Converting petro wealth into sustainable human development

Azerbaijan’s economy has grown at an unprecedented rate during the last decade, with real GDP increases averaging 21 percent between 2005 and 2009 alone.  This spectacular growth reflects a major expansion of the oil and gas production and significant increases in public spending for both infrastructure and social needs.  As a result, Azerbaijan’s economy exceeded its 1991 level in 2005 and ranked fourth in the CIS in per capita income.  And it was one of the few post-Soviet states whose sovereign rating has risen to investment grade, clear testimony not only of the country’s overall growth but also its prudent management of oil revenues and credit. There was also a significant improvement in the standard of living and other social indicators.  Between 2003 and 2009, the official poverty rate fell from 45 percent of the population to 11 percent, while unemployment fell from 15 percent to 6.5 percent in 2007.  Like other countries, Azerbaijan has been affected by the global financial crisis but not nearly so severely.  In 2009, for example, its economy expanded by 9.3 percent, the highest in the East European region but the least for Azerbaijan since 1999. 

 

And Azerbaijan’s future looks bright as well.  With proven oil reserves of 7 billion barrels as of 2009, Azerbaijan’s oil production has risen by 400 percent between 1997 and 2008 to 875,000 bbl/d.  Over the course of same period the share that oil and gas production accounted for in GDP grew from 10 percent to 47 percent in 2009, a level likely to remain more or less constant until at least 2015.  

Moreover, oil output is likely to rise further as new wells come online and new discoveries are made.  Baku and the BP-led consortium are expected to approve a $10 billion project expanding Azeri Light oil production from the Azeri-Chirag-Gunashli (ACG) fields to a rate of 1 million bbl/d rate until 2019.  If that project does not go forward, Azerbaijan’s oil production is projected to reach a peak in 2014 and then decline through 2024 (US Energy Information Administration 2009).

 

Azerbaijan exports most of its oil, thereby earning much needed foreign exchange and allowing it to finance capital imports and strategic economic development priorities.  This plan is helped by declines in domestic consumption.  In fact, domestic oil consumption fell from 203,000 bbl/d in 1992 to 128,000 bbl/d in 2008, thus allowing Azerbaijan to export 749,000 bbl/d in 2008, twice the level of 2005 and earning the country 29 billion US dollars in 2008 (US Energy Information Administration 2009). 

In addition to oil, Azerbaijan also has proven natural gas reserves of 30 trillion cubic feet (Tcf).  Industry analysts consider Shah-Deniz to be one of the world’s largest gas field discoveries in the last 20 years, with possibly 15 trillion cubic feet of natural gas and 600 million barrels of condensate recoverable.  The startup of the Shah-Deniz gas field in 2007 transformed Azerbaijan from a net gas importer into a net gas exporter.  In 2008, Azerbaijan produced 572 billion cubic feet of natural gas mainly from the ACG and Shah Deniz fields, of which 66 percent was consumed domestically.  When Phase 2 of Shah Deniz is completed in 2016, its overall production capacity will reach 1 trillion Tcf.  From 2016 on, ACG and Shah Deniz together are expected to be producing roughly 1.4 trillion cubic feet natural gas, much of which will be exported. 

Because the oil and gas fields are nationally owned, revenues from them can be used by the government to increase public spending on both capital projects and current expenditures. 

Consolidated public spending which includes both increased four times from 2.8 bln. manats to more than 12 billion manats during the 2003-2009 period, and consolidated public investments accounted for the largest share of increase in public spending.  To renew much needed social and economic infrastructure, the government increased consolidated public investment expenditures 1000 percent to 4.4 billion manats in 2009. [1] Indeed, growth in non-tradable non-oil sectors such as construction, communication, trade, tourism and travel services have been largely driven by these government expenditures or by the multiplier effects of massive investments in the oil and gas sector.  

Azerbaijan’s non-oil sector is dominated by these non-tradable sectors and by social services.  The share of these industries in the economy has steadily increased, from 59 percent in 2002 to 67 percent in 2009.  On the other hand, the share of the tradable sectors such as non-oil manufacturing and agriculture declined over the same period by 12 percent.  Non-tradable sectors also grew much faster over the same period, posting 15.4 percent average real growth versus 5.8 percent average real growth of tradable sectors. 

The non-oil sectors of the economy have withstood the global economic and financial crisis relatively well.  They even grew 3.2 percent in 2009 thanks largely to rises in agriculture, communication, transportation, travel and tourism and trade.  At the same time, non-oil manufacturing and the construction sectors declined by 13.8 percent and 8.2 percent respectively, reflecting the vulnerability of these sectors to international trends. 

Diversification of the economy, development of the non-oil economy, creation of enabling business and investment environment remain major strategic objectives of the government.  The National Employment Strategy (2006-2015), the State Program on Sustainable Development and Poverty Reduction (2008-2015) and the medium-term economic social development program (2009-2012) focused on the creation of the supportive business environment, particularly in the non-oil sectors.  As part of this, Azerbaijan has cut the number and rate of taxes since 1998. [2] 

The positive changes in the business environment of the non-oil economy the government sought to create were reflected in the 2009 Doing Business ranking of 2009.  According to the ranking (which assesses economies based on 10 indicators of business regulation, Azerbaijan was listed at the top as the most reforming country in both 2008 and 2009: It rose from 97th place to 33rd place in the global rankings over that period.  Another World Bank survey in 2009 reinforced those findings. [3]

At the same time, international financial institutions project that the oil and gas sector will not be the main driver of economic growth from this year through 2014 when the Chirag field becomes operational.  But these projections do not account for Phase 2 Shah Deniz field development, which is expected to come online in 2016, the development of disputed oil fields with proven reserves in the Caspian sea, and the likely discovery of new oil and gas fields.  Moreover, growth of the transit trade will also partially offset the projected decline in oil production, once Kazakhstan and possibly Turkmenistan begin using Azerbaijan as a link to Western markets (The Economist Intelligence Unit 2009).  And if the government and BP led consortium approve a $10 billion project to tap the oil reserves below the ACG fields, this will extend oil production from the ACG fields at 1 million bbl/d rate until 2019 (US Energy Information Administration 2009).  

But even if no new oil fields are discovered, Azerbaijan will continue receiving large oil revenues throughout the coming decade.  IMF projects that Azerbaijan’s Oil Fund assets will reach 98 billion US dollars by 2015, 6.5 times of the 2009 level.  At more favorable world oil prices this amount could prove to be much larger.  The coming on stream of the Phase 2 Shah Deniz field in 2016 will also boost growth, export revenues and international reserves further.  

Nonetheless, at some point in the future, Azerbaijan will run out of oil and gas as its reserves are relatively modest.  Consequently, Azerbaijan needs to reduce its dependence on revenues from this sector and improve the country’s long-term outlook by developing a viable non-oil sector, promoting balanced regional economic development, organizing effective wealth redistribution schemes, creating favorable business environment, and making massive investments in human capital development.

Failure to do so could entail serious problems.  At present, non-oil exports make up only 5 percent of overall exports, and the tradable sector accounted for only 9.7 percent of GDP in 2009.  If these figures do not change, the economy’s capacity will be strained after 2020 and the real GDP growth will slow.  At the 2009 oil prices and hydrocarbons production forecast, the Economist Intelligence Unit projects annual average real GDP growth of 3.8 percent for the period of 2009-2030 and 2.8 percent for the period of 2021-2030, much lower than the historical average in the last decade (The Economist Intelligence Unit 2009).  Put in the starkest terms: a viable non-oil sector in Azerbaijan is essential for social cohesion and harmony in the country, given that it provides employment and income to 98.9 percent of the total workforce, while the oil and gas extraction industry employs only the remaining 1.1 percent. [4] 

The Economist Intelligence Unit projects that Azerbaijan’s population will reach 10.3 million by 2030, with the working-age population growing by 0.44 percent between 2009 and 2030.  The youngest working-age cohort (15-24) currently has the highest unemployment rate among all age groups.  In spite of improvements in the performance of labor markets and reported reduction in unemployment, nearly a third of the population pointed to unemployment as the country’s greatest problem except for the Karabakh conflict. [5]  

In the future, Azerbaijan must further improve the business environment, generate an educated workforce, build new infrastructure, and improve opportunities in all non-oil and gas sectors.  In 2010 staff consultations with the IMF, Azerbaijani authorities generally agreed with the Fund’s recommendations on these and other point, including improved economic planning and budgeting and improved investment in human capital via education.  For Azerbaijan to succeed, government efforts will not be enough.  Individual Azerbaijanis must come to believe that investing in education will help them and their families and thus their country as well (Maharramov 2009).

References

Fitch Ratings (2010) Press Release, 20 May, London.

The Economist Intelligence Unit (2009) Azerbaijan: Ten-Year Growth Outlook, July.

The Economist Intelligence Unit (2010) Azerbaijan Country Report, March. 

Maharramov, Ramil (2009) Black Sea Labor Market Reviews—Azerbaijan, Unpublished Report, ETF, February. 

US Energy Information Administration (2009) Country Analysis Briefs, October.

Notes

[1] IMF Article IV Country Report Statistics, May 2010. 

[2] IMF Article IV Country Report Statistics, May 2010.

[3] World Bank, Enterprise Surveys: Azerbaijan, 2009.

US Energy Information Administration (2009) Country Analysis Briefs, October. 

[4] The State Statistics Committee, Labor Market Statistics, 2008. 

[5] IFES, Survey on Public Opinion in Azerbaijan, 2006, p. 10.