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Alda Kokallaj PhD Candidate Political Science Carleton University (Note: Please do not cite without author’s permission) Title: Corruption and rent-seeking in Extractive Industries in Post-communist settings: The case of Azerbaijan Introduction Governments typically depend on taxes for their policies, which they have to justify to their citizens/taxpayers. In the case of resource rich countries this expectation is broken, as the state is transformed from a ‘rational manager’ of resources to the ‘controller’ of resources that are in turn used on the basis of patron-client relationships in order to perpetually maintain the control over resources. Azerbaijan is a resource rich country especially in oil and gas. Its GDP has grown strongly in the recent years fuelled by oil and gas exports that constitute approximately fifty percent of government’s revenue. In mid-1990s Azerbaijan was estimated to have the largest shadow economy of the Commonwealth of Independent States and corruption was a crippling problem for Azerbaijan. On the other hand Azerbaijan was one of the first countries to implement the Extractive Industries Transparency Initiative, a promising initiative that makes public the revenue that governments receive from oil and extractive industries. By drawing on my research about the Baku-Tbilisi-Ceyhan pipeline I will address the question: How have practices of corruption evolved in Azerbaijan? I will inquire the role of EITI as a necessary but perhaps insufficient institution and actor in shaping and/or transforming corruption practices in this post-communist country. The key argument of this paper is there are two factors enabling corruption in Azerbaijan. On the one hand Azerbaijan was faced with the transition from a Soviet republic to a post-Soviet state with a consolidated market democracy. On the other hand, the ready available hydrocarbon resources create opportunities for the ruling elite to stay in power without having to accommodate the requirements of the majority of the citizens and without the diversification of the economy away from oil and natural gas dependence. The paper is divided in three parts. The first part looks into the relation between extractive industries and corruption, from a theoretical perspective. More specifically it looks at different manifestations of corruption and its implications for the consolidation of strong and democratic states. These issues are seen with a specific consideration of post-communist transition economies. The second part of the paper delves into the case of Azerbaijan, by discussing how this post-Soviet state successfully managed to achieve economic growth by establishing itself as an important energy supplier to the European markets. This part also highlights that Azerbaijan’s

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energy exports are positive to the extent that the EU pushes for transparency and good-governance in order to ensure stability of its energy imports, but dependence on oil exports pushes Azerbaijan further towards the resource curse. The third part looks at how corruption has been tackled in Azerbaijan. More specifically it looks at Extractive Industries Transparency Initiative (EITI) as a significant step towards increasing transparency in the oil and natural gas revenue. It concludes that, although, EITI is a significant development, it still remains insufficient in capturing and addressing various manifestations of corruption in the oil sector in Azerbaijan. Part I

The relation between extractive industries and corruption

Corruption is a basic concern for many countries around the world. Regardless of its manifestations corruption is considered to hinder the construction of the legal state as well as for larger socio-economic developments of a country. The definition of corruption that is followed here is that of Transparency International (TI) that is “the abuse of entrusted power for private gain”. The concept of transparency is also important to be clearly stated as transparency is at the core of Extractive Industries Transparency Initiative (EITI) that is at the center of this paper. According to Transparency International, “transparency” can be defined as a “principle that allows those affected by administrative decisions, business transactions or charitable work to know not only the basic facts and figures but also the mechanisms and processes”.1 Similar perspective on corruption is shared by the European Union and the United Nations' Global Programme against Corruption. The European Union anti-corruption policy strives to target corruption within its member states but also to make the fight against corruption an integral part of its external and trade police.2 The perspective of the European Union on corruption is important to consider in relation to Azerbaijan and the EU is a significant trading partner for Azerbaijan and particularly of its hydrocarbon resources as it will be shown in more detail below.

Resource abundance is considered to be an asset for countries that have them as the use of such resources can contribute in the development of the economy, the improvement of the standard of living within a country as well as increase the influence of a country in the international stage. For instance, in the face of increased demand for energy by the industrialised countries and the emerging economies such as China, India and Brazil, petroleum resources have emerged as an important asset for countries that have them. It is precisely petroleum resources as a portion of extractive industries that are the focus of this paper. While the benefits of petroleum resources in                                                                                                                          1 Transparency International http://www.transparency.org/news_room/faq/corruption_faq 2 A comprehensive EU anti-corruption policy. (2007, July 12). Retrieved January 2012, from:http://europa.eu/legislation_summaries/fight_against_fraud/fight_against_corruption/l33301_en.htm  

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possession of a country are numerous and well-known, I will focus on the challenges that are associated with petroleum wealth. States with petroleum resources available to them are faced with a balancing act regarding the use of the hydrocarbon resources. On the one hand governments can benefit from increasing their sovereignty and control over these resources, while on the other hand they must balance the incentive for greater revenue against the negative repercussions in the economic sphere. Greater sovereignty over natural resources would give the government control over policies for economic and social development such as investment in providing for public goods. But more government control could also mean more possibility for corruption and rent-seeking by government officials. Corruption can also take many forms. One aspect is the cost efficiency that makes sense for international oil and mining companies. As they seek to keep their costs low they would prefer to obtain resources at a cost that is below the market value. In order to achieve this, government officials are bribed instead of figuring out other more efficient ways. This could be extended further in areas of social responsibility or environmental impact assessment. As the fulfillment of such responsibilities is considered costly by the companies they are bypassed through bribing of officials involved in the process. Another form of corruption is when natural resources are sold to domestic firms at below the value price and government officials either get an ownership share or some of the revenue from the sale. 3

Challenges of petroleum wealth can be manifested in economic, political and social aspects in a state. Economically governments that rely on petroleum wealth can face challenges that other governments can ignore. The production and sale of hydrocarbon resources requires economic policies that address the challenges associated with the volatility of international petroleum prices, the eventual depletion of their hydrocarbon reserves, and avoiding the ‘Dutch Disease’ phenomenon. Income from hydrocarbon exports often results in harmful effects on especially two important economic sectors: that of agriculture and manufacturing. These two sectors are important for employment but also provide more sustainable income in long term. As a result the shrinking of these two sectors would have economic and social implications. Revenues that governments draw from hydrocarbon exports have political and social implications. Governments that depend on revenues from oil and gas resources do not need to rely on taxation from citizens, thus they have less incentives to become accountable to them. Citizens, who are not taxed, in turn tend to be less demanding of the government about the income generated from petroleum exports. Even if the citizens disagree with government policies they do not possess the financial means to withdraw their support for the government. The withdrawal of citizens from the political life and reliance of the government on natural resources reduces the likelihood of the establishment of a democratic political system. States that are nondemocratic and that rely on oil and natural gas resources face a bigger challenge in developing a democratic political system than undemocratic states that do not possess significant amounts of natural resources. Thomas                                                                                                                          3 Indra Overland, Heidi Kjaernet, Andrea Kendall-Taylor. (Eds) (2010). Caspian Energy Politics Azerbaijan, Kazakhstan and Turkmenistan, Abingdon Oxon: Routledge, pp.15-16; Macartan Humphreys, Jeffrey D Sachs, Joseph Stiglitz. (Eds). (2007). Introduction: What is the problem with natural resource wealth? In Humphreys, M., Sachs, J. D., Stiglitz, J. (Eds). Escaping the resource curse, New York: Columbia University Press, pp.10-11.

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Friedman summarized this phenomenon in what he called the First Law of Petropolitics. According to Friedman the First Law of Petropolitics posits “the higher the average global crude oil price rises, the more free speech, free press, free and fair elections, an independent judiciary, the rule of law, and independent political parties are eroded”.4 Friedman defines petrostates as states that are oil dependent and that have weak state institutions. In this group he includes Azerbaijan, Angola, Chad, Egypt, Equatorial Guinea, Iran, Kazakhstan, Nigeria, Russia, Saudi Arabia, Sudan, Uzbekistan, and Venezuela. He excludes from this classification countries such as Norway, Britain and the United States that have solid state institutions and have managed a diversification of the economy before the discovery of oil. Contrary to the countries in the former group, those in latter used the oil to fuel the rest of the sectors that contributed in the high economic growth experienced by these countries. In countries of the first group, unaccountable government coupled with passive citizenry results in the former having fewer incentives to invest in health provision and better education.

Replacement of taxation with bribing and other ‘rent seeking’ practices hinders the building of a strong state that directs the development of the country. In this way a vicious circle is perpetuated in which the gap between the government and citizens is widened and reliance on petroleum as source of revenue is strengthened further. Through the use of revenue from oil and gas a leader could be more interested in buying off opposition rather and seeking popular support through legislative means. Moreover, large profits resulting from hydrocarbon exports, coupled with government accountability, can encourage corruption and ‘rent-seeking’ by government officials and other outside groups that are keen to share in the wealth. In some cases the presence of oil and gas is itself a recipe for generation of corruption, but their presence can also be indirectly linked to corruption. The most obvious manifestations of this are weak state structures coupled with large bureaucracy that make corrupt practices easy for officials. The demonstration of this was most obvious in post-communist transition countries. Because these countries were/are facing the challenge of state building as part of the transition period, the lack of consolidated institutions created the opportunity for corruption to flourish, especially in the resources sector. Additionally, in their early post-communist years these countries were characterised by large bureaucracies, which have made the enhancement of transparency difficult. 5 These challenges can be more salient when countries are in transition from one system to the next. In the case of post-communist countries the transition from communist rule to market democracy has been marked by high levels of corruption. This could be attributed to the

                                                                                                                         4 Thomas Friedman. (2006, April 25). The first law of petropolitics. Foreign Affairs. Retrieved January 2012, from http://www.foreignpolicy.com/articles/2006/04/25/the_first_law_of_petropolitics 5 Indra Overland, Andrea Kendall-Taylor and Heidi Kjaernet. (Eds) (2010). Caspian Energy Politics Azerbaijan, Kazakhstan and Turkmenistan, Abingdon Oxon: Routledge, pp.1-2; Michael.L. Ross. (2001). Does oil hinder democracy? World Politics, 53 (3), pp. 330; Macartan Humphreys, Jeffrey D Sachs, Joseph Stiglitz. (Eds). (2007). Introduction: What is the problem with natural resource wealth? In Humphreys, M., Sachs, J. D., Stiglitz, J. (Eds). Escaping the resource curse, New York: Columbia University Press, p.1.

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underdeveloped institutions and it is not specific to post-communist transition, but also to transitions from autocratic rule more broadly. 6

Because corruption is illegal it is often difficult to detect since it must be kept secret. Some manifestations of corruption can be collection of bribes by government officials for provision of permits and licencing, for giving passage through customs, or for prohibiting the entry of competitors. Corruption then determines the goods that are imported in the country and the kind of projects that are undertaken. The opportunity to maximise personal revenues by governmental officials determines the development model that is followed. This could explain why many poor countries and new-states spend their resources on infrastructure projects and defense where opportunities for corruption are higher and not on education and health. This in turn translates in costs that the society has to endure due to the secrecy of corruption. Another facet of corruption and the secrecy of it is hindrance of innovation. Keeping corruption secret also means that the number of people involved in it will be kept as small. This not only helps to keep it secret but also to maximize the revenues from corruption. The lack of transparency feeds into the lack of innovation and ultimately economic growth suffering. 7 In the sections that follow I will focus on the case of Azerbaijan and how these facets of corruption have manifested themselves in this oil-rich country.

Part II

Azerbaijan Background: Post-soviet Development

From the dissolution of the Soviet Union in 1991, there emerged fifteen independent states. Four of these states bordered the Caspian Sea, namely the Russian Federation, Kazakhstan, Turkmenistan and Azerbaijan. Previously, the Caspian Sea had been split between the Soviet Union and Iran, but the end of the twentieth century witnessed an increased number of state players. In addition to the newly independent post-Soviet states, the United States of America (USA) and the European Union (EU) entered the scene. In the framework of the Cold War, the USA had looked to balance the expansion of the Soviet Union. In the post-Cold War period the USA had three interests in the Caspian region: a geostrategic interest, an economic interest, and a sociopolitical one. The EU’s interests in the Caspian region were economic and sociopolitical.8

The shared interest in energy security between the West and Azerbaijan has resulted in a virtuous circle. In this virtuous circle, Azerbaijan has been able to achieve its post-Cold War era objective of consolidating its political independence and economic development by forging ties with the US and EU, and in so doing finding a steady market for its abundant natural resources: oil and

                                                                                                                         6 Samuel. P. Huntington. (1968). Political order in changing societies. New Haven, CT: Yale University Press. 7 Andrei Shleifer and Robert Vishny (1993). Corruption. Working Paper No. 4372, Cambridge, MA: National Bureau of Economic Research, pp. 599-615. 8 Robert Ebel and Rajan Menon (Eds.) (2000) Energy and Conflict in Central Asia and the Caucasus. USA: Roman and Littlefield Publishers,Inc.

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natural gas. In turn, the West has found in Azerbaijan a reliable supplier of energy, while also having a positive working relationship and impact on the social stability and prosperity of this country. Before delving into the role that energy exports have played in Azerbaijan, the concept of energy security calls for definition. The International Energy Agency (IEA) describes energy security as “the uninterrupted physical availability at a price which is affordable, while respecting environment concerns”9. At the state level there are different concepts of energy security depending on the state and its needs for energy. Very few states are energy sufficient let alone independent. For energy exporting states energy security means continued demand for their exports, i.e. “security for demand”. For states that depend on importing oil, gas and other sources of energy, energy security means the abundant and uninterrupted supply of oil and gas that is not prone to manipulation, i.e. “security for supply”. Certainly states that are involved in the transit of energy depend on this demand and supply of energy to generate income for their own economies. Thus energy security has many facets when considered from the perspective of states.10 Just as there in no unified definition of energy security, there is no global regulation of energy either. Energy is a sector that is not regulated globally, as it remains a realm of national governments and multilateral arrangements.

These different facets of energy security apply to Azerbaijan’s relationship with the West, as the latter is interested in energy supply and the former is a country abundant in oil and gas. Post-independence Azerbaijan has pursued: political independence, economic development, and social stability and prosperity. The issue of sovereignty and political independence is closely connected to the Nagorno-Karabakh conflict, which constitutes one of the most salient political issues for Azerbaijan. This will be explained in detail below. The first years of independence proved difficult for Azerbaijan. The country entered the post-Soviet transition period and was also immersed in a war. The initial phase of transition from 1991 until 1995 was associated with a decline in real wages, decrease in government funding, high unemployment and depletion of foreign exchange reserves. The severity of the economic decline can be seen in the precipitous fall in GDP. Azerbaijan’s GDP fell significantly between 1991 and 1994. In 1994, it was only 44 percent of its 1990 level. There was a decline in aggregate demand, foreign direct investment and public sector investment.11 The reasons why Azerbaijan’s economy suffered in the early transition years had to do with the legacy of the Soviet Union. In the final years of the Soviet Union, Azerbaijan had fared poorly and was ranked 10th in comparison to the other 15 Soviet Republics. The second factor was related to the war with Armenia. This conflict started between Azerbaijan and Armenia in 1988 and culminated in a war between the two countries until a ceasefire was reached in 1994. At the moment of the cease-fire, ethnic Armenian forces held

                                                                                                                         9 Energy Security, International Energy Agency. Available at: http://www.iea.org/subjectqueries/keyresult.asp?KEYWORD_ID=4103 10 Daniel Yergin.(2006). Ensuring energy security. Foreign Affairs. 85(2). 11 Ramil Muharremov .(2010). Petroleum-fuelled public investment in Azerbaijan: Implications for competitiveness and employment. In Indra Overland, Heidi Kjaernet and Andrea Kendall-Taylor (Eds.) Caspian Energy Politics Azerbaijan, Kazakhstan and Turkmenistan. USA and Canada: Routledge.

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Nagorno-Karabakh and seven other provinces in the internationally recognized Azerbaijani territory that surrounded the region.12 The war had a major impact on Azerbaijan’s transition and socio-economic progress, as it led to a major displacement of persons and the loss of productive capacity and especially land. The occupied land was rich and used to contribute 35-40 percent of the national agricultural output.13

Thus between 1991 and 1994, Azerbaijan faced the dilemma of asserting itself as an independent state. The assertion of statehood had to be achieved in the face of several forces that were international and domestic in nature. International forces were the war with Armenia, and the necessity of consolidating itself on the international stage by diversifying its international relations. As a post-Soviet state, the Russian Federation constituted an obvious connection for Azerbaijan and it faced the choice of either bandwagoning with Russia or balancing relations with it by forging strategic partnerships with the West. The pursuit of diversification was necessary given that the war with Armenia had left Azerbaijan isolated. Since the election of Heydar Aliyev as President of Azerbaijan, and later with the coming to power of his son Ilham Aliyev, Azerbaijan has firmly pursued a foreign policy whereby relations with the West are integrated while relations with Russia are kept cordial.14

In order to come to grips with these post-Soviet transition issues, Azerbaijan pursued economic development, specifically energy development. This strategy was crafted so as to provide Azerbaijan with the assets to diversify its international relations, simultaneously attracting and creating outreach to the West, especially the EU and USA. From 1996, Azerbaijan managed to make socio-economic progress. Foreign Direct Investment (FDI), especially in the petroleum exploration industries, played a very significant role. In 2005 and 2006 foreign direct investment into the oil industry was US$3.5 billion.15 In 2008 Azerbaijan’s economic growth reached 10.8%, and while it slowed over the next two years because of the Global Financial Crisis, it still remained relatively high at 9.3% and 5% respectively.16 According to the International Monetary

                                                                                                                         12 Azerbaijan. The World Factbook, Central Intelligence Agency. Retrieved January 2012, from: https://www.cia.gov/library/publications/the-world-factbook/geos/aj.html. 13 Ramil Muharremov. (2010). Petroleum-fuelled public investment in Azerbaijan: Implications for competitiveness and employment. In Indra Overland, Heidi Kjaernet and Andrea Kendall-Taylor (Eds.) Caspian Energy Politics Azerbaijan, Kazakhstan and Turkmenistan. USA and Canada: Routledge 14 Heidi Kjaernet. (2010). Azerbaijan-Russian relations and the economization of foreign policy. In , in Indra Overland, Heidi Kjaernet and Andrea Kendall-Taylor (Eds.) Caspian Energy Politics Azerbaijan, Kazakhstan and Turkmenistan. USA and Canada: Routledge p.152. 15 Ramil Muharremov .(2010). Petroleum-fuelled public investment in Azerbaijan: Implications for competitiveness and employment. In Indra Overland, Heidi Kjaernet and Andrea Kendall-Taylor (Eds.) Caspian Energy Politics Azerbaijan, Kazakhstan and Turkmenistan. USA and Canada: Routledge. 16Azerbaijan. The World Factbook, Central Intelligence Agency. Retrieved January 2012, from: https://www.cia.gov/library/publications/the-world-factbook/geos/aj.htm

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Fund (IMF), Azerbaijan’s GDP (PPP) was $12.681 billion in 1995. In 2010 Azerbaijan GDP (PPP) was $ 91.060 billion, ranking 73rd in the world.17 This was a remarkable accomplishment.

The FDI that fuelled economic growth after 1995 followed the signing of a production sharing agreement between Azerbaijan and a consortium of foreign oil companies. Since 2004 Azerbaijan has signed 30 production sharing agreements. The most recent contract envisages the exploration and development of Shafag and Asiman gas structures in the Azerbaijani section of the Caspian Sea. This contract was signed between SOCAR and BP in October 2010 and was ratified by the Azerbaijan Parliament in May 2011. 18 The first production sharing contract was called ‘the contract of the century,’ and it arranged for development of the Azeri-Chirag-Guneshli complex. The consortium is headed by British Petroleum, which now holds a 34.1 percent stake in Azerbaijan International Oil Company, and which is the operator for the three-field complex19. The agreement called for an investment of $7.4 billion over thirty years. The reserves in 1994 were estimated at 4 billion barrels and another characteristic of oil extracted in Azerbaijan is its lightness and hence low costs of refining. According to ‘the contract of the century’ Azerbaijan’s government would receive approximately 80 percent of the total profits. This includes the royalties and the shares of State Oil Company of Azerbaijan Republic (SOCAR), which held 20 percent stakes in this oil development. Only the remaining 20 percent of profits would be divided among the consortium members.20 The agreement signed in September 1994 also called for the construction of a pipeline as an infrastructure project that would facilitate the transportation of Azerbaijani oil into the international market.

This plan was realised in 2006 when the Baku-Tbilisi-Ceyhan (BTC) pipeline became operational. The BTC pipeline is a major infrastructure project that takes Azerbaijani oil to international markets. The BTC oil pipeline is one of the longest of its kind in the world at 1760 km long crossing three countries. The capacity of this pipeline is one million barrels of crude oil per day, and it is the first direct transport link for exporting crude oil between the land-locked but hydrocarbon rich Caspian Sea and the Mediterranean.21 The pipeline has been developed by a

                                                                                                                         17 World Economic Outlook Database, IMF September 2011. Retrieved January 2012, from: http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/weorept.aspx?pr.x=85&pr.y=12&sy=1995&ey=2016&scsm=1&ssd=1&sort=country&ds=.&br=1&c=912&s=NGDPD%2CNGDPDPC%2CPPPGDP%2CPPPPC&grp=0&a=; Azerbaijan. The World Factbook, Central Intelligence Agency Retrieved from: https://www.cia.gov/library/publications/the-world-factbook/geos/aj.html. 18British Petroleum Press Release (2011, May 10). Azerbaijani Parliament Ratifies Shafag-Asmian PSA. Retrieved January 2012, from: http://www.bp.com/genericarticle.do?categoryId=2012968&contentId=7068914. 19 John Roberts. (2008). Caspian oil and gas: How far have we come and where are we going? In Sally N. Cummings (Ed.), Oil, Transition and Security in Central Asia. USA and Canada: Routledge. 20Nasser Sagheb and Masoud Javadi. (1994). Azerbaijan’s “contract of the century” finally signed with Western Oil Consortium. Azerbaijan International, 2(4). Retrieved January 2012, from: http://azer.com/aiweb/categories/magazine/24_folder/24_articles/24_aioc.html 21 International Finance Corporation. (2006, September). Lessons Learned. The Baku-Tbilisi-Ceyhan (BTC) Pipeline project. Retrieved January 2012, from: Retrieved January 2012, from:

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consortium of companies. British Petroleum is the managing company of this consortium and it also has the largest shares, 34.76%. The other members of the consortium include: Unocal (USA) (8.9%), Statoil (Norway) (8.71%), Turkish Petroleum (6.86%), ENI (Italy) (5%), TotalFinaElf (France) (5%), Itochu (Japan) (3.4%), Delta Hess (USA) (2.36%) and Azerbaijan State Oil Company (SOCAR) (25%).22 In 2010 the one billionth barrel of crude oil was transported from the Sangachal terminal in Azerbaijan to Ceyhan in Turkey. 23The BTC has helped to break the isolation of newly independent post-Soviet states such as Azerbaijan and Georgia from Russia and help them forge ties internationally with the USA, Western Europe and Japan. Western investment in the BTC pipeline was viewed by Azerbaijan as a sign of more permanent commitment to the region by the West and the US in particular.24

In tandem with the increase in FDI, Azerbaijan has also witnessed increased social stability. While the two are mutually influential, the increase in social stability and prosperity are also driven in part by partnership with the EU. This has been by way of the EU-Azerbaijan Partnership and Cooperation Agreement (1996/1999), EU Neighbourhood Policy (2004) and its attendant EU-Azerbaijan Action Plan (2006), and now Eastern Partnership (2009), which is part of the EU Neighbourhood Policy (ENP) and now subsumes the EU-Azerbaijan Action Plan.25 The EU has different interests in Azerbaijan. The first and foremost of these interests relate to energy security. The EU has considered the Caspian region to be a reliable alternative to Middle-Eastern oil. Having acknowledged this interest of the West, Azerbaijan has made the oil and gas resources central to its relations with the West. Secondly, the ENP is an instrument of mediation and of bringing Azerbaijan and Armenia closer in order to make progress on the Nagorno-Karabakh conflict. A third reason for EU’s involvement in Azerbaijan has to do with the principle of non-discrimination among similar countries. If Georgia was offered a position as part of the ENP, then Azerbaijan could not have been legitimately refused. The ENP offer to Azerbaijan represents a significant change in comparison to the EU-Azerbaijan Partnership and Cooperation Agreement, which provided little in the way of concrete aid. Europe is a large consumer of energy. Since the resources of the North Sea have been exploited beyond their peak, Europe depends on its energy supply from non-EU countries. Some of these regions are economically insecure such as Russia and Middle-East. In terms of oil, the EU gets                                                                                                                                                                                                                                                                                                                                                                                                        http://www1.ifc.org/wps/wcm/connect/d01d2180488556f0bb0cfb6a6515bb18/BTC_LOE_Final.pdf?MOD=AJPERES&CACHEID=d01d2180488556f0bb0cfb6a6515bb18 22Nasser Sagheb and Masoud Javadi. (1994). Azerbaijan’s “contract of the century” finally signed with Western Oil Consortium” Azerbaijan International. 2(4). Retrieved January 2012, from: http://azer.com/aiweb/categories/magazine/24_folder/24_articles/24_aioc.html 23British Petroleum in Azerbaijan Sustainability Report. (2010). Retrieved January 2012, from: http://www.bp.com/liveassets/bp_internet/globalbp/STAGING/global_assets/downloads/A/Azerbaijan_Sustainability_Report_2010.pdf 24Rafael Kandiyoti. (2008).Pipelines: Flowing oil and crude politics. London: I.B. Tauris & Co Ltd. 25 Ministry of Economic Development. Republic of Azerbaijan. Available at: http://www.economy.gov.az/eng/index.php?option=com_content&view=article&id=206&Itemid=70

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45 percent of its oil imports from Middle East. For gas, EU depends on Russia, Algeria and Norway, which provide 45 per cent, 30 percent and 25 percent of gas imports, respectively. By 2030 more than 60 percent of EU gas imports are expected to come from Russia.26 Thus the building of the BTC pipeline was significant for the EU because it provided relief from its energy dependence on Middle East oil producing countries and OPEC. The fact that Azerbaijan was a newly independent country, undergoing transition as well as eager to develop its hydrocarbon potential, provided the EU with an opportunity to encourage political stability in a country that would be turned into a reliable source of energy supply. The trade relations between EU and Azerbaijan were intensified especially after 2003. As a result of this intensification in 2010 the EU27 was Azerbaijan’s first import and export partner with 25.4 percent of its imports coming from the EU and 47.9 percent of its exports going to the EU. This constituted 1236,9 million Euros and 7650,5 million Euros respectively. Azerbaijan on the other hand in 2010 ranked as the 29th partner for EU in terms of imports and the 56th in terms of exports. Out of the total exports from Azerbaijan to the EU in 2010, 99.2 percent consisted of mineral fuels, lubricants and related materials.27 Azerbaijan remains a lucrative energy provider possessing 7.0 billion barrels of oil reserves and 1.3 trillion cubic meters of natural gas reserves. In 2010 Azerbaijan’s oil production reached 1.037 billion barrels per day and 15.1 billion cubic meters of gas per day.28

Azerbaijan’s Diversifying Strategic Partnership with the EU

Energy cooperation is key to the strategic partnership in EU-Azerbaijan relations. Beyond that the main EU cooperation objective is “to develop an increasingly close relationship, going beyond past levels of cooperation to gradual economic integration and deeper political cooperation, principally in the framework of the Partnership and Cooperation Agreement and the more recent European Neighbourhood Policy”.29 Azerbaijan has continuously confirmed its commitment to play a significant role in the EU’s energy security. Within this framework Azerbaijan has supported the development of the Southern gas corridor with Nabucco as the prominent project and the trans-Caspian transportation project.30 In 2010 the cooperation in the field of energy was strengthened further as Baku confirmed that the EU remains its priority destination regarding its energy exports, even though diversification of exports is also pursued.

                                                                                                                         26Geopolitics of EU energy supply. (September 24, 2007). Retrieved January 2012, from: http://www.euractiv.com/energy/geopolitics-eu-energy-supply/article-142665 27Azerbaijan.EU bilateral trade and trade with the world. DG Trade Statistics. (2012, 10 January). Retrieved January 2012, from: http://trade.ec.europa.eu/doclib/docs/2006/september/tradoc_113347.pdf 28British Petroleum Statistical Review of World Energy. (June 2011). Retrieved January 2012, from: www.bp.com/statisticalreview. 29 European Commission. (2007). European Neighborhood and Partnership Instrument: Azerbaijan Country Strategy Paper, 2007-2013. Retrieved January 2012, from: http://ec.europa.eu/world/enp/pdf/country/enpi_csp_azerbaijan_en.pdf 30 European Commission. (2010). Implementation of the European Neighbourhood Policy in 2009. Progress report: Azerbaijan. Retrieved January 2012, from: http://ec.europa.eu/world/enp/pdf/progress2010/sec10_519_en.pdf

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The BTC oil pipeline and Baku-Tbilisi-Erzurum gas pipeline have been helpful in exportation of trans-Caspian oil. In 2010, oil from Turkmenistan was shipped over the Caspian Sea and brought to international markets via the BTC pipeline. The close cooperation of the EU and Azerbaijan on the field of energy was strengthened further by the signing of a Joint Declaration on gas delivery for Europe, signed by the Commission President Barroso and President Aliyev.31 The EU’s interest in energy supply is reflected in the economic interaction with Azerbaijan, but this is linked to conditionality and expectations on certain governing standards. EU’s expansion of relations with Azerbaijan is not strictly focused on economic development. Economic progress is expected to have a spillover effect on other areas such as state-society relations and good governance. Development of stronger and sustainable ties between the government and its citizens would provide Europe with a predictable energy partner as well as neighbour. Moreover a stable and prosperous Azerbaijan would have implications for the diplomatic resolution of the Nagorno-Karabakh problem and for better relations with the Caspian region countries, which are also undergoing the transition process. For Azerbaijan on the other hand good governance and stronger state-society relations would mean consolidation of the state building process internally. Such development would be vital for Azerbaijan beyond the hydrocarbon resource depletion point. In accordance with the Partnership and Cooperation Agreement (1999) and EU-Azerbaijan ENP Action Plan (2006) three areas are prioritized: democratic development and good governance; socio-economic reform (with emphasis on regulatory approximation with the EU (acquis), fight against poverty and administrative capacity building; support for legislative and economic reforms in the transport, energy and environment sectors. The key to the cooperation between the EU and Azerbaijan lies in developing a close partnership which goes beyond the level of cooperation to gradual economic integration and deeper political cooperation principally within the PCA and ENP frameworks. Azerbaijan and the EU have both agreed to deepen and broaden their relations. In 2010 they started negotiations about an Association Agreement that is in parallel with the Eastern Partnership framework. Considerable progress is required in the field of democracy, electoral processes, protection of human rights, fundamental freedoms and the independence of the judiciary.32 Azerbaijan has been able to use its energy wealth in enhancing regional partnerships in addition to the partnership with the West. In 2007 following the announcement of Gazprom to raise the price of natural gas sold to CIS countries, Azerbaijan decided to cut gas imports from Russia and

                                                                                                                         31 European Commission and High Representative of the European Union for Foreign Affairs and Security Policy (2011). Implementation of the European Neighbourhood Policy in 2010. Country report: Azerbaijan. Retrieved January 2012, from: http://ec.europa.eu/world/enp/pdf/progress2011/sec_11_640_en.pdf 32 European Commission and High Representative of the European Union for Foreign Affairs and Security Policy (2011). Implementation of the European Neighbourhood Policy in 2010. Country report: Azerbaijan. Retrieved January 2012, from: http://ec.europa.eu/world/enp/pdf/progress2011/sec_11_640_en.pdf.

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provided Georgia with natural gas at US$120 per 1000 bcm.33 Moreover in 2008, the Azerbaijani state oil and gas company SOCAR purchased parts of the Georgian gas distribution network. 34 Discussions about the Trans-Caspian oil pipeline also indicate a closer relation with Kazakhstan and Turkmenistan as Azerbaijan would serve as a transit route for the direction of hydrocarbon resources from Kazakhstan and Turkmenistan westwards via the BTC and Baku-Tbilisi-Erzurum gas pipeline. Azerbaijan has already had negotiations with Kazakhstan about the terms of transporting the Kazakh oil through the BTC and tanker traffic transporting Kazakh oil across the Caspian Sea is an indication of the increased oil volumes exported via the BTC. Turkmenistan has expressed interest over the proposed trans-Caspian pipeline, which would make it contribute in the Nabucco gas pipeline. The two countries share common interests in international affairs as well as in the diversification of energy exports. Azerbaijan considers friendly relations with Turkmenistan not only fruitful for the two countries, but also for the entire region.35 With Turkey Azerbaijan has had a traditionally high level relationship and a strategic partnership. The position of the two countries on regional and international issues is very close and the two states support each other in international organizations.36 Their strategic partnership is only enhanced given Turkey’s role as an energy corridor to the West. The construction of the BTC and BTE pipeline as well as the planned Nabucco gas pipeline are examples of this partnership. On December 2011, Azerbaijan and Turkey signed an agreement to build the Trans-Anatolia pipeline that will carry natural gas from the Caspian region to Europe.37 The signing of this contract is another example of Azerbaijan’s ability to forge regional partnerships. More importantly it is a significant indicator of how Azerbaijan has consolidated its position in the international stage by employing its economic resources.38

Part III

Tackling corruption in Azerbaijan: EITI’s successes and limitations

The success Azerbaijan has achieved in the establishing a reputation in the international security and in diversification of energy resources for Europe is also associated with many of the issues that were discussed in the first part of this paper. As a country in transition Azerbaijan was faced                                                                                                                          33 Liz Fuller. (2007, 5 January). Caucasus: Georgia, Azerbaijan seek alternatives to Russian gas, Radio Free Europe/Radio Liberty. Retrieved January 2012, from: http://www.rferl.org/content/article/1073826.html 34 Heidi Kjaernet. (2010). Azerbaijan-Russian relations and the economization of foreign policy. In Indra Overland, Heidi Kjaernet and Andrea Kendall-Taylor (Eds.) Caspian Energy Politics Azerbaijan, Kazakhstan and Turkmenistan. USA and Canada: Routledge p.156. 35 H. Hasanov.(2010). Ambassador: Azerbaijan-Turkmenistan relations experience stage of new rapid development. Trend. Retrieved January 2012, from: http://en.trend.az/news/politics/1701950.html 36 Ministry of Foreign Affairs Republic of Azerbaijan. Bilateral Relations. Available at: http://mfa.gov.az/eng/index.php?option=com_content&task=view&id=552&Itemid=123 37 Ali Berat Meric. (2011, 26 December). Turkey Azerbaijan agree on 7 billion euro gas pipeline plan. Bloomberg. Retrieved January 2012, from: http://www.bloomberg.com/news/2011-12-26/turkey-azerbaijan-agree-on-7-billion-euro-gas-pipeline-plan-1-.html 38 Robert M. Cutler. (2011, 23 November). Baku takes control of gas export policy. Asia Times. Retrieved January 2012, from: http://www.atimes.com/atimes/Central_Asia/MK23Ag01.html

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with building a state, a market economy, democratic institutions and broader development policies for the society at large. Unlike successful cases of ‘petrostates’ where oil resources were used to fuel other already developed sectors of the economy, in Azerbaijan (as shown in the previous section) hydrocarbon resources were used to fuel most of the economy. This was also conditioned by the role that Azerbaijan had fulfilled as part of the Soviet Union. As part of the Soviet Union, Azerbaijan was specialized in oil exploration and extraction, which was later on directed to other parts of the Soviet Union. This specialization left Azerbaijan with only one properly developed sector of the economy that was the oil sector and that became the obvious option for building post-independence Azerbaijan. In accordance with Friedman’s First Law of Petropolitics as the government of Azerbaijan has secured its revenue from exporting oil resources, the country continues to experience authoritarian control and domination of the political life by President Ilham Aliyev. In its survey Freedom in the World 2011, Freedom House classifies Azerbaijan as ‘not free’ and states that “[c]orruption is widespread, and wealth from the country’s massive oil exports creates ever greater opportunities for graft. Because critical institutions, including the news media and judiciary, are largely subservient to the president and ruling party, government officials are rarely held accountable for what are considered to be widespread corrupt practices among the country’s ruling elite”. 39 In Transparency International’s 2011 Corruption Perception Index Azerbaijan ranked 143rd out 183 countries in the world that is nine places down from its ranking in 2010. This ranking is the highest in the region compared to Georgia, Armenia, Kazakhstan and Turkey.

But how has Azerbaijan tackled the issue of corruption in the oil sector and what effects have these steps had? In recent years, the government of Azerbaijan has adopted a number of anti-corruption measures, including new laws and programs. The government established the “State Program addressed to the fight against corruption” and “Fund of the struggle against Corruption” in February 2004. Also the 2007-2011 “National Strategy with respect to increasing transparency" has been accepted. These are steps taken to target elimination of circumstances that create corruption, to increase transparency, to implement preventative measures, and to continue those effective measures. The areas identified with high levels of corruption are the police, civil servants, the education system and courts.40

A common expectation shared by policy-makers and most scholars of transitology was that administrative and economic reforms undertaken by the post-communist states would address the issue of corruption and bribery in a short time. More than twenty years later most of the post-communist countries and societies suffer the effects of rampant corruption. The systematic character of corruption continues to impede important processes such as the development, progress, and establishment of democracy, rule of law, and the elimination of poverty. More

                                                                                                                         39 Freedom House Index: Azerbaijan Country Profile. Retrieved January 2012, from: http://www.freedomhouse.org/report/freedom-world/2011/azerbaijan 40 Center for Economic and Social Development . (2011). Anti-Corruption Strategy for the Republic of Azerbaijan. Retrieved January 2012, from: http://unpan1.un.org/intradoc/groups/public/documents/apcity/unpan047861.pdf

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specific concerns that are linked to corruption and that are more relevant to the post-communist context are those linked to the formation of private property and destructive interference for businesses. Under circumstances where bribing is required in every step of an investment the number of companies that can enter the market is limited, which ultimately results in reduced competition. Corruption creates conditions that concentrate revenues in a small group of the society thus hindering the formation of a middle class in the country. 41

In Azerbaijan these negative aspects of corruption have been targeted by the undertaking of two initiatives that could have positive consequences. The first one is directly connected to the oil industry and it is Azerbaijan’s decision to sign up to Extractive Industries Transparency Initiative. This decision was declared in June 2003 and in November of the same year a state committee on EITI was established. The second is the decision of the President of Azerbaijan Ilham Aliyev to lead his government’s anti-corruption drive and to place it at the centre of his reform programme.42

Since his inauguration in 2003, President Ilham Aliyev has taken several anti-corruption initiatives the latest of which was launched in spring 2011. The most notable initiatives are the adaptation of the Law on Combating Corruption in 2004, the establishment of the Commission on Combating Corruption in 2005, and the State Programme on Combating Corruption 2004-2006. This was succeeded in July 2007 by the National Strategy on Increasing Transparency and Combating Corruption 2007-2011. These initiatives have resulted in the removal of some high-ranking officials. Azerbaijan has also ratified the UN Convention against Corruption in 2005, the European Criminal Law Convention on Corruption and European Civil Law Convention on Corruption and it is also a member of the Council of Europe Group of States against Corruption. As part of the latest anti-corruption campaign undertaken at the beginning of 2011 several local investigations were undertaken that resulted in the dismissal of several state employees including the head of prisons service, the chief of the water utility company and senior officials at the Ministry for State Emergencies. Other areas of society also witnessed progress. For instance a presidential decree ordered that all fines imposed by traffic police should be paid through banks and one-quarter of the amount should be allocated to the salaries of police. Also at some schools, teachers were told not to accept flowers, gifts, or money on 8 March, which is International Women’s Day. 43 However, observers have argued that these anti-corruption policies have been used by different factions of political elite in struggles with each other rather than directly                                                                                                                          41 ibid 42 Caspian Information Centre. (2011). Fighting corruption in Azerbaijan: The importance of transparency. Occasional Paper, No. 12. Retrieved January 2012, from: http://unpan1.un.org/intradoc/groups/public/documents/apcity/unpan047821.pdf 43 TrustLaw. Anti-corruption profile: Azerbaijan. Retrieved January 2012, from: http://www.trust.org/trustlaw/country-profiles/good-governance.dot?id=f42045e6-9928-456a-a278-e0cc8feb2d6d#country-snapshot; OECD Anti-corruption network for Eastern Europe and Central Asia- Istanbul Anti-corruption plan: Azerbaijan Monitoring Report. (2010). Retrieved January 2012, from: http://www.oecd.org/dataoecd/8/11/44996103.pdf

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targeting corruption practices. Also the fight of bribery and corrupt practices was accompanied by a significant increase in bureaucracy and paperwork that left ordinary citizens equally dissatisfied. For instance as reported by Radio Free Europe in Ganja that is Azerbaijan’s second-largest city, “…car owners couldn’t get their vehicles through official checkups because the computers at the relevant office of traffic police mysteriously stopped working”.44 In addition to this, the fight against corruption had not reached certain areas such as customs offices near Baku and truck drivers complained about corruption at the Transportation Ministry. 45

Azerbaijan’s decision to sign Extractive Industries Transparency Initiative (EITI) represents another development in the fight against corruption especially in the oil sector. But first, what is EITI and what were the immediate implications of this initiative for Azerbaijan? EITI is a global initiative established in 2002 to promote and support improved governance in resource-rich countries through the full publication and verification of company payments and government revenues from oil, gas, and mining. This is a voluntary association of stakeholders with shared goals and its structure has been open and participatory to a broad range of stakeholders. An EITI board oversees the initiative, along with an elected chair and members representing resource-rich developing countries; donors and supporting countries; international and national oil, gas, and mining companies; civil society members; and investor representatives. Also representatives from, international development agencies such as the World Bank, the International Monetary Fund, and the African Development Bank attend EITI meetings as observers. Since 2004 the World Bank Group, supported by a multi-donor trust fund to support EITI implementation, the EITI Secretariat, and other bilateral donor agencies, has been the primary source of technical and financial assistance for countries implementing EITI.

Countries that are rich in oil, natural gas, or mineral resources have found EITI to be useful in demonstrating a government’s commitment to good governance, increasing scrutiny over revenue collection, and improving a country’s investment climate. 46 EITI is both part of the World Bank’s response to its own Extractive Industries Review, and also one of the many tools identified in the Bank’s Governance and Anti-Corruption Strategy. In this context, the World Bank also works with governments on EITI issues as part of broader Bank-supported programs on extractive industries reform, natural resource management, and good-governance/anticorruption.47 The “EITI criteria” were established in 2005 at the second EITI conference and they describe what happens during the EITI process. The several steps include: 1. Regular publication of all material oil, gas, and mining payments by companies to governments (“payments”) and all material revenues received by governments from oil, gas and                                                                                                                          44 Ali Novruzov. (2011, February 22). Azerbaijani anticorruption campaign unfolds before wary public eyes. Radio Free Europe/Radio Liberty. Retrieved January 2012, from: http://www.rferl.org/content/anticorruption_campaign_azerbaijan_wary_public/2317662.html 45 Ibid 46 World Bank. (2008). Implementing the Extractive Industries Transparency Initiative: Applying Early Lesions from the Field. Washington, DC: The International Bank for Reconstruction and Development/The World Bank. p.1 47 ibid, p. 5

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mining companies (“revenues”) to a wide audience in a publicly accessible, comprehensive, and comprehensible manner; 2. Where such audits do not already exist, payments and revenues are the subject of a credible, independent audit, applying international auditing standards; 3. Payments and revenues are reconciled by a credible, independent administrator, applying international auditing standards and with publication of the administrator’s opinion regarding that reconciliation, including discrepancies, should any be identified; 4. This approach is extended to all companies including state-owned enterprises; 5. Civil society is actively engaged as a participant in the design, monitoring, and evaluation of this process and contributes toward public debate; 6. A public, financially sustainable work plan for all the above is developed by the host government, with assistance from the international financial institutions where required, including measurable targets, a timetable for implementation, and an assessment of potential capacity constraints.48

On 24 November 2004, the EITI Committee, local and foreign oil and gas companies and the Increasing Transparency in the Extractive Industries coalition of NGOs signed a Memorandum of Understanding (MoU) on implementing the EITI in Azerbaijan. The MoU envisages the key aspects of the EITI process in Azerbaijan as producing EITI reports twice a year; assigning an internationally recognized audit company to review and collect the submitted reports; submission of the audit company’s findings within 30 days after the deadline for the submission of reports to the audit company; a joint press release regarding the report by parties to the MoU; and the findings of the report are presented to parties to the MoU. In Azerbaijan EITI implementation is overseen by the National Committee on EITI, chaired by the State Oil Fund of the Republic of Azerbaijan (SOFAZ). The directors of SOFAZ are accountable only to the President. 49 The decision of Azerbaijan to join EITI was an important step with long-term implications for the conduct of business. Also the change in attitudes among the country’s ruling elite that appears to have preceded this decision is a significant development in Azerbaijan’s endeavour to bring transparency with regard to revenues from the oil sector. The change in attitudes happened not because there was lack of Foreign Direct Investment in Azerbaijan. On the contrary foreign investors sent frequent complaints to the Ministries that in their dealings with the bureaucracy there was no established system of accountability and oversight. Another importance of transparency and anti-corruption steps undertaken in the field of oil and natural gas resources is that this top-down drive is likely to have more credibility with the population and with international investors than one which focussed purely on small scale bribery by traffic police and customs officers.

Since joining EITI in 2003 Azerbaijan has made significant progress in its implementation. In recognition of the progress it has made so far, in 2007 SOFAZ was awarded the Certificate for

                                                                                                                         48 Ibid, p.4 49 Coffey International Development. (2009). Validation of the Extractive Industries Transparency Initiative (EITI) in the Republic of Azerbaijan. Berkshire, United Kingdom: Coffey International Development Ltd. p.2

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Improving Transparency, Accountability and Responsiveness in Public Service at the UN Public Service Awards. In 2008, Azerbaijan was the first country to officially start the validation process of EITI. 50 This progress was also acknowledged in a report published by the Revenue Watch Institute, in 2010 where Azerbaijan was listed at the top of the classification for comprehensive revenue transparency. In this report Azerbaijan was the ninth out of 41 energy resource developing countries listed for the transparency of their business dealings Azerbaijan achieved a rating of 75.1 compared to Brazil, the top-rate country in the index with a rating of 97, and the bottom-rated country, Turkmenistan, with a rating of 9.7. Only 12 countries, including Azerbaijan, were rated as fully transparent in the dealings of their private and state-owned companies. This report also reveals that public access to information or public disclosure of major investment agreements in the oil, gas and mineral sectors is not achieved by many countries. Azerbaijan’s government does not publish contracts and agreements with the oil operating companies. These agreements are published by the operating companies themselves. In this respect Azerbaijan has made more progress in comparison to countries like Turkmenistan and Sudan whose governments do not even disclose contracts to their legislators. 51 Although oil and gas companies operating in Azerbaijan publicize their contracts in the case of the ‘contract of the century’, which laid the foundation for the exploration of the Azeri-Chirag-Guneshli oil field and the subsequent construction of the BTC pipeline, the contracts were made available to the public during the construction phase of the BTC oil pipeline.

Oil and gas receipts are estimated to account for over 70% of Azerbaijan’s exports and nearly 50% of budget revenues. To date, the Government has published eight annual EITI reports and seven semi-annual reports covering the 2003-2010 periods. All of the 26 oil and gas companies in Azerbaijan participate in the EITI process. The State Oil Fund of Azerbaijan (SOFAZ) also holds quarterly press conferences dealing with all aspects of its revenues and outgoings and provides detailed information on its website. 52 Oil and gas revenues currently flow directly to SOFAZ and to the State Budget. Taxes that are paid by SOCAR and foreign oil enterprises flow directly to the Budget, while revenues from the state's share of oil and gas from Production Sharing Agreements, bonus payments, royalties and earnings from the transport of oil and gas through the Baku-Tbilsi-Ceyhan (BTC) pipeline constitute the budget of SOFAZ. 53

Although Azerbaijan has made some progress in fighting corruption, increasing transparency and participating in international initiatives, corruption remains a pervasive issue. The weak                                                                                                                          50 ibid 51 The Revenue Watch Institute. (2010). 2010 Revenue Watch Index-Transparency: Governments and the oil, gas and mining industries. Retrieved January 2012, from: http://www.revenuewatch.org/rwindex2010/pdf/RevenueWatchIndex_2010.pdf 52 Extractive Industries Transparency Initiative: Azerbaijan. Retrieved January 2012, from: http://eiti.org/Azerbaijan 53 Caspian Information Centre. (2011). Fighting corruption in Azerbaijan: The importance of transparency. Occasional Paper, No. 12. Retrieved January 2012, from: http://unpan1.un.org/intradoc/groups/public/documents/apcity/unpan047821.pdf

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institutionalization of the state structures and the lack of free media and weak civil society, in particular provide a fertile ground for ‘rent-seeking’ activities. But also the extent of progress made in increasing transparency relates to the limits of EITI itself. Is EITI the answer to addressing corruption in extractive industries in resource-rich countries and how far could this initiative go? The first limitation of EITI relates to its voluntary bases. This is a process that is initiated by donor country governments and it is up to these governments to become part of this process and even follow them. Secondly, the EITI focuses on one facet of the value chain only that is transparency in revenue collection and it does not focus on the expenditure side. As such it does not scrutinize activities dealing with the obtaining of the right of exploring and exploiting the resources in the first place as well as the distribution of oil revenues for public expenditure. The expenditure side is clearly the key in many of the corruption related problems faced by resource-rich countries. The expenditure side is the one where cilentalist politics can take place through transferring of funds and positions to supporters. Thirdly, although EITI is a positive development in terms of transparency, it takes place in countries that lack accountability. Under weak accountability mechanisms it is unclear what the implications of a country’s failure to comply with EITI criteria would be. Fourthly, the EITI requires the construction of a multi-stakeholder group to participate in the validation process. These groups are representatives of the government, oil companies, and of civil society. However, civil society in countries with low accountability is weak and might not necessarily be a representative of the larger population. Additionally, the risk of stakeholder group involvement is that they can develop their own rent-seeking practices. 54  

These limitations of the EITI are illustrated in several instances where investigative journalists and activists denounce corruption in the oil sector I Azerbaijan. Khadija Ismayilova, an Azerbaijani investigative journalist formerly responsible for Radio Free Europe Azerbaijan, vocally critiqued the EITI for not having a retroactive application for “Nobody knows the entity of the payments made by foreign oil companies to the Government of Azerbaijan in the 1990s, when the decisive contracts were signed”.55 Even with the implementation of the EITI many companies continue with the culture of secrecy, especially the small companies.

Also, as early as 1997, The Committee of Oil Industry Workers’ Rights Protection, that is an organization that protects the rights of employees in the oil sector of Azerbaijan and struggles against corruption and bribery, has published facts about corruption in the oil sector. In 2003, as part of their campaign to enhance transparency in the oil sector in Azerbaijan, this Committee prepared a report for the investigation arms of the European Bank for Reconstruction and Development (EBRD) and for the International Finance Corporation (IFC). In this report some

                                                                                                                         54 Ivar Kolstad and Arne Wiig. (2009). Is transparency the key to reducing corruption in resource-rich countries? World Development, 37 (3). 55 Luca Franza. (2011, December 7). Azerbaijan, where oil is not transparent. Osservatorio Balcani e Caucaso. Retrieved January 2012, from: http://www.balcanicaucaso.org/eng/Regions-and-countries/Azerbaijan/Azerbaijan-where-oil-is-not-transparent-108423

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cases of corruption were presented that directly link SOCAR and the construction of the Baku-Tbilisi-Ceyhan/Erzurum pipeline. The Committee expressed concern that the loan provided by the EBRD and IFC for the construction of this pipeline would support the corrupt practices in the oil sector. They presented a basic corruption scheme that showed how top managers of SOCAR fund, although indirectly, their own private enterprises. Then SOCAR submits some orders to the subcontractor firms, which are owned by SOCAR managers or by their relatives. In the final step the invoice for the work done is much higher than the actual market price or the work that is done is much less in scope, but the documentation about these work are presented as correct. As Mirvari Gahramanli, chair-woman of the Committee of Oil Industry Workers Rights Protection had stated “Azerbaijan has been unable to shake off Soviet era corruption and remains one of the most corrupt states in the world. . . . SOCAR is arguably the central point of corruption in Azerbaijan. It operates with oil incomes, which are the main part of the state budget, and is directly controlled by President Heydar Aliyev and his family.” 56

The issue of transparency is even more questionable in terms of how SOFAZ revenue is spent. While the generation of this revenue is made public, the way that this income is spent lacks transparency and accountability. Galib Efendiyev, director of an oil revenue-monitoring program at the Open Society Institute office in Baku states that "There's no clear strategy right now for the money in the state oil fund and there's no democratic way for deciding how this money will be used. There's no input from the society on how the money will be used. One person, the president of the fund, controls how it is used”. 57 Due to that many NGOs are not only calling for more detailed information about SOFAZ, but have even demanded that SOFAZ be answerable to Parliament and not only to the President as it is at present. This examples highlight that, although Azerbaijan has made progress in terms of consolidating its stance in the international community, revenues from oil are used to further strengthen the patronage of the government, which has consolidated its control over media and has invested more in internal and external security. In 2010 Azerbaijan approved a military budget of about $3.12 billion. The survival of this state in transition is used as justification by the ruling elite to fully control the oil resources, limiting the freedom of media and freedom of assembly for oppositional political parties. 58

 Conclusion                                                                                                                          56 Bankwatch Network. (2003, October 8). Oil pipeline will exacerbate corruption in Azerbaijan. IFC and EBRD receive complaint about State Oil Company practices. Retrieved January 2012, from: http://old.bankwatch.org/newsroom/release.shtml?x=164606 57 Yigal Schleifer. (2005, December 30). Azerbaijan oil: A mixed blessing. The Christian Science Monitor. Retrieved January 2012, from: http://www.csmonitor.com/2005/1230/p06s01-wosc.html 58 Mina Muradova. (2011, January 19). Azerbaijan boosts defence production. Central Asia Caucasus Institute. Retrieved January 2012, from: http://www.cacianalyst.org/?q=node/5482; Shahin Abbasov. (2010, October 22). Azerbaijan: Baku embarks on military spending surge, seeking Karabakh peace. EurasiaNet. Retrieved January 2012, from: http://www.eurasianet.org/print/62223

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  All post-communist states, but especially those that were newly independent countries, had to complete simultaneously a process that is linear in nature that is the consolidation of sovereignty, the formation of national identity, the creation of market economies, and the construction of stable and democratic politics. For Azerbaijan further development of the petroleum sector was the obvious answer to consolidate its statehood and achieve economic growth and social stability. Although initially it lacked the transportation infrastructure for hydrocarbon resources and was dependent on the Russian pipeline network for its oil and gas exports, the completion of the BTC pipeline and the partnership with the West has increased its independence.59 In twenty years of its independence Azerbaijan has been able to use its energy resources as a tool in foreign policy to generate a virtuous circle that has taken the country from a state of international isolation, instability and poverty to one of politically promising stability and prosperity internally, a crucial energy supplier for the West and an important regional player in the Caspian region and more broadly. The result of this virtuous circle and the relations with other energy exporting countries in the region and energy transit states has shown that Baku has worked on securing regional stability instead of conflict. Regional stability serves as a safeguard for FDI in Azerbaijan’s petroleum sector.

However, Azerbaijan’s success in securing an energy market has contributed in a breeding ground for corruption in the oil sector and more broadly. The pervasiveness of this phenomenon has been recognized not only by international monitoring bodies, but also by civil society groups and investigative journalists inside Azerbaijan. The civil society groups from Azerbaijan that engaged in developments around the BTC pipeline identified corruption as one of the major problems. Because of the lack of government accountability, these groups in coalition with other civil society groups in the region and Europe looked at the international institutions such as the EBRD and IFC for support. Within the framework of EU partnership and pressure from international institutions, Azerbaijan has taken certain steps in addressing corruption. In this respect compliance with EITI is a significant step towards tackling corruption in the petroleum sector. As a consolidated energy exporter in the region Azerbaijan’s steps towards more transparency and its willingness to cooperate with European Union and the United States on matters of good governance could be a good example for other oil and natural gas producing countries in the region, particularly for Turkmenistan. Although important, the EITI initiative has its own limitations. Anti-corruption and increased transparency need not only be enhanced through institutional arrangements, but through broader development processes. One of these processes is the diversification of the economy away for the oil sector and the creation of employment opportunities that would avoid the necessity for rent-seeking. In addition transparency is key to reducing political corruption by helping make politicians more                                                                                                                          59 Heidi Kjaernet.(2010) “Azerbaijan-Russian relations and the economization of foreign policy” in , in Indra Overland, Heidi Kjaernet and Andrea Kendall-Taylor (eds.) Caspian Energy Politics Azerbaijan, Kazakhstan and Turkmenistan. USA and Canada: Rutledge p. 155.

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accountable to the public. More generally, transparency can facilitate cooperation over opportunistic rent-seeking and help maintain norms of integrity and trust. Direction of the oil revenues towards the education, for instance could contribute to addressing corruption in the education system itself and in promoting transparency as a norm. Although Azerbaijan, has managed to generate a virtuous circle internationally, it still needs to transform the vicious circle of rent-seeking especially in the petroleum sector into a virtuous one.

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