U/S JEFFERY MEETS WITH KEY AZERBAIJANI MINISTERS

C O N F I D E N T I A L BAKU 000446

SIPDIS

E.O. 12958: DECL: 05/13/2018
TAGS: ECON EFIN PREL PGOV AJ
SUBJECT: U/S JEFFERY MEETS WITH KEY AZERBAIJANI MINISTERS
AND ENERGY EXECUTIVES

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


1. (C) SUMMARY: During an April 22 visit to Baku, Under
Secretary for Economic, Energy, and Agricultural Affairs and
Coordinator for International Energy Affairs Reuben Jeffery
III discussed with the Foreign Minister and State Oil Company
president the importance of gas transit and securing Caspian
regional gas for export to Europe. Private energy companies
also spoke to Jeffery about the difficulties of operating in
Azerbaijan. The Minister of Finance and Oil Fund Executive
Director told U/S Jeffery about Azerbaijan's efforts to
modernize Azerbaijan while saving for future generations.
END SUMMARY.

FOREIGN MINISTER STRESSES ENERGY COOPERATION
--------------


2. (C) Foreign Minister Elmar Mammadyarov stressed that
Azerbaijan's successful development of its energy resources
was due to strong cooperation with the United States, and
sought continued U.S. assistance as Azerbaijan develops new
gas resources and export routes to Europe. Mammadyarov
commented that Azerbaijan's energy policies had strengthened
Azerbaijan's sovereignty, independence, and regional role.
He questioned EU support for new Caspian energy projects,
adding that Berlusconi's election could put the
Turkey-Greece-Italy interconnector in question. However,
negotiations with the Turks on gas transit arrangements were
moving in a positive direction, as the Turks were
reconsidering their position on the 15 percent netback
proposal which Azerbaijan opposes.


3. (C) Mammadyarov was positive about Azerbaijan's growing
relationship with Turkmenistan. He confirmed that Turkmen
President Berdimuhamedov would travel to Baku next month and
the GOAJ was hopeful that the visit would result in "good
progress" on new Trans-Caspian energy projects. Azerbaijani
Deputy Foreign Minister Khalaf Khalafov will travel to
Turkmenistan during the week of April 28 for preparatory
talks. The GOAJ hopes to press for cooperation on offshore
projects, leaving agreement on a median line for Caspian
delimitation to "later." He added that Azerbaijani-Turkmen
agreement on Caspian delimitation would solve "all problems"
with respect to Iran's Caspian claims. Asked what more the
U.S. can do to support Azerbaijan-Turkmenistan cooperation,
Mammadyarov said nothing for the moment. Mammadyarov
promised to brief the U.S. following Berdimuhamedov's visit
to Baku, noting that Azerbaijan's fledgling cooperation with
Turkmenistan was "very sensitive and fragile," although
moving the right direction.


4. (C) Mammadyarov said that development of non-energy
sectors was critical for Azerbaijan's long-term prosperity.
Azerbaijan is using its estimated USD 70 billion in energy
revenue for much-needed infrastructure and regional
development projects. Mammadyarov agreed that improvements
in Azerbaijan's business climate were needed to attract
foreign investment, and stressed that he wanted more U.S.
companies to work in Azerbaijan. Mammadyarov also agreed to
look into U.S. company Cargill's long-standing commercial
dispute (and subsequently instructed his aide to follow-up).
He commented that U.S. company Bechtel's trans-national
highway proposal was "extremely expensive," adding that
Korean companies were prepared to build roads at half the
price. However, the Bechtel project is "still under
consideration."

MINISTER OF FINANCE
--------------


5. (C) Finance Minister Sharifov provided an overview of
Azerbaijan's macroeconomic conditions, noting that increased
global commodity prices were affecting consumer prices in
Azerbaijani. Sharifov said that Azerbaijan's National Bank
was going to change its exchange rate policy and peg the
Azerbaijani manat to a basket of currencies from its primary
trading partners. Sharifov hoped that this adjustment would
allow the manat to appreciate slowly and dampen inflationary
pressures. Sharifov also hinted that the GOAJ would trim
expenditures in order to keep overall prices down, although
he argued that Azerbaijan was using its capital expenditures
(approximately USD 4.6 billion in 2008) to modernize and
build critical infrastructure. Sharifov also noted that the
GOAJ is working on a supplemental 2008 budget and that the
2009 budget expenditures will total approximately USD 13
billion. Sharifov said that Azerbaijani commercial banks
were borrowing from international markets and argued that it
was important to match monetary supply with increased demand,
noting that "internal problems" (monopolies) dampened demand.
Sharifov recognized that inflation is a tax on the poor and
reiterated that the GOAJ is working to combat rising prices.


6. (C) Sharifov said that the GOAJ is keen to continue the
economic dialogue, noting that the Economic Partnership
Commission (EPC) is a valuable forum and that Azerbaijan is
looking to expand its economic cooperation with the U.S.
Sharifov explained the reasons for postponing the EPC, noting
time constraints and the supplemental budget deliberations.
Sharifov said that the EPC should be re-scheduled for a
convenient time in June. He said that the GOAJ wanted to add
new agenda items, such as repeal of the Jackson-Vanik
amendment, in order to make the dialogue a "two-way street."
Sharifov told U/S Jeffery about the government's plans to
fund, through the Oil Fund, Azerbaijani students' studies
abroad. He said that GOAJ had formed an education
commission, chaired by Presidential Chief of Staff Ramiz
Mehdiyev, to review selection guidelines and procedures.


STATE OIL FUND
--------------


7. (C) State Oil Fund (SOFAZ) Executive Director Shahmar
Movsumov briefed U/S Jeffery on SOFAZ's mission, operations
and future plans. Movsumov said that SOFAZ currently had USD
3.5 billion in assets, adding that in 2008 SOFAZ would
receive approximately USD 12 billion and in 2009 USD 15-17
billion in energy revenues. Movsumov stated that in May 2008
SOFAZ expected to receive USD 1.5 billion in revenue inflows,
its largest monthly inflow ever. In the next five years,
SOFAZ expects to receive between USD 100-120 billion in
revenues. Movsumov told U/S Jeffery that 97 percent of
SOFAZ's revenues comes Azerbaijan's share from the sale of
Azeri-Chirag-Guneshli profit oil. He explained that the ACG
operator, BP, sells the oil on behalf of the Azerbaijani
State Oil Company and the proceeds are transferred to SOFAZ.


8. (C) Movsumov said that the fund's assets were invested in
50 percent U.S. dollar denominated assets and 50 percent in
non-U.S. assets, including Euros, Sterling pounds and other
sovereign and corporate debt issuances. Movsumov said that
SOFAZ would begin investing in equities in 2009, adding that
SOFAZ would need to use external asset managers for its
equity investments. Currently, SOFAZ manages 95 percent of
its portfolio internally, and uses three international money
managers to invest the remaining 5 percent of SOFAZ assets.
Movsumov noted that SOFAZ has its own research and analysis
team for its fixed income investments.


9. (C) In order to prepare itself for these massive energy
revenue inflows, Movsumov stated that SOFAZ had been working
to improve its personnel's knowledge and skill capabilities
through various trainings. In addition, SOFAZ noted that the
U.S. Trade Development Agency had also been providing
on-going technical assistance through a series of grants
which had resulted in a stronger institution. Movsumov
briefed U/S Jeffery on SOFAZ-funded national projects,
including several water infrastructure projects and the
Government of Azerbaijan's plans to fund studies abroad for
Azerbaijani students.


10. (C) Noting its transparency and number of annual and
quarterly reports, Movsumov told U/S Jeffery that Azerbaijan
was a leading country in the Extractive Industries
Transparency Initiative. Movsumov said that Azerbaijan was
the first country to prepare full EITI reports. Turning to
the current debate on sovereign wealth funds, Movsumov said
that Azerbaijan wanted to contribute to the current
discussion and that SOFAZ would always invest based on return
and not political agendas. Movsumov cautioned that expanding
the EITI-concept to other parts of the supply chain, an idea
proposed by the World Bank, could dilute the impact of EITI
and have potential negative results.

SOCAR
--------------


11. (C) In a meeting that was severely truncated due to an
earlier-than-expected meeting with President Aliyev (septel),
SOCAR President Abdullayev said the recent gas sales
agreement with Georgia would supply enough GOAJ gas for
Georgian demand for this year and the next. On Shah Deniz
Phase Two (SD2) gas sales, SOCAR was negotiating with the
various commercial entities involved with the major pipeline
projects (TGI, TAP, Nabucco). The two major issues in the
way of SD2 gas sales to Europe were agreement with Turkey on
terms for transit of Azerbaijani gas and the EU's gas
marketing restrictions. Abdullayev said that "SOCAR was
ready" for gas sales; it was Europe and the EU that were
dragging their feet. For example, SOCAR had told the Nabucco
consortium in 2006 that it was ready to sell it 4 billion
cubic meters annually, and SOCAR Vice-President Elshad
Nasirov was negotiating with the EU so that Azerbaijan could
sell directly to Europe. On Azerbaijani energy sector
development, Abdullayev said that Azerbaijan had two trillion
cubic meters of proven gas reserves and additional unproven
reserves. SOCAR had a "major gas program" to develop these
resources, to include exploratory drilling at the "Umid"
offshore field starting before the end of 2008.

DINNER WITH ENERGY EXECUTIVES
--------------


12. (C) Executives from BP, Hess, Chevron, and ExxonMobil
discussed the difficult business environment, Azerbaijan's
relationship with its neighbors, and the importance of
ensuring security for energy transportation. Chevron's
Country Manager said the GOAJ's attempts to squeeze more
money out of the larger energy companies despite previously
agreed to PSAs, is problematic and sets a bad example for
other companies looking to do business in Azerbaijan.
Corruption and the conflict of interest of many high-ranking
GOAJ officials make it even more difficult for smaller
companies or sub-contractors working for the Azerbaijan
International Oil Company (AIOC) operators. The executives
contrasted the high level of corruption in Azerbaijan with
Georgia, where they said corruption is lessening. While the
executives agreed that the lack of institutional capacity
means that some orders from top GOAJ officials are not always
correctly carried out at the working level, they cited
examples like SOCAR's newly purchased company plane as an
example of how high-ranking GOAJ officials set a bad example
for spending and corporate governance. COMMENT: SOCAR
justifies the plane, according to SOCAR VP Nasirov, as
supporting Azerbaijan's intensified energy diplomacy in
Europe and the Caspian.


13. (C) The executives noted that Azerbaijan faces a complex
regional position. So far, they said, Azerbaijan has been
willing and able to resist Russia's energy pressure, but has
not gone so far as to build strong mutual ties with other
neighbors. Although the GOAJ was disappointed by a perceived
lack of gratitude for its decision to supply Georgia with
gas, one executive noted that the GOAJ had been willing to
help because it could pass the cost along to the companies
operating in Azerbaijan. The executives argued that
Azerbaijan could learn an important lesson about ensuring
that democratic institutions are strengthened to prevent
society from turning to the institution it does have --
religion. One executive noted that despite Iran's thin
veneer of piousness and anti-American sentiment, many people
are not deeply religious and harbor no personal ill will
towards America and the West where many now have family
members living. ExxonMobil's Country Manager pointed out
that there is little cooperation between Kazakhstan and
Azerbaijan despite the fact that both could benefit from
working together.

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


14. (C) U/S Jeffery's visit to Baku underscored the USG's
commitment to working with Azerbaijan as an economic and
energy partner. The GOAJ is moving in the right direction on
many fronts, especially in regard to its energy policy, its
relationship with Turkmenistan and transit discussions with
Turkey. Azerbaijan needs to do more, however, to promote the
broader economic reforms -- particularly in the non-energy
sector -- necessary to ensure its long-term, sustainable
development. Finally, Minister Sharifov's commitment to the
EPC is positive, but while GOAJ officials regularly say the
right things, concrete steps are needed to improve the
business climate.


15. (U) U/S Jeffery cleared this cable.
DERSE