A carefully crafted political course that involved the adoption by Azerbaijan of a neutral multi-vector foreign policy had helped stabilize the situation in the country and in the South Caucasus after a series of military conflicts that preceded and immediately followed the dissolution of the USSR. This stability had helped to attract international investors to enter the country’s oil and gas industry, thus enabling the creation of a new trade route that, although flanked by Russia to the north and Iran to the south, made its way from Azerbaijan to Georgia and Türkiye, ensuring stable, uninterrupted supplies of hydrocarbons to Europe and other international destinations for decades to come.
The steps taken by Azerbaijan were an important prerequisite for strengthening its political and economic viability, but these efforts alone would hardly have borne fruit if conditions had not developed in international crude oil markets in the 1980s and 1990s that contributed to the emergence of a strong interest on the part of major international companies in investing in hydrocarbon reserves in the post-Soviet space. And if, on the other hand, the outgoing leadership of the USSR, and subsequently independent Russia, Azerbaijan and the Central Asian states, had not had to face a deep economic crisis, which prompted them to seek international partners to jointly develop their countries’ natural resources.
Crude oil market trends that shaped international investments in Russian and Caspian reserves
In the 1980s and 1990s the large vertically integrated oil and gas companies representing the countries of the collective West were going through difficult times.
Problems began to accumulate with a series of oil asset nationalizations that swept across countries such as Algeria, Iran, Iraq, Libya, Saudi Arabia, Nigeria, Qatar and Venezuela in the 1970s. Partial or complete nationalizations led to the write-off of reserves and production volumes from the oil companies’ balance sheets. Alongside these developments, the companies’ holdings in Alaska and the North Sea were already in decline. As a result, the oil majors experienced more than a 50% decline in oil production from reserves they controlled.
This created a situation where majors became important net buyers of crude oil after a long time of being vertically integrated sellers of their equity volumes to their own refineries. While oil majors were denied access to vast reserves across the globe, nationalized state oil companies from developing countries and the USSR entered the international oil market as major competitors and sellers of crude, supported by previously minor Western players such as Occidental, Marc Rich + Co. AG and other newly formed trading companies such as John Deuss’s JOC.
The silver lining for the oil majors in this situation was that the tight oil market conditions of the early 1970s, followed by the 1973–74 oil embargo, the Iranian revolution and the Iran–Iraq war, led to a 15-fold increase in crude oil prices. However, Western industrialized economies soon responded with policies aimed at reducing dependence on crude oil in favor of coal, natural gas, and nuclear energy. These measures led to a sharp drop in oil prices in the mid-1980s, which continued into the 1990s.
The combined effect of falling oil prices and declining reserves forced the international majors to undertake a series of mergers within the industry, which allowed them to pool the reserves they still controlled into larger entities and restructure the companies by reducing their operating costs, or to channel capital expenditures into lower-margin business segments whose characteristics were, to some extent, compatible with the management and operating models of the oil companies (e.g. coal, packaging, retail).
The only sustainable long-term solution to this industry crisis appeared to be an attempt to penetrate markets with high exploration potential that had previously been considered inaccessible for political, economic, operational or legal reasons. At the top of the list of such country destinations was the Soviet Union, whose reserves had been closed to foreign investors for almost six decades, but were prized the world over.
Rationale for partnering with international oil majors on the part of the energy-rich post-Soviet states
By the mid-1980s, the USSR and the Warsaw Pact countries had accumulated structural weaknesses in their governance model, experienced a decline in overall economic performance, lower industrial and agricultural productivity, a growing technological gap with the West and increased dependence on foreign borrowing. The fall in global oil prices and rising military spending further complicated this situation. The end of the planned economy and the opening up of the USSR were intended to address these issues.
The first stages of commercial negotiations with Western majors to develop oil and gas fields in the Soviet republics of Russia, Kazakhstan and Azerbaijan took place during the Perestroika era and were aimed at attracting large-scale foreign investments and gaining access to advanced technologies and engineering solutions in areas where the USSR’s experience was limited. The projects identified for joint development included hard-to-recover reserves of supergiant fields located off the coast of Sakhalin Island and on the Caspian Sea shelf of Kazakhstan and Azerbaijan.
Azerbaijan, once the center of the oil industry of the Russian Empire and later the Soviet Union, had seen its role diminish after 1967 as its onshore oil reserves declined and priority was given to developing fields in Siberia. The slow but steady decline continued until the 1990s, when the remaining oil and gas output amounted to only 1-2% of the total Soviet production. The involvement of international majors could radically change the situation. In a world where giant oil fields were increasingly rare, several proven, development-ready mega-fields remained untapped in the Azerbaijani section of the Caspian Sea shelf.
The subsequent dissolution of the USSR made the former Soviet republics owners of the resources located within their borders, capable of directly negotiating with foreign governments and investors. At the same time, the economies of the newly independent states spiraled down into a deep crisis. Attracting foreign capital in exchange for access to natural resources (not just oil and gas) became one of the main sources of macroeconomic stability, especially for smaller post-Soviet states which experienced hyperinflation and deindustrialization.
Hydrocarbon reserves located on the Caspian shelf were not yet connected to the main oil and gas pipeline system of the USSR. Thus, the central issue in the negotiations between oil majors and post-Soviet states became the construction of new privately owned transport infrastructure – an approach actively promoted by the US government, which supported the creation of a private oil and gas sector in Russia and a new transport corridor for the export of Caspian hydrocarbons that would cross Türkiye, bypassing Russia and Iran.
The Contract of the Century in Azerbaijan and oil and gas mega-projects in Kazakhstan
Since the beginning of the negotiation process, a pattern emerged whereby international majors tended to negotiate in parallel with Moscow on projects in Russia and with the governments of Azerbaijan and Central Asian states on projects in these countries. Foreign investors sought presence in both markets: Russia possessed resources of such magnitude that majors could not afford not to be present there, while the Caspian region included countries that also owned significant resources and whose markets were easier to penetrate.
Given the strategic importance of the oil and gas sector, the talks were heavily influenced by foreign policy considerations. As noted in the previous article, the West prioritized relations with Russia, encouraging its pro-Western orientation and fast-tracking liberal reforms. In parallel, it sought to strengthen the viability of the Caspian states by limiting their dependence on Russia’s “iron umbilical cord” of oil and gas pipelines, so as to prevent the re-emergence of Russia’s hegemonic power. Another strategic goal of the US was to prevent the creation of infrastructure that could transport Caspian resources to the Persian Gulf or the Indian Ocean via Iran.
After several years of complex negotiations, which transcended changes of governments and military conflicts in Armenia, Azerbaijan, Georgia, and the Chechen war in Russia, the following panorama of joint projects emerged in the Caspian region in the second half of the 1990s:
Three international consortiums were formed in Kazakhstan to develop three mega-projects: the Tengiz, Kashagan and Karachaganak fields. US companies collectively took the leading role in these projects that required investments of several tens of billions of US dollars, followed by Eni and the Royal Dutch Shell, with Kazakhstan retaining a minority participation stake.
Russia’s privately owned Lukoil also received a minority stake in the upstream, but the Russian state secured the construction of the Caspian Pipeline Consortium (CPC) oil pipeline through its territory by foreign investors, which transports more than 80% of all crude produced in Kazakhstan to Russian Black Sea port infrastructure. Russia also retained control over the transportation of natural gas exports from Central Asia through its state-owned gas pipeline infrastructure until China’s CNPC entered the region in the mid-2000s.
On the western side of the Caspian Sea, a consortium led by BP, comprising the State Oil Company of Azerbaijan (SOCAR) and nine other foreign companies from six countries was created to develop three giant Azeri, Chirag and Gunashli (ACG) fields, named the “Contract of the Century”.
Unlike Kazakhstan, Azerbaijan proved to be “a low-hanging fruit” in terms of building transport infrastructure bypassing Russia. Initially, two smaller-size Soviet pipelines were refurbished to transport equal quantities of “early oil” production through Russia and Georgia. Subsequently, the Baku-Tbilisi-Ceyhan (BTC) main export pipeline was built through Georgia and Turkiye by an international consortium also led by BP to export the lion’s share of Azerbaijan’s oil. The war in Nagorno-Karabakh ruled out a pipeline route through Armenia, while military conflicts in Georgia shifted the country’s foreign policy away from Russia, paving the way for the BTC pipeline route.
Iran was denied participation in ACG, and its proposal to transport crude to the Persian Gulf was rejected. As leverage, Iran laid claim to the ACG and other offshore fields due to the unresolved delimitation of the Caspian Sea shelf. In 2000, BP had to recall its vessel exploring the Araz-Alov-Sharg acreage after an Iranian gunboat threatened to open fire on it. In 2016, SOCAR and its foreign partners decided to abandon this project.
In summary, taking into account all megaprojects with foreign participation in the Caspian, approximately equal quantities of oil exports passed through Russia – the CPC from Kazakhstan plus one “early oil” pipeline from Azerbaijan, and bypassing Russia – the BTC plus another “early oil” pipeline, both from Azerbaijan. Proposals to build large-scale infrastructure that would transport oil from Kazakhstan and gas from Turkmenistan to Azerbaijan and Turkey, bypassing Russia and Iran, received lukewarm support on both sides of the Caspian Sea.
Azerbaijan had managed to enlist support of the collective West and its leading corporations to underpin its sovereignty. Although it did not bandwagon Russia and Iran, it did not antagonize them either. The calculation paid off in economic terms: Azerbaijan’s oil and gas sector accounted for more than 80% of total foreign direct investment in the country by 2001. Increased productivity in the sector contributed to GDP growth of 60% between 1995 and 2001.
Conclusions
Russia and Iran were not interested in seeing a hostile or even neutral state closely aligned with a peer competitor emerge on their borders. An unmistakable strategic calculation meant that Russia preferred to preserve its advantage in the South Caucasus, not least because its retreat could signal potential weakness to separatist groups that remained active in Russia’s North Caucasus. Iran had similar concerns about the Azerbaijani minority in the north of the country.
A classic balance of power logic dictated the West’s interest in expanding its global reach and creating counterpressure to Russia and Iran. Azerbaijan sat at the intersection of these goals. The question was not whether the West could achieve dominance in the region – influence is rarely won or lost overnight. It was to what extent the power of the West’s competitors could be reduced over time.
A compromise was reached at the level of geopolitics, expressed in the relative gains and losses of each of the two competing camps in the wider region of the South Caucasus and Central Asia, and reflected in the oil and gas industry on both sides of the Caspian Sea. The presence of a geographic barrier in the form of the Caspian Sea proved decisive, with the Central Asian states adopting the policy of strict neutrality and reliance on Russian transit. In the South Caucasus a pattern of three “small states” emerged, each pursuing a different political line.
The result was a regional balance of power that strengthened investor confidence and signaled that Azerbaijan and Georgia could host capital-intensive investment projects and infrastructure facilities. This experience subsequently unlocked the implementation of another strategic project – the Southern Gas Corridor.
Photo: Peretz Partensky from San Francisco, USA – Oil Mining across the salty lake, CC BY-SA 2.0
