CONSULTANT FORSEES SERIOUS PROBLEMS FOR

C O N F I D E N T I A L BAKU 000669 SIPDIS SIPDIS E.O. 12958: DECL: 05/03/2016 TAGS: EPET ENRG EAID PREL AJ AM TX KZ SUBJECT: CONSULTANT FORSEES SERIOUS PROBLEMS FOR AZERBAIJAN'S ELECTRICAL GRID Classified By: Acting DCM Joan Polaschik, reasons 1.4 (b),(d) and (e). ¶1. (C) SUMMARY. A consultant working on a USAID contract predicted serious difficulties for Azerbaijan's power sector in the coming years. The Barmek crisis has scared away private sector investment, and the GOAJ will be forced to rely on loans from IFIs. The consultant recommends that any such loans be conditioned on serious changes, including privatization, reorganization, and the creation of an independent regulator. The GOAJ has recently refused IFIs loans due to their conditionality. END SUMMARY. ¶2. (C) Energy officer met with a consultant from a USAID implementing partner working on domestic power regulation issues. The contractor had put together a plan and draft legislation for Azerbaijan to create an independent energy regulator, which the GOAJ ultimately declined to do. For this reason the project is being shut down this summer. The consultant predicts the problems plaguing the electrical grid here -- government and public corporations not paying their bills, absurd rates, and ancient equipment that is neither maintained nor upgraded -- will continue to mount. ¶3. (C) The entry of a private company into the electric distribution business would help the situation, said the consultant. However, the extremely negative experience of Turkish distribution company Barmek (facing a tax investigation and criminal charges, which many observers believe stem from the company's ties to jailed ex-Minister Farhad Aliyev) will scare most investors away. The only companies willing to enter the market, the consultant speculated, will be Russian ones. The consultant said that Russian companies will most likely behave the way he sees them as having behaved in the Georgian energy market: they will "keep things going" but will not perform maintenance or upgrades, and will in the end abandon the market. ¶4. (C) The end result of the above, says the consultant, is that Baku will begin to face power outages in the next year or two and the countryside will suffer more severe and prolonged shortages. Eventually, he believes, the GOAJ will come to the IFIs for loans for a solution. Energy officer asked why the GOAJ would seek undoubtedly condition-laden loans from international institutions when it has billions in energy revenue in the State Oil Fund. The consultant responded that investing in domestic electric power generation is "not on the radar screen" of the State Oil Fund, and the State Oil Fund may already have obligated its monies to other projects when this crisis strikes (COMMENT: The GOAJ has made a distinct move away from IFIs' conditional lending in the last year; it is hard to envision a scenario, even one this serious, where it would turn again to the IFIs and their conditions). ¶5. (C) The consultant believes that when the above situation comes to pass, the IFIs should grant loans only if the GOAJ agrees to meet the following six conditions: --the leadership of Azerbaijan's power sector must be changed (the consultant specifically named AzerEnergy chief Etibar Pirverdiyev), --power distribution must be privatized, --a truly independent energy regulator must be created, --BakuGaz must be privatized, --AzerEnergy should be reorganized, with its transmission department being separated the its power-generation department, and; --Azerbaijan's grid should reintegrate with Armenia's. ¶6. (C) Energy officer observed that the sixth condition is highly unlikely to be met. The consultant agreed, and explained that he suggested it for two reasons. First, the power distribution system in the south Caucasus was designed by the Soviets to function as a single unit, and that really is the most efficient way for it to operate. More importantly, the sixth condition is a negotiating tactic. The GOAJ will never agree to integration with Armenia, said the consultant, and will be so focused on removing that condition from the package that they will end up accepting the other five points. Only that kind of extreme tactic, in the consultant's view, will get GOAJ to agree to do what it has refused to do so far, and make the necessary reforms in the domestic power sector -- even when conditions get as bad as he predicts in the coming years. HYLAND