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Ten Questions About Extension of Massive Azerbaijan Oil Deal

Note: This item was translated into Azaerbaijani and re-posted by Makroblog.

On September 14, Azerbaijan’s government, BP and other partner companies agreed to amend the contract for the Azeri-Chirag-Guneshli (ACG) oil field in the Azerbaijani section of the Caspian Sea. The so-called “contract of the century” was originally signed in 1994 and was set to expire in 2024. The new contract is valid through 2049.

Based on the new agreement, the exact terms of which neither party has disclosed to the public, the Azerbaijan state oil company, SOCAR, increases its share in ACG to 25 percent from 11.65 percent. BP’s stake drops to 30.37 percent from 35.8 percent. (BP will remain the operator.) As much as USD 40 billion is expected to be invested in project development in the next decades. The new contract has been hailed as “even more profitable for Azerbaijan” than the previous one.

The new contract also seems unique and to a certain extent unprecedented in the history of production-sharing agreements, known as PSAs, in Azerbaijan and perhaps the region.

First, at 32 years, the duration of the new contract is unusually long. PSAs in Azerbaijan and the region are typically valid for 25 years. (There are exceptions, such as Kazakhstan’s Kashagan deal, which lasts 40 years.)

Second, the contract stipulates a one-off bonus of USD 3.6 billion to be paid to the State Oil Fund of Azerbaijan in eight tranches over eight years. To contrast, the government received a USD 300 million bonus in the previous ACG agreement, thought to be the largest ever at the time. Big bonuses are usually made at the earlier stages of resource extraction when the host government needs foreign capital to stabilize the macroeconomic situation.

All this begs the question: Why did the consortium agree to pay a giant bonus after 23 years of Azerbaijan operations? It seems plausible to assume that the larger the bonus paid upfront, the higher the likelihood that that the host government will be offered a smaller amount of future oil production and profits.

Third, the contract comes as a continuation of the previous one. This is another unique example in the history of PSAs in Azerbaijan. On one hand, this contract can be considered new. On the other, it covers the same oil field, implying that it uses dividends from the previous contract. It’s difficult to clearly delineate where the old contract ends and a new one begins. Accordingly, it is difficult to assess the particular benefits of this new contract for Azerbaijan.

Given these issues and the fact that the contract has not been published yet, answers to 10 questions would clarify its benefits for Azerbaijan.

  1. Under the terms of the previous ACG contract, Azerbaijan was still in a beneficial position for another seven years before the end of its term. According to the profit sharing formula, the country would continue to receive 75-80 percent of production (minus operational and minimum capital expenses) without any additional costs. Why curtail such a profitable operating scheme?
  2. Normally a PSA contract (and any other type of contract) assumes that vast amount of expenditure incurred by corporate partners in the initial phase would be compensated by a higher stake in the first phase of profit sharing. If the contract is built upon this generally accepted principle, does this mean that Azerbaijan will start to receive only 25 percent of profits until the new project reaches a certain level of profitability?
  3. The ACG field has already been largely developed. If the new contract is signed only due to new technologies available for maximizing extraction, does this mean that there will be no need for large investments? By extension, would this mean that foreign companies will not get the generally accepted high percentages of profits oil in the initial phase of development?
  4. According to expert analysis of the original contract, assuming high commodity prices, Azerbaijan should have received USD 200 billion in income, while all international companies could roughly expect about USD 40 billion in net income. Foreign companies received their income almost in full. However, due to the suspension of the contract ahead of schedule, Azerbaijan only received USD 120 billion to USD 130 billion. Does this mean that robust knowledge of PSA contracts and its nuances by international companies helped them get the better of the government?
  5. The previous contract, with a total investment of about USD 30 billion, brought USD 125 billion of revenue to the country, while all the necessary infrastructure for oil production and pumping, including the construction of the BTC pipeline, was built from scratch. How much investment will Azerbaijan have to provide for the current contract, with its announced USD 40 billion investment?
  6. Does the increase in SOCAR’s stake in ACG imply an increase in the commitment of new investments by a national company? If so, how does the company intend to secure funds in the current lower oil price context?
  7. What is the rationale behind the USD 3.6 billion bonus? Is this a partial compensation to Azerbaijan in the transition from the old contract to new, less favorable conditions?
  8. Are foreign companies compensated somehow under the contract for the bonuses to be paid, for example through reimbursement of costs? Or is the bonus a premium to the country from net profit?
  9. In terms of contract transparency, Azerbaijan was for years seen as a regional and global best practice leader. Contracts, including ACG, Shahdeniz and others could be easily found in open access. Publishing the text of the text of the amendment would follow the good practice established with all other PSAs in Azerbaijan and would be important given the magnitude of the contract and its impact on the country. So, what is the rationale behind the strict confidentiality so far with the new ACG contract?
  10. Transparency of contracts is encouraged by EITI. With Azerbaijan’s withdrawal from the EITI this is no longer directly relevant, but it raises the question: What is the state commission on transparency in the extractive industries’ reaction to the non-disclosure so far of the contract?

Given the impact and importance of the contract for Azerbaijan, a roundtable organized by key actors such as SOCAR and BP, where different stakeholders, including independent experts and civil society, could probe these issues would be highly useful. Monitoring and evaluation of the contract would top the agenda. It would also be an opportunity to examine the obligations of companies, including regarding procurement, labor and environmental protection.

Ingilab Ahmadov is the director of the Eurasia Extractive Industries Knowledge Hub at Khazar University.