Overview (March 2004) - International Law Office

Legal Regime
Government Authorities
Production-Sharing Agreements
Pipelines

Legal Regime

Azerbaijan obtained independence from the Soviet Union in 1991. In the post-independence period it has taken great steps to reform and replace its Soviet-era legislation, with a particular view towards attracting foreign investment in its oil and gas industry, which, while one of the first areas of oil production in the world, was suffering seriously from lack of investment by the time Azerbaijan won independence.

Although there has been discussion in recent years of the possible enactment of an oil and gas law which would provide a framework for exploration and development of the fields in Azerbaijan, draft legislation has not yet materialized. Ionstead, a separate production-sharing agreement (PSA) is concluded for each individual hydrocarbons field and each such PSA represents the highest legal authority for exploitation of that field.

Government Authorities

In Azerbaijan, the state entity responsible for administering PSAs is the State Oil Company of the Azerbaijan Republic (SOCAR). SOCAR has to date been the entity with which participants contract and from which they seek permits under the PSAs.

The Ministry of Fuel and Energy was granted authority over the energy sector by the 1998 Law on Energy and the bylaws of the ministry. In practice, however, all PSA activity is still administered by SOCAR. No change in this regime is anticipated without a presidential decree implementing the provisions of the bylaws of the ministry.

Production-Sharing Agreements

The PSA regime operates effectively as a separate legal regime within Azerbaijan. Once signed, a PSA will be ratified by the Parliament, the Milli Mejlis. This gives each PSA so ratified the status of a law of Azerbaijan. The legal provisions of the PSAs in respect of matters such as tax, customs and employment therefore prevail over the provisions of Azeri law. Tax is levied on a fixed percentage basis, depending on the PSA. Typically, rates vary from 5% to 8%. The format of each PSA is largely the same, with the text in both the English and Azeri languages.

The most significant PSAs in Azerbaijan are currently the Azeri Chirag Gunashli PSA and the Shah Deniz PSA, the first producing oil and the second natural gas. Exploration continues offshore in the Caspian Sea. The Azeri Chirag Gunashli field is a production field from the Soviet era, which modern technology has been able to revitalize and make highly viable once again. The Shah Deniz field, by contrast, is a new find.

SOCAR is a participant on behalf of Azerbaijan under each PSA (carried share) and a SOCAR oil affiliate (a subsidiary of SOCAR) is the participant under the relevant joint operating agreement. In the case of each such joint operating agreement, the exploration and production costs are shared among the participants (excluding the SOCAR oil affiliate, whose costs are borne by the others) according to their participation shares.

All PSAs are subject to resolution of disputes by means of international arbitration. The position of PSA participants has improved in recent years with the ratification by Azerbaijan of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards.

In general, the PSAs have constituted an extremely stable regime for oil companies operating in Azerbaijan.

Pipelines

Historically, all oil produced in Azerbaijan had to be exported through the Soviet Union and, following independence, the Russian Federation. In view of the undesirability of such political and economic dependence on Russia, the post-independence period has seen the rapid construction of pipelines for the export of Azeri oil and gas by alternate routes.

Currently there are two pipelines in operation: the Northern Route between Baku and Novorossisk (Russian Federation), and the Western Route between Baku and Supsa (Georgia).

With both increased production and demand, the Main Export Pipeline is now under construction with documentation for a multi-billion dollar financing being signed on February 3 2004. The pipeline runs from Baku via Tbilisi in Georgia to Ceyhan on the Mediterranean coast of Turkey.

The Main Export Pipeline will be accompanied as far as Erzurum in Northeast Turkey by the South Caspian Pipeline, which will transport natural gas produced in the Shah Deniz field for consumption in the growing Turkish domestic market.

Each of the existing pipelines operates under a legal framework based upon inter-governmental agreements together with host government agreements. The Like the PSAs, the Azerbaijan host government agreement, having been adopted with the status of a law of Azerbaijan, constitutes a separate legal regime for the construction, financing and operation of the pipelines. Specific provision is made for matters such as tax and customs.

With the hydrocarbon-rich Central Asian states Kazakhstan and Turkmenistan in an even more inaccessible position for the export of oil and gas, Azerbaijan has been perceived as a potential energy corridor of the future.

For further information on this topic please contact Benjamin Paine at Ledingham Chalmers by telephone (+994 1293 6669) or by fax (+994 1298 7132) or by email (Benjamin.Paine@LedinghamChalmers.com).