKoil had also paid an unofficial sum to Azeri authorities in order to settle the issue. At the same time, it should be taken into consideration that the Azerbaijani government, despite its threats, did not have much capacity to demand this payment from

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LUKoil, because the case would eventually have to be taken to court. For that, the Azerbaijani government had neither the capacity nor the desire to argue with the Russian giant. Once again, informal relations between Vagit Alekperov and the Azerbaijani political leadership played its role.

Hovsany-Zykh, Shakh-Deniz and Yalama A change in LUKoil’s strategy in Azerbaijan continued in 2003, when LUKoil decided to withdraw from the Hovsany-Zykh contract citing that the economic performance of the project did not meet the company’s requirements for return on investment, due to considerable expenses for the environmental reinstatement of the contractual area in view of the highly worked out deposits92. LUKoil’s head in Baku, Fikret Aliyev, told Reuters on 4 June 2003 that the company would need $100m of the total investment of $300m to rehabilitate the heavily polluted territory around the field. ‘We are facing very high ecological risks, which significantly lower the project’s profitability,’ Aliyev said93. SOCAR subsequently decided to go ahead with drilling by itself. In May 2004, LUKoil proposed to SOCAR to increase the former’s stake in the project for the sake of increasing its commercial attractiveness94. LUKoil also proposed some other alternative solutions to increase the amount of oil to be exported95. But after ‘difficult negotiations with SOCAR’ and failure to reach an agreement on these proposals, LUKoil decided to pull out from the PSA, which it had done by 16 February 200596. LUKoil also announced in 2002 that it would sell its shares in the Shakh-Deniz consortium led by BP. The international investment bank

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J.P. Morgan was chosen as the consultant to manage the sale97. The decision to sell was seen as a continuation of the company’s overseas strategy to focus only on the development of upstream fields where it controlled the majority of shares in a given project. Yet on 29 August 2003, the head of LUKoil Overseas Ltd’s office in Baku, Rim Bagmanov told Azerbaijan’s MediaPress news agency that the company had no plans to sell its 10 per cent stake in the project (owned through the joint venture LUKAgip created with the Italian company Eni on a 50/50 basis). ‘I am a member of the project’s managing committee and I have no information about LUKoil pulling out of the project,’ he said98. His words were confirmed by Vagit Alekperov, LUKoil’s president, on 5 September 200399. Following this on 30 June 2004, LUKoil announced that it would buy Eni’s 50 per cent holding in the LUKAgip joint venture, thus acquiring a 5 per cent stake in the Shakh-Deniz project for a sum speculated by experts to be $140m-$260m. Eni and LUKoil established LUKAgip in 1996 with each company having 5 per cent of the Shakh-Deniz PSA. LUKAgip also owns 8 per cent of the midstream gas marketing company for Shakh-Deniz, the Azerbaijan Gas Supply Company and 100 per cent in LIKAgip (Midstream) which holds the venture’s 10 per cent interest in the South Caucasus Pipeline Company100. LUKoil has clearly made a decision to continue its participation in this project. In the words of Alekperov, LUKoil does not have many projects in Azerbaijan and does not want to withdraw from the country’s oil industry101. In October 2004, LUKoil started drilling in the Yalama oil field with the help of the Dutch company Maersk’s drilling rig named Heydar Aliyev (the former Lider rig). The commencement of drilling had been

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delayed by half a year due to the lack of rig availability102. After initial drilling commenced, the company decided to abandon its first well in November 2004 and began a new one, due to the technological and geological problems103.

TNK-BP carries forward Russia’s economic interests The overall decreasing presence of LUKoil in Azerbaijan does not indicate a departure of the Russian economic interests in the country. The construction of the BTC pipeline, which started in September 2002 and finished in May 2005, became another project where the possibility of the participation of Russian companies circulated. In December 2004, David Woodward, BP’s president in Azerbaijan, spoke to local journalists and made a sensational statement. He informed the public that the shareholders of BTC were considering, together with the British-Russian oil company TNK-BP, the possibility of transporting Russian oil through the BTC pipeline104. Zerkalo also speculated that this could be done through exporting Siberian oil from the Russian city of Novorossiysk to Baku, as it had been envisioned during the Soviet era. Currently this pipeline is working in the reverse direction, exporting Azeri oil to Novorossiysk. TNK-BP is the third largest oil company in Russia. Established in September 2003 and employing 100,000 people, TNK-BP works in such geographic areas as western Siberia, the Russian Far East and the Urals. In 2003, TNK-BP increased its output by 14 per cent. Unlike LUKoil, TNK-BP is little known in Azerbaijan. Azeri political analysts welcomed Woodward’s comments. ‘From the beginning of the BTC idea, Russia

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opposed it and argued that it was not commercially viable,’ said Vafa Guluzadeh, former presidential advisor on foreign affairs, in an interview to the Jamestown Foundation’s Eurasia Daily Monitor on 3 January 2005. ‘Russia lobbied hard to prevent the construction of BTC, yet it failed. Now it seeks ways to participate in this project, because BTC is the best option in the region for exporting oil to the European markets due to the over-crowdedness of the Bosporus straight.’ Another prominent political scientist in Baku, Nasib Nasibli of the opposition Musavat party, said that the participation of Russian companies in BTC would only increase the stability of this pipeline. ‘I don’t think it will increase Azerbaijan’s dependence on Russia. On the contrary, Russia will become a partner in this project.’105 The independent daily, Zerkalo, argued that the willingness of the BTC shareholders to invite more players into the BTC pipeline could be explained by the increasing costs of the project. Indeed, in the same press conference, Woodward informed those present that the construction costs of the BTC had increased due to the increase in prices for construction materials and equipment in the world markets. He also did not exclude the possibility of transporting Kazakh oil through BTC. Kazakhstan currently ships its oil to Iran from the Russian port of Astrakhan106. The Russian daily, Nezavisimaya Gazeta, argued on 24 December that Russia intends to boost its presence in Caucasus energy projects in order to balance the increasing influence of the US in the region. Meanwhile, there are those who believe that the idea to invite a Russian company into the BTC project has nothing to do with geopolitics of the region, but is purely of an economic decision. Economists argue that BTC

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has the capacity to transport more oil than Azerbaijan can provide thus providing an opportunity to transport further throughput. TNK-BP is a 50/50 consortium between TNK and BP107. Hence transporting Russian oil through BTC would well suit the interests of BP. Shareholders of TNK-BP own 50 per cent of the Belorusian oil company Slavneft also known for its close connections with the Azerbaijani government. Further, Azerbaijani politicians do not perceive TNK-BP as a company close to Kremlin circles. In fact, in 2005, TNK was hit with a $1bn demand for back taxes which has also hurt its partner, BP.108 While regional analysts continue to speculate on the real reasons for the Russian oil company’s plans regarding BTC, the press service for TNKBP said that ‘it was too early to speak about the involvement about the company in the project of the century.’109

Gazprom While the participation of the Russian oil companies in BTC remains speculation, the presence of the Russian gas and electricity companies in the country has become a reality. This trend began with the onset of the Putin presidency and continues to spiral upwards. Contrary to the oil sector, the gas and electricity sectors have become cards for expanding Russian foreign policy in the Caucasus since 2001. Azerbaijan currently has a domestic consumption level of 10bn–11bn cubic metres (bcm) of gas. Since its own domestic production is well below that level (only 5 bcm), the country faces a necessity of importing natural gas from abroad. During Soviet times, the country imported gas from Russia. But these imports had been reduced to zero by 1997110.

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Russia, on the other hand, is the world’s largest producer, as well as the single largest holder of global natural gas reserves. It has some 1,700 trillion cubic metres of gas and produces twice more than Iran, the world’s second largest producer. Gazprom is a government owned and poorly managed giant. It dominates the Russian gas market, having 144,000 km of pipeline network and controlling 70 per cent of the country’s gas reserves. Through Gazprom, Russian gas deliveries have become a more important tool of political leverage over South Caucasus states for Russia than its oil card111.

Shakh-Deniz and the South Caucasus pipeline The gas industry of Azerbaijan experienced a major turning point in July 1999, when BP, the Shakh-Deniz project operator, announced the discovery of a giant gas find. This discovery was governed under the terms of a contract which was signed in 1996. Based on the huge reserve estimated at 700 bcm, Azerbaijan would be capable of becoming a net gas exporter rather than a net importer. Gas from the Shakh-Deniz field is also beneficial due to the large and valuable co-products: indeed the liquids are valuable enough for the field to be developed, even if the gas were given away112. In March 2001, Azerbaijan signed a 15-year agreement with Turkey to supply it with gas. Although it originally planned to start gas exports in 2004, the slowing Turkish economy and lack of domestic demand have pushed back this date by several years. The export of the gas from Baku to Turkey is planned to be facilitated by the construction of a pipeline from Baku through Tbilisi to Erzurum in

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Turkey. In short, the construction of the South Caucasus Pipeline (BakuTbilisi-Erzurum) puts Azerbaijan in direct competition with Russia. The latter has been involved in the construction of the Blue Stream pipeline under the Black Sea which began in 2002 with an agreement to export up to 16 bcm of gas to Turkey by 2008113. As was the case with BTC, Russia lobbied against the construction of Baku-Tbilisi-Erzurum pipeline, saying that the project was not commercially viable and that the Turkish gas market could not absorb so much supply. Instead, Russia lobbied Azerbaijan to direct its gas supply to the European markets through Gazprom’s network controlled by Gazexport.

Itera The discovery of Shakh-Deniz gas reserves has not solved the gas shortage problems of Azerbaijan in the short term. Statoil, the operator of the field, only approved the first phase of gas field development in February 2003114. Since 2000, following harsh winters and severe shortages of electricity in Baku and other regions of the country, the Azerbaijani government decided to purchase Russian gas for electrical power generation enabling the country to use its own modest production of gas for residential heating115. At first, Itera, the Russian international group of companies, supplied gas to Azerbaijan116. The Azerbaijani government favored this company over Gazprom because it had fewer links to the Russian government. It was also a joint Russian-American company as opposed to a purely government-owned business. Besides, famous Azerbaijani oilman, Farman Salmanov, who had been developing the oil industry of the Soviet Union for

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50 years, served as an adviser to the president of Itera, thus making relations with the Azerbaijani government much smoother and closer. In December 2004, President Ilham Aliyev awarded Salmanov the highest award of the Azerbaijan Republic: Shohrat (‘Glory’) for the great contribution to the development of economic, science and friendship in relations between Russia and Azerbaijan117. As an independent natural gas producer, Itera also signed a contract with Azerbaijan on the supply of 4 bcm of gas. Besides Azerbaijan, Itera has also delivered gas to Ukraine and Kazakhstan, but still has had to rely on Gazprom’s distribution network of pipelines to make this happen. In 2002, a dispute between Gazprom and Itera over the debt of the latter to the former led to the situation in which Gazprom threatened to limit gas deliveries to Azerbaijan. This has pushed SOCAR officials to seek alternative ways of purchasing Russian gas starting in 2003. Azerbaijan has signed a contract with Gazprom on the delivery of 1 bcm annually. ‘If in the future any difficulties arise with gas imports to Azerbaijan, it will be easier for us to resolve them if we have an alternative supplier,’ said Natig Aliyev, president of SOCAR, on 20 November 2002118.

Neo-imperialist policies elsewhere It should be noted that Putin’s neoimperialist policies have touched not only South Caucasus states, but also other former Soviet republics. Just as in Azerbaijan, Gazprom managed to eliminate Itera from the Armenian market. Whereas in 2002 Itera had a virtual monopoly over the Armenian market, by January 2004 the company had been almost completely boxed

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out of the market119. Russian analyst Alexandra Vertlyugina believes that Gazprom chief Alexey Miller was given instructions from the Kremlin concerning the Caucasus and began incorporating them into the company’s economic policy120. At the same time, Gazprom has waged battles in Ukraine and the Baltic states with similar goals. In 2001, Putin appointed former Gazprom head Viktor Chernomyrdin as Russian ambassador to Ukraine with the special position of presidential envoy for the development of Russian-Ukrainian trade and economic ties. It was a clear signal that President Putin was preparing for the heavy involvement of Russia in Ukraine. Immediately after Chernomyrdin’s appointment, pressures on Ukraine started in the energy sector when Gazprom forced Ukraine to buy Turkmen gas through Gazprom itself121. Most recently, in July 2005, Gazprom vice-president Alexander Medvedev stated that Russia, once again portraying Ukraine as an unreliable transit country, wants to go ahead with the Russian-UkrainianGerman memorandums of understanding of 2003-04 regarding the ownership and management of Ukraine’s gas transit system. This means that, if the project is successfully implemented, Russia will take over the gas transit system on Ukraine’s territory122. Russia has also pressured the pro-Western government of President Yushchenko with the disruption of gas supplies, which in turn threatens the Ukrainian economy as a whole. Similarly, Russia has been eager to take over the energy assets of the Baltic states in order to increase its political influence in the region. Most importantly, the Russian government has been pushing for seizing control over Lithuania’s largest economic asset, the Mazeikiai oil complex, includ-

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ing the sole refinery in the Baltic states (12m tons annual processing capacity), the Butinge oil maritime terminal (8m tons of two-way loading capacity annually) and a number of retail outlets and pipeline groups123. Thus one can conclude that Putin’s policy towards the Caucasus, particularly towards Azerbaijan, is part of a larger policy course adopted by the Kremlin. It is important to note this trend because clearly Azerbaijan was only one area in the FSU targeted for attention by Russian energy companies.

Gas supply contracts in the FSU The export of gas by Gazprom to Azerbaijan has been through the pipeline on Dagestan’s Caspian shore, known for its instability and high crime. The pipeline has been blown up on several occasions halting temporarily gas exports, as was the case on 21 April 2004. In 2004, due to the fact that Itera did not have a gas transmission capacity, the Azerbaijani side asked Gazprom to increase the supply to over 4 bcm124. Gazprom in turn signed a contract with the Azerbaijani government on the delivery of 4 bcm of gas annually for the period of five years. The contract was worth $208m (at a price of 1000 cubic metres for $52). Later the price increased to $60 per 1000 cubic metres125. The source of the gas for this contract came from Gazprom’s supply in Kazakhstan, Turkmenistan and Russia, the former being a delivery collateral. Later, as a result of discussions with the Azerbaijani side, Gazprom has agreed to increase the volume to 4.5 bcm from 2004126. Sabit Bagirov, former head of SOCAR, said that this agreement would eventually make Azerbaijan completely dependent on Russian gas127.

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The fact that Gazprom has been buying Turkmen gas and selling it to other former Soviet republics at more expensive prices showed the power of monopoly that Gazprom holds on the gas distribution network. At the same time, it showed how dangerous and unreliable the situation is, because on 1 January 2005 Turkmenistan suspended the delivery of gas to Gazprom demanding an increase in the price for gas from $44 to $60 per 1000 cubic meters. Gazprom refused, citing that the three-year long contract setting the purchase price of Turkmen gas at $44. Yet the ten-day suspension forced Gazprom to cut its deliveries to Azerbaijan, because all of its own available resources were set to be delivered to European markets. In return, SOCAR officials warned that they would halt the oil flow into the Baku-Novorossiysk pipeline: it would take the oil dedicated for export and refine it in Azerbaijan to obtain fuel oil for electric power generation in place of gas128. The expansion of Gazprom in the Caucasus was not only seen in Azerbaijan, but also in the neighboring state of Georgia. In December 2004, the Georgian energy minister, Nika Gilauri, proposed that Gazprom rehabilitate and use the AzerbaijanGeorgia gas pipeline, built in the 1960s but dormant since the 1990s. Gazprom’s director-general, Alexander Medvedev, said that the company might consider it129. This proposal prompted a great deal of criticism and anger on the part of US policy-makers and Georgian nationalists in parliament130. The dominance of Gazprom and another Russian energy giant, Transneft, in the former Soviet republic was also noted by a US official on Caspian basin energy affairs, Ambassador Steven Mann, on 10 March 2005, while speaking at the Jamestown Foundation. He stated that the core of the US energy policy in the region is

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that of ‘anti-monopoly’131. Jamestown Foundation’s senior fellow, Vladimir Socor, speaking at the same event, defined Russian energy strategy in the Caucasus and Central Asia as one that ‘seeks control over the gas’. He warned that ‘if successful, this policy would double the volume of natural gas reaching Europe from Russia and would maximize the EU’s dependence on Russian-supplied gas’132. Perhaps for this exact reason, Georgian officials ultimately decided not to privatize the pipeline. Instead, after the visit of President Bush to Tbilisi and the allocation of assistance to Georgia by the US Administration through the Millennium Challenge Fund, Tbilisi has decided to spend $40m to repair the gas pipeline133. Russian officials seemed openly hostile to this news. Russian MP Konstantin Zatulin and independent expert Alexander Blokhin both stated that this decision was another attempt by the US to drive a wedge between Russia and the FSU republic134. Meanwhile, the delivery of natural gas by Gazprom to Azerbaijan was the subject of talks between company officials and Azerbaijani President Ilham Aliyev during his visit to Russia. Alexander Medvedev, a member of Gazprom’s management committee and director-general of Gazexport Ltd, and Alexander Ryazanov, deputy chairman of Gazprom’s management committee, met with President Aliyev in 2004 to discuss Gazprom’s increasing interest to Azerbaijan. Speaking at the press conference with Azerbaijani journalists on 2 February 2004, Medvedev said that Gazprom is interested in issues beyond bilateral trade, such as offshore development of oil and gas fields135. Gazprom officials also advocated the export of Shakh-Deniz gas through the Blue Stream pipeline that has been built under the Black Sea with the aim of exporting Russian gas to

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the Turkish market. Medvedev called the idea ‘economically viable’136. However, the desire and interest of the Azerbaijani government to diversify its export routes has led to the construction of the South Caucasus Gas pipeline through Georgia to the Turkish city of Erzurum. The discovery of Shakh-Deniz gas and the construction of the South Caucasus gas pipeline will soon lead to the complete independence of Azerbaijan from the Russian gas. This process will be further helped by the gas, received from the ACG oil field. AIOC, operator of the field, forecasts that until 2015 this field will yield 128 bcm of gas from which 39 bcm will be given to SOCAR. In the words of SOCAR representatives, beginning in 2008 Azerbaijan will no longer be importing Russian gas137. Perhaps this factor explains why Azerbaijani officials have agreed to work with Gazprom despite the fact that it is a state-owned company. The agreement with Gazprom is of a temporary nature and which is why it is not seen by Baku officials as a longterm threat to its national interests.

RAO-UES (Unified Energy System) Another Russian energy giant that has attempted to enter the Azerbaijan market is RAO-UES (Unified Energy System). It is well known that this company has close links with Russian government circles as 52 per cent of the company’s shares belong to the state. The head of the company is Anatoly Chubais, a former privatization tsar, and a former first deputy prime minister of Russia. Chubais is the poster boy for Russia’s concept of liberal empire as a way of reestablishing Russian control over the former FSU. RAO-UES’s board of

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directors also includes Alexander Voloshin, former head of presidential administration. The company produces 70 per cent of the electric power across the CIS and generates more than 70 per cent of all electricity generated in Russia itself138.

FSU acquisitions Any attempts by RAO-UES to enter Azerbaijan are very similar to their earlier exploitation of the weakness of the Georgian government in the run-up to elections in the fall of 2003 when it bought 75 per cent of the electricity generation and distribution assets for the Georgian capital of Tbilisi from AES of the US139. Vladimir Papava, vice-chairman of the Georgian parliamentary committee on budget and finance, described the situation as ‘the economic occupation of Georgia by Russia…. Russian capital is either government or government controlled’140. Similarly, RAO-UES has used a debt-for-equity swap in Armenia and as a result has gained control over the power-generation facilities there, including the country’s only nuclear power plant, Metsamor. Most recently in August 2005, RAO-UES purchased 100 per cent of the shares of the largest energy producing facility in Moldova141. It is clear that RAO-UES has political goals in mind in its entry into the Caucasus, because of the weak commercial attractions of assets such as Georgia’s electricity system. In fact, AES was losing money on this project142. Yevgeny Arzyukhin, Russian analyst, wrote in the Russian government daily Rossiyskaya Gazeta that ‘the political implications of UES’s economic expansion are obvious … electricity supply being vital for the people to have a normal life, Moscow is set to gain control over key economic sectors and over their overall existence in general’143. Overall, where

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investments by large Russian companies in the FSU are concerned, distinguishing between political and commercial drivers can be difficult to discern. One indication that politics often plays a larger part in these decisions than commercial rationality is that most of these investments are made by state-controlled companies or by privately controlled companies close to the state144.

Energy co-operation between Georgia and Azerbaijan It looks like the new Georgia government of Mikheil Saakashvili has realized the danger of Russian ownership of its electricity network and is looking for ways to break this monopoly. In the words of the new minister of energy, Nika Gilauri: ‘Georgia is not planning to have only one energy company. We are going to invite other companies into our market as well. Our principles are that at least two players must be present in the Georgian energy market. Turkey could be a big and good partner for Georgia in this regard.’145 At the same time, the Georgian ministry of fuel and energy has looked for ways to develop bilateral cooperation with Azerbaijan. Georgian energy experts traveled to Baku in June 2005 and their Azerbaijani colleagues visited Tbilisi on 1 July 2005 to work on the details of synchronizing the countries’ two energy systems. It is expected that the synchronization of these systems would enable them to exchange electricity during summer and winter times (Georgia wants electricity from Baku in winter and is willing to export it back over the summer). Gilauri has stated that his government would spend $10m$12m from the US’s Millennium Challenge Fund in order to finance the

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construction of a parallel mode of energy generation and exchange146. Meanwhile, the Russian acquisition of Armenian electricity assets has given RAO-UES the opportunity to export electricity to Turkey and Azerbaijan, because as soon as RAOUES carries out the repairs and concludes its lease of the high-voltage transmission lines from Armenia to these countries, it would be able to do so despite the lingering political problems between these countries. Chubais, himself, denies that the company seeks political gain. He has said, ‘we do economics, not politics’, in an interview with the newspaper, Russkii Kur’er147. Indeed, while on a visit to Armenia in October 2003, Chubais said that RAO-UES sees as its priority task in Armenia as connecting its grid to the parallel operations of the TransCaucasus power grids. ‘Even if the net power flow is zero, it will benefit both Armenia and Azerbaijan.’148 This clearly shows that RAO-UES is eyeballing Azerbaijan as its next target.

Electricity in Azerbaijan Azerbaijani authorities have refuted rumors on possible cooperation in the sphere of energy exchange between Armenia and Azerbaijan. ‘Before the solution of the Nagorno-Karabakh conflict, no energetic cooperation between Azerbaijan and Armenia is possible,’ said Marlen Askerov, chief engineer of Azerenergy149. Azerbaijan has the capacity to produce 5.2 GW of electricity, but it produced only 17.6 billion kilowatt hours (Bkwh) in 2002 (20 per cent of which comes from six hydroelectric plants and 80 per cent from eight stateowned thermal plants)150. Meanwhile, the consumption of electricity has reached 17.4 Bkwh151. Azerbaijan still needs to import electricity from abroad, because of the country’s inefficient distribution network, to

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make up for transmission losses (7 percent of total generation in 2002). At the moment, all generating capacity is state owned. It is also a net importer of electricity from Iran (540m kwh), Russia (1.3bn–1.5bn kwh), Turkey (400m kwh) and Georgia152. The electricity network of Azerbaijan has been plagued with high inefficiency153. The system has deteriorated over the last decade due to lack of funds. Many areas of the country receive restricted amount of electricity and experience frequent localized outages and occasional widespread system failures. In addition, the sector is not yet financially viable due to tariff levels below production costs and the sector demonstrates a low level of collections for payment. At present no adequate private sector funding is available to the country for the full rehabilitation of the system154. In 2002, electricity exports from RAO-UES to Azerbaijan reached 1.09 Bkwh. RAO-UES also approved a ‘comprehensive programme for enhancing reliability of operations of cross-border transit line of 300 kwh UES of Russia-Dagenergo-Azerbaijan’, which consists of measures to ensure the uninterrupted operation of the energy systems of the Russian Federation and Azerbaijan155. RAO-UES has begun negotiations with the Azerbaijani leadership on the possibility of RAO-UES’s participation in the completion of the construction project at the ninth power unit of Azerbaijanskaya TPP and on the construction of a new 330 kV transmission line to Iran156. In 2003, RAO-UES exported 54 mwh of electricity to Azerbaijan157. The head of Azerenergy, Etibar Piriverdiyev, stated on 30 September 2003 that the country plans to import 1.5 Bkwh of electricity from Russia in 2004, the same as in 2003, at the cost of 2.6 cents per kwh. He added that there was no possibility of expanding

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this volume due to insufficient internal transportation capacity. The current import of electricity is being done via the 300 kwh Derbend–Yashma line, but RAO-UES wants to build another Derbend–Yashma line, which will make it possible to increase imports by 300–400 kwh158.

The Chubais visit The 24 May 2004 a visit by Anatoly Chubais to Azerbaijan raised speculation about Russia’s intentions in the South Caucasian republic. Chubais, who met with the President Aliyev, Prime Minister Rasizadeh and the head of Azerenergy, Etibar Piriverdiyev, discussed bilateral economic relations and the possibility of increasing cooperation between the two countries in the field of energy. At the same time, Chubais informed journalists present that one of the goals of his visit was to support regional cooperation on energy issues and to support the implementation of regional issues159. ‘Russia has had three winters in a row without a single energy crisis. We are entitled to declare that the Russian energy sector’s recovery from crisis is complete. It is this that gives us the opportunity to advance further, into other regions, including Azerbaijan,’ said Chubais160. During the meeting with President Aliyev, bilateral Russian-Azerbaijani relations were touched upon. President Aliyev, reminded of his recent visit to Moscow and his meeting with President Putin, noted that the relations between the two countries were developing not only in political, but also in economic spheres. The fact that Chubais paid a visit to Baku right after the visit of President Aliyev to Moscow shows the connection between the political and economic aspirations of the Kremlin in Azerbaijan and makes it harder for the Azerbaijani leadership to refuse the proposals of RAO-UES. The timing of the trip was

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obviously outstanding from a RAOUES standpoint161. During the meeting President Aliyev noted the high importance of cooperation in energy and said that he wanted cooperation for electricity exchange to be carried out fully. ‘Mutual energy cooperation has already been established between our countries. Joint projects on the transportation of oil and gas [are] economically important for both countries. The exchange of energy between our countries is increasing. We want to expand this cooperation and carry out a broader energy exchange in the future,’ Aliyev said162. Chubais, in return, noted that a growing Azeri economy would be in need of more electricity and that Russia is watching Azerbaijan’s development with interest. To that end, Chubais not only offered the idea of synchronizing the energy systems of Russia, Azerbaijan and Iran, but also said that the purchase of electrical facilities in Georgia by RAO-UES opened new opportunities for bilateral cooperation between Azerbaijan and RAO-UES163. As a result of this meeting, Chubais was not only able to secure President Aliyev’s principal support for these projects, but also pushed for the formation of working groups on these issues. It must be also noted that unlike Western businessmen, who often act in very formal ways, Chubais carried out some diplomatic gestures that were aimed at winning the sympathy of President Aliyev. For instance, he visited the grave of the late President Heydar Aliyev and mentioned during the meeting with President Ilham Aliyev that he had fond memories of his father and that the two-hour meeting that he had had with him in the past had influenced his life. These kinds of acts do not go unnoticed in local Azeri culture and often require the return of a favour.

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Local analysts immediately labeled the Chubais visit as an attempt by Russia to increase its presence in Azerbaijan, and, more specifically, to increase the control over Russian interests in the country’s energy systems, so providing the use of these systems as a tool of political leverage in the future. The opposition press and some political parties negatively reacted to the visit. ‘Giving Azerbaijan’s energy sector into someone’s hands is not only an economic issue, but also a political issue, because the countries, that want to limit our independence, should not have such an important tool of pressure in their hands’, exclaimed the opposition daily Yeni Musavat.

Turkey’s Barmek and electricity distribution Some analysts argued that the object of Chubais’s interest was Baku’s electric distribution network, which has been rented to the Turkish company Barmek for the next 25 years. The tender had been finalized and the contract signed in 2001, after Barmek had outbid two other competitors, the German company Siemens and the Dutch company AES, with its promise to invest $300m in the rehabilitation of the distribution network. But the local media reported that it was the personal lobbying of the former Turkish president, Suleyman Demirel, which had helped Barmek to win the tender. Later, Barmek was also granted a license to operate the Sumgait city electricity distribution network, as well as the electricity distribution network of the northern regions of the country. Barmek has thus far fulfilled all of its obligations vis-à-vis Azerbaijan and there is no evident reason for the government to annul the contract.

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Otherwise, the country runs the risk of being sued in the international economic courts. From time to time, pro-government deputies in the Parliament and local media tied to government circles launch attacks against Barmek, which lead many to think that the government wants to get rid of Barmek and deliver the network to Russian hands. Many explain this as a return favour of President Ilham Aliyev to President Putin for his support during the last year’s presidential elections. At that time, Putin strongly endorsed the candidacy of Aliyev. Barmek’s president, Huseyn Arabul, refutes all of the rumors about the transfer of Baku’s electricity distribution network into the hands of Russians and says that the company intends to stay in the country until the contract concludes and that, in the event of a breach in this contract, those responsible would have to pay $250m. However, in June 2005, the head of Azerenergy, Etibar Piriverdiyev, submitted a recommendation to the cabinet of ministers of Azerbaijan to break the contract with Barmek, arguing that the company had not fulfilled its obligations in the fields of investments and payment for electricity received. Indeed Barmek refuses to pay for the received electricity because of the debts of some government bodies164. Days after this, the minister of economic development, Farhad Aliyev, stated that Barmek was having some minor problems in its performance, but they were not reason enough to break the contract. Additionally, the tax ministry has decided to sue Barmek in court on charges of tax evasion. The deputy minister of taxes, Namik Aliyev, informed the media that the company had not paid the state its budgeted taxes of 19bn manats ($4.1m). Arabul replied that this was a dirty campaign carried out against his company which exhibited some ‘ordered feature’165.

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Arabul himself has stated, as reported in Yeni Musavat on 4 September 4 2005 that someone in the government was trying to ‘kick the company out’ of the country. He did not specify who it was but said that he had sent a letter to the prime minister about the situation166. Later, he also requested a meeting with the president himself, saying that the company’s work in Azerbaijan is being hindered by nine-month-long tax inspections. Generally speaking, the government’s attitude to Barmek is often determined by how pro-Russian the politicians involved are. The head of Azerenergy, Etibar Piriverdiyev, and the head of the presidential apparatus, Ramiz Mehtiyev, are known as pro-Moscow politicians, which is why there is no coincidence in the fact that the attacks on Barmek have come mostly from Azerenergy and Mehtiyev-controlled ATV. At the same time, the minister of economic development, Farhad Aliyev, and President Aliyev himself are very proWestern politicians. Thus they oppose the transfer of Azerbaijan’s electricity system to the management of RAOUES. In October 2005, President Aliyev has publicly supported the work of Barmek in the country and said that he did not support its departure. Arabul subsequently said that this statement has solved ‘all of their problems’.

No debt for equity Meanwhile, Andrei Yegorov, head of the public relations department of RAO-UES, in an interview with the Azerbaijani independent daily Echo, confirmed the interest of his company in the Azerbaijani electrical market. ‘If there is a new tender, we will study the necessity of our participation in it and first of all, we will conduct an

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assessment of the economic effectiveness of this deal.’ 167 Chubais himself has said that he has no interest in Baku’s distribution network and has noted that he and his company were more interested in long-term broad-based cooperation with Azerbaijan. ‘The goal of Russia is to restore the unified electrical space on the territory of former Soviet Union,’ said Chubais. Indeed, the purchase of Azerbaijan’s energy system by RAO-UES seems unlikely, simply because Azerbaijan, unlike Georgia and Armenia, does not have large outstanding debts to Russian companies, mainly related to the supply of energy168. As a result of the visit, a bilateral working group has been set up to develop economic projects of joint interest. One idea on the table is to rent the energy-generating capacity of Azerbaijan to RAO-UES. More specifically, RAO-UES seems to be interested in the newly renovated Shimal power station in Baku, which is one of the largest of its kind in the country. Overall, it is clear that, despite President Aliyev’s visible desire for deepened cooperation, Azerbaijan is not interested in debt-for-equity swaps with Russia, as has been carried out in Armenia and Georgia. Further, while the Russians are apparently interested in Azerbaijan’s electricity network from a generation perspective, the government is not interested in pursing such a transfer to RAO-UES at present. Considering the fact that RAO-UES already controls most of the generating capacity in Georgia and Armenia, doing so in Azerbaijan would pose a strategic danger to Azerbaijani national energy security, as well as political problems for Azerbaijan’s political leadership and its people. Such a transfer would diminish the economic and thus political independence of Azerbaijan from Russia. Azerbaijani experts also be-

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lieve that should Russia take over Azerbaijan’s electricity system, this would weaken the country’s negotiating position with Russia on other matters. At least, for the time being, Azerbaijan authorities are able to pressure Barmek and demand from them fulfillment of their contractual obligations, such as adequate investments, rehabilitation and payment. This would be much more difficult if it were RAO-UES with its backing from the Kremlin.

Resistance to Moscow The resistance of the Azerbaijani government to Moscow’s initiatives is not surprising. Russia has a large population, economic power and political ambitions, all of which make it a dominant partner. Additionally some of the more nationalist members of Russia’s elite have openly remarked on the intentions of Russia in the region which in turn creates fear in the FSU downstream states. For instance, in May 2004 economist Mikhail Delyagin said that Russia needed the Common Economic Space (CES) in order to acquire the best firms in the former Soviet Union, which should be working for Russia169. While this may resonate in Moscow, the same cannot be said for those outside the country. Another reason why the Azerbaijani political leadership hesitates to deliver its electricity network into the hands of RAO-UES is due to pressure from the US. It was precisely due to the pressures from the US state department that the Georgian leadership shelved its plans to sell its gas pipeline to Gazprom. In March 2005 plans for this deal were well underway, but shortly thereafter Georgia’s energy minister, Nika Gilauri, said that the country’s leadership was more interested in preserving the security of the

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country’s energy network and thus would not sell it to Gazprom. This turnaround came after Steven Mann, the US state department’s Caspian energy adviser, said: ‘the US categorically opposes any step that could ruin its years’ long effort to secure Georgia’s energy independence.’ Mann also said that the sale would be perceived in the US as ‘hindering the realization’ of the South Caspian gas pipeline project170. Similarly, the US put pressure on Armenia in July 2005, when the country’s leadership blessed the sale of the electricity networks of Armenia under the control of Midland Resources Holding, a British registered firm, to RAO-UES for $73m. The US Agency for International Development (USAID) in a statement on 19 July 2005 announced that it was ‘reviewing’ its assistance projects in Armenia pending the receipt of an official explanation from the Armenian government171. And the Japanese government agency, Japan Bank for International Cooperation, financing the reconstruction of a big thermal power plant in Yerevan has added its voice to Western concerns172. It is clear that the Azerbaijani leadership has taken note of these remarks.

Power generating capacity In order not to fall into an energy dependent relationship on Russian electricity companies, Azerbaijan has been aggressively developing and upgrading its own power-generating capacity. With the help of a Japanese government loan, it has upgraded the first block of the Shimal power generation station in Sumgait (400 mw) and has concluded negotiations with the Japanese Bank of International Cooperation about the construction of the second block, which is planned to finish by the end of

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2005173. In addition, President Ilham Aliyev announced in 2005 that the government would purchase small, mobile power generators in order to quickly install them in the regions outside of Baku. And in August 2005, the German company Siemens announced that its power generation division would build an electricity plant in Azerbaijan for $320m. The 500 mw ‘combined cycle’ plant will not only burn natural gas but also use heat from the gas’s exhaust. The project was ordered by Azerenergy, the state power utility, to meet the rising demand for electricity. The plant will be sea-water cooled and will include two gas turbines and one steam turbine174. It will be ready by 2007175. Besides, Azerbaijani leadership has been actively working with international financial institutions to improve its energy sector and increase its energy independence. On 21 May 2005, the World Bank approved a $48m power transmission project, which will improve the reliability, quality and cost-effectiveness of the electricity supply in the country through investments improving management and performance of the high-voltage transmission network. The project will consist of three components. The first component, power transmission management, will upgrade the electricity dispatch system in the country, which in turn will support more reliable, secure and economic operation of the electricity sector and facilitate financial settlements in a future wholesale electricity market. The second component, transmission network rehabilitation, will cover priority investments in rehabilitation of highvoltage transmission lines and selected high-voltage substations. Under the third component, management assistance, technical assistance will be provided to improve the management systems of Azerenergy and prepare the company for a future restructured

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energy sector176. It therefore appears that, unlike LUKoil in 1994, the Azeri government is not eager to welcome RAO-UES into the country.

Synchronization with Russia and Iran The only areas where Azerbaijan is willing to cooperate with RAO-UES is in the area of the synchronization and transmission of electricity. On 24 May 2004, Chubais reached an agreement in Baku to construct new power grids and to put the energy systems of Azerbaijan, Iran and Russia into parallel operations177. These issues were reflected in the Memorandum on Cooperation in the Sphere of Electricity that was signed between RAO-UES and Azerenergy. The memorandum also reflects the sides’ interest in longterm mutual supplies of electricity in agreed amounts. In order for that to take place, Russia and Azerbaijan intended to create the necessary infrastructure on their territories. ‘We know that our Azerbaijani colleagues have conceived projects for the construction of new power lines between Azerbaijan and Iran. This will inevitably raise the issue of including Iran in the single energy area and of synchronizing its energy systems. Such a project could be implemented only jointly. And we are interested in it,’ Chubais said178. This visit was followed by a visit of an Azerenergy delegation to Moscow to attend the tenth session of the CIS electrical power council. This organization was responsible for a meeting in Baku on 19 October 2004, which was again aimed at further deepening the cooperation between RAO-UES and Azerenergy. Russia arrived at the meeting with an impressive delegation, headed by Chubais himself and accompanied by Vladimir Rushaylo,

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CIS executive secretary and a former Russian interior minister. Rushaylo’s inclusion into the delegation showed the inter-connection between the Russian government and the business sector when it comes to domination of the post-Soviet space. During his stay in Baku, Chubais visited Shimal hydro-electrical power plant. Chubais stated during this visit that Azerbaijan had a great potential to become an important transit country in the region179. Subsequently, the 11-member delegation from Russia and a five-member group from Azerbaijan visited Tehran on 22 October 2004 with the aim of conducting negotiations with their Iranian counterparts, focusing on conditions of the trio deal. The three sides discussed different aspects of a seasonal exchange of between 5001000 mw of power within their territories. Russian experts believed at that time that the technical synchronization of the power supply systems of the three countries would not be easy180. Nevertheless, the agreement was sealed in December 2004, according to which the three countries agreed to synchronize their power grids181. The agreement was signed by Russia’s Reivas, Azerbaijan’s Azerenergy and Iran’s power generation, transmission and distribution company, Tavanir. Its chief executive, Mohammad Ahmadian, said that such synchronization would enable the three countries to benefit from the facilities of one another’s grids in case of power shortage or failure. He also added that the volume of energy exchanged among the three signatories would be at 500 mw. ‘The operations for the construction of power transmission lines are already underway and the exchange of electrical energy will start in 2006,’ he concluded. Chubais added: ‘Once the project is implemented, the power grids of the three countries will operate in parallel. This

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would facilitate transmission of power to any destination in the three countries at any time.’182 This, in many ways, is another step towards the complete dominance of RAO-UES over the electricity system of the South Caucasus. Trilateral meetings of the energy experts of Azerbaijan, Russia and Iran also continued on 21 July 2005 in Baku behind the closed doors183. Azerbaijani officials have an-

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nounced that they planned to increase the import of electricity from Iran by up to 700 mwh184. On September 2004 Chubais said on the programme Vremya that Russia must become a ‘liberal empire’. ‘I believe this mission … means that Russia is obliged to support in every way the expansion of its business outside Russia.’

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PART THREE: Russian energy policy in Azerbaijan: what next?

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A strategic partnership

T

he expansion of Russian energy influence in Azerbaijan in the last two-three years has also coincided with visits of high ranking Russian officials and the business elite to Baku. These ‘special envoys’ included Moscow mayor Yuri Luzhkov, the head of Russia’s audit chamber head, Sergei Stepashin (a former prime minister), the transport minister, Igor Litvin, and others. Their visits raise speculation about Russia’s intentions in Azerbaijan and confirm fears that Russia wants to dominate Azerbaijan economically and through this, politically. Litvin, for instance, proposed to restore the direct railway between Baku and Sochi and to intensify the activities of the North-South transport corridor185. Newly elected President Ilham Aliyev has come under increased pressure from his Russian counterpart Vladimir Putin to change the foreign policy course of the republic towards the Kremlin. Putin attended the funerals of late President Heydar Aliyev and President Ilham Aliyev returned the visit with ones to Moscow and St. Petersburg. Analysts calculate that President Aliyev is among those presidents whom President Putin most frequently calls. The growing relations between the two countries can be also seen from the standpoint of cultural events: 2005 was declared as the year of Azerbaijan in Russia and 2006 will be the year of Russia in Azerbaijan. Visiting Baku, Russia’s foreign minister, Sergei Lavrov, said that the relations between the two nations have moved on to a new level. Alexander Yakovenko, the official representative of the Russian foreign ministry, called the emerging relations between Russia and Azerbaijan ‘a strategic partnership’186.

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West and East Nevertheless, it should be noted that President Aliyev’s seemingly growing ties with Russia only derive from the insecurity of his own power base and from his desire to satisfy Russia in order to prevent the Kremlin from meddling in Azerbaijani internal affairs. On a more strategic level, Azerbaijan seeks to preserve a balance in its foreign policy between the West and East and most likely it will continue to do so in the future. On 26 May 2005, the BTC pipeline was officially inaugurated. While the presidents of Turkey, Kazakhstan, Georgia and Azerbaijan attended the celebration in Baku, the Russian energy envoy, Igor Yusupov, called in sick, clearly an indication of Russia’s displeasure with the project187. No other Russian official replaced him at the ceremony. Indeed, the launch of BTC was a significant blow to Russia’s attempt to take over the energy network in the South Caucasus and thus exert political influence over Azerbaijan and Georgia through the means of energy supply and transit. As it was said by the Georgian president, Mikheil Saakashvili, during the opening ceremony: ‘in practical terms, BTC and the Baku-TbilisiErzurum gas pipeline [to be completed soon] are extremely important projects for Georgia. When the gas pipeline is launched, the issue of Georgia’s energy independence will be finally solved. Georgia will no longer depend on a single source for its energy supplies. This will be the most important guarantor of our energy independence.’188 These words are surely applicable for Azerbaijan as well. Vafa Guluzadeh, former foreign affairs advisor to President Aliyev, told The Wall Street Journal that BTC would neutralize any Russian attempts to use economic levers to bring

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former Soviet republics back under its wing189. In response to the launch of BTC pipeline, President Putin took advantage of the Caspian Security Conference on 14 July 2005 to promote the restoration of Russia’s influence in the Caspian region. This meant beefing up its Caspian military presence by expanding the flotilla, based in Astrakhan to two frigates, 12 patrol ships and a variety of smaller vessels. During the same event, Russia hosted a meeting of the five countries bordering the Caspian sea and proposed the creation of a joint flotilla to patrol the sea in an effort to reduce the movement of terrorists, drugs and arms that now crisscross the Caspian. Experts believe that while a stronger military presence in the Caspian would help Russia combat terrorism and improve security, energy issues also play an important role in its calculations190. While it is clear that although the motivation behind the idea is very real, it can not be seen separately from the desire of Moscow to combat US influence in the region. Earlier in the year, the Pentagon announced that it would spend $200m to develop the Caspian Guard together with Azerbaijan and Kazakhstan.

Russia and the Caspian In order to compete with other regional powers, especially the US, the Kremlin has lately stepped up its efforts to develop the oil fields in the north of the Caspian. On 6 July 2005, Russia and Kazakhstan signed a $23bn, 55-year PSA for the Kurmangazy oilfield in the Caspian Sea (7.3bn barrels of reserves)191. Two state-owned Russian oil companies, Rosneft and Zarubezhneft, will share 50 per cent of the venture. Earlier in 2005, Russia also agreed to work with Kazakhstan on the Khvalynskoye oil

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field, promising to invest $1bn. Later on, Putin traveled to Astrakhan and discussed various energy projects with executives from Gazprom and LUKoil192. All of these efforts demonstrate that Russia has decided to do its best to prevent the transportation of the Kazakh oil through the BTC pipeline, as it is desired by the official Baku and the US administration. Strenuously courting Kazakhstan over this issue comes with the hope of diminishing the role of the BTC pipeline in the region and in increasing Russia’s energy, as well as its economic, political and geostrategic, presence in the Caspian region. Yet it looks as if Kazakhstan will eventually export some oil through the BTC pipeline, thus further undermining Russia’s efforts in the Caspian region. Azerbaijani and Kazakh delegations have been engaged in negotiations over the tariffs for Kazakh export oil through the BTC pipeline and it is expected that the agreement on this will be signed in 2005. The preliminary agreement was already signed between the Azeri and Kazakh presidents during the BTC’s opening ceremony in Baku. According to official statements, Kazakhstan is ready to transport 309m tons of oil through the BTC pipeline193. The pipeline that would carry Kazakh oil would be laid under the bottom of the Caspian Sea194. As the BTC pipeline starts its operations and major oil revenues gradually are received into the Azerbaijani budget, it is expected that the economic and thus political independence of Azerbaijan from Russia will increase. This will lead to less involvement by Gazprom and RAO-UES in the Azerbaijani market, as domestic production of gas and generation of electricity satisfies the needs of the Azerbaijani consumers. It is clear that Russian energy policy in Azerbaijan has not achieved its desired results, as

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it did in Georgia and Armenia. Perhaps for this reason, Russian policymakers seem to have accepted the loss of their oil game in the Caucasus. Vice-president of Transneft, Sergei Grigoryev, has said that each state had the right to build what it needs195. And speaking recently at an energy forum in Geneva, Russia’s energy minister, Igor Yusupov, as well as the representatives of President Putin, called on Western investors to contribute to the improvement of the infrastructure, to fund new transportation routes, to develop new oil pipelines and railways in the Caspian basin196. Similarly, after major disagreements with the Western-leaning govern-

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ments of Georgia and Ukraine about reform in the CIS, Russia itself seems to be frustrated with the CIS and announced on 24 August 2005 that it would seek to base its political and economic relations with CIS countries on international standards, including stopping the supply of oil and gas at below market prices197. This means that should Russia increase the prices of oil and gas to the former Soviet republics, including Azerbaijan, this would further diminish Russia’s energy influence in the country over the long haul and lead to the gradual departure of Russia from Azerbaijan.

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Notes and references 1

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‘Caucasus: is BTC oil pipeline saving Europe from Russia or from OPEC?’, 31 May 2005, EIN News. Saivetz, Carol, ‘Putin’s Caspian policy,’ Policy Brief 1, Caspian Studies Programme, Harvard University, October 2000. Saivetz, Carol, ‘Caspian geopolitics: the view from Moscow’, The Brown Journal of World Affairs, Summer/Fall 2000. Ibid. Ibid. Ibid. Ibid. Ibid. ‘ Moscow’s heavy hand seen in LUKoil pullout from Caspian project’, www. rcnetwork.net. ‘ Russian LUKoil president brought new proposals to Baku’, http://ourworld.compuserve.com/homepages/usazerb/970415a.htm. ‘ Russia’s LUKoil to stay in Azerbaijan project’, 11 November 2005, Interfax. www.first-exchange.com/fsu/azer/news/ news0711.htm. ‘ LUKoil increases stake in Azerbaijani oil project’, 18 April 2003, RFE/RL Newsline. ‘ LUKoil increases its share in D-222 (Yalama) project’, 4 April 2003, www.capitallinkrussia.com. ‘ Azerbaijan main export gas pipeline – prospect or reality?’, www.caspenergy.com/ no4rus3.html. ‘New emphasis seen in the US Caucasus policy’, 6-13 July 1997, Moskovskiye Novosti, # 27. ‘New emphasis seen in the US Caucasus policy’, 6-13 July 1997, Moskovskiye Novosti # 27. Stauffer Thomas, ‘Caspian Fantasy: the economics of political pipelines’, Brown Journal of World Affairs, Summer/Fall 2000. Koyama, Ken, ‘Oil/gas development in Russia, Azerbaijan and Kazakhstan and the impacts on the international markets’, a report on studies commissioned from the Institute of Energy Economics in Japan by the Agency of Natural Resources and Energy and by the Ministry of Economy, Trade and Industry. ‘ LUKoil tempts Azerbaijan with two new projects’, 9 September 1999, Azer-Press News Agency.

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Teague Edward, ‘Georgia: velvet underground in overdrive’, 24 November 2003, Paranoid Obsessive. Gleason, Gregory, ‘Financing Russia’s Central Asian expansion’, 3 November 2004, Central Asia-Caucasus Analyst. ‘Debating Russia’s Fate’, 9 May 2005, The Geopolitical Intelligence Report, www. stratfor.com. Saivetz, Carol, ‘Putin’s Caspian policy’, Policy brief 1, Caspian Studies Programme, Harvard University, October 2000. Ibid. Saivetz, Carol, ‘Caspian geopolitics: the view from Moscow’, The Brown Journal of World Affairs, Summer/Fall 2000. Ibid Ibid. Ibid. Ibid. Saivetz, Carol “Putin’s Caspian Policy” Policy Brief 1, Caspian Studies Programme, Harvard University October 2000. Oxford Analytica Russia/ CIS Daily Briefs, 7 July 2005. Oxford Analytica Russia/ CIS Daily Briefs, 13 June 2005. Saivetz, Carol, ‘Putin’s Caspian Policy’ Policy Brief 1, Caspian Studies Programme, Harvard University October 2000. Ibid. Oxford Analytica Russia/ CIS Daily Briefs. 22 July 2005. Gleason, Gregory, ‘Financing Russia’s Central Asian expansion’, 3 November 2004, Central Asia-Caucasus Analyst. Sabonis-Helf, Theresa, ‘Power and influence? RAO-EES in the Southern Tier’, PowerPoint presentation. Tsereteli Mamuka, ‘Russian economic expansion in the Caucasus: a challenge for Georgia’, 9 March 2005, Central AsiaCaucasus Institute. ‘Russia’s LUKoil, Azerbaijan SOCAR to sign a new oil PSA’, 21 December 2000, Dow Jones International News. ‘Russia LUKoil, Azeri SOCAR sign $250m contract’, 10 January 2001, Reuters. 13 June 2001, www.top.az. ‘Russia’s LUKoil overseas holding opens office in Azeri capital’, 6 September 2001, BBC Monitoring Service.

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‘LUKoil studies possibility of participating in new project in Azerbaijan’ Middle East Economic Survey, 2003 ‘LUKoil claims 10–15 per cent share in ArazAlov-Sharg Caspian project’ December 2001. Habarlar-L News Distribution Network. ‘LUKoil is likely to consider an issue of BTC coupled by Alov project’, 23 February 2002, Sherg News Agency. ‘Will Russia’s joining Baku-Ceyhan settle the fate of disputed fields?’, 27 December 2001, 525-ci Qazet. ‘LUKoil may hold 7.5 per cent stake in BakuTbilisi-Ceyhan project’. Habarlar-L News Distribution Network. May 2001. Ibid ‘ Baku-Tbilisi-Ceyhan pipeline: oil or politics?’, 7 June 2005, Kazinform News Agency. Echo, 19 July 2005. US-Azerbaijan Chamber of Commerce report 2005 From the official LUKoil website www.lukoil.ru . From the official website of LUKoil in Azerbaijan. www.lukoil.ru . Ibid ‘ LUKoil to cut Azeri interests’, October 24, 2002 Habarlar-L News Distribution Network. ‘Russia LUKoil, Azeri SOCAR sign $250m contract’, 10 January 2001, Reuters. ‘LUKoil has no plans to join Baku-TbilisiCeyhan oil project’, 19 October 2002, ItarTass. ‘ LUKoil revenue from Azeri-ChiraqGyuneshli project amounts to $273 million’ Habarlar-L News Distribution Network. ‘ Azeri-Chiraq-Gyuneshli consortium approves second phase of project’, 24 September 2002. Habarlar-L News Distribution Network. ‘Kazakhstan, US plan to continue cooperation in Baku-Ceyhan project’, 9 January 2002 Habarlar-L News Distribution Network. ‘ Azeri-Chiraq-Gyuneshli consortium approves second phase of project’, 24 September 2002. Habarlar-L News Distribution Network. ‘LUKoil president is awarded Glory order’, www.baku.ru. ‘LUKoil: a decade in existence’, 12 October 2001, 525-ci. ‘LUKoil invests $420m to Azerbaijani economy’, 26 March 2001, Azadinform news agency. ‘ Yukos interested in developing shallowwater section of Gyuneshli field’ Habarlar-L News Distribution Network. June 2001. Ibid. ‘Is LUKoil leaving Azerbaijan?’, 1 November 2002 http://www.gasandoil.com/goc/company/cnc25097.htm.

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‘Moscow’s heavy hand seen in LUKoil pullout from Caspian project’, www.rcnetwork.net. ‘Is LUKoil leaving Azerbaijan?’, 1 November 2002 http://www.gasandoil.com/goc/company/cnc25097.htm. ‘LUKoil’s plan to sell Azerbaijani assets raise questions’, 29 October 2002, RFE/RL. ‘ LUKoil chief discusses withdrawal from Azeri-Chiraq-Gyuneshli with SOCAR,’ 30 December 2002 Habarlar-L News Distribution Network. ‘Is LUKoil leaving Azerbaijan?’, 1 November 2002. Oxford Analytica, Russia/ CIS Daily Briefs, 31 May 2005. www.hairenik.com. ‘Russia’s LUKoil, Azerbaijan SOCAR to sign a new oil PSA,’ 21 December 2000, Dow Jones International News. ‘Aliyev calls for talks with LUKoil over its pull-over from ACG,’ 2 January 2003, Habarlar-L News Distribution Network. ‘LUKoil’s plan to sell Azerbaijani assets raise questions’, 29 October 2002, RFE/RL. ‘LUKoil to cut Azeri interests’, 24 October 2002 Habarlar-L News Distribution Network. Gorts, Isabel, ‘Japan’s INPEX buyer of LUKoil’s Caspian stake’, 23 December 2002,Rosbalt. ‘LUKoil completes sale of its interest in the Azeri-Chiraq-Guneshli project to INPEX’, 28 April 2003. ‘Moscow’s heavy hand seen in LUKoil pullout from Caspian project’, www.rcnetwork.net. ‘ LUKoil mends fences in Baku’, 10 April 2003. Habarlar-L News Distribution Network. ‘Azerbaijan demands $250m in taxes from LUKoil’, 8 May 2003 www.troika.ru. ‘ Azerbaijan insists LUKoil pay $250m in taxes’, 9 June 2003, Rosbalt. ‘ For solution of tax issues with LUKoil, Azerbaijan involves international auditor companies’, 11 May 2005 Today.az. ‘Criminal charges against Barmek, Garadag Cement and LUKoil’, 31 May, 2005, Echo. ‘LUKoil denies Azerbaijan’s demand on payment of $250m in taxes’, 30 March 2003, Trend News Agency. ‘Azerbaijan demands $250m in taxes from LUKoil’, 8 May 2003 www.troika.ru. Renaissance Capital Informational Newsletter http://www.ebanking.ru/eng/research/ MorningMonitors/viewall.asp? MMID=1447&MMSection=3 ‘Taxes? What taxes?’, April 28, 2003 http:// www.gasandoil.com/goc/company/ cnc32387.htm

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92 93 94 95

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www.rigzone.com/news/article.asp? a_id=20351 ‘ Russia’s LUKoil mulls quitting Azeri onshore oil deal’, 4 June 2003, Reuters. ‘LUKoil to increase its share in HovsanyZykh project’, 14 May 2004, Kommersant. ‘ LUKoil may withdraw from HovsanyZykh oilfield project’, 30 September 2004. Habarlar-L News Distribution Network. ‘SOCAR starts drilling at Hovsany without LUKoil’, 11 August 2003, Caspian Information Agency. ‘Is LUKoil leaving Azerbaijan?’, 1 November 2002. Habarlar-L News Distribution Network. ‘Official does not confirm LUKoil plans to quit Shah-Deniz’, 29 August 2003, PrimeTass News Agency. ‘ Russian mammoth not to cede Azeri gas stock’, 5 September 2003, RIA Novosti. ‘LUKoil buys out Eni stake in LUKAgip’, 6 July 2004, www.neftegaz.ru. ‘ Russia’s LUKoil to stay in Azerbaijan project’, 21 September 2004, InterfaxAzerbaijan News Agency. ‘ LUKoil to start exploratory drilling at Yalama D-222 in June’, 6 February 2004, Prime-Tass News Agency. ‘Russia’s LUKoil plans to abandon Caspian well’, 29 November 2004. 22 December 2004, Zerkalo. Ismailzade, Fariz, ‘Russian oil through BTC pipeline: a political scheme or economic strategy?’, Jamestown Daily Monitor, 6 January 2005. 24 December 2004, Echo. From the website of TNK-BP. Oxford Analytica Russia/ CIS daily briefs, 22 June 2005. 24 December 2004, Nezavisimaya Gazeta. Koyama, Ken, ‘Oil/gas development in Russia, Azerbaijan and Kazakhstan and the impacts on the international markets’, report on studies commissioned by the Institute of Energy Economics in Japan by the Agency of Natural Resources and Energy and the Ministry of Economy, Trade and Industry. Nanay, Julia, ‘Caspian infrastructures: roads, rails and pipelines’, 11-12 December, The Columbia Caspian project Stauffer Thomas, ‘Caspian fantasy: the economics of political pipelines’, Brown Journal of World Affairs, Summer/Fall 2000. Koyama, Ken, ‘Oil/gas development in Russia, Azerbaijan and Kazakhstan and the impacts on the international markets’, report on studies commissioned by the Institute of Energy Economics in Japan by the Agency of Natural Resources and Energy and the Ministry of Economy, Trade and Industry. Ibid

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115 Socor Vladimir, ‘Temporary halt of Turkmen gas deliveries via Russia sends ripples downstream’, 12 January 2005, Eurasia Daily Monitor. 116 ‘Gazprom to supply gas to Azerbaijan’, BBC Monitoring Former Soviet Union. 117 ‘ Renowned oilman Farman Salmanov awarded with Shohret order’, 12 May 2004, Azertaj News Agency. 118 ‘Gazprom to supply gas to Azerbaijan’, BBC Monitoring Former Soviet Union. 119 Martirosyan Samvel, ‘Will gas be a “lethal weapon” in the South Caucasus’, Rosbalt. 120 ‘Gazprom following Kremlin’s instructions’, 11 March 2004 www.russianjournal.com. 121 Kupchinsky, Roman, ‘Analysis: Russia’s new imperialism’, 27 November 2004, RFERL. 122 ‘Ukraine’s reputation at stake in gas trade with Russia’, 5 July 2005, Eurasia Daily Monitor, Jamestown Foundation. 123 Socor, Vladimir, ‘Moscow prepared unfriendly takeover of Lithuania’s oil complex’, 1 July 2005, Eurasia Daily Monitor, Jamestown Foundation. 124 Press conference of Alexander Medvedev, director-general of Gazexport, 9 February 9 2004, www.gazprom.ru. 125 Socor Vladimir, ‘Temporary halt of Turkmen gas deliveries via Russia sends ripples downstream’, 12 January 2005, Eurasia Daily Monitor. 126 Press conference of Alexander Medvedev, director-general of Gazexport. 9 February 2004, www.gazprom.ru. 127 Martirosyan Samvel, ‘Will gas be a “lethal weapon’ in the South Caucasus’, Rosbalt. 128 Socor Vladimir, ‘Temporary halt of Turkmen gas deliveries via Russia sends ripples downstream’, 12 January 2005, Eurasia Daily Monitor. 129 ‘Gazprom studies gas transit to Azerbaijan’, Interfax Information Services. December 9, 2004 http://www.gasandoil.com/goc/company/cnc45157.htm 130 Socor Vladimir, ‘Speculation on pipeline sale to Gazprom detrimental to Georgia’s interests’, 1 March 2005, Eurasia Daily Monitor. 131 ‘US senior advisor on Caspian energy speaks at Jamestown Forum’, 10 March 2005, USAzerbaijan Chamber of Commerce newsletter. 132 Ibid. 133 ‘Russia upset by decision not to privatize gas pipeline’, 18 May 2005, The Messenger. 134 Ibid. 135 Press conference of Alexander Medvedev, director-general of Gazexport, 9 February 2004, www.gazprom.ru. 136 Ibid. 137 ‘From 2008, Azerbaijan will not depend on Russian gas’, 29 July 2005, Regnum News Agency.

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138 Teague Edward, ‘Georgia, velvet underground in overdrive’, 24 November 2003, Paranoid Obsessive. 139 Tsereteli Mamuka, ‘Russian energy expansion in Caucasus: risks and mitigation strategy’, 27 August 2003, Central Asia-Caucasus Analyst. 140 ‘Russia is striving for the economic occupation of Georgia’, 9 February 2005, Nezavisimaya Gazeta. 141 ‘RAO-EES has monopolized the energy system of Moldova’, 27 July 2005, www.lenta.ru. 142 Tsereteli Mamuka, ‘Russian energy expansion in Caucasus: risks and mitigation strategy’, 27 August 2003, Central Asia-Caucasus Analyst. 143 Teague Edward, ‘Georgia, velvet underground in overdrive’, 24 November 2003, Paranoid Obsessive. 144 Oxford Analytica, Russia/ CIS Daily Briefs, 22 July 2005. 145 Interview with Georgian minister of energy, Nika Gilauri, 16 May 2005 Regnum news agency. 146 ‘Azerbaijan, Georgia to sign agreement on synchronizing energy systems’, 13 July 2005. Azerbaijan State Telegraph Agency. 147 Torbakov, Igor ‘Russia seeks to use energy abundance’, 19 November 2003, Eurasianet.org. 148 ‘No early shutdown planned for Armenian nuclear power plant, Russian energy boss’, 22 October 2003, Arminfo News Agency. 149 ‘ Before the adjustment of the NagornoKarabakh conflict the energetic exchange with Armenia is not possible, the officials of Azerenergy confirms’, 24 October 2003, Media-Press. 150 Energy Information Administration, country analysis- Azerbaijan http://www.eia.doe.gov/ emeu/cabs/azerbjan.html 151 Ibid 152 27 August 2005, Gun Seher. 153 Sabonis-Helf, Theresa, ‘Power and influence? RAO-EES in the Southern Tier’, Powerpoint Presentation. 154 ‘World Bank supports power sector in Azerbaijan’, 21 May 2005, Azertaj News Agency. 155 From the official website of RAO-EES: http:// old.rao-ees.ru/en/business/ report2002/9_4.htm. 156 Ibid. 157 From the official website of RAO-EES. 158 ‘Azerbaijan’s import levels of Russian electricity to remain the same’, 30 September 2003, Interfax News Agency 159 ‘ Russian electricity sector’s plans for cooperation with Azerbaijan, Iran viewed’, 20 October 2004, Nezavisimaya Gazeta. 160 Ibid. 161 ‘President of Azerbaijan, Ilham Aliyev, receives chief of JSC Unified Electric System of

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182 183 184 185

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Russia, Anatoly Chubays’, 24 May 2004, Azertaj News Agency. ‘Russia, Azerbaijan agree on energy cooperation’, 27 May 2004, Azernews. ‘President of Azerbaijan, Ilham Aliyev, receives chief of JSC Unified Electric System of Russia, Anatoly Chubays’, 24 May 2004, Azertaj News Agency. ‘The fighting in energy system is continuing’, 6 August 2005, Zerkalo. ‘Criminal charges against Barmek, Garadag Cement and LUKoil’, 31 May 2005, Echo. 5 September 2005, Yeni Musavat. ‘RAO-EES confirms its interest to Azerbaijan’,11 June 2005, Echo. ‘ Russian electricity sector’s plans for cooperation with Azerbaijan, Iran viewed’, 20 October 2004, Nezavisimaya Gazeta. 22 July 2005, Oxford Analytica Russia/ CIS Daily Briefs. 9 May 2005, Business Eastern Europe, Economist Intelligence Unit. Danilyan, Emil, ‘Russian takeover of Armenian power grid prompts concern’, Jamestown Daily Monitor, 21 July 2005. ‘Japanese donor concerned about Russian takeover of Armenian utility’, 17 August 2005. ‘The fighting in energy system is continuing,’ 6 August 2005, Zerkalo newspaper. ‘Siemens to build Azerbaijan power station’, 6 August 2005, Baku Today. Ibid. ‘ World Bank supports power sector in Azerbaijan’, 21 May 2005, Azertaj News Agency. Baghdasaryan, Laura, ‘Within the maze of transit corridors: the US needs Armenia, Russia needs Georgia and Azerbaijan’, 1-8 June 2004, Heqt. ‘ Russian electricity sector’s plans for cooperation with Azerbaijan, Iran viewed’, 20 October 2004, Nezavisimaya Gazeta. ‘Azerbaijan: President, CIS electrical energy council chief praise relations’, 20 October 2004, Trend News Agency. ‘ Russia, Azerbaijan, Iran start talks on power exchange’, 23 October 2004, www.netiran.com/?fn=nwv(1860,56,4. ‘Iran, Russia and Azerbaijan agreed to synchronize power grids’, 11 December 2004, www.iranian.ws. Ibid. 22 July 2005, Regnum Information Agency. 21 August 2005, Azerbaijan State Telegraph Agency. Ismailzade, Fariz, ‘Azerbaijan under Iranian and Russian pressure on relations to US’, 3 November 2004, Central Asia - Caucasus Analyst. Trifonov, Yevgeniy, ‘Woe betide the losers’, www.newtimes.ru.

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187 27 June 2005, Los Angeles Times. 188 Peuch, Jean-Christophe, ‘Caspian-Mediterranean oil pipeline launched in Baku’, 25 May 2005, Radio Free Europe/ Radio Liberty. 189 ‘Caucasus: Is BTC oil pipeline saving Europe from Russia or from OPEC?’, 31 May 2005, EIN News. 190 Blagov, Sergey, ‘Russia eyes stronger clout in Caspian region’, 15 July 2005, Eurasianet.org. 191 ‘Russia and Kazakhstan sign $23bn Caspian Sea oil deal’, 7 July 2005, EinNews. 192 Blagov, Sergey, ‘Russia eyes stronger clout in Caspian region’, 15 July 2005, Eurasianet.org.

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193 ‘ Kazakhstan’s participation in BTC catches Russia off guard’, 31 May 2005, The Messenger. 194 ‘ Pipeline will pass through the bottom of Caspian Sea’, 4 August 2005, Rezonans. 195 ‘ Baku-Tbilisi-Ceyhan pipeline: oil or politics?’, 7 June2005, Kazinform News Agency. 196 ‘Caspian oil is necessary for the world’, 6 July 2005, Azerbaijan News. 197 24 August 2005, Oxford Analytica Russia/CIS Daily Brief.

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About the series: Russian foreign energy policy reports

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his series of reports establishes for the first time the confluence of Russian foreign policy with the acquisition of foreign energy assets by Russian entities. Nine specific country profiles focus on the oil, gas, electricity and nuclear power industries. Each report, written by an author of international standing, explains how Russian foreign energy downstream mergers and acquisitions are transpiring to consolidate the new Russian empire. These unique studies address many questions of substance for energy industry professionals, investors, policy experts, and decision makers who seek to make sense of the dynamic changes that have overcome the Russian energy complex and altered the balance of global energy geopolitics. Series Editor Kevin Rosner Ph.D., is a specialist in Russian oil and gas, security of critical energy infrastructure, and international energy-security policy. He is an external expert to the NATO and presently serves as the Director, NATO Forum on Energy Security. He is a Senior Fellow both at the UK Defence Academy and at the Institute for the Analysis of Global Security (IAGS) in Washington, DC. Posts held include Senior Security Advisor to the Baku-Tbilisi-Ceyhan pipeline company, Project Director with the Program on Cooperation with the Russian Federation at the OECD, and Project Manager with the UNESCO Science Division in Paris. Dr. Rosner is the founder of The Rosner Group serving leading members of the global oil and gas community with energy and security analytical products.

‘Russian Involvement in Eastern Europe’s oil, Petroleum Industry: The Case of Bulgaria’ Adnan Vatansever

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his report answers questions such as: as one of the largest foreign acquisitions by a Russian company occurred in Bulgaria, what lessons are applicable to charting future Russian downstream takeovers? Why have Eastern Europe and Western FSU countries been the primary focus of Russian acquisitions? What drives LUKoil (and other Russian oil companies) to pursue acquisition of assets in these regions? Finally, what is the stance of the Russian government in terms of promoting such acquisitions abroad? Adnan Vatansever is a freelance energy consultant and the author of a number of reports for Cambridge Energy Research Associates. He is currently in the process of completing his Ph.D. dissertation on Russia’s energy sector at the Paul Nitze School of Advanced International Studies, Johns Hopkins University. He holds a B.A. in International Relations from the Middle East Technical University in

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Ankara, M.A. in Russian and East European Studies from Georgetown University’s School of Foreign Service. Hardcopy ISBN 1-905050-40-2 E-report ISBN 1-90505080-1

‘Kazakhstan: Energy Cooperation with Russia – Oil, Gas and Beyond’ Dr Ariel Cohen

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his important study explains how Russia, with its private sector and policy makers working in tandem, has exerted a significant amount of control over Kazakhstan’s vast natural resources and its economic freedom. It looks at the way Russia and Kazakhstan agreed to divide the Caspian Sea shelf and how Kazakhstan has managed to maintain good relations with Moscow overall, despite its insistence on exporting energy resources to China and Europe directly and its hopes to export through Iran. Ariel Cohen, L.L.B., Ph.D., is an international expert in international security/ terrorism; Russian, Eurasian, European and Middle Eastern foreign, security, economic and business policy. He is Senior Research Fellow in Russian and Eurasian Studies and International Energy Security at the Davis International Studies Institute at the Heritage Foundation. Dr. Cohen has conducted conferences and briefings for the US Government departments and agencies. He appears on major US and foreign TV networks. Dr. Cohen also has extensive experience consulting for the private sector, international organizations, and technical assistance projects in the Central and Eastern Europe and CIS regions. Hardcopy ISBN 1-905050-41-0 E-report ISBN 1-905050-81-X

‘Georgia: Russian Foreign Energy Policy and Implications for Georgia’s Energy Security’ Liana Jervalidze

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his report shows that as Georgia has restructured its energy sector, the new Russian and Georgian political elites exerted their influence, particularly through the participation of Russian gas company Itera in privatizations of Georgian gas enterprises. And how, over the past few years, Russian-Georgian business groups with their offshore capital have been working to monopolise the Georgian economy and Russia’s gas industry has been consolidating its hold over the CIS pipeline infrastructure, particularly through the expansion of Gazprom. However, Gazprom failed to take control of Georgia’s pipeline infrastructure and Georgia is insistent on developing its pipeline potential in order to boost its role as a transit route to Europe, Turkey and Iran. Liana Jervalidze has worked with several government and research institutions working on Caspian region energy policy and development. She has advised private sector companies in on the development of east-west energy corridor and Georgia’s

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potential role in regional integration. Since 2003, Ms.Jervalidze has been working on the development of Georgia’s gas market. She has spoken on regional energy policy at international conferences in the CIS, Europe and the US. Her analyses have been published in both Georgian and English. Hardcopy ISBN 1-905050-35-6 E-report ISBN 1-905050-84-4

‘Russia’s Energy Interests in Azerbaijan’ Fariz Ismailzade

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n 2003-2004, an increased number of senior Russian officials and major energy companies, such as Itera, Gazprom and RAO UES visited Baku in the hopes of participating in energy projects in Azerbaijan. While maintaining diplomatic relations with Moscow, Azerbaijan is more hesitant when it comes to close cooperation with Russian energy companies. Baku fears that if Russia gains more assets in Azerbaijan, control of these assets will be used for political purposes. This unique study looks at the confluence of Russian private and public sector interest Azerbaijan’s energy sector. Fariz Ismailzade works with the Inter-national Republican Institute in Baku and is a part-time lecturer at the department of political science at the Western University in Baku. He holds an MA in Social and Economic Development from Washington University, St. Louis, and a BA in Political Science from Western University, Baku. Hardcopy ISBN 1-905050-42-9 E-report ISBN 1-905050-87-9

‘Ukraine: Post-revolution Energy Policy and Relations with Russia’ Olena Viter

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his report looks at how the new Ukrainian government plans to decrease Russian influence over Ukraine’s energy sector. President Viktor Yushchenko has declared goals which include the diversification of oil and gas supply sources, the reform of the domestic market, and the creation of a strategic oil stock. Ukraine’s search for more partners in the energy sphere has affected the relationship between Ukraine and Russia; from a “brotherly” relationship to one of pragmatic interest. Olena Viter is a Senior Adviser to the Operational Department of the Secretariat of the President of Ukraine. She is Coordinator of Energy Programs at the School of Policy Analysis, National University of Kyiv-Mohyla Academy, and a member of the non-governmental Expert Council on Energy Security. In 2002, she was an intern at the Hudson Institute, and in 2003 she participated in drafting Ukraine’s Energy Strategy. Hardcopy ISBN 1-905050-31-3 E-report ISBN 1-90505077-1

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‘Turkmenistan-Russian Energy Relations’ Gregory Gleason

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urkmenistan has large gas reserves, but as its immediate neighbours have little import demand, Russia holds the key to its gas transport. In April 2003 Turkmenistan and Russia concluded a 25 year transport and marketing agreement for Turkmen natural gas. The new arrangements permit Turkmenistan’s gas production to reach 100,000 million cm per year in 2007. This unique study details the background and looks at the prospects for Turkmenistan’s gas production and export in the context of Russian strategy, and at Turkmenistan’s role in the new energy strategies throughout Eurasia and the Middle East. Gregory Gleason, Ph.D., is an internationally recognized expert in energy policy and international relations. A professor of political science and public administration at the University of New Mexico, Dr. Gleason has extensive field experience in Turkmenistan and the other countries of Eurasia and Central Asia. He has served as a consultant to Lawrence Livermore National Laboratory, Sandia National Laboratories, the Asian Development Bank, and the US Agency for International Development. His research has been sponsored by the National Science Foundation and the National Academy of Sciences as well as other public and private foundations. Hardcopy ISBN 1-905050-33-X E-report ISBN 1-905050-82-8

‘Belarus: Oil, Gas, Transit Pipelines and Russian Foreign Energy Policy’ Dr Margarita M Balmaceda

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elarus relies on Russia for about 85% of its total energy needs, while Russia needs Belarus’ oil and gas pipelines to export its supplies to Western Europe. How will energy exports from Russia and Belarus’ transit capabilities impact Western Europe if this interdependent relationship ends, either through political changes in Belarus or if Russia ends its energy subsidies to Belarus? This report looks at transit, infrastructure and investment issues and analyzes both the state of the current infrastructure, as well as the possibilities this transit opens to Western investors, particularly as the Yamal Pipeline nears completion. In addition, it looks at the current conflict between Belarus and Russian investors for control of the country’s gas transit system and oil refineries. Margarita M. Balmaceda is Associate Professor at the John C. Whitehead School of Diplomacy and International Relations, Seton Hall University, New Jersey, and an Associate of Harvard University’s Davis Center for Russian and Eurasian Studies and the Harvard Ukrainian Research Institute. She received a Ph.D. in Politics from Princeton University (1996), and Post-Doctoral training at Harvard University. She has published widely on Russian, post-Soviet and East European energy and foreign policies. Hardcopy ISBN 1-905050-34-8 E-report ISBN 1-905050-83-6

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‘Gazprom and the Russian State’ Dr Kevin Rosner

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azprom is the world’s single largest producer of natural gas, long acknowledged as a state-within-a-state. In 2005 it reached a turning point in its history when the Russian government reasserted its majority stakeholder position, whilst also continuing its own push to gain control over an increasing share of Russia’s energy complex overall. This timely report provides answers to questions such as: what do these movements mean for the future of the Russian energy sector? What will be the impact of state control over Gazprom on domestic and foreign shareholders? And what do these changes portend for the future of natural gas exploitation, production, distribution and the ultimate export of Russian gas to downstream consumers? And what will these changes mean to world? Hardcopy ISBN 1-905050-30-5 E-report ISBN 1-905050-85-2

‘Baltic Independence and Russian Foreign Energy Policy’ Dr Harold Elletson

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stonia, Lithuania and Latvia are uniquely dependent on the Russian Federation for energy supplies. The security of energy supplies are national security issues in the three ex-Soviet republics, which are now part of the EU. Increasingly dependent on Russian gas imports and with negligible sources of domestic energy supply, the Baltic countries have been the target of aggressive Russian commercial activity and a sustained attempt to lock them into a long-term reliance on Russia. Now, as Baltic political leaders, energy specialists and intelligence analysts consider their options, the implications for the security and independence of the three Baltic States are a matter of concern well beyond the Baltic. This important report will be essential reading for anyone with an interest in the future energy supplies of both the Baltic States and eastern Europe. Dr Harold Elletson leads The New Security Programme, which conducts research into the implications of the new security environment. He was previously Director of the NATO Forum on Business and Security. A former Member of the UK Parliament, he served as Parliamentary Private Secretary to the Secretary of State for Northern Ireland and as a member of the Select Committee on Environment. An international public affairs consultant and a fluent Russian speaker, he has advised many leading companies on aspects of their business in the former Soviet Union, including BP in Azerbaijan and Alstom in Siberia Hardcopy ISBN 1-905050-36-4 E-report ISBN 1-905050-89-5

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