AZERBAIJAN LEADS EITI EFFORTS; PROBLEMS STILL EXIST

C O N F I D E N T I A L SECTION 01 OF 02 BAKU 000480 SIPDIS SIPDIS DEPT FOR S/P DIRECTOR KRASNER FROM AMBASSADOR HARNISH E.O. 12958: DECL: 03/30/2016 TAGS: ENRG EPET EFIN ECON AJ SUBJECT: AZERBAIJAN LEADS EITI EFFORTS; PROBLEMS STILL EXIST Classified By: AMBASSADOR RENO L. HARNISH III PER 1.4 (B,D). ¶1. (C) SUMMARY. We warmly welcome your April 4-6 visit for the Extractive Industries Transparency Initiative International Advisory Group meeting. Your visit is an excellent opportunity to engage the GOAJ on the importance of effectively managing its oil wealth, strengthening public investment planning and ensuring a stable and sustainable economic development. The GOAJ has taken an active role in implementing and adhering to EITI principles. The State Oil Fund and its Executive Director Samir Sharifov have implemented a thorough system to capture and quantify Azerbaijan's oil revenue. The State Oil Company's (SOCAR) lack of transparency and the Oil Fund's imprecise quarterly reports remain the primary weaknesses. In addition, a critical issue outside of the Oil Fund and EITI, is the manner in which the government is using the Oil Fund for budgetary support purposes. The GOAJ needs to account for the oil revenue funds transferred to the budget in order to ensure that the funds are properly spent and used. END SUMMARY. OIL FUND LEADS GOAJ's EITI EFFORTS -------------- ¶2. (C) The Government of Azerbaijan's efforts, through the State Oil Fund of Azerbaijan, in implementing and adhering to the Extractive Industries Transparency Initiative (EITI) principles are to be commended. In an economy full of opaque business dealings and widespread corruption and waste, the Oil Fund's role in organizing and publishing the amount of revenue obtained from the country's natural resources is second to none. The Oil fund transparency model is so successful that there are rumors President Aliyev wants to replicate it in other areas of the economy and government. ¶3. (C) The Oil Fund's Executive Director, Samir Sharifov, is the principal driver behind the organization's transparency and forward-leaning role. Sharifov is a close confidant of President Aliyev and has deftly guided the Oil Fund to international respectability. In addition, Sharifov's role in GOAJ energy policy decision-making has recently evolved and grown into a powerful influence. In meetings over the past months with EconOff, the major international energy companies, IFIs and NGOs all agreed that the Oil Fund and its audited reports capture most, if not all, of the oil and gas provided by international companies to the State Oil Company, SOCAR. As of December 31, 2005, Oil Fund assets totaled USD 1.4 billion. EITI WEAKNESSES -------------- ¶4. (C) Despite the success of the Oil Fund and its regular reports, there are weaknesses in the system. One major weakness in the EITI process is the complete lack of transparency and accounting at the State Oil Company of Azerbaijan (SOCAR). The international community has actively engaged with the GOAJ to increase the openness of SOCAR. In addition, the U.S. and the European Bank for Reconstruction and Development are funding a reorganization and restructuring study at SOCAR. By 2008, SOCAR will be required to submit to international financial accounting standards that will also increase its overall transparency. It is unclear, however, if SOCAR will be able to meet this deadline. ¶5. (C) Most economic observers believe that SOCAR is not reporting to the Oil Fund all its own oil and gas production data and revenues. While this is a problem, it is an extremely small part of Azerbaijan's total oil production revenue that comes from its Production Sharing Agreements with international energy companies. According to the resident European Bank of Reconstruction and Development Bank representative, SOCAR's underreporting is insignificant. ¶6. (C) Another weakness of the EITI process in Azerbaijan is that the current report template does not provide an accurate view into the amount of actual revenues entering into the Oil Fund. As described below in its third report, the data reported indicated aggregate amounts of oil and associated gas, as well as royalties and other fees, that SOCAR received without actually quantifying the amount of revenue obtained from the sale of the oil and gas. BAKU 00000480 002 OF 002 GOAJ's THIRD EITI REPORT -------------- ¶7. (SBU) On January 27, the Oil Fund published its most recent report containing the payments and allocations received from the extractive industries for the January-June 2005 period. This is the Oil Fund's third EITI report and its remains an important tool in maintaining transparency in the energy sector. ¶8. (SBU) The report indicates that the GOAJ received 4.3 million barrels of in-kind oil and 628.2 million cubic meters of in-kind natural gas from foreign companies. The SOFAZ report indicates that the GOAJ received zero receipts from local companies during the period. In addition, the report indicated the GOAJ received USD 1.28 million in acreage fees and USD 8.77 million in transit fees from foreign companies. ¶9. (SBU) During the covered period, the GOAJ received receipts from local companies royalties totaling AZM 195.9 billion (USD 42.6 million) in royalties, AZM 42.8 billion (USD 9.3 million) in profit taxes and AZM 356.7 billion (USD 77.5 million) in other taxes that include employee income tax, social tax and withholding taxes. COMMENT -------------- ¶10. (C) While Sharifov should be commended for his excellent work at the Oil Fund and its overall transparency, the GOAJ needs to be pushed to increase transparency at SOCAR. Sharifov has told international interlocutors that he cannot push for increased transparency at SOCAR since that decision rests solely with the President. The manner in which the government is using the Oil Fund for budgetary support purposes - although outside the purview of the Oil Fund and EITI - is another critical issue. The 2006 State Budget projected the Oil Fund would transfer USD 616 million to the budget to fund unspecified infrastructure projects, refugee assistance, and other social improvement projects. The GOAJ needs to account for the oil revenue funds transferred to the budget in order to ensure that the funds are properly spent and used. HARNISH