Oil Trade in Azerbaijan After Soviet Union, Research Paper Example

During the early 1900s, Russia underwent a chaotic period in its history. After the last tsar to rule Russia abdicated his throne in March of 1917, following the March Revolution, the country became a free-for-all of power grabbing. For a short time, the Russian Provisional Government took over. In November of 1917, what is now considered the October Revolution took place, led by the Bolshevik leader Vladimir Lenin. This revolution led to a long and bloody Civil War between the pro-Communist Red Army (The Reds) and the anti-Communist White Army (The Whites). The Civil War lasted between 1917 and 1923. On December 30, 1922 the Soviet Union was officially formed, after delegations approved the Treaty of Creation of the USSR and the Declaration of the Creation of the USSR. Despite the official formation, it wasn’t until February of 1924 that the British Empire officially recognized the union. During the same time period, the Soviet Union approved a Constitution.

When the Soviet Union formed, it annexed many smaller countries surrounding Russia. One of those lands happened to be a small region located next to the Caspian Sea that is now known as Azerbaijan. During the time that Azerbaijan was controlled by the Soviet Union, it was not a powerful region. It was used for its plentiful resources, but given no political power to reflect that status. This led to feelings of aggravation and political turmoil in the region during the Soviet rule.

Between August and December of 1991, all of the individual republics of the Soviet Union including Russia itself seceded from the union and declared their own sovereignty. Realizing the inevitable, on December 26, 1991 the Soviet Union officially dissolved. The dissolution of the Soviet Union was fairly peaceful, with President Mikhail Gorbachev handing over the office to Boris Yeltsin along with the Russian missile launch codes.

The dissolution of the Soviet Union birthed a tumultuous time period in the history of the region, with many countries scrambling to establish their place in the world political environment. One of the most interesting of the newly minted countries is Azerbaijan. Azerbaijan was perhaps one of the most successful and lucky of the Soviet Union successor countries. Because Azerbaijan is located next to the Caspian Sea, Azerbaijan has no shortage of oil reserves. These oil reserves have created an economic boom for the small country. Azerbaijan’s oil reserves remain its “trump card” when it comes to relations with surrounding countries.

Despite the fact that Azerbaijan has many advantages as a recently created country with many economic resources, it continued to have difficulties in maintaining stability in the region in the 1990s. Due to the Azerbaijani-Armenian War over Karabakh at the time, thousands were dead or wounded and Azerbaijan had lost a significant amount of its territory. Another consequence was the flood of displaced war refugees. Because of this political instability and challenges to the legitimacy of Azerbaijan as a country, Azerbaijan was haunted as a fledgling democracy. Corruption continued to create division between the rich and poor in the country, and many larger countries continued to force their own interests on the country.

In 1993, the former Soviet Union first secretary Heydar Aliyev showed back up in the political scene, this time in Azerbaijan. Aliyev took the fledgling democracy and turned it into an autocractic society. Although many people consider Aliyev’s post-Soviet reappearance to be simply a play for power (as it may look that way on the surface) there are some that believe Aliyev saved Azerbaijan from dissolution. The Azerbaijan Popular Front was abandoned along with democracy when Aliyev came into power in Azerbaijan, and Azerbaijan began to more closely resemble what it looks like in today’s society. In 2003, oil windfalls began to flood into the Azerbaijani economy. Heydar Aliyev’s son, Ilham succeeded him as president. After two decades under Aliyev rule, Azerbaijan developed into a relatively stable autocratic political system.

Some experts on the subject have suggested that despite Azerbaijan’s willingness to become a democracy, the prominence of oil in Azerbaijan’s economy encourages an autocratic political system. With oil in such high demand, oil rich countries become breeding grounds for those in search of wealth and power. There is no better way to become rich and powerful than to find a resource that is in extremely high demand and exploit it. As such, this has been Azerbaijan’s legacy—as a fledgling democracy, an autocratic regime took over and has prospered due to the oil rich economy of the country. Others state that the autocratic regime that took power had nothing to do with the oil and more to do with the fact that the Azerbaijan Popular Front was simply not experienced enough to deal with the responsibility of running a country and dealing with the Armenian conflict. Whatever the cause, the end result was that instead of a small, young democracy, Azerbaijan became an autocratic nation with rich oil reserves.

Despite the fact that Azerbaijan’s energy produces one third of the country’s Gross Domestic Product, it only provides one percent of the country’s employment. In addition to the tension between Azerbaijan and Armenia, the discrepancies between Gross Domestic Product and employment, and the continuing pressures placed upon the country from the West to become more democratic, Azerbaijan has an even bigger problem. Experts estimate that by the year 2025, Azerbaijan will deplete its oil and gas reserves. With all of the issues that Azerbaijan is facing, along with the threat of a thirty-three percent decrease in Gross Domestic Product, it becomes increasingly apparent that Azerbaijan must do something to reign in the corruption in its government.

When countries such as Azerbaijan are rich in oil, they sell it to make a profit. To do this, they often enter into contracts with other countries. In the 1990s, when Azerbaijan was establishing its independence as a country, it entered into contracts with international oil companies to sell its reserves of oil.

Regarding the oil contracts, it is often beneficial for oil rich countries to renegotiate the oil contracts that they sign with international oil companies later on due to higher profitability margins. Russia and Azerbaijan are polar opposites when it comes to contracts with international oil companies. While Russia has chosen to renegotiate its oil contracts with international oil companies to increase their profits, Azerbaijan has chosen to honor the long term commitments in order to retain their reputation with the international oil companies.

Because both countries still require the connections that the international oil companies provide, one could argue that Azerbaijan has the better idea. It is obvious which country the international oil companies will choose to do more business with when looking at it from an unbiased perspective—if one had to choose between doing business with someone that had reneged on their contract and someone that had honored that contract, the choice would be a very simple one from a business perspective. The international oil companies stand to make more of a profit from Azerbaijan because Azerbaijan honors the long term commitments of the contracts that it signs. That being said, although Azerbaijan may lose money in the short term game, in the long term, they stand to make more profit when the international oil companies continue to do business with them and offer them a better deal from the outset because they know that Azerbaijan will not defect on the deal that it makes to begin with.

Critics of the post-Soviet countries that force renegotiations of oil contracts in the middle of said contracts say that the renegotiations are typical of countries with “weak rule of law.” They also state that the renegotiations are short sighted and politically motivated. With that being said, most of the countries with long term oil contracts have defected and renegotiated their contracts with the international oil companies because of the skyrocketing price of oil. Azerbaijan has resisted the temptation to do so, and it remains unclear whether that resistance is due to a sense of honor or a more long term mindset.

Because of the recent oil boom, the post-Soviet countries are no longer tied down to the international oil companies and can take their business elsewhere if need be. This has a lot of influence on why the oil rich countries are defecting on their long term oil contracts from the 1990s and renegotiating who they trade oil with and for what price. In their eyes, it doesn’t make sense to continue selling billions of dollars of their Gross Domestic Product for mere millions. That being said, most of the oil rich countries that are doing this are not looking at the bigger picture.

The countries that are renegotiating their oil contracts and capitalizing on the benefits are not taking into account how that increased oil revenue is fueling the corruption in their own countries. Many have suggested that there should be a better “policing” of the contract law between international oil companies and the countries that are selling said oil. The idea is that it will cut down on the oil contract renegotiations and keep countries “honest.” That poses the question, though, about what the effect of all of the extra money will do to the international oil companies. There always has to be a trade off when it comes to money. The best option would be to find a balance somewhere in the middle where both sides profit but not in a grotesque manner.

When talking about the oil contracts of the post-Soviet countries, it is imperative that one discuss the 1970s obsolescing bargain model. This model focuses on “the internal political and economic balance of power between the international oil companies and the government over the course of the contract.” What that means is that, in the beginning, the obsolescing bargain model “predicts, oil-rich countries need international oil company investment; thus, international oil companies exploit this powerful position by forcing favorable contractual provisions.” However, after the international oil company makes the investment, there is nothing forcing the oil rich country to honor the investment. At that point in time, it becomes advantageous for the oil rich country to renegotiate the contract.

The international oil companies have to agree to the renegotiation because to do otherwise would lead to a complete loss of their investment. Even though taking a loss in profits through renegotiation is less than ideal, it is better than losing the entire investment through a complete break of the contract. This is the premise of the obsolescing bargain model—as more time passes, the oil rich country will have more reasons to renegotiate the contract, and the international oil companies will have less ground to prevent such renegotiations.

Although scholars have claimed that the obsolescing bargain model is obsolete for some time now, it can currently be observed through the contract renegotiations occurring in the countries surrounding Azerbaijan. Russia is one prime example of a country that has renegotiated its oil contracts for increased profits. The reason that many of these countries are renegotiating their oil contracts is simple—money.

Money is the motivator for many things, especially when one is talking about the political world. Because of the drastic increase in the price of oil, countries are wanting a “bigger piece of the pie.” Another large reason that these countries are doing this is to establish “sovereignty” as a country. They are doing it as a show of power to their people, as if to say that they are still in charge when it comes to their resources. The obsolescing bargain model predicts that while oil prices are high, so are the incentives for the oil rich countries to renege on their oil contracts and force a higher payout to them. Assuredly, if every oil rich country renegotiated their oil contracts, it would not be long before the international oil companies folded and went out of business.

The international oil companies could not afford the massive losses in profitability that would accompany such a large scale renegotiation. That being said, despite all of the reasons that the oil rich countries have that encourage them to renegotiate their oil contracts, many countries have chosen not to renegotiate their oil contracts. This begs the questions—why?

The key to that questions is this—reputations. Many countries refuse to renegotiate their oil contracts for the simple reason that they want to save face and be considered an honorable people. Game theory demonstrates this perfectly—when two players are playing a game, they both have the option of complying with or reneging on an agreement. Although it would be better for both players to comply with the agreement, both players benefit by reneging on one transaction. As the game progresses, however, reputation becomes more important to each of the players. It begins to matter more to the players what their reputation is, rather than just what the concrete benefits are. These same ideas can be translated to the oil industry in Azerbaijan.

For the international oil companies, they will always benefit if they cooperate with the oil rich country. The international oil company has already invested quite a bit of money into the country’s oil industry, and they would like to continue making a profit off of their investment. For the oil rich country, however, it is extremely beneficial to them to cooperate at the beginning of the operation. As time goes on, however, it becomes more profitable to break the contract that they signed with the international oil company and increase the profit margin. Looking at the situation from such a black and white perspective, it is obvious which choice the oil rich country will make.

Until you bring the reputation of the country into the picture. Some countries feel that although it would bring a higher monetary profit margin to renegotiate their oil contract with the international oil companies, they would lose face and their reputation would be tarnished. For many of the smaller countries, their reputation is just as important, if not more important than their profit margin. In many countries, honor is valued above all else, and Azerbaijan is one of those countries. With a strong Islamic population, many Islamists consider a man’s word to be his bond. Thus, Azerbaijan considers their reputation to be more important than the increase in profits that they could earn if they forced a renegotiation with the international oil companies.

In the past, Russian defection payoffs have been high. With increased profit margins from the oil sales, it is very simple to say that Russia was extremely smart in renegotiating its oil contracts. It continues to do business with the international oil companies and makes a much larger profit. Azerbaijan, on the other hand, has not renegotiated any of its oil contracts.

Azerbaijan signed more than 20 oil contracts before the oil boom of the late 2000s, and it has yet to renegotiate even one of those contracts. In fact, it is the complete opposite. Oil companies are abandoning those contracts because they are performing poorly. International oil companies would drill in some of the oil fields in Azerbaijan, find nothing, and abandon the contract, assuming that there was no profit to be made. During a couple of these instances, Azerbaijan has found the oil that the international oil companies missed during their first pass and has made a considerable profit off of the oil that the international oil company walked away from.

As stated before, the stability of the oil contracts in Azerbaijan are not simply a result of mathematical equations. Azerbaijan has carefully weighed the short term benefits against the long term benefits and has made the decision that higher profits in the short term are not worth the reduction in business with the international oil companies in the long term. Azerbaijan, while haunted with political and logistical problems, seems to have the right idea when it comes to economics and oil contracts.

Works Cited

Bishku, Michael. “Azerbaijan Since Independence.” The Middle East Journal (2012): 369-370.

Breyfogle, Nicholas. “Azerbaijan Diary: A Rogue Reporter’s Adventures in an Oil-Rich, War-Torn, Post-Soviet Republic.” Nationalities Papers (1999): 541-543.

Guliyev, Farid. “Oil And Regime Stability in Azerbaijan.” Demokratizatsiya (2013): 35.

Karimov, Rovshan. “Demographic And Economic Development Of Large Cities In Azerbaijan.” International Journal of Business and Social Science (2011).

Partlett, William. “Enforcing Oil and Gas Contracts Without Courts: Reputational Constraints on Resource Nationalism.” Demokratizatsiya (2010): 74-93.