"The Role of Caspian Oil in Maintaining  Stability in the Caucasus Region: In the Case of Mountainous  Karabakh Conflict"

This dissertation is broken up into 5 chapters on Virtual Azerbaijan (VAR):


Chapter I

Chapter II

Chapter III


                                                CHAPTER TWO


            The Recent Oil and Gas Developments in Azerbaijan.

"not one drop of Azeri oil will flow from the Caspian to international markets"

                                                            The President of Armenia, R. Kocharyan.

Contract of the Century

            It is essential to note that since 1994, oil and gas developments in Azerbaijan and a peaceful solution of the Karabakh conflict, began very close to each other.  It also brought regional and international powers such as the USA and the UK into Caucasus politics.  Actually, it was an old "Great Game" of the 19th Century between the British and Russian empires for influence in the Caspian region.  Since the collapse of the Soviet Union, this game started again in a different manner and new actors.

            Nowadays, only two economic factors are of real significance in this region: oil and gas and transport.  Considering the fact that the transport issue is of the greatest international concern, as the routing of pipelines to carry the oil and gas of the Caspian basin to world markets; both of these factors are closely connected to each other.  Therefore, it is clear that control over, or at least guaranteed access to oil supplies is a crucial state security concern. Consequently, in recent years, the oil and pipelines factor has even overtaken the conflict as the prime focus of international power interest in the Caucasus region.  Compared to Armenia and Georgia, having significant oil and very recently discovered gas reserves, gives Azerbaijan an opportunity for future leadership in the economical development of the Caucasus region as a whole.

            The oil industry had been one of the most ancient and most developed in the Caucasus region.  In fact, oil began to play a role in the life of Azerbaijan as far back as the period of antiquity.  According to Karl Marvin, who mentioned this in 1887, there is unequivocal evidence of the export of oil from the Apsheron Peninsula to the Middle East and India two and a half thousand years ago.[1]  Arab historian Masudi (10th century), and later on European visitor Marco Polo (13-14th centuries), and many others, wrote of springs near Baku that produced oil; the region in and around the present-day capital of Azerbaijan has been known to be rich in oil.  Natural  gas too left irs mark on the culture and religion of the area.  Gas was known in some places to escape from the earth, and at times to ignite. These fiery displays played a central role in the evolution of Zorastrian belief.  The Zorastrian temple and "Yanar Dag" (Mountain of Fire) in Surkhany  still  exist.

            The first well in the world was drilled in Absheron Peninsular in 1848.  It was eleven years earlier when in America, the first oil well was drilled in Pennsylvania.  Towards the end of the 19th century, Baku became the centre of attention as far as the world's industrial capital and investment were concerned.  In 1870-1880's, the famous Nobel brothers and French branch of Rothchilds, financed the Baku oil industry. [2]

            Bulent Gokay has drawn attention to the fact that because of Baku oil, the Russian empire became the largest oil-producing company in the world.  At the beginning of the twentieth century fifty per cent of the world's oil was produced in the Baku region.[3]

            During the Soviet era, Baku oil revenues were taking away from the budget of Azerbaijan and were included in the Central Soviet budget.  In 1940, Azerbaijan was providing 71.55% of the entire Soviet oil demands.  However, after World War II, significant oil discoveries in Russia's Volga-Urals region, decreased Baku's oil demand.  Thus, in 1980, Azerbaijan was providing 2.4% of the USSR oil demands. [4]

        A new era in Azerbaijanian oil began with the coming of independence in the Autumn of 1991.  Discussions between Azerbaijan government and both American and British oil companies had already begun in the closing years of the Soviet system, focusing primarily on two deep-water fields, Azeri and Clurag, besides Guneshli.  After signing letters of intent with three different groups of companies, Baku decided to unitise the project in 1992, creating the consortium that eventually created the Azerbaijan Operating Company (AIOC). [5]

            During the Abulfez Elchibey’s presidency, talks about oil contracts and the possibility of having them signed were planned in London.  The President himself was also to attend these meetings.  However, two weeks before Elchibey's visit to London in June of 1993, a military revolt occured in Azerbaijan.  Therefore, the political climate changed in Azerbaijan.  Initially, the new regime of President Aliyev postponed the signing of the contract.  As President Aliyev himself said, "I understand that the oil companies involved in Azerbaijan have their own economic interest.  It is quite natural.  But at the same time, we should put the interest of our country above the interest of the companies". [6]

            On September 20th in 1994, after three and a half years of arduous negotiations, Azerbaijan and a Consortium of foreign oil companies, signed a production sharing contract in Baku to develop Azerbaijan's Caspian Oil reserves.

The contracts conditions were as follows:

•     Term of contract - thirty years

•     Deposits intended for operation - Guneshli, Azeri, Chirag

•     Estimated stocks - 511 million tons (4 billion barrels) of oil

•     Property of the republic - 258 million tons of oil and all the passing gas in the volume of 55 billion cubic metres

•     Property of the foreign companies - 64 million tons of oil

•     To compensate for capital, operational and transport charges - 194 million tons of oil

•     Volume of investments - 7.4 billion US dollars

•     Profit of Azerbaijan - 34 billion US dollars (witjout regard for inflation)

•     Profit of the companies - 8 billion US dollars

As previously mentioned, the contract was based on the "production sharing" principles.  Consequenltly, the shares of the participants of the contract were distributed as follows:

- About 80% was to remain in the republic

- Share of all companies - 20 per cent

In turn, this 20% of profits will be divided among the other Consortium members. The final division of stakes among the final eleven multinational signatories is as follows: [7]

SOCAR (Azerbaijan) - 20%

British Petroleum (UK) - 17. 127%

Amoco (USA) - 17.01%

Lukoil (Russia) - 10%

Pennzoil (USA) - 9.82%

Unocol (USA) - 9.52%

Statoil (Norway) - 8.563%

McDermott International (USA) - 2.45%

Ramco (Scotland) - 2.08%

Turkish State Oil Company (Turkey) - 1.75%

Delta - Nimir (Saudi Arabia) - 1.68%

            After signing a contract, Azerbaijan became a pioneer in developing its huge oil reserves in the Caspian Sea.  Azerbaijan also, compared to other Caspian republics such as Khazakhstan and Turkmenistan, first opened its market for foreign investment.  According to Azeri officials, preliminary estimates of Azerbaijan's overall profit are projected to be $ 81 billion over thrity years. [8]  Viewing a major contract with global oil giants as a way to bolster Azerbaijanian sovereignty vis-a-vis Russia and demonstrate its growing international prestige, President Aliyev presided over the signing of the so called "Contract of the Century", on 20th September 1994.

            There are some truths for Azerbaijan behind President Aliyev's statement.  Besides the direct economic benefits, the contract  created favourable ground for investments in other areas, such as telecommunications, consumer goods, the service sector and many others.  The contract revived the petroleum industry of Azerbaijan and created a multitude of jobs, which was no small account for a republic with nearly one million refugees.  Generally speaking, it gave a chance to maximise the revenue available to boost Azerbaijan's slowly recovering economy, both in direct oil revenues and in the spin offs of direct foreign investment in the region's infrastrcture.  Furthermore, Baku claimed that the deal would strengthen the republic's sovereigny besides its ties with the West.  While regional powers such as Russia and Iran took up opposition [9] to the Azerbaijan oil deal, between 1995 - 1997.  Azerbaijan signed numerous contracts to develop new oil fields such as "Karabakh", "Shah Deniz", "Dan Ulduzu" and "Ashrafi".

            Moreover, very recently, on NATO's 50th anniversary in Washington, the Azeri President signed another three oil contracts worth $10billion, with Exon, Mobil and Moncrief companies. [10]

            According to observers, it is believed that Azerbaijan's recoverable oil reserves, could be between 0.5 and 1.5 billion tons of oil, compared to Nigeria's 2.8 billion tons, Russia's 6.8billion tons and Kuwaits 13 billion tons. [11] If this proves to be the case, Azerbaijan could be considered to be potentially a medium sized oil - producing country.  Nevertheless, Azerbaijan's attractiveness, has lain less in the total reserves, than in the Caspian basin's status as the last major unclaimed petroleum territory, and the fact that successive governments have deliberately set out rapidly to attract international investment, by offering favourable contractual terms.  As Edmund Herzig indicates, thses factors and their complex interface with stategic interests and the special export issues involved in Caspian oil production, have combined to make Caspian, and particularly Azeri petroleum, the subject of high profile and often hectic international interset and manoevering in the 1990's. [12]

Pipelines and Transport

            Despite the preliminary exciting news concerning the oil boom in Azerbaijan, transportation of Caspian energy resources to international markets, is one of the most controversial and pressing issues in the global economic integration process.

            It is obvious that the Caspian states of Azerbiajan, Kazakhstan, Turkmenistan and the Caspian itself, are all landlocked.  Hence, they will have to have pipelines to carry their oil, either directly to customers further afield, or to witing tankers with access to the world's oceans.  According to the terms of the consortium which came into force on 12th December 1994, the companies have agreed to export "early oil",[13]  beginning at about 40,000 b/d in two years.  [14] The real key to the sucess of the project however, is how to export the early oil and "main oil" production.  Exactly where such a pipeline will go, who will finance it and who will control it, are the key issues on which billions of dollars and the political future of the region, depend.

            "Early oil", from the AIOC venture in Azerbaijan, already started along two routes: one is the Baku - Novorosiisk and the other, Baku - Supsa.  Exports began in late 1997, along a northern route from Baku to Novorosiisk, the first of two "early oil" pipelines built to carry initial volumes of oil to world markets.  This route was in pre - existance of the Russian pipeline connection to Baku, that made this the most obvious choice for exports of Azerbaijan's "early oil".

        Initially, AIOC made clear its assumption, that the Baku - Novorosiisk route was set to be adopted as the only route for the export of Azerbaijan's "early oil".  The main reason for this decision was that the long term success of their Caspian operations, would depend on Russian goodwill.  However, having pressure from both Turkey and the USA, the AIOC opted for a compromise scheme, by announcing that the "early oil" would be exported through two pipelines, via Georgia and Russia. [15]

            In addition, in early October 1995, President Clinton held a twenty five minute telephone conversation with Azeri President H.Aliyev, in order to assure him that the USA believed that the two - pipeline option was best for Azerbaijan.  The idea appealed to the Azeri's, who did not want to be dependent on Russia for access to world markets, and yet at the same time, did not want to antagonise Moscow by refusing major  route to Russia in the "Contract of the Century". [16] The Baku - Novorosoiisk pipeline, also referred to as the northern pipeline, goes through Russian territory to Novorosiisk via Dagestan and Chechnya, which is quite unsafe because of the absence of stability and peace in the North Caucasus.  In other words, two recent events make this route's future uncertain.  Firstly, a blow up of the Baku - Novorosoiisk pipeline in the North Caucasus, forced AIOC to carry "early oil" by train to Black Sea ports, avoiding Chechnya.  Secondly,, recent Russian army forces, attacked to destroy Islamic militants in Dagestan, gives an unpredictable future for this route.  Therefore it is no longer viewed as a reliable route, although it is the only route for Azerbaijan to carry oil.

            The second route available for the export of Azerbaijan's "early oil", is via a pipeline from Baku to the Georgian Black Sea port of Supsa, and was welcomed by both Azerbaijan and Turkey. [17] It was obvious that due to this pipeline, Azerbaijan would not be completely dependent on Russia's monopoly as a transit point for oil to European and world marketsAlternatively, Turkey could still hope that this southern route would be extended south to its own terminal, Ceyhan on the Mediterranean, when the time came to build to a new, major pipeline to export the greater part of the Caspian's oil, as full scale production began in new fields.

            On 20th April 1999, Presidents of Azerbaijan, Georgia and Ukraine, inaugurated a Baku - Supsa pipeline.  The repair and completion of the 830 km. long Baku - Supsa terminal cost $565 million.  As was previously mentioned, it is the second of two pipelines which will carry more than five million tons of "early oil", a year from Azerbaijan and its main foreign oil consortium in the next few years. [18]

            Despite the fact that initially Turkey welcomed the Baku - Supsa route, it also repeatedly warned that increased traffic by larger tankers, through the Bosphorous Straits would be an an environmental hazard.  Even though, the 1936 Montreux Convention restricts Turkey's ability to regulate traffic in the Straits, Turkey has warned that once Caspian Oil extraction reaches its peak, an overland route avoiding Istanbul, will have to be found. [19]

        However, like the Baku - Novorosiisk, the Baku - Supsa pipeline is not without political problems.  One needs to consider the fact that this route passes in close proximity to several unresolved conflict zones, including the ethnic Armanian controlled Nagorno - Karabakh enclave and surrounding occupied territories.

            One of the most controversial oil export destinations is the Baku - Ceyhan route.Starting in Baku and ending in Ceyhan, this pipeline would run for 468 km. through Azerbaijan, 225km. through Georgia and 1,037 km. through Turkey. [20] The purpose of this route, was to supply Western markets with "main oil" from Azerbaijan and Kazakhstan in the next millenium. [21]

            On October 29th 1998, support for this option was affirmed with the signing of the Ankarra Declaration, backing the Baku - Ceyhan route.  The Ankarra declaration, also backs a proposed cross-Caspian natural gas pipeline from Turkmenistan  to  Azerbaijan, that would follow part of the Baku - Ceyhan oil pipeline route, to bring gas to Turkey.  The declaration was signed by the governments of Azerbaijan, Georgia, Kazakhstan, Turkey and Uzbekistan, with Turkmenistan abstaining. [22] The United States also has backed this route.  Washington wants regions oil and gas , through friendly countries such as Azerbaijan, Georgia and Turkey and away from Russia and Iran.  The US supports the Ceyhan route, because it is both the furthest away from Russian power in the region, and it integrates Turkey into the USA regional strategy.

            Despite the Ankarra Declaration and USA support, transportation of oil by the Baku - Ceyhan route faces a number of problems.  First of all, the AOIC favours the cheaper and shorter option, of expanding the Baku - Supsa pipeline, to a Georgian Black Sea port over the plan to build a pipeline to Cehan on the Mediterranean Sea, in Turkey.  As the President of the AOIC, David Woodward states, "Widening the Baku - Supsa pipeline, will alow them to move forward corresponding with the interests of Azerbaijan and our auctioneers at the initial stage of the project, and satisfy different sides that consider it necessary for the transportation of Baku - Ceyhan pipeline.". [23]

            Secondly, the Baku - Ceyhan pipeline crossed the Armenian enclave of Javakhetia [24] in Georgia and the Turkish part of Kurdistan, which AIOC admits, does not favour the projects chances of success.  Moreover, in Summer1998, American companies started negotiations with Kudish rebel leaders about the fate of the Baku - Ceynhan route.

            Thirdly, the first well drilled at Azerbaijan's offshore field known as "Shah Deniz", has found enormous amounts of gas. [25]  To put it simply, "Shah - Demiz" gas discovery, does not help for building a Baku - Ceyhan route.  “Shah Demiz” was seen as a potential source of oil that could help to fill the Baku - Ceyhan line to its capacity of one million barrels a day, adding its volume to that of the Azerbaijan International Operating Company.  Therefore, a new oil discovery would have helped to justify the cost of building a main export pipeline from Baku to the Turkish port of Ceyhan.

            On the other hand, recent gas discovery puts Turkmenistan's future gas prospects at the greatest risk, for they recently signed an agreement to supply gas to Turkey, with a trans - Caspian pipeline that would run through Azerbaijan.  While Azerbaijan has been seen as an oil producer, Turkmenistan is viewed as a source of gas.  The USA designs for a Baku - Ceyhan oil line and a trans -Caspian gas line from Turkmenistan, may now both be at risk if Azerbaijan turns out to be a producer of more gas and less oil than originally planned.

            Despite its attractiveness, the Baku - Ceyhan route is still a project and it could be delayed. [26] Compared to other routes to export Azeri oil, only the Baku - Supsa line, now seen as the most operational line, while the Baku - Novorosiisk pipeline as previously mentioned,  were already engaged with several problems.  Therefore, the future export of Azeri oil depends on how Azerbaijan will negotiate over the oil and gas fields in the Caspian region with its neighbours such as Russia, Iran and Turkmenistan.  Furthemore, it depends upon how Azerbaijan could satisfy both Russian and USA strategic interests.

[1]Elkhan Poluklov, " Contract of the Century: The Problem in an Historical Retospective"  Caucasian Regional Studies, 2(1) 1997  (http://poli.vub.czc.be/publi/crs/eng/0201-05.html.)

[2] Nasib Nassibli " The Independent Azerbaijan's Oil Policy"

(http://scf.usc.edu/~baguirov/azeri/nasibzade1.html. 15 April, 1998).

[3] Bulent Gokay " The Battle for Baku (May-September 1918): a peculiar episode in the history of the Caucasus", Middle Eastern Studies, 34 (1) January 1999, 30.

[4] Nasib Nassibli " The Independent Azerbaijan's Oil Policy".

[5] Dan Yergin ," Historical Overview of Azerbaijan Oil"  Azerbaijan Investment Guide  1998,  51.

[6] Elkhan Polukhov, " Contract of the Century: The Problem in an Historic Retrospective".

[7] Nasser Sagheb and Masoud Javadi " Azerbaijan's Contract of the Century"  Azerbaijan International, 2(4) Winter 1994


[8] Nasser Sageb and Masoud Javadi "Azerbaijan's Contract of a Century" Azerbaijan International.

[9] In light of the fact that giant Russian oil company Lukoil, held a 10% share in the Azerbaijan contract, the Russian Foreign Ministry claimed that the treaty concluded between Russia and Persia in 1921, and between the Soviet Union and Iran in 1940 was still in force.  According to this document, the Caspian Sea was, until 1991, divided into two zones, one Soviet and one Iranian.  With the collapse of the USSR, thr emergence of three new states: Azerbaijan, Kazakhstan and Turkmenistan.  Moscow said that resource development of the Caspian, should be developed in common.  Supported by Kazakhstan, Turkmenistan and Azerbaijan objected that the treaty should not be binding on states that had not signed it..  However, the dispute over the legal staus of the Caspian Sea, is far from the aim of this dissertation, because it is in itself , a problematic area.  See for details: Oxman, A.B., "Caspian Sea or Lake: What Difference Does It Make?".  Caspian Crossroads Magazine. 1(4)  Winter 1996.


[10] Azerbaijan Newsletter via Habarlar-L,  Embassy of the Republic of Azerbaijan.  Washington, 30 . April 1999.

[11] IMF Staff Country Reports, No. 97/1. "Azerbaijan Republic - Recent Economic Developments" , 10. Interbnational Development Agency, "Caspian Oil and Gas: The Supply Potential of Central Asia and Transcaucasia" (IEA, 1998), 157

[12] Herzig Edmund "The New Caucasus: Armenia, Azerbaijan and Georgia" (London: Royal Institute of International Affairs, 1999),  134.

[13] "Early oil", is the term used to describe the oil that is to be produced in the immediate future from known fields, without the need for further exploration, large scale infrastructure investment and wholly new export routes.

[14] Forsythe Rosemarie "The Politics of Oil in the Caucasus and Central Asia" Adelphi Paper-300 (London: Oxford University Press, 1996) ,44.

[15] Suha Bolukbasi " The Controversy Over the Caspian Sea Mineral Resources: Conflicting Perspectives, Clashing Interests" Europe - Asia Studies  50(3) May 1998, 404.

[16] Suha Bolukbasi "The Controversy Over the Caspain Sea Mineral Resources: Conflicting Perspectives, Clashing Interests"  , 404 - 405.

[17] Paul Sampson "Playing the Caspain Pipelines" Transitions l6 (2) February 1999.

[18] Tolyan Naegele "Caucasus: Georgia, Azerbaijan and Ukraine Inaugurate Oil Pipeline.


[19] The Turkish Straits -  the Dardanelles and the Sea of Marmara divide the city of Istanbul and separate Europe and Asia.  The straits have been a source of conflict and a global conquest for many centuries. In March 1994, two vessels collided and twenty nine people died in the Bosphorous straits.  Tons of oil poured into the Bosphorous, and the resulting fire raged for about a week.  As a result, Turkey imposed several limitations on the passage of tankers carrying oil and inflammable materials through the Bosphorous and Dardenells.  The new navigation rules went into effect on November 24th 1994.  These new regulations require all vessels entering the straits, to comply with the Turkish reporting system.  According to this system, ships take on a qualified pilot and all ships over two hundred meters long, navigate the area in daylight.

Gokay, Bulent. "Caspian Uncertainties: Regional Rivalries and Pipelines" Journal of International Affairs 111 (1) March - May 1998, 60.

[20] Bulent Gokay "Caspian Uncertainties: Regional Rivalries and Pipelines"  Journal of International Affairs  111 (1) March - May 1998, 60.

[21] In an environment of official oil markets, Azeri and Kazak oil would generate a higher net revenue, if  exported to Europe rather than to Asia.  This reflects a combination of factors including relative transport costs for Azeri and Kazak oil, compared to the costs of competing suppliers.  However, if Saudi Arabia insists on maintaining a significant presence in the European market, the option for Kazakhstan to export its oil to Pakistan by pipeline, might in this case, provide a higher net revenue, than to Europe.  This would not be the case for Azeri oil, which is geographically closer to the European market.

[22] Paul Sampson "Playing the Caspian Pipelines" Transitions  6(2) February 1999, 27.

[23] Azerbaijan News Distribution List "Habarlar-L," Transportation of pipeline could be delayed,   12  August 1999.

[24] Javakhetia is along a Baku - Ceyhan piepline route, since the pipeline would traverse this enclave as it heads south into Tukey from Tblisi.  Javakhetia is demanding autonomy from Georgia. It also has a Russian military base. See: Julia Nanay "The US in the Caspian: The Divergence of Political and    Commercial Interests" Middle EastPolicy, October1998. (http://web1.infotrac.galegroup.com.itw/...yn=81!xrn-2-0-A53344931?sw-dep=keeleitc)

[25] On July 12th 1999, British Petroleum - Amoco has announced a "world class gas discovery"  Shah Deniz.  Analysis of the first test well, has led to the conclusion that  “Shah Deniz”, contains in addition to oil, between 400 and 700 billion cubic metres of gas.  According to the President of Azerbaijan, Haydar Aliyev, this gas discovery gives a chance for Azerbaijan, to supply the whole of Turkey's gas demand for at least twenty five years.  Source: ANS TV, Baku, in Russian 1500gmt, 12 July 1999.

[26] On August 11th 1999, the Azerbaijan Interantional Operating Company (AIOC), a consortium led by BP - Amoco that is developing gas fiels in Azerbaijan, announced that it may delay a US $3.1 billion expansion of its Azeri operations, if negotiations over the furture of pipelines for exporting oil and gas from Azerbaijan are not decided in its favour.  Source: Azerbaijan News Distribution List "Habarlar-L" United States Squeezes Turkey on Pipeline Deal , 16 August 1999.

Copyright © 1999-2001 by Dadash Alishov. All rights reserved.

Web presentation with exclusive permission from the author.

Copyright © 2001 by Virtual Azerbaijan (VAR).