Transparent Gas? Azerbaijan and the EITI

A2 examines the economic and political consequences of Azerbaijan’s decision to leave a global transparency initiative for the extractive industry.



INTRODUCTION
On 10 March, Azerbaijan announced it was leaving the Extractive Industries Transparency Initiative (EITI), effective immediately. The purpose of the EITI, an international grouping of organisations concerned with accountability in the extractive industry, is to improve governance along the entire supply chain, from transparent tendering processes to publicly available information about the end-use of extractive revenues. EITI members include major international financial institutions, such as the World Bank. Multiple major energy and extractive companies, including Anglo-Dutch multinational Royal Dutch Shell, are also participants in the EITI project. Furthermore, 50 countries have signed up to the EITI.

A day earlier the EITI had announced that Azerbaijan would be suspended from the initiative, citing the country’s lack of progress in relaxing its restrictive environment for civil society organisations. Although the government had taken some minor steps to comply with the EITI’s requests, for instance by loosening restrictions on NGOs in January 2017, the EITI board assessed that Azerbaijan had not taken any serious measures to reengage civil society.

The withdrawal marked the nadir of worsening relations between Baku and the EITI, which in October 2016 had threatened Azerbaijan with suspension over the same issues. The year before, in April 2015, the EITI had downgraded Azerbaijan’s status from ‘compliant’ to ‘candidate’, also for continued policies of repression against anti-government activism.

RISKS

Azerbaijan’s withdrawal from EITI poses several risks to companies in-country. From a business perspective, it potentially jeopardises foreign investment in a substantial planned gas infrastructure programme, as well as increasing the risk that investments in Azerbaijan will be corrupt or perceived to be corrupt, thereby attracting the close attention of prosecutors in the U.S. and Western Europe. Furthermore, from a political perspective, Azerbaijan’s withdrawal is representative of government authoritarianism and repression which poses immediate and credible risks to deployed personnel.

Azerbaijan’s economy is heavily dependent on the energy sector, and oil and gas make up over 90 per cent of its exports. These are overwhelmingly destined for European markets, primarily Italy. However, the fall in the global price of oil, as well as declining productivity from active well sites, has led the government to take steps to diversify its economy away from this reliance.

Azerbaijan’s economy is heavily dependent on the energy sector

Despite some success in the development of agribusinesses, and an increase in the percentage of the workforce employed in non-energy sectors – notably construction – energy continues to represent a plurality of Azerbaijan’s GDP. Any disruption to the energy sector, therefore, will have outsized economic consequences for the republic.

BUSINESS RISKS

The Southern Gas Corridor

Withdrawal from EITI could potentially jeopardise Azerbaijan’s participation in the Southern Gas Corridor (SGC), a planned series of infrastructure projects that will connect Azerbaijan’s Caspian Sea Shah Deniz 2 gas development via several pipelines to the Italian gas transmission network. The pipelines are divided into three distinct projects: The South Caucasus Pipeline (SCP) between Baku and Georgia, the Trans Anatolian Pipeline (TANAP) through Turkey, and the Trans Adriatic Pipeline (TAP), through Greece, Albania and Italy.

The proposed developments will cost a combined total of around USD45 billion, and are being funded by a variety of international financial institutions, such as the World Bank. Successful completion of the project will result in around 6 billion m3 per annum of gas being exported by Azerbaijan by 2020, a figure which could eventually double as the SGC matures. There are multiple stakeholders in the project, from the World Bank to multinational U.K.-based energy company BP.

EITI is not directly involved in the corridor, and it lacks the ability to sanction entities for breaching or leaving the organisation. However, Azerbaijan’s withdrawal poses a dilemma for investors: whether the commercial benefit of the project is sufficient to continue investment, despite Baku’s rejection of the principles of transparency embodied by the EITI. A number of investors, such as the European Bank for Reconstruction and Development and the World Bank, have linked funding to membership of the EITI. Although not a legal requirement, membership of EITI does play a role in stakeholder decisions on whether to invest in projects.

Any shortfalls in funding would deprive Azerbaijan of a much-needed revenue stream, which will have to be found elsewhere. Even if international investors temporarily postpone or reduce funding, rather than outright elimination, this would still cause substantial uncertainty over the viability of the project.

Furthermore, the European Court of Auditors, an E.U. institution, pointed out in a 2015 report that the SGC was one of 27 gas projects being developed in Europe, and that there had been no assessment by E.U. investment authorities over how to prioritise each project’s worth.

Any shortfalls in funding would deprive Azerbaijan of a much-needed revenue stream

In conjunction, the report argued that there was ‘uncertain demand’ for gas over the long term, given shifting consumption patterns within the European Union. The lack of clarity about the overall value of the project, therefore, reduces the incentives for investors to risk funding the SGC even without Azerbaijan’s EITI membership.

This would be to the detriment of the numerous support companies who are involved with the SGC in some capacity. Even if such businesses calculate that EITI withdrawal is insufficient grounds to remove themselves from the SGC, construction and development could be hampered by reduced funds from major donors. A2 advises businesses considering contracts related to the SGC institute contingency plans, to be enacted in the event that funding is rapidly removed.

Corruption

The withdrawal from EITI eliminates one key mechanism for identifying corruption at both the state and corporate levels. Although membership of EITI is not in itself proof of this – EITI benchmarks for compliance are not rigorous – it does obligate governments to provide a level of transparency to the industry. Given that Azerbaijan suffers from what the U.S. Department of State termed ‘pervasive corruption’ in a 2016 report, EITI withdrawal increases the risk that officials, agents and some businesses will feel confident to continue with corrupt practices.

This goes beyond the extractive sector itself. By leaving the EITI, Azerbaijan is sending a strong indicator that it is not committed to enforcing its own domestic anti-corruption legislation, and this could lead to an increased sense of impunity throughout the Azerbaijani economy to use bribery and other corrupt practices as tools for developing business relations.

Furthermore, the withdrawal from EITI will act as a ‘red flag’ to extra-territorial anti-corruption bodies, such as the U.S. Office of Foreign Assets Control. It is likely that such organisations will pay increased attention to potential violations of international and relevant national law by businesses operating within Azerbaijan throughout 2017.

This combination of factors means that A2 advises companies with interests in Azerbaijan, particularly those tendering for government contracts, must immediately review the effectiveness of their own due diligence processes. They should assume that prosecutors in third countries will scrutinise their behaviour in the country in minute detail, and should ensure that their relationships with Azerbaijani consultants and agents are de-risked against U.S. regulatory criteria, with due diligence conducted to ensure local intermediaries are not connected to politically exposed persons.

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