The Economist
August 19, 2006
U.S. Edition

Too much of a good thing; Azerbaijan and oil

Managing oil revenues

A case study in the perils of being a petro-state

THE beaches near Baku are popular weekend spots. But their view of
the Caspian is spoiled by a rusty oil platform towed close to the
shore years ago. By contrast, an hour’s drive south is the gleaming
Sangachal terminal, the starting-point of the new $3.9 billion
Baku-Tbilisi-Ceyhan (BTC) oil pipeline.

The old and the new, the past and the future, are never far apart in
Azerbaijan, which 100 years ago was briefly the world’s largest oil
producer. Now, after 15 years of independence, Azerbaijan is seeing
another boom. By 2010, oil production is expected to triple, to
1.3m barrels a day, and gas output to quadruple, to 28 billion cubic
metres a year. The first oil was delivered through the BTC pipeline
in June. A Baku-Tbilisi-Erzurum gas pipeline will open later this
year. If oil prices average $50 per barrel (they are now over $70),
these two will bring a massive $140 billion into Azerbaijan’s state
coffers over the next 20 years, claims President Ilham Aliev.

Such a gushing of money ought to be a blessing for this impoverished
country. It has just 8m people, but that includes some 800,000 refugees
left from the war with Armenia over Nagorno-Karabakh in the early
1990s. Yet few oil-rich countries have avoided the triple threats
of corruption, competitive rent-seeking or "Dutch disease"-in which,
thanks to exchange-rate appreciation, oil production crowds out other
economic activity.

Azerbaijan is, according to Transparency International, one of the
most corrupt places in the world. Under Mr Aliev, it is a thinly
disguised autocracy. Yet it has taken some steps. A national oil fund,
set up in 1999, holds some $1.6 billion. Azerbaijan has also signed
up to the Extractive Industries Transparency Initiative (EITI),
an anti-corruption scheme established by Britain’s Tony Blair in
2002. Oil companies report payments to the oil fund, which publishes
full details. An independent auditor checks the fund. "I think it
has worked very well," says David Woodward, associate president of
BP Azerbaijan, the biggest foreign investor in the oil industry.

The problem is that, even if revenues are well-monitored, spending is
not-since it is not covered by the EITI. Observers in Baku say the
government is already spending too much money, too quickly and with
too little oversight (needed to stop such things as the awarding of
contracts to close relatives). Inflation has risen and the currency,
the manat, has appreciated, symptoms of a possible outbreak of Dutch
disease.

The model that Azerbaijan, like other oil producers, aspires to is
that of Norway, which has built a huge stabilisation fund without
distorting its economy. Even Russia’s economic management has been
better than some critics feared. But it would be miraculous if a poor
country, under intense social pressure, managed a similar feat. The
risk for Azerbaijanis, as for Venezuelans or Nigerians, is that the
oil bonanza will end up hurting the people it ought to help.

GRAPHIC: Nice beach, shame about the view