SCENESETTER FOR EEB A/S SULLIVAN'S AUGUST 15-16

C O N F I D E N T I A L SECTION 01 OF 03 BAKU 001011 SIPDIS SIPDIS DEPT FOR EEB AND EUR/CARC; BERLIN PLEASE PASS TO A/S SULLIVAN E.O. 12958: DECL: 08/10/2017 TAGS: PREL ECON ENRG ETRD PGOV AJ SUBJECT: SCENESETTER FOR EEB A/S SULLIVAN'S AUGUST 15-16 VISIT TO BAKU REF: A. BAKU 533 ¶B. BAKU 949 ¶C. BAKU 926 Classified By: Charge d'Affaires Donald Lu per 1.4 (b,d). ¶1. (C) Summary: Your August 15-16 visit to Baku presents an opportunity to advance energy cooperation and showcase Azerbaijan's role as an energy producer and regional transit hub, including growing Trans-Caspian cooperation. With Shah Deniz Phase II gas scheduled to become available for export in 2013 and increased SOCAR gas production, Azerbaijan will have enough gas to fill the TGI pipeline and start the Nabucco project. Azerbaijan is moving ahead on Turkish transit talks, a prerequisite for the Southern Corridor project; it also is exploring new energy cooperation with Turkmenistan. Azerbaijan's booming energy sector continues to fuel strong GDP growth but risks distorting the economy. ¶2. (C) Summary Continued: The Economic Partnership Commission (EPC) is a valuable mechanism to address Azerbaijan's precarious macroeconomic position, and we hope your visit will prompt the GOAJ to implement unmet EPC obligations in the areas of legislative reform and assistance co-financing. Your visit presents a good opportunity to probe Finance Minister Sharifov on his vision for macroeconomic dialogue and possible technical assistance; his involvement and support will be key to any future efforts. Senior GOAJ officials continue to affirm their commitment to Azerbaijan's WTO accession, but their efforts are hampered by a lack of resources and capacity. We expect President Aliyev to issue a decree soon to accelerate WTO accession; it is vital that this decree include the necessary financial resources. Given recent, serious declines in media freedom, it is vital that senior Azerbaijani officials understand that progress in Azerbaijan's democratic development is equally important to the development of our bilateral relationship. End Summary. ENERGY -------------- ¶3. (C) Your upcoming informal energy dialogue with GOAJ interlocutors on energy issues comes after the initial "Energy Diplomacy Dialogue" in February and the subsequent March Energy Security MOU signed by Foreign Minister Mammadyarov and the Secretary in Washington. Your visit will advance bilateral energy cooperation and will be a very visible sign of U.S. support for Azerbaijan's role as a key energy producer and regional transit hub. The Baku-Tbilisi-Ceyhan pipeline is working well, pumping close to 800,000 barrels a day. During President Aliyev's August 7-8 trip to Kazakhstan the two countries signed agreements for strategic cooperation in the oil and gas sector, and Azerbaijan has expressed interest in a new oil pipeline to the Black Sea, in preparation for the increased volumes expected from Kazakhstan. It is hoped that during your visit the USTDA grant proposal for study of a oil and gas pipeline from Kazakhstan to Azerbaijan will be signed. Existing disputes between Azerbaijan and Kazakh energy sector entities on overland oil transportation to terminals in Georgia (with Chevron in the middle) are on their way to an agreed-upon commercial resolution. ¶4. (C) On the gas front, President Aliyev has told us that all Shah Deniz Phase II gas would be available for export to Europe, and that due to SOCAR production increases and decreased domestic gas use, even some SOCAR-produced gas will be available for export. Shah Deniz Phase II gas production is scheduled to start approximately 2013, which means that the GOAJ will have enough gas to fill the TGI pipeline and start the Nabucco project, presupposing a slightly delayed Nabucco starting date. On August 2, the GOAJ signed an Energy memorandum on, inter alia, Azerbaijani support for the Turkish-Greece-Italy interconnector project, and on August 7, Azerbaijan sent a team to Ankara to begin negotiations on the transit of gas through Turkey, the resolution of which is an essential prerequisite for the Southern Corridor project. Shah Deniz gas wells are producing above expectations and as of late July the SCP pipeline system, to include the portion inside Turkey, is functioning. BAKU 00001011 002 OF 003 ¶5. (C) BP, as the major energy operator in Azerbaijan, submitted to the GOAJ in early August an ambitious proposal to extend the length of its Production Sharing Agreement (PSA) for the ACG field and also to access ACG "Deep Gas," not covered by the current PSA. If agreed by the GOAJ, the PSA extension would increase the amount of oil recoverable from the ACG mega-field, making the GOAJ's production and revenue drop-off after 2012 much more gradual. Access to ACG deep gas (estimated to be half the size of the Shah Deniz mega-field) would substantially increase the amount of gas the GOAJ had available for export. ¶6. (C) On the Turkmenistan front, Chevron has opened offices in Ashgabat and is (with GOAJ consent) pursuing development of the Sardar/Kapaz field. Any such development would be joint with the GOAJ, and if achieved would in large measure solve bilateral delimitation issues, even further isolating Iran in its Caspian stance. MACROECONOMIC OVERVIEW -------------- ¶7. (C) Azerbaijan's booming energy sector continues to fuel strong GDP growth (35 percent in the first half of 2007). However, the influx of revenue from the energy sector is beginning to distort Azerbaijan's economy, with inflation approaching 20 percent. Some IFIs believe the real figure may be closer to 30 percent. A recent GOAJ supplemental budget increase of nearly USD 700 million (ten percent of the 2007 budget) indicates that the GOAJ continues to struggle with fiscal policy. A strong local currency is lowering the prices of imports, with negative effects for Azerbaijan's already struggling agricultural sector. Although the State Oil Fund has presented macroeconomic models to key Cabinet officials outlining the risks of unrestrained spending, it is unclear whether senior GOAJ officials have taken this message to heart. The GOAJ is likely to continue to increase government expenditures in the run-up to the 2008 presidential election. Anecdotal reports from Azerbaijani and foreign business contacts indicate that corruption has worsened in recent months (ref a). EPC FOLLOW-UP -------------- ¶8. (C) Given Azerbaijan's precarious macroeconomic situation and critical importance to U.S. interests, the Economic Partnership Commission continues to be a valuable vehicle to press for real reform. GOAJ implementation of its EPC commitments unfortunately has been mixed. We hope that your visit will encourage the GOAJ to take action on its unmet commitments, particularly in the areas of legislative reform and co-financing. The GOAJ has not submitted to Parliament key legislation on Anti-Money laundering and terrorist financing, conflicts of interest, an ethics code for civil servants, or the necessary amendments to the civil code creating criminal liability for corporations/legal persons. We understand that these pieces of legislation still await approval from President Aliyev's office. Submission of these key pieces of legislation to Parliament for consideration in its autumn session would be an important demonstration of the GOAJ's commitment to rule-of-law and serious anti-corruption measures. The GOAJ also has been slow to respond to our proposed structure for the co-financing working group. Although Minister of Finance Sharifov personally does not need to participate in the working group's deliberations, it is critical that he appoint and empower a senior Finance Ministry official to begin substantive discussions with us. ¶9. (C) Your visit also will provide a good opportunity to probe Sharifov on his vision for a broader bilateral dialogue on macroeconomic policy and development. Treasury sent a short-term advisor to Baku earlier this summer, who concluded that the GOAJ lags far behind other post-Soviet republics in the area of government capacity-building. While Sharifov previously has expressed a desire for this type of assistance, his Ministry's track record in working with the current Treasury Budget Advisor (charged with developing a GOAJ budget manual and rationalizing the GOAJ budget process) has been mixed. Building a stronger GOAJ economic decision-making process remains a high priority for this mission, but we need the strong support and involvement of BAKU 00001011 003 OF 003 senior officials such as Sharifov for any possible future assistance programs to be effective. ¶10. (C) On a more positive note, the GOAJ has taken steps to fund and train personnel to maintain the USAID-funded legislative database; has completed all legal procedures required for the Customs Mutual Assistance Agreement to enter into force; and has convened the first meeting of the bilateral telecomm and IT working group. The USG has met all of its EPC commitments, sending Commerce UnderSecretary Sampson to Baku June 4-5, securing funding for a new USDA technical assessment of the agriculture sector (planned for this fall),and organizing a DOE workshop on energy-efficient, earthquake-resistant building materials in July. WTO --- ¶11. (C) Senior GOAJ officials -- including President Aliyev -- continue to affirm their commitment to accelerate Azerbaijan's WTO accessions, but their efforts are hampered by a serious lack of resources and capacity. Since the EPC, the GOAJ has raised its WTO commission to the Deputy Minister level and refocused government efforts to implement WTO provisions. We expect President Aliyev to issue a decree soon to accelerate Azerbaijan's WTO accession, which will include a nine-step roadmap and an announcement of USD 1 million in GOAJ funding to support WTO accession activities (ref b). We have encouraged the GOAJ to spend part of this money on a GOAJ-funded advisor to assist with WTO negotiations, market access offers, and Q&Rs. President Aliyev and reform-minded ministers have stressed that Azerbaijan must join the WTO before Russia in order to avoid problems, a goal that a USAID short-term advisor concluded is possible within two years, as long as Azerbaijan focuses its efforts. It is critical that senior GOAJ officials understand the need to devote serious resources -- including professional advisors -- to its WTO accession efforts. GOAJ co-financing of the new USAID Trade and Investment Program also would be an important sign of the GOAJ's commitment to WTO accession. DEMOCRACY AND HUMAN RIGHTS -------------- ¶12. (C) There has been a steady decline in media freedom over the last 18 months, with a series of attacks on journalists, eight journalists in prison, a growing backlog of defamation cases, and increasingly serious financial difficulties at most of the pro-opposition and government newspapers. Many observers worry that these developments are the result of a deliberate government campaign to squeeze out significant independent voices in the run-up to the 2008 presidential election (ref c). Although President Aliyev and his senior advisors repeatedly affirm their commitment to Azerbaijan's democratic development, they have been reluctant to take concrete steps to address the deteriorating media environment. It is vital that President Aliyev understand that Azerbaijan's continued democratic development is essential to the development of the bilateral relationship. Progress in any one area, whether security cooperation, energy security, or economic and political reform, cannot be separated from our other interests in this strategically important country. LU