AZERBAIJAN - Energy Base.

The energy base of Azerbaijan has been shrinking since 1990. In each of 1989 and 1990, Azerbaijan's energy consumption used to average 22.9m tons/year of oil equivalent. This has dropped to 15.9m t/yoe in 1995 and to 12.1m t/yoe in 2003. In 2005 energy consumption rose to 13.3m t/yoe and in 2006 this is expected to be higher but still way below the 1995 figure.

Azerbaijan is positioning itself to become a major player in the energy world this century. In the early 1990s the country emerged from the Soviet era with a teetering economy, environmental degradation and a conflict with neighbouring Armenia. The recession ended in late 1995, but it was only in 1999 that economic recovery began to accelerate.

Azerbaijan is rich in natural resources. It has a wide range of minerals, including iron, aluminium, zinc, copper, arsenic, molybdenum, marble and fire clay. Scanty reserves of gold in the Armenian-occupied Kelbajar region has been extracted by Armenians. Azeri reserves of oil and gas are more than enough to meet domestic demand in the long-term (see OMT & Gas Market Trends).

Azeri scientists consider the Abseron Yasaqligi (Absheron Peninsula), including Baku and Sumqayit and the Caspian Sea, to be the most ecologically devastated area in the world because of severe air, water, and soil pollution. Soil pollution results from the use of DDT as a pesticide and from toxic defoliants used in the production of cotton.

The economy faced a negative fallout resulting from the collapse of the Soviet Union in 1991, when Azerbaijan proclaimed independence. In the subsequent years there was severe internal turmoil as pro- and anti-Moscow groups fought for power in the country, while a war was going on for control of the predominantly Armenian enclave of Nagorno-Karabakh. The situation began to stabilise after President Gaidar Aliyev assumed power in June 1993. Hyper-inflation has since been brought under control. The Azeri currency, called manat, is relatively less unstable and the country's GDP has been rising since 1996 after falling by two-thirds since 1989.

Azerbaijan could make $3 bn in oil revenues in 2006 and may see the figure double in 2007. David Woodward, President of BP-Azerbaijan, recently said part of the money would be brought in by exports of crude oil from the Azeri-Chirag-Gunashli (ACG) complex of oilfields. BP-Azerbaijan is the developer and operator of the ACG offshore deposit, which holds an estimated 5.4 billion barrels in oil reserves. Woodward said the project would receive some $20 bn in capital investment at the development stage. The BP official, attending an international Caspian Oil and Gas conference in the Azeri capital, Baku, said that if world crude oil prices remained above $60/b in the coming years, the country would see its oil earnings double every year, outstripping GDP by a factor of three by 2009. According to Rovnag Abdullayev, CEO of the state-owned NOC Socar, Azerbaijan will produce more than 476 million barrels of crude oil a year - i.e., over 1.3m b/d - by the end of the decade.

The Local Market: Azerbaijan's energy consumption mix comprises oil, natural gas and hydro-power. Theoretically, it is one of the most gasified countries in the FSU, as a result of heavy investment during the Soviet era. Its gas transmission and distribution network has the capacity to cover 70% of the population of almost 8.5m, of which more than 2.5m are in the capital Baku.

However, Azerbaijan has suffered from gas shortages after the collapse of the Soviet Union. This year, as in 2005, it is importing 4 BCM of gas from Russia. With Azerbaijan producing 4.5 BCM/year, its gas consumption in 2006 will amount to 8.5 BCM as in 2005, compared with 7.8 BCM in 2001, 5.4 BCM in 2000, 15.1 BCM in 1991 and 15.8 BCM in 1990. But it will rise as the Shah Deniz gas field will be supplying the local market as well as export a major volume of natural gas.

Azerbaijan has proven gas reserves of about 30 TCF, and the potential for a 100-200 TCF range. Because there is insufficient infrastructure to deliver the country's natural gas from offshore fields (the source of most of the country's production), natural gas has been flared off instead of being piped to markets. Shah Deniz will change the situation (see gmt2AzerProd-Jul10-06).

Virtually all of Azerbaijan's natural gas is produced from offshore fields. Output from Gunashli's shallow-water field accounts for about 50% of the gas produced in the country. Socar's plan since 2004 has been to invest $224m to expand gas production by drilling 23 gas wells in Gunashli, by expanding existing platforms, and by building underwater gas pipelines. The company hopes this will help increase production to around 9.3 BCM/year in 2010.

Statoil of Norway, a partner in major E&P ventures in Azerbaijan, is assisting Baku in the development of the country's gas industry and infrastructure. The company has stakes in AIOC, the gas-rich Shah Deniz project and the Alov venture (see Gas Market Trends).

Oil consumption in Azerbaijan reached a low point of 73,000 b/d in 2002, compared to a peak of 171,000 b/d in 1995. It averaged 170,000 b/d in 1990 and fell to 165,000 b/d in 1991-93. Now crude oil being refined for domestic consumption amounts to 95,000 b/d. The country has two oil refineries in Baku with a combined capacity of 398,978 b/d. Until a few years ago, Azerbaijan used to be the only net exporter of refined products in Central Asia.

The oil retail business is controlled by Azpetrol, which was established in 1997. Its network of filling stations, built in 1997-99, cover the whole country and are located 50 km away from one another. Each filling station offers fast food and beverages, spare parts and auto-care products as well as auto-repair services.

Azpetrol's auto-service stations, which are fairly well equipped, are open 24 hours a day. Apart from mogas produced by the local refineries, Azpetrol is the distributor of Shell's oil products, Goodyear tires and Champion auto-parts and accessories. It has a fleet of delivery vehicles. The company is also involved in exporting oil products. It has built a terminal for reloading of raw oil from sea tankers to railroad containers.

The Oil Refining Sector: An old refining sector, this consists of two plants: the Azerineftyag (Baku) refinery, with a capacity of 238,978 b/d; and the Haydar Aliev (formerly called Azerneftyanajag) refinery, which has a capacity of 160,000 b/d.

Both refineries have been running well below capacity. Overall refinery utilisation rates are as low as 40%. Middle distillates (e.g. diesel fuel, gasoil and kerosine) comprise the majority of Azeri refinery output. Both of the country's refineries are in need of modernisation and pollution control equipment. Under a $500 million modernisation project approved in 2004, new equipment is being installed at both refineries and at the specialised port of Dubendi to increase throughput to 260,000 b/d by 2010, compared to 159,500 b/d at present.

The refining sector is exporting about 60,000-62,000 b/d of petroleum products to markets outside Azerbaijan. By 2010, with the local market to increase its consumption of natural gas, the refining sector's exports will be much higher.

The Power Sector: Azerbaijan's electric power sector has an installed generating capacity of about 5.2 gigawatts (GW). Eight state-owned thermal plants account for about 80% of generating capacity. The country has six hydro-power plants, all of which are owned by the state.

Now that the BTC crude oil pipeline has been on stream, oil export revenues will drive economic growth and local electricity demand. But, because of the country's inefficient distribution network, Azerbaijan must import some of its power to make up for transmission losses (about 10% of total generation).

In order to supply electricity to all parts of the country (including the Nakhichevan exclave), Azerbaijan imports power from Russia, Turkey, Iran, and Georgia.

Although the state's electric company AzerEnergy has a monopoly on power generation, the country's national power network is divided into five regional grids: Baku; Nakhichevan; the North (Sumqayit); the South (Ali Bayramli); and the West (Ganja). Each of these units has been opened to foreign investors via joint stock companies. But foreign interest has been lacking.

Currently, below-cost tariff levels, low payment collections, and inadequate private sector funding have made rehabilitating the power sector very difficult. Recent reform plans have been announced to help improve the situation. In May 2004 Russia's dominant electricity group, UES, signed an agreement with AzerEnergy to construct new networking infrastructure to help bolster Russia's electricity exports to Azerbaijan and to neighbouring Iran. In May 2005 the World Bank announced a $48m programme to improve the Azeri transmission performance.

Plans entail upgrading the power transmission system which would facilitate financial settlements in a future wholesale electricity market, investing in new high-voltage transmission lines and substations, and improving AzerEnerjy's management system for future restructuring.

Built in the Soviet era, the power infrastructure is in poor condition, with minimal investment and maintenance since independence. The country's economic contraction during the first half of the 1990s, along with systemic problems - such as prices capped below market rates and frequent non-payment by customers - have left the power sector without sufficient capital to upgrade ageing facilities.

The international donor community has undertaken several projects to restore and add new capacity to Azerbaijan's power sector. These include a $53 million loan by the World Bank to build the 4,000 MW Yenikand hydro-power plant (completed in May 2000), and the European Bank for Reconstruction and Development's roughly $21m loan in conjunction with the Islamic Development Bank and the European Union for reconstruction of the 360-MW Mingechaur hydro-power station on the Kura River completed in 2001. In early 2003, Azerbaijan's newly completed Severnaya power plant began operation with the help of Japanese companies Mitsui and Mitsubishi. The 400-MW, gas-fired unit provides power mainly to the Absheron Peninsula, and raised 2003 electricity capacity by 6% over 2002 levels.

During a meeting on energy problems Azeri President Ilham Aliyev in late June 2006 instructed the presidents of Azerigas and AzerEnergy to take measures to raise the rate of natural gas and electricity bill collection. Azeri Economic Development Minister Heydar Babayev told journalists that the untimely payment of gas and electricity bills resulted in additional subsidies and growing inflation.

In 2005, President Aliyev allowed the poor not to pay for gas and electricity. After the broadcasting of that meeting on TV, the collection rate sharply decreased. In 2005 the rate of collection of gas bills was only 20%, of electricity bills in the regions - 30%. For the moment, the rate of collection of gas and electricity bills makes up only 40% of their cost.