Non-regional Actors, Political Risk and Foreign Direct Investment in Azerbaijani Oil Pipeline Routing Negotiations

Changes in the international political and economic system have fundamentally recast the power that "weak states" have vis-a-vis multinational corporations (MNCs). The spread of neo-liberal institutions and global production methods have altered the balance between "host countries" and foreign MNCs. The end of the Cold War has recast geopolitical and economic alliance and opportunities for foreign-direct investment (FDI) previously unimaginable. Due to this new FDI environment, studies of trans-national infrastructure investment projects are critical for their ability to inform interested parties about the factors influencing investment decisions. Many scholars maintain that "weak states" have little flexibility in policy-making and must accept international dictates without question. Others believe that "weak states" have a significant amount of maneuvering room during extended bargaining sessions with other states and large MNCs.

A fascinating case study of the new bargaining environment for "weak states" is Azerbaijan, which has attracted international attention for its prolific oil and gas. Azerbaijan has been able to leverage its unique geographic and political position to maximize its control of the pipeline bargaining process in the new globalized era. Unusual factors, including its own instability, have allowed Azerbaijan to retain flexibility, power, and freedom in negotiations with MNCs and more powerful states, despite its inherently weak geopolitical and institutional position.

The growing enthusiasm of international actors in these Caspian Basin resources has been dubbed "The New Great Game," evoking comparisons to the international competition for Middle Eastern oil resources between the United States and Great Britain in the mid-1900s. Azerbaijan has been the nexus of new foreign investment activity in the Caspian Basin since early 1991 and is at the geographic center of efforts to export the petroleum resources of the Caspian to growing world markets. The estimates of the amount of foreign direct investment that Azerbaijan will receive in the next ten years vary from six to sixteen billion U.S. dollars. Regardless of the final dollar totals, the country should vie with Kazakhstan for the largest amount of direct Western petroleum investment in the Caspian, and will certainly be at the forefront of regional integration efforts.

Currently, three nation-states and several multinational oil companies have formulated an agreement, brokered by US negotiators, that will construct an approximately US$2 to 4 billion oil pipeline between the oil terminals located outside Baku and the Mediterranean port of Ceyhan, Turkey. Announced at a November 1999 OSCE meeting in Istanbul, Turkey, this route was chosen after an intense competition in which various actors developed and battled for their own "favorite" pipeline projects. Four major routings captured serious international attention during the 1990s: the Iranian-Persian Gulf route, the Baku-Ceyhan mega-pipeline, the short Baku-Georgia Black Sea line, and the northern Baku-Novorossiyk Russian route. Each of these options had significant advantages and disadvantages for the involved parties, but the ultimate construction of the main oil export pipeline will be pivotal for the future of the development of the Azerbaijani state and economy and for the balance of power within the region.

Azerbaijan continues to lie at the heart of a strife-ridden region, whose oil industry has suffered more than six decades of sometimes-benign neglect, yet at times malicious rule by Soviet officials. However, Azerbaijan has begun o position itself to enjoy the benefits of the post-Cold War world. It became the first republic to declare its official independence from the disintegrating USSR and is in a unique position to benefit from an oil bonanza because of its historic orientation to the West. Recently, its government has taken steps to formalize European ties and has also begun discussion of Azerbaijan's application for full NATO membership, despite the country's new Western-leaning policy perspective, strong cultural and religious links with Islamic, Persian Iran.

The newly discovered underwater oil and gas fields off the Azerbaijani coast require Western deep drilling technology if they are to be productively explored. Estimates of the total reserves available in the Azeri-controlled fields vary from less than 10 bbl of oil to over 80 bbl of oil1, but there are four potential routes for the "big oil" still under consideration. These four routes are each plagued by their own geopolitical, ethnic, and economic obstacles, but to the Azerbaijani leadership, the importance of finding an "acceptable" main oil export pipeline is apparent; without one, Azerbaijan will not benefit from the vast resource wealth under its territory.

Azerbaijan has been particularly successful at attracting critical hard currency investment dollars into its petroleum industry. The tenacity of western investors, even in the face of remarkable political and ethnic conflict, says as much about Azerbaijan's marketing efforts as it does about the fearlessness with which the world's oil companies operate. Baku, Azerbaijan's capital, has been transformed into a mini-Dallas by Western MNCs convinced that the future economic prosperity of the region will be critical in tomorrow's global economy. The spectacular wealth that has been created in the state is precarious at best, though, since surrounding states and MNCs wanted to force

Azerbaijan to accept terms potentially more favorable to them than to Azerbaijan.

Azerbaijan has thus far been adept, be it through luck or skill, at maintaining its leverage against MNCs and other state actors by advocating a "multiple routes, multiple pipelines" strategy for main oil exploration, which has created uncertainty about the final oil producing and exporting infrastructure. The most vexing of these questions continues to be the "acceptable" route for the vast supplies of oil that must be shipped to international oil markets. According to Bob Simon of 60 Minutes, the biggest problem with oil pipeline routing in Azerbaijan is its landlocked location:

For the oil companies to make a killing, all they have to do is get the stuff to the west. It's a shame they can't fly it out, because Azerbaijan sits in a very tough neighborhood. An old pipeline to the north goes through war-torn Chechnya; another over there to the west passes near Armenia, which has threatened to blow it up. (Simon, "Baku, Capital of Azerbaijan has a large quantity of oil." Oct. 25, 1998)

Thus, the unique geographic and political position of Azerbaijan is key to understanding how a weak, geopolitically vulnerable state creatively used the new international environment of the 1990s to retain flexibility, power, and freedom in negotiations with MNCs and more powerful states. Azerbaijan effectively leveraged its "multiple pipelines, multiple routes" strategy into bargaining power from 1992 to 1999. Its negotiators used flexible concessions to dissuade state and non-state partners with less politically and economy advantageous routes from demanding participation through force or economic disruption.

Traditional forms of FDI should undermine a politically "weak state," like Azerbaijan, according to traditional FDI theorists, because the state loses bargaining leverage once the investment decision has been made. The size and scope of the energy projects in the Caspian Sea (which may have total oil reserves of the North Sea and Alaska North Slope combined) have allowed Azerbaijan to demand several separate petroleum pipeline projects during the 1990s.

The conscious or unconscious strategy of multiple pipeline flexibility was formalized in 1995 by Azerbaijan and the Russian Federation as the "two-route compromise of October 1995," which required that the "early oil" from the newly developed resources be transshipped through existing Soviet-era pipelines north to Russia and out of the Black Sea. Although the "two-route compromise" implied that at least one new oil export pipeline would be built, the existing early oil pipeline is unacceptably exposed to ethnic warfare in Chechnya and is in need of serious renovation. This exposure to war and political violence is one of many factors that make any potential routing through Russia less than desirable, leading Azerbaijan clearly to pursue new arrangements that alter the spirit and letter of the pipeline decisions implied by the AOIC-Russian pact.

Azerbaijan has attracted investment from Iranian, Russian, Turkish, European, Middle Eastern, and United States-based oil companies, and they all have an interest in exerting influence over the pipeline route selection. Although Azerbaijan does contain some of the oldest exploited oilfields in the world, the magnitude of the new offshore reserves have caused considerable excitement among resource deprived Western MNCs. In order for the MNCs to continue to create shareholder wealth in the future, new reserves are absolutely essential, and their proximity to the growing markets of S. Asia and Eastern Europe only enhances the attractiveness of Azerbaijan's resources.

The companies' "home" countries have also asserted national security interests in maintaining relative control over or expanding access to global petroleum reserves.2 Hydrocarbons power everything from cars to power plants to military hardware and are also a vital ingredient in many of the modern construction materials of today. Despite its critical position in the world economy, oil is a finite natural resource with few accepted substitutes. Since industrialized and industrializing states are profoundly concerned by the access to, availability of, and control over oil resources, Azerbaijan has had the opportunity to play competing state and corporate interests against one another.

Azerbaijan has been itself constrained in its possible pipeline construction options by its desire to join the broader European community of nations. In their attempt to encourage investment, Azerbaijani leaders began preliminary discussions with European organizations that are seeking to expand into the newly independent nations of Eastern Europe. Azerbaijani leaders have recognized that Azerbaijan will not be in the first or even second rounds of this expansion; however, they know that a record of exemplary international behavior would enhance the chances for accession to such European based groups in the future. Azerbaijan hopes that by tying itself to the nations of the West it can find allies with sufficient geopolitical clout to prevent any of it regional neighbors from dominating it militarily or economically. Thus, Azerbaijan's recent leadership has been quite sensitive to the pipeline routing expectations of the United States and Western European countries.

Whether a conscious or unconscious strategy, Azerbaijan's negotiating position in the New Great Game for its oil wealth underwent a remarkable transition during the 1990s. From the first post-dissolution Communist regime to the Popular Front to Heidar Aliyev's authoritarian rule, the method and strategy by which Azerbaijan dealt with the outside actors changed remarkably.

Azerbaijan's inherent structure has been "weak" throughout the recent history. Its institutions remained underdeveloped and the rule of law hardly existed. Political stability does not exist as rumors of Russian intervention or internal opposition swirl around Baku constantly. Yet, in this environment of political uncertainty, policy-makers capitalized on the turmoil to achieve greater concessions from MNCs and regional states. Through periodic reevaluation of MNC agreements, especially at each regime change, Azerbaijan could extract maximum benefit for itself. Negotiators had no choice but to return to the bargaining table to insure continued access to the large resource deposits off the Azeri coast.

While this finding contradicts a good deal of previous literature about the role and position of "weak state" bargaining power in the Cold War, it is notable for the consistency of its application in this case. Each time Azerbaijan descended into political turmoil, the resulting agreement renegotiated with the MNCs and the regional states came out more strongly in favor of Azerbaijan's interest.

However, now that a route has been chosen; albeit not yet fully financed, new regime turmoil could sabotage the future of FDI projects in the Azerbaijani energy sector, and leverage could be lost. The apparent "weakness" of the Azerbaijani state did not prevent it from stabilizing important problems facing the Azeri nation, such as that of the future oil development. The "multiple routes, multiple pipelines" strategy that leaders employed, was more complex than simple advocacy for more than one pipeline route. As negotiators became more sophisticated, they began to provide concessions in lieu of promises of a main export pipeline. These concessions did not always placate the foreign policy or energy apparatus of the slighted government, but it created significant stakeholders in the future of Caspian Sea oil exportation (not just development). By complicating the domestic environment of objecting states, Azerbaijan arrested any momentum for serious international challenges to its development plan.

Geography, so long the curse of Azerbaijan in its energy development dreams, also became more and more of an asset throughout the pipeline routing decision-making process. The larger the discovered reserves got, and the more oil that was likely to be shipped out of the region, the more strongly nations and MNCs vied for influence. This enabled Azerbaijan created a strong alliance of MNC oil companies and financing institutions to lobby their domestic governments for real economic assistance in the construction of a mega-pipeline from Baku. A formally insignificant, weak state was able to use its own political and strategic minuteness to its advantage in the efforts and negotiations to develop the natural resources it possessed.

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End Notes

1 Estimates of oil and gas reserves in the Caspian Sea are very unreliable and closely held. The estimates used in this paper reflect the range given in most reliable journal and journalistic articles. Industry and finance experts believe the true magnitude of reserves will only be known once Western exploration techniques are employed throughout the country and the Basin.

2 See David S. Painter's article, "International Oil and National Security" in Defense & Dependence in a Global Economy edited by Raymond Vernon and Ethan B. Kapstein for a longer discussion of the security implications of oil.