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By Dr. Gubad Ibadoglu

The 15th anniversary of the contract of century that Azerbaijan signed with foreign companies to exploit the oil reserves of the Caspian sea for 30 years is about to be over. Fifteen years are enough to judge the gains of the contract of century for Azerbaijan from different perspectives and approaches. Despite the previous efforts to make such an evaluation, it is of even greater importance to do so when the contract is already half-way since it is a good time to review the contract signed for 30 years in retrospective and perspective terms.

Though the contract of century was traditionally viewed from the perspective of gains and losses for the economic and social life, now given the enough history of contract implementation, it is time to gauge the contract in terms of its geostrategic, political and environmental importance. That is, even upon the conclusion of the contract, one of the major arguments was that the contract importance should not only be limited to economic gains, but rather be seen as a tool to strengthen the fair position of Azerbaijan with regard to the Garabagh issue and its resolution.

Such an argument that used to sound very strong and thereby create confidence in people about the resolution of Garabagh issue has already become soap foam and does not require any opponent perspective. Quite obviously, such an argument was to serve to divert the attention away from the economic and social gains of the contract and function as a lie for a while. Thus, the past 15 years have shed enough light especially on the political evaluation of the contract as well as review the economic and social gains from a variety of angles. Since it is almost the same distance with respect to the past and the future, let’s take a look at the past period.

First myth: A giant oil policy was launched in Azerbaijan with the conclusion of the contract of century in 1994. It happened when the country lived through the politically and economically hard life and it was a matter of great wisdom to persuade and bring the foreign investors to Azerbaijan then.

Reality: It is true that with the conclusion of the “contract of century” a start was given to a new political and economic stage; the first oil came in 1997 and the profit oil was exported beginning from 1999 as a result of the activities implemented within the framework of this contract. It is also true that the contract was signed at an economically and politically hard time and there was a need to attract investments into the country, apply advanced management and technology in the oil industry. Just because of these reasons and without the adequate funding, it was almost impossible to widely exploit oil reserves with local resources. However, bringing the renowned foreign companies to Azerbaijan should not be seen as the end-product of a wise policy.

First, companies were driven by their corporate interests and had already made their estimations on the potential profits before they decided to enter the country. Secondly, the world was long ago fairly aware about the abundant oil resources of Azerbaijan, which had newly gained its independence. The “Azeri-Chirag-Guneshli,” even at the soviet times, was verified to contain huge oil reserves and it was particularly attractive for the corporative purposes, since there was no risk involved. Thirdly, the suitable geographical location of Azerbaijan between Iran and Russia added on more value to its strategic importance and the Western countries were interested in removing it from Russian control. Therefore, the entrance to Azerbaijan was the political decision of different countries and the influential transnational corporations represented them. Such initiatives dated back to the early years of independence. Even in 1991-1992 Western companies commenced a series of negotiations in order to sign a contract with more lucrative terms for Azerbaijan [1]. Transnational oil companies made their way into the country as a consequence of the transition of the state-controlled economy into a market economy and also because newly independent Azerbaijan had insufficient investments and technology in 1994 to do it on its own.

Second myth: Azerbaijan got recognized as an oil country. The contract of century became the foundation of the economic independence of Azerbaijan encouraging the application of free economic mechanisms and dynamic integration into the world economy thus playing an important role in country’s development.

Reality: Azerbaijan has a long history of recognition as an oil state. Formerly produced in primitive ways for centuries and then industrialized over the last hundred years, the Baku oil was at the focus of world’s famous companies even hundred years ago. In 1901 alone, the oil production reached 12 million puds in Baku, half of the world’s oil production size at that time. It also remains an undeniable and also unforgettable fact that in the former USSR’s 75 percent of oil production was concentrated in Baku during the Soviet times , especially during the World War II.

In fact in the current political and economic conditions and new century of specialists and brain products being increasingly more valuable as compared to the oil, it is no longer a pride for Azerbaijan to be an oil state. We should not be lying to ourselves with banal statements that oil contracts are implemented in a phenomenal and exceptional way in Azerbaijan when the oil remains as a core factor for economic wellbeing in this country. It goes without saying that Azerbaijan should rather be proud of non-oil product exports into the world market. However, the customs statistics for the first half of 2009 reveal that oil and related products had a share of 92 percent in the overall exports volume in that period.

This is one of the problems that the contract of century created. Quite naturally, I am far from denying the fact that this contract played a role in the economic growth and expansion of the economy and increasing aggregate supply. The increasing oil exports and revenues were the key factor in the implementation of large-scale public expenditures, and the investments into the oil sector pushed the GDP growth up to 26.4%, 34.5%, 24.5% and 10.8% in 2005, 2006, 2007 and 2008 respectively. If these growth trends were sustainable and constant, it would be worthwhile to be proud of them. However, according to state statistics committee figures, GDP grew by 3.6 percent in the first half of this year. Given the fact that the growth at such a level was recorded in the fiscal year of the oil production expected to be at its peak in the oil history of Azerbaijan, one does not need to be an economist to predict the implications that will follow the lower production size in years to come.

Third myth: Manufacturing of high quality and competitive products by virtue of bringing foreign investments, modern technologies and equipment, and management practices into the economy turned into a cornerstone of the economic development strategy of Azerbaijan. The implementation of the oil strategy starting from 1994 had an enormous role in the success of the economic development of the country.

Reality: According to the “contract of the century” there is no fault in the investment flow into Azerbaijan. It is true that thanks to the contract of century, Azerbaijan’s economy, especially oil sector did not suffer from the lack of investments over the last ten years. Statistics show that an average annual amount of investments into the capital over 1995-2005 years was 2 billion manats (1 manat roughly equals to $1.2-ed.).

Just because of the contract, the foreign investments into the economy comprised 228 million manats in 1995, 967.8 million manats in 2000, 1.2 billion manats in 2001, 2.2 billion manats in 2002, 3.8 billion manats in 2003, 4.9 billion manats in 2004, 5.8 billion manats in 2005, or 22.2 times as compared to in 1995. Data available for the April 1, 2009 show that 21 billion US dollars have been spent on the exploitation of the Azeri-Chirag-Guneshli deposit.

Approximately one year ago Azerbaijan International Operation Company (AIOC) announced zero balance date in the investments under the “contract of century”. It overlapped with the time when the operating and capital expenditures reached 19 billion US dollars, which means a 5 billion difference between the initial and final values of the “contract of century.” Naturally, the rising world market prices were to raise the costs of this project. Nevertheless, the fact that the cost of the contract has risen up by 35 percent as compared to its initial value is not in favor of Azerbaijan’s interests. In accordance with the terms of the contract, 80 percent of the direct and indirect costs related to the exploitation and management of the Azeri-Chirag-Guneshli deposit must be covered by the companies, which also need to be financed by incomes from the profit oil exports of Azerbaijan. It is to say that the contract of century costs Azerbaijan so much: about 100 million tons of oil, i.e. from 7th November 1997 until 31st June 2009, 143 million tons of oil or one billion sixty million barrels of oil were drilled out of the Azeri-Chirag-Guneshli deposit, nearly more than 100 million tons (about 700 million barrels- ed.) of which covered the period until AIOC announced zero balance date.

Foreign investments to Azerbaijan have been drastically slowing down over the last years. According to the State Statistics committee, the total investments went down by 7.1 percent to the final 3 billion 375 million manats in the first half of 2009, 82.4 percent of which were domestic investments. It means a 63 percent decline in the foreign direct investments to Azerbaijan as compared to the same period of the preceding year.

The decline in the foreign investments to Azerbaijan is associated with the ending construction works in the Azeri-Chirag-Guneshli deposit under the contract of century and such a tendency will lead to less foreign investments to the country in the next 5-6 years to come. Thus, though the contract of century stimulated growth in the flow of investments into Azerbaijan for a while, it is currently inducing investments to decline rather than go up.

In fact, the huge investments into the economy of Azerbaijan by big companies were expected to improve the business environment and develop entrepreneurship in the country to a large extent as this process, along with attracting investments, were contributing to the lesser investment risk in Azerbaijan. It opened good perspectives for the production of high quality and competitive products. Yet, due to the ungrounded and wrong economic policy led in the country and because of the existing barriers caused by monopolies, lower diversification index of the economy, loss of comparative advantage in international trade, misbalance between tradable and non-tradable sectors in the oil sector, and rapid inflation did not allow such pledges to come true. Rather, benefiting from the oil resources only for short-term interests, the government nurtured corrupt relationships between the government and businesses by fostering the populist and ungrounded decision-making in the non-tradable sector, which ultimately converted the classically known corruption sources of construction and transportation sectors into the public expenditure priorities upon allocating the oil revenues.

While, on the one hand, the expensive projects in these sectors functioned as leitmotifs of government’s economic campaigning, it contributed to the worsening corruption ranking, weakening international competitiveness of the economy and economic development being limited only to the growth in non-tradable sector on the other hand. On the background of year-by-year rapid increase in revenues and at the time when institutional changes are necessary for the economy, reforms were forced to the back-front, and under the name of reforms pseudo-institutions were established.

Fourth myth: Hundreds of thousands of jobs are created by ensuring the balanced economic development through the increase in the domestic investments coming from the oil revenues that fall into the share of Azerbaijan in the framework of the “contract of century”.

Reality: It is true that public investments have been increasing at the cost of the expanding domestic funding sources resulting from increasing oil inflows in Azerbaijan. In general, the investments into infrastructure, which are not attractive for the private sector, were considered as a crucial factor to reduce the cost value of goods and services. Nevertheless, the non-transparent way of implementation of these investments widened the scope of corruption and diminished the efficiency and efficacy of these investments.

Meanwhile, high prices caused by increasing aggregate demand in the non-tradable sector raised the profitability and this sector ultimately attracted the resources of the private sector along with the capital generated by the oil boom. Hence, the diversification turned into a much bigger concern. The GDP is composed of the following major elements – mining and quarry; processing industry; electricity, gas and water supply; agriculture; construction; trade, public catering and hotel; transportation, storage and communication; social and informal services; pure taxes. According to the estimations on the basis of these elements demonstrate that the diversification index equaled to 3.3 for Azerbaijan’s economy in 2006 [2].

The diversification index close to one points out the unbalanced economy in Azerbaijan. That is why it is useless to talk about balanced economic development in Azerbaijan. The pattern shows a year-by-year decline in the diversification index of the economy as a result of enhanced oil and gas production and inadequate development of the non-oil sector.

The situation with other sectors of economy that could guarantee the sustainable economic development can be interpreted in different ways as compared to the passive situation with the non-oil sector industry in a sense that the situation with the agricultural production, which can serve as the main guarantor of the overall employment in Azerbaijan, is not that hopeful. The 2005-2008 year statistics show that the economic areas with the lowest growth speed were agriculture and processing industry, while those with the highest speed were trade, transportation and communication. Scholar Ribchinsky’s “non-industrialization effect” [3] can best describe the recession in the non-oil sector of Azerbaijan, especially in agriculture and processing industry. Ribchinsky points out that a new sector caused by the “Dutch disease” absorbs the assets of industry into more profitable oil and non-trade sectors. The previous year’s statistics apparently prove Ribchinsky’s scientific postulate in Azerbaijan’s economy.

As per 2008 year final figures, 3 percent of all investments from all sources into Azerbaijan’s economy went to agriculture, which has a 38 percent share in the overall employment and 6 percent in GDP. The agriculture was recorded with 7 percent growth in that period [4]. Hence, the agriculture and processing industry, the traditional sources of employment in Azerbaijan, are deteriorating. Also, the recent year reduction of around 2500 specialists in the activity areas related with the “contract of century”, reinforce the tension among the qualified and experienced personnel, along with the tension among the unqualified and young workers in Azerbaijan.

Given the temporary and self-employment nature of most of the newly created jobs, hundreds of thousands of jobs seem to remain just on papers, serving the political interests and not able to withstand the substantial economic arguments.

Fifth myth: The goal in signing the contract of century was not limited to oil production, transportation and revenue making. Rather, it sought to convert all the oil revenues into political, economic and other gains for the nation and its wellbeing of Azerbaijan.

Reality: It is clear from the contract that both sides (Azerbaijan government and companies) seek to make profit from the contract implementation. The BTC pipeline construction was started only after long political discourses and when the world oil prices were set to increase. It denotes that the overriding interest of consortium participants is to make profits. It does not require extensive explanation from the corporate and economic perspectives.

When it comes to the issue of spending the revenues on people’s wellbeing, though views differ, one truth is clear to everybody: As a result of direct influence of revenues from the implementation of the contract of century, the social inequality has deepened because it was anticipated that the flowing investments to earn high revenues would intensify the polarization, confront poverty with wealth and aggravate the inter-polar conflicts.

Meanwhile, the transition from the “totalitarian” socialism economy into the “democratic” market economy brought about a new social base and ideological superstructure. The society was divided into poles differing from each other in their life styles, condition, social needs, behavior and even morality and culture. Criminal incomes under the name of capital accumulation and private properties and rights formed through unlawful privatization started to be protected not by the rule of law, but by the strengthened police regime. Such being the case, the investments into the authoritarian ruling rather than into the development of market institutions did not allow Azerbaijan to differ from other developing oil-rich countries in positive terms.

The empirical studies in oil-rich countries in the world show that countries without the management based on rule of law, transparency and accountability, the growth in oil production can lead to challenges such as uncontrollable national economies. Under such circumstances, “light oil money” earned from the oil sale in the country builds self-possession in officials, and turns the attention into the fight over faster distribution of the oil revenues rather than into the balanced and sustainable development and making it look like a competition [5].

Under such a competition, which brought about the tension within intra-government groups, it is impossible to achieve a better and sustainable welfare for the people over a long-term, which is verified by official statistics as well. An average monthly salary is the generalized indicator of the level of people’s welfare in every country. According to State Statistics Committee data for July 1, 2009, it was 298 AZN manat in Azerbaijan, whereas Russia had this level in 2006 and Kazakhstan in 2007. Currently, the average monthly salaries in those countries exceed US$ 600 and US$ 500 respectively. Having the same political history, showing no contrasting living differences in the starting period and being ready to purchase Azerbaijan’s oil-gas resources at world market prices, Central and Eastern European countries have much better social conditions. The average monthly salary in 2007 [6] was 759.4 Euro in Lithuania, 719.4 Euro in Latvia, 827.1 Euro in Estonia [7], 842.3 Euro in Slovakia, 983.2 Euro in Poland, 1104.3 Euro in Hungary, 1126.2 euro in the Czech republic and 1871.0 euro in Slovenia.

The corresponding figure in Azerbaijan is 250 Euro, while the statistics show that the growth rate in average salaries in the second quarter of 2009 was twice less than in the first quarter from the 26.5 percentage points into 19 percent. Another important point is that salaries were not raised in the private sector in this period, which implies that statements about the oil revenues serving future interests and welfare of Azerbaijani nation are more of political nature.

As regards the distribution of incomes by different means, Azerbaijan is not comparable even with Saudi Arabia, where newly born babies are given 10 thousand USD, people who want to build their own houses are given 80 thousand dollar, graduates from higher or secondary schools are given 13 thousand dollar to cover their expenses until they find employment, Kuwait, where newly born babies are given 3 thousand dollars from the oil fund, citizens building their own houses are given interest-free and long-term 220 thousand dollar, parents who have below the adult age annually receive 170 dollar, and housewives are given 300 dollar. In Turkmenistan household members are given water, salt, 50 sq. m gas and 100 kvt/hour, and automobile owners receive 120 liters of fuel for free.

Azerbaijani government is selling current goods and services to its citizens at regional market prices, which restricts chances of all citizens to get their shares from oil revenues. Only employees in oil sector and budget sphere get such chances via salaries. In such a case, it is useless to talk about the equal and fair distribution of oil revenues from the contract of century among Azerbaijani citizens and their worth for the future wellbeing of the people.

Sixth myth: The oil revenues coming from the implementation of the “contract of century” speed up citizens’ access to social and economic wellbeing. The increasing budget revenues are becoming a significant source of meeting social needs in Azerbaijan. The investments into education and health confirm the proper and efficient use of oil revenues.

Reality: Though the social and investment expenditures of the budget are growing year-by-year as a result of oil revenues, the analysis shows that Azerbaijani citizens’ still have limited access to the social and economic wellbeing. Under the circumstances of year-by-year expansion of budget revenues along with expenditures, indicators of people’s access and its quality to education and health care services are deteriorating.

The results of the entrance exams to universities and the high-school graduation exams for this year indicate the gradually deteriorating situation in education. 35.8 percent of the 1st group applicants to the university for the academic year of 2009-2010 (those taking the exams for specialties requiring special ability excluded), 24.4 percent of the 2nd group, 25.5 percent of the 3rd group, 49.2 percent of the 4th group scored less than 100 points, which is the lowest level in comparison with the previous years.

It seems we will not be able to compensate our loss from oil with the achievements in education in the near future. It is also a serious concern that 23 percent of high-school graduates were not able to obtain an appropriate certificate this year as it was expected since the 2008-2015 poverty reduction and sustainable economic development approved last year but not made public for a long time included information about the net secondary education participation index as being below 50 percent unlike 81 percent in Latvia, 89.7 percent in Lithuania, 86.8 percent in Estonia, 94.4 in Poland, 87.6 in Hungary, 94.5 in Czech republic, 81 percent in Bulgaria and 82 percent in Bulgaria [8] despite the fact that Azerbaijan does not differ from or lag behind these countries in terms of the size of investments into the education both from formal and informal sources. The government is spending billions both from the budget and other sources on increasing education budget and improving infrastructure in education premises. The investments into education excluded, the expenditures for running the education policy only were approved to be the second budget priority for 2009 and comprised one billion 353 million manats.

The same problems can be found in healthcare sphere. Lagging other spheres by the implementation pace of reforms and coverage, the health care expenditures 4 percent of all budget expenditures and one percent of GDP, whereas in Central and Eastern European countries in 2007, the health care expenditures were 3.1 percent in Latvia, 3.9 percent in Lithuania and Estonia, 6.5 percent in Czech republic, 6.4 percent in Hungary, 7.4 percent in Slovenia, 4.8 percent in Slovakia, 3.8 percent in Poland and Romania, 4.5 percent in Bulgaria. Apparently, inefficient use of increasing oil revenues by the government of Azerbaijan remains as one of the key barriers to people’s benefiting from the socio-economic achievements. The same thing can be found in the state-funded scientific studies. That is, funds from the 2009 year budget into science equaled to one percent, or 0.2 of GDP.

In conclusion, according BP information, one billion sixty million barrels out of 5.4 billion barrels [9] discovered in Azeri-Chirag-Guneshli deposit have already been extracted. Overall, 20 percent of the current reserves were exctracted and exported and the western industrial machines were set on moving and oil money of Azerbaijan is kept in Western European and American banks. In return, the majority of industrial enterprises in non-oil sectors of Azerbaijan stopped their production, and the banks suffering from the lack of funding turned to western banks and credit institutions to take credits and meet their obligations in the country.

The welfare of people also suffers in the light of the situation in which the oil shares of future generations has already been spent while part of the population is still suffering from poverty in Azerbaijan. The majority are looking forward to the contemporary consequences of the socio-economic progress in developing countries. Thus, the “democratic” dictatorship of the criminal capital on the background of increasing oil incomes is ruling in Azerbaijan, with flourishing corruption and human rights and freedoms limitations.

September 18, 2009

Dr. Gubad Ibadoglu is Chairman of the Board of the Economic Research Center In Azerbaijan.

Footnotes:

1. Steve Levin , The Oil and the Glory: The Pursuit of Empire and Fortune on the Caspian Sea, 2007.

2. The lowest index within 1 through 9 shows the one-sidedness of the economy.

3. Legal Education Society, www.monitoring.az/public/print.php?lngs=aze&ids=306

4. Azerbaijan in figures 2008, State Statistics Committee “Seda” printing house 2008

5. Current state of Azerbaijan’s economy: myths and realities, Germany Springer Wien New York, 49, Volume XV 2/2008, http://www.springerlink.com/content/v34k0nl2861m5700/

6. Source: Euro-stat

7. 2006 end-year figures

8. European Commission Education and Training GD: “Progress towards the Lisbon objectives 2010 on education and training.”

9. According to BP, if the government of Azerbaijan agrees to purchase BP technology, the production in Azeri-Chirag-Guneshli can be increased up to 6.5 billion barrels.