AZERBAIJANI FINANCE MINISTER ON EPC, CO-FINANCING,

C O N F I D E N T I A L SECTION 01 OF 03 BAKU 000446

SIPDIS

SIPDIS

E.O. 12958: DECL: 04/18/2017
TAGS: ECON EFIN EAID EPET ENRG AJ
SUBJECT: AZERBAIJANI FINANCE MINISTER ON EPC, CO-FINANCING,
UTILITY SECTOR REFORM AND GAS TO EUROPE

Classified By: AMBASSADOR ANNE E. DERSE PER REASONS 1.4 (B,D)


1. (C) SUMMARY: Ambassador Derse called on Finance Minister
Sharifov April 14 to discuss next steps for the Economic
Partnership Commission, including the creation of the
Co-Financing Working Group and a proposed June DVC with A/S
Sullivan. Sharifov said that upon receipt of the U.S.
Proposal for a Co-Financing Working Group, the Government of
Azerbaijan (GOAJ) would respond and organize its ministerial
participation. Sharifov told the Ambassador that the
Ministry of Finance is reviewing the terms of reference for
the U.S. Treasury's budget advisor and may have additional
duties for her to perform. Turning to budgetary issues,
Sharifov stated that GOAJ plans to use the supplemental
budget to fund the budget shortfall at government ministries
and agencies that resulted from the January price increases.
Sharifov said the January price increases were part of a
broader GOAJ effort to reform utilities, including the
domestic energy market, and outlined plans for further energy
reforms and new power generation projects. Sharifov said
that a transit agreement with Turkey is critical to
Azerbaijan's future sales of gas to Europe; a sale without
the transit agreement could set a precedent with Turkey and
undervalue any future gas sales. During his recent trip to
Hungary, Sharifov said he sent clear messages that Azerbaijan
is interested in participating in the Nabucco gas line and
would have 4.5 bcm available in 2012 for the pipeline.
Sharifov told the Ambassador that Azerbaijan needs to take
its own energy security concerns into account and that the
country's domestic needs come first. END SUMMARY.


2. (C) Ambassador met with Finance Minister Sharifov April 14
to discuss Economic Partnership Commission (EPC) next steps,
including the formation of the Co-Financing Working Group.
USAID Country Coordinator and EconOff accompanied the
Ambassador to the meeting. Sharifov briefed the Ambassador
about his recent trip to Turkey for a meeting of the Economic
Cooperation Organization meeting. The Ambassador told
Sharifov that the first digital video conference (DVC) with
EEB Assistant Secretary Sullivan to discuss EPC progress
could happen in mid-June, depending upon Sullivan and
Sharifov's schedules. Sharifov indicated that mid-June would
be a good time and an opportunity to announce the creation of
the Assistance Co-Financing Working Group.


3. (C) Regarding the Ambassador's inquiry on the status of
the U.S. Treasury budget advisor and the position's updated
terms of reference (TOR),Sharifov said that the Finance
Ministry was still working on the TOR and would likely have
additional areas it would like the budget advisor to cover.
Sharifov added that he would expedite an answer to the
Ambassador's December 2006 letter. Turning to the
medium-term economic framework, Sharifov said that inflation
was the largest challenge for the GOAJ. He stated that first
quarter inflation totaled 16.6 percent, with four to five
percent attributable the January increase in tariffs.
Sharifov said that the GOAJ would soon implement
anti-inflation measures, including budget and fiscal
discipline, capital account liberalization and hard currency
liberalization. Sharifov cautioned that liberalization could
lead to an increase in foreign exchange speculators being
attracted to Azerbaijan, aggravating the economic situation.
(COMMENT: In view of the important link between inflation and
economic growth, it is encouraging that the GOAJ is beginning
to recognize the growing inflationary pressures and its
possible negative effects on the economy.)

CO-FINANCING WORKING GROUP
--------------


4. (C) The Ambassador raised the Co-Financing working Group,
a key outcome from the EPC in February, and requested
Sharifov's input on possible GOAJ members. Sharifov told the
Ambassador that the Ministry of Finance had not yet received
from the relevant ministries and agencies the co-financing
budget estimates for implementation of AID projects.
Sharifov said that the Finance Ministry needed to know how
much the GOAJ's part of the co-financing would total and what
kind of projects would be implemented. From the Ambassador,
he requested USG views on the establishment of the working
group, noting that it would not be a problem for the GOAJ to
organize ministerial participation. Sharifov told the
Ambassador that he would officially request by letter this
week additional details regarding the working group,
including U.S. leadership and a list of participants. Upon
receipt of the U.S. response, Sharifov stated that he would
organize the first official meeting of the working group.


BAKU 00000446 002 OF 003


SUPPLEMENTAL BUDGET
--------------


5. (C) Sharifov told the Ambassador that the GOAJ would use
the supplemental budget (planned for June) to increase budget
allocations at government ministries and institutions to make
up for the increase in prices and utility tariffs. The
January increase in electricity, gas, water and gasoline
prices has depleted the operating budgets at many ministries.
Sharifov noted that the supplemental budget was not linked
to the government's need for additional revenues and that the
government was not going to "pour money" into the budget.
Sharifov said that the GOAJ subsidized the utility bills of
internally displaced persons, adding that the GOAJ was
examining ways to "educate" IDPs in conserving and saving
electricity and water.


6. (C) Sharifov stated that the increase in utility prices
was an important step in the reform of the utility sector,
especially the electricity sector. He admitted that the
local population did not "accept" enthusiastically the price
increases, but he noted that the amount of cars on the street
remained the same despite the increases. Sharifov argued
that the increase in prices would force Azerbaijan to use its
natural resources more efficiently. He highlighted Iran's
gas coupon system as an example of a bad policy. Sharifov
stated that government ministries and offices needed to be
more "thrifty" and not waste the government's money or
resources.

ENERGY SECTOR REFORM
--------------


7. (C) Sharifov stressed the importance of the market
dictating the price of electricity. He stated that power
generation in Azerbaijan was now feasible and that with new
tariffs the electricity distributors could make money. At an
April 13 Cabinet of Ministers meeting, President Aliyev noted
that GOAJ utility subsidies totaled more than USD 1.4 billion
per year and that the economy needed to conserve more.
Sharifov briefed the Ambassador on the GOAJ's new electricity
tariff system, highlighting the creation of a uniform tariff.
He said that the tariff increases "were inevitable" and not
an "easy decision." He added that the President had the
political will to take the tough step of increasing prices in
order to develop a market basis for the sector.


8. (C) Sharifov also said that at the April 13 Cabinet
meeting, President Aliyev stressed that the GOAJ needed to
ensure energy security in power generation. Azerbaijan needs
to provide sufficient domestic capacity to power the
expanding economy. Sharifov detailed to the Ambassador the
current energy generation projects, including the
commissioning of five modular power units, the north power
station, a 500 megawatt power plant in Sumgayit and the
rehabilitation of the Mingeshevir power station. Sharifov
said that a new power station would be built in Alibayramli
as the current station consumed too much fuel oil.


9. (C) Sharifov stated that Azerbaijan was interested in
attracting independent power generators to Azerbaijan to
supplement domestic generators, noting that several Asian
companies have already expressed interest. He stated that to
faclitate direct foreign investment, however, the GOAJ would
need to pass a new law on electricity regulation to create
the legal grounds to finalize reform. The Ministry of
Finance is already working on a draft power and electricity
sector reform law which will cover the following areas: power
generation, high voltage infrastructure and distribution.
The GOAJ would like to create a stand-alone power distributor
that would be independent from the power grid. Sharifov
stated that the private power stations would be able to sell
their electricity to the state-owned power distributor, thus
creating a market benchmark and maximizing power distribution
and usage.


10. (C) Sharifov outlined to the Ambassador the problems with
the current utility system, noting the "no payment" cycle
that flows from customers to distributors to generators to
the State Oil Company to the Ministry of Taxes and finally to
the budget. Non-payment of utility bills, according to
Sharifov, decreases revenues to the state budget. Reforming
the sector, including providing customers with pre-payment
electricity cards to avoid the problem of irregularities in
metering and payments, would help eliminate payment
delinquencies. Sharifov recognized that the GOAJ needed to
provide citizens and businesses with reliable public services
but underscored that these services could not be "free."

BAKU 00000446 003 OF 003




11. (C) Upgrading current energy infrastructure is critical,
according to Sharifov. Upgrading transmission lines and
power substations and increasing collection efforts could
save the GOAJ more than USD 200 million in lost kilowatt
hours. The GOAJ also needs to change the mentality of users
and the collectors with the goal of instilling a new culture
of conservation and maximizing of natural resources.
Sharifov noted that after the increase in prices in January,
electricity usage dropped by more than six percent, adding
that it was good the population was saving electricity.

GLOBAL ENERGY ISSUES
--------------


12. (C) Sharifov told the Ambassador that obtaining a transit
agreement with Turkey was critical to Azerbaijan's future
sales of gas to Europe and now was the time to put momentum
into the effort. He said that Ambassador Aleskerov, the new
GOAJ energy ambassador, would take the lead in negotiating
the transit agreement with Turkey. Sharifov said that Turkey
and Azerbaijan need to start talking. Sharifov said that the
GOAJ should not rush to sell gas to Greece without a transit
agreement with Turkey. Sharifov is concerned that a sale
without the transit agreement could set a precedent with
Turkey that Azerbaijani gas could be sold in other ways than
transit and possibly undervalue any future gas sales.
Sharifov highlighted that Turkey wants to resell gas and that
it has a relationship with Gazprom. Sharifov stressed that
the GOAJ does not want to spoil any long-term strategic
energy sales by tactically rushing to sell gas to Greece.


13. (C) Sharifov stated that during his recent trip to
Hungary, he sent clear messages that Azerbaijan is interested
in participating in the Nabucco gas pipeline. In addition,
Sharifov stated that SOCAR has told OMV that it will have 4.5
bcm available in 2012 for the pipeline. Sharifov stated that
Azerbaijan needs to allocate gas for Europe and that a
trans-Caspian pipeline with Kazakh and Turkmen would also
increase the amount of gas available to
Europe.


14. (C) Sharifov told the Ambassador that Azerbaijan needs to
take its own energy security concerns into account and that
the country's domestic needs come first. He stated that
Azerbaijan plans to build from scratch a new petrochemical
industry, to replace Azerkimia, and that based on the almost
completed feasibility study done by a U.S. company, the
petrochemical plant would pay the same price for the gas as
Europe, but without any of the side costs, such as transit
fees. (NOTE: The feasibility study for the new plant is
scheduled to be released in early May. The Azerbaijani
Investment Company is a major shareholder in the project.
The total project is reportedly worth more than USD 1
billion). The petrochemical plant in the first stage would
consume 1.2 bcm per year and would eventually consume 2.2
bcm. To support his argument that Azerbaijan needed to keep
more of its gas, Sharifov reiterated to the Ambassador that a
strong domestic economic situation in Azerbaijan would
translate into a strong U.S. partner in the region.

COMMENT
--------------


15. (C) Sharifov's comments regarding the government's
planned anti-inflationary measures is a welcome step towards
focusing on a growing economic issue and may translate into
more disciplined fiscal and monetary policies in the future.
Sharifov's description of overall reform in the utility
sector, especially in electricity distribution and
generation, is important in enabling market forces to set
correct prices in support of the growing economy. The GOAJ's
willingness to proceed with co-financing of assistance and
seeking USG advice and thoughts on co-financing next steps
demonstrates the growing political will to develop this new
option for sustainable economic development. Sharifov's
commitment to advance talks with Turkey on a gas transit
agreement is good news and Embassy will monitor the
discussions closely.
DERSE