Since the collapse of the Soviet Union, the South Caucasus region’s strategic location and energy resources have played a significant role in increasing the region’s importance and attracting international attention, and major investments have been made in new pipelines and the search for new oil and gas deposits. The South Caucasus region includes Azerbaijan, Georgia, and Armenia and covers a definition with a distinct geopolitical and ethnopolitical background.

Today Azerbaijan is one of the major recipients of the Foreign Direct Investments (FDIs) in the Caucasus region. Several data sets from various sources conclude that the flow of foreign direct investments to Azerbaijan has increased rapidly in the last two decades, and the majority of those investments focused on Azerbaijan’s energy sector, more specifically on the oil and gas sector.

Historical background

Azerbaijan is one of the oldest oil manufacturers in the world and the capital Baku along with the Absheron Peninsula are very famous as historic places for oil. The first oil well in the world was drilled in Abhseron Peninsula, Bibiheybat in 1847.

Baku is the home to the world’s first oil refinery, which was built in 1878. By the end of the 19th century, Baku began to be a center for world-scale industrial investments. According to historical resources, during the Russian Empire period, Baku was the main oil provider, supplying 97.7% of Russia’s oil in 1890, and half of the world’s output in 1901; and in World War II, during the Soviet era, Azerbaijan supplied 23.5 million tons in 1941, which accounted for approximately 75% of the total oil output of the former Soviet Union.

Azerbaijan oil and gas sector

Throughout history, oil has been a driving force in Azerbaijan’s political and economic life. Making simple and acceptable legislative and regulatory frameworks in oil and gas contracts is one of the biggest successes of the Azerbaijani government in terms of attracting foreign investments to develop its energy sector. Total energy production is increasing year by year with the support of these strategic achievements.

Azerbaijan was the first of the former Soviet Union countries to attract foreign oil and gas companies to its energy sector in the 1990s, and since the first day of its independence, Azerbaijan’s energy policy has been an important factor in instituting its independence. The energy policy is more than just producing and exporting oil to the global market; after the development of the Southern Gas Corridor (SGC) and Shah Deniz II Phase, Azerbaijan is also becoming one of the world gas giants.

According to the research results, an important factor that should be mentioned in Azerbaijan’s energy sector – the “oil shock”. The sharp decline in oil prices in the world market in 2014 has made the “oil shock” in all the oil producer countries, and obviously, Azerbaijan was no exception. After that “oil shock”, the energy policy of Azerbaijan changed. It changed the country’s financial capacities, the attitude towards energy projects, and especially the existence of the very expensive Southern Gas Corridor (SGC) changed the financial standpoint of Azerbaijan to oil-related projects. The SGC is a US $ 40 billion (estimate) project. The extremely high cost of the SGC and falling world oil price encouraged Azerbaijan to continue its cooperation with BP, as in 1994. On September 14, 2017, the Azerbaijani government, SOCAR, BP, and the other joint venture energy companies signed a new contract for the extension of the “Contract of the Century” until 2050.

The 2014 “oil shock” proved that the Azerbaijani government should decrease its economy oil dependence and diversify the economy as soon as possible. The diversification of a country’s economy is more important in the context of the energy policy. However, both inclusive and sustainable development entirely depends on how the Azerbaijani government can diversify the economy and at what level it can overcome its oil dependence.

Today the energy sector accounts for a big part of the GDP of the country. According to the Ministry of Finance, 54.2% or 13776.0 million manats (Azerbaijan National Currency) of projected state budget revenues for 2021 fall to the oil sector, while 45.8% or 11651.0 million manats relate to the non-oil sector. Currently, both in leading and lagging macroeconomic indicators, the energy sector maintains its domination in the Azerbaijan economy.

A brief overview of the China – Azerbaijan relations in the oil and gas sector

Energy security is one of the top priorities of China’s national policy. It remains a critical strategic concern for China as the country sets the goals of modernization and common prosperity for its large population.

The State Council Information Office of the People’s Republic of China announced that China increased its efforts to explore and exploit oil and gas resources to increase reserve and production volumes. The three largest Chinese national oil companies, CNPC, Sinopec, and CNOOC have been actively seeking overseas opportunities for exploration, exploitation, production, investment, and trading of the oil and gas sector to expand energy cooperation and greater participation in the international energy competition. Nowadays, China’s overseas strategy in the oil and gas sector covers the diversification of the sources of oil imports, investment in overseas exploration and production, the development of political relations with oil exporter countries, purchase and use of overseas refineries, etc.

Central Asia and the South Caucasus region always were important focus areas for China. Despite its limited geostrategic interests, China is interested in the South Caucasus region for the development of trade with the petroleum-rich Caspian basin countries, in the example of Azerbaijan. As a regional economic leader, Azerbaijan represents a specific interest of China.

Azerbaijan is close to both Europe and Asia. This fact makes Azerbaijan very interesting for investors in the energy sector. Asia is the most expensive market in terms of energy prices. Europe is the second expensive market, and Azerbaijan is practically in the between the two most expensive markets. Of course, this is one of the most important factors to attract investors to Azerbaijan’s energy sector.

In terms of investment destination in the South Caucasus region, Azerbaijan is the most important country for China. Because Azerbaijan has its energy sector, and in terms of energy profitability Azerbaijan is superior when compared to other countries in the region. This being so, we can observe the strengthening of the cooperation between China and Azerbaijan, and the attraction of the Chinese investment to Azerbaijan.

According to the State Oil Company of Azerbaijan Republic – SOCAR, today in Azerbaijan’s oil and gas sector China is represented by CNODC, Fortunemate (FAL), Petro Hong Kong, and Noble Sky with 50% of the Chinese investments.

The Minister of Energy of the Republic of Azerbaijan Parviz Shahbazov, during his visit to China, attended the “Belt and Road Energy Partnership” ceremony, mentioned that the Chinese companies made more than the US $ 800 million investments into Azerbaijan’s oil and gas sector. This is an important indicator of Azerbaijan – China energy cooperation.

The Chinese oil companies entered Azerbaijan’s oil market in 2002. At the same time, the Chinese companies are involved in trading oil industry equipment, technical services, oil and oil products trading, etc. In 2016, CNPC and SOCAR signed a memorandum of cooperation in the GPC Project. SOCAR has launched GPC Project to maximize the added value of the upstream-midstream-downstream oil and gas chain and create a cutting-edge standard processing industry in Azerbaijan. SOCAR GPC Project is the beginning of a new era in the development of Azerbaijan’s petrochemical industry. Azerbaijan will become a global player in the petrochemical industry with the completion of this huge project. In May 2017, during the “Belt and Road” Forum for International Cooperation, CNPC, the China Development Bank, and SOCAR signed a memorandum of understanding on the GPC Project. The total amount of the investment in the framework of this project is more than the US $ 4 billion. This project is the largest in terms of investment between the companies of these two countries to date.

Compared to the vast size of Western, Russian, and Turkish economic interests, particularly in Azerbaijan’s energy sector, China is not one of the key players for now. The Chinese companies mainly have chosen to focus on “out of sight” areas where the competition is less intense. The development of oil manufacture at some older and less commercially attractive on-shore fields, such as, Salyan, Garachukhur, Gobustan, and building a hydroelectric power plant at Mingechaur are notable examples.

But one point should be mentioned, Azerbaijan’s undiscovered oil and gas deposits are large. That means Azerbaijan’s potential resources are fast. If there is a large-scale energy project in Azerbaijan, the Chinese energy companies definitely will participate in it. In 2014-2015 the global oil market price sharply decreased and was caused by the significant devaluation of manat. For this reason, the Chinese oil companies suffered a lot of losses. It made them adjust their business model, cut costs, and so on, to survive the crisis. But the main point is they did not leave the country and sell their shares as the same as some other countries’ representatives did.

Also, the research results show, currently, there are no specific political interests and motives of the Chinese investments in Azerbaijan’s energy sector. But, it should be taken into account that China intends to enter the South Caucasus region through Azerbaijan. Eventually, the investments in the energy sector would also allow China enter the South Caucasus region with a larger amount of investment and a broad representation. From this point of view, currently, China is in the East Caspian Sea region: Kazakhstan and Turkmenistan, and obviously, China wants to be in Azerbaijan too.

By Sadig Gachayev

Ph.D. in Public Administration at Yanshan University, China

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