Azerbaijan Unravelled: Opportunities and Challenges for Businesses
Baku, capital of Azerbaijan.
Key Takeaways:
Continued short-to-medium term growth is predicted for Azerbaijan’s oil and gas sector given the increased European demand after decoupling from Russian supply.
Renewable energy generation is the biggest opportunity for foreign investment in Azerbaijan in the next 5-10 years. This will benefit businesses specialising in small hydropower plants, wind farms and solar plants.
The war in Ukraine continues to inhibit the export of both conventional energy products and future renewable energy exports. This highlights security in the Black Sea as a critical area of focus for Eurasian energy security.
Azerbaijan’s authoritarian leadership has entrenched an economy of corruption and concentration of power among elites. State-owned companies dominate the resource industries, making product sharing agreements and local partnerships a vital strategy for outsiders to gain market access.
Agriculture in Azerbaijan is in desperate need of modernisation. This creates an abundance of opportunity for agricultural consultants, land restoration experts, machinery suppliers and food processors.
Situated in the crossroads of Europe and Asia, Azerbaijan is a state endowed with abundant resources and geographical importance. Its fortuitous position on the Western Caspian is reflected by its rich reserves of conventional energy resources and opportunities for renewables. Above ground, Azerbaijan has a sizeable agriculture sector which employs approximately 37% of the population, exporting products such as tomatoes, wheat, cotton and livestock. Beyond its natural endowments, the country has been actively expanding its critical infrastructure, investing in railways, roads and ports to enable trade for Eurasian states and unlock potential for businesses. Whilst the government has made efforts to attract foreign trade, lingering concerns over proximity to Russia and effects of the war in Ukraine present pertinent considerations for foreign investors alongside the unresolved territorial dispute with neighbouring Armenia. This report aims to address these concerns to provide a comprehensive insight into the business environment in Azerbaijan. By shedding light on these complexities, we hope to guide potential investors to make informed decisions while navigating the unique geopolitical and regional challenges.
Conventional Energy Resources
Azerbaijan’s oil and gas industry has a long history, evident from the early oil fields, refineries, and transport infrastructure of the late 19th century. Soviet nationalisation acknowledged its value, and during WWII, Azerbaijan contributed around 80% of the USSR's oil supply. Geographically, Azerbaijan’s oil and gas is concentrated in its offshore fields in the Caspian Sea, such as the Shah-Deniz, as well as onshore in fields like the Mishovdagh and Kelameddin.
Azerbaijan's transition to independence in 1991 prompted a strategic shift in its investment and export approach. A pivotal move was the 'Contract of the Century,' where the President, representing state-owned oil company SOCAR, signed product sharing agreements (PSAs) in 1994. This foundational step in Azerbaijan's embrace of a free-market economy enabled established private oil companies like BP, Lukoil, and Equinor to contribute expertise and capital for joint resource development.
This surge in investment also necessitated upgraded pipeline networks to efficiently export crude oil and gas to global markets. The Baku-Supsa and Baku-Novorossiysk pipelines channel oil to Black Sea ports, while the Baku-Tbilisi-Ceyhan and South Caucasus pipelines transport oil and gas respectively through Turkey to reach markets via the Mediterranean and the TAP pipeline through Eastern Europe. This sector stands as the backbone of Azerbaijan's economy, accounting for approximately 80% of annual exports and 50% of GDP.
Although opportunities in the sector have largely been harnessed, potential collaborative projects under PSAs with the SOCAR/BP-led consortiums are likely to emerge given the government’s pledge to double gas exports to the EU by 2027. Challenges arise from Azerbaijan's intricate regulatory framework for oil and gas licences outside of major PSAs. Geopolitical dynamics also introduce challenges; tensions over the region of Nagorno-Karabakh pose potential threats to historically targeted pipelines, and war in Ukraine casts uncertainty over security, with exports via the Baku-Supsa pipeline currently halted due to the risk to tankers crossing the Black Sea. In navigating these, Azerbaijan's oil and gas industry continues to shape the nation's economic trajectory.
Renewable Energy
Given the dominance of its oil and gas industry, Azerbaijan has taken great steps in recent years to diversify and transition towards a greener economy. This presents an abundance of opportunity for businesses in the green energy sector. In 2022, approximately 90% of electricity was generated by thermal power stations fuelled by natural gas, prompting the government’s pledge to increase the share of renewables in domestic electricity generation to 30% by 2030. The establishment of the Azerbaijan Renewable Energy Agency in 2020 has provided the means for coordinating and regulating efforts in this rapidly growing sector. While the impetus for this transition is undoubtedly the desire to curtail domestic reliance on fossil fuels, another strategic objective involves capitalising on surplus gas reserves to meet the energy demand in European markets.
At present, Azerbaijan’s renewable energy production is dominated by hydropower. A combination of large and small hydropower plants in the north-west of the country have the potential to produce up to 30% of Azerbaijan’s electricity, with significant potential for smaller hydro projects further downstream on the Kura and Aras rivers. Solar and wind power, whilst currently dwarfed by hydro, are predicted to grow rapidly in the next 5-10 years. This provides opportunity for established businesses with expertise in wind and solar plants, as well as maintenance and manufacturing. Large-scale projects in wind and solar have been agreed since 2020 with ACWA Power of Saudi Arabia and Masdar of the UAE for Solar PV plants and wind projects, both on and offshore. The government have also begun to sign agreements with foreign companies for smaller renewable developments from bioenergy and green hydrogen, to offshore wind ventures, which the World Bank has described as having "immense" potential.
Despite big talk of Azerbaijan’s renewable potential, the government have been unclear how these projects will be funded, and whether they will require significant investment from the companies involved. The biggest challenge for investors is how renewable power will be exported if it is not sold on the domestic market. The EU and Azerbaijan have recently agreed to pursue the Caspian Sea-European Union Green Energy Corridor, a power cable route which crosses Georgia, the Black Sea, Romania and Hungary. However, this project is contingent on the laying of subsea cables in the Black Sea; a task too dangerous to undertake whilst Russia and Ukraine are still at war, given the associated concerns over sea mines and sabotage akin to the Nord Stream 2 pipeline.
Mining
Although modest in comparison to hydrocarbon resources, Azerbaijan has a notable mining sector, largely focused on Gold, Silver and Copper, concentrated in regions along the western border with Armenia. This industry, whilst potentially lucrative for larger companies with established PSAs, is fraught with challenges related to the wars and border disputes with Armenia over Nagorno-Karabakh. The Anglo Asian Mining Company, which is the most prominent in Azerbaijan, has had to relinquish a number of its mines due to disruption from the conflict in Nagorno-Karabakh, ecological damage, and border changes. One of these gold mines, located just outside of Sotk, now directly straddles the Azerbaijan-Armenian border, creating logistical and legal challenges. In addition to the ongoing politicised use of mining to blockade Nagorno-Karabakh and concerns about the transparency of tendering processes, southwest Azerbaijan’s susceptibility to conflict presents substantial risks for any enterprise seeking to expand mining ventures in the country.
Agriculture
The agricultural sector in Azerbaijan is not only critical for domestic food security and stimulating economic diversification, but also offering employment to nearly 40% of the population. For this reason, the government heavily subsidises agricultural endeavours and equipment. Despite its substantial labour force, this sector constitutes only around 7% of GDP. This can be attributed to the transition from historical Soviet collective farms to a model of smallholder farming, wherein families manage their own plots of land of two to five hectares. Whilst inputs are largely subsidised, smallholders are responsible for their land’s maintenance and output, limiting large-scale agricultural development and modernisation. Livestock commands a notable share of agricultural activity in these smaller farms, with families typically selling meat and dairy products alongside their chosen regional grain, fruit or vegetable.
The decentralised, small-scale nature of Azerbaijani agriculture has created high demand for automated food processing and packaging technology, as well as dealers specialising in the provision of used farming machinery and parts. There is also a shortage of agricultural experts to support development, diversification and distribution of agricultural activity, opening significant avenues for established consultative services in land surveying, management and agricultural economics.
However, the industry faces a sizeable challenge stemming from the degradation and salinisation of land, a consequence of outdated Soviet infrastructure and inadequate maintenance. A substantial portion of the country urgently requires enhanced irrigation networks and land rehabilitation. This scenario presents a unique prospect for specialists in this domain, particularly as the government begins to explore strategies for large-scale implementation of these necessary measures.
Logistical Infrastructure
Azerbaijan’s geography makes it a critical nexus in international trade. Located on the Absheron Peninsula, the Port of Baku operates as perhaps the most important point in Europe-Asia trade, processing the constant flow of goods and resources crossing the Caspian Sea. The main route, which departs from the Turkmenbashi Port in Turkmenistan, is faster than travelling on land through Russia or Iran, and far less likely to be impeded by sanctions and customs complications. Once through the port, Europe-bound trade can continue its journey following the ‘Middle Corridor’ either by road, into Georgia and onwards, or via the Baku-Tbilisi-Kars Railway, which follows a similar route. This route was developed in response to the more direct routes through Armenia being consistently disrupted by conflict and political tension. The Middle Corridor is a joint project between the EU and independent states of the former Soviet Union, designed to increase their market access and reduce their inherited dependence on Russia-centric transport networks. It plays a pivotal role in facilitating Europe-China trade, substantially reducing journey time compared to shipping, and circumventing Russian interference.
Despite participating in this project and experiencing periods of political hostility, Azerbaijan retains strong trade relationships with its neighbours Russia and Iran. It also facilitates trade between the two as part of the North-South Transport Corridor, a railway route that connects Russia, via Azerbaijan and Iran, to the Gulf of Oman and markets in India. Azerbaijan’s participation in this project has received widespread criticism from Western countries for helping Russia and Iran to escape US sanctions. These sanctions could present challenges for enterprises seeking to utilise the North-South Transport Corridor for expedited exports to India and Pakistan. Further strain on relations between Azerbaijan and Iran may also create barriers to trade along this route in the future.
Political and Business Environment
Azerbaijan's political environment is characterised by corruption and authoritarianism, with key industries and contracts under the influence of elites associated with the ruling Aliyev family. Ilham Aliyev, who has been the President of Azerbaijan since 2003, succeeded his father. He is surrounded by a cabal of oligarchs who have amassed wealth primarily through the consolidation of the country's natural resources. As is often the case in authoritarian regimes, there are constraints on free speech and press freedom. Nevertheless, foreign enterprises have been greeted with openness, particularly if they introduce technological innovation or foster avenues for domestic economic advancement. In these instances, the government typically makes exemptions for taxes and customs duties to create a favourable investment environment. However, given the predominant role of state-owned enterprises and product sharing agreements in major industries, foreign businesses that pose a challenge to the economic supremacy of Azerbaijan's holding companies will likely encounter revocation of contracts and business permits, often with ambiguous justifications. Similarly, judicial independence and transparency remains poor, and foreign companies may face challenges in business disputes with domestic companies.
The most effective strategy for market entry for both SMEs and multinationals is partnership with a local industry leader and the establishment of a country or regional office. Businesses operating remotely will suffer significantly from lack of oversight and will miss out on tenders due to limited physical presence in comparison to competitors. As with any foreign investment, comprehensive due diligence on potential partners is critical. It is worth noting that numerous companies in Azerbaijan might not adhere to the same ethical and business standards as companies in the West, thereby potentially exposing foreign enterprises to environmental, social, and governance (ESG) risks.
