VZCZCXRO4567
RR RUEHAG RUEHDBU
DE RUEHKB #0581/01 1070427
ZNY CCCCC ZZH
R 170427Z APR 06
FM AMEMBASSY BAKU
TO RUEHC/SECSTATE WASHDC 0156
INFO RUCNCIS/CIS COLLECTIVE
RUCNMEM/EU MEMBER STATES COLLECTIVE
RUEHAK/AMEMBASSY ANKARA 1581
RUEAIIA/CIA WASHINGTON DC
RHMFISS/CDR USEUCOM VAIHINGEN GE
RHEBAAA/DEPT OF ENERGY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

C O N F I D E N T I A L SECTION 01 OF 02 BAKU 000581 
 
SIPDIS 
 
SIPDIS 
 
DEPT FOR S/P 
 
E.O. 12958: DECL: 04/17/2016 
TAGS: ECON EFIN EPET ENRG PREL PGOV AJ KZ
SUBJECT: AZERBAIJAN: S/P DIRECTOR AND EUR DAS BRYZA DISCUSS 
OIL REVENUE MANAGEMENT AND SUSTAINABLE ECONOMIC DEVELOPMENT 
 
REF: (A) BAKU 480 (B) 05 BAKU 1669 
 
Classified By: AMBASSADOR RENO L. HARNISH III PER 1.4 (B,D). 
 
¶1. (C) SUMMARY:  In an April 3 meeting, S/P Director Stephen 
Krasner discussed macroeconomic development and prudent oil 
revenue management with Minister of Economic Development 
Babayev and Minister of Finance Alakbarov.  Babayev and 
Alakbarov stressed to Krasner that the GOAJ was aware of the 
dangers of over-reliance on oil for development and that the 
newly formed State Investment Company would use Oil Fund 
assets to fund non-oil development activities.  In a separate 
meeting with the Executive Director of the Oil Fund Samir 
Sharifov, Krasner, joined by EUR DAS Matthew Bryza, reviewed 
Oil Fund operations and possible modifications to the overall 
asset allocation.  Sharifov told Krasner that the Oil Fund 
planned to modify its asset allocation to increase its annual 
return.  The Oil Fund leads the GOAJ's EITI efforts and is 
hosting International Advisory Group meetings this week. 
Sharifov said that the GOAJ remained committed to the 
East-West energy corridor, adding that the GOAJ is ready to 
work with Turkey, Italy and Greece to ensure that Azerbaijani 
gas is sold in Europe.  END SUMMARY. 
 
¶2. (C) In a candid and frank conversation at the Ambassador's 
residence April 3, S/P Director Stephen Krasner, Finance 
Minister Avaz Alakbarov and Economic Development Minister 
Babayev discussed the importance of effective oil revenue 
management, development of the non-oil sector, transparency, 
corruption and macroeconomic development.  Krasner raised the 
importance of transparency in public expenditures and warned 
of the effects corruption can have on an economy.  Alakbarov 
and Babayev explained to Krasner the GOAJ's plans for using 
the Oil Fund and its future assets (current assets total USD 
1.5 billion) to fund social, infrastructure and other special 
projects to increase the pace of economic development.  Both 
ministers recognized the dangers of Dutch Disease and its 
inherent effects of higher inflation and currency 
appreciation.  Both indicated that International Financial 
Institutions would play an important role in Azerbaijan's 
development. 
 
¶3. (C) Alakbarov highlighted that the Oil Fund will be 
maintained to support "future generations" while at the same 
time funding current projects.  Babayev indicated that 
development of Azerbaijan's "human resources" was an 
important goal for the GOAJ.  Both ministers stressed the 
need for Azerbaijan to utilize effectively its oil revenues 
to develop the non-oil sector, boost employment and reduce 
poverty.  Responding to Krasner's question regarding the 
negative economic effect oil can have on a country, Babayev 
recognized the threat and explained that the GOAJ would 
develop the country's manufacturing sector and petro-chemical 
capabilities to boost local production.  In addition, he said 
that the GOAJ was developing its agricultural sector and 
providing much needed funds to local entrepreneurs. 
Alakbarov continued that the GOAJ would look to implement a 
balanced approach to development, focusing on keeping 
inflation down while maintaining robust growth.  He 
recognized that the GOAJ would increase budgetary 
expenditures, develop a securities market and continue with 
social and investment projects. 
 
New State Investment Company 
---------------------------- 
 
¶4. (C) Alakbarov briefed Krasner and the Ambassador on the 
newly formed State Investment Company (REF B) that will 
invest in non-oil sector companies and projects.  Alakbarov 
said that the Oil Fund will provide USD 100 million in 
initial capital to establish the new investment company. 
Babayev said that he would be the chairman of the new 
investment company's supervisory council.  Other members 
would also include the Executive Director of the Oil Fund, 
the Chairman of the National Bank, and the First Deputy 
Minister of Finance.  Babayev added that the GOAJ planned to 
invite international investors to invest in the company in 
the future.  Neither Babayev nor Alakbarov explained how the 
GOAJ would select appropriate companies or industries to 
invest the investment's company money. 
 
Oil Fund and EITI 
 
BAKU 00000581  002 OF 002 
 
 
----------------- 
 
¶5. (C) In a late afternoon meeting with Oil Fund Executive 
Director Samir Sharifov, Krasner and EUR DAS Bryza discussed 
the Oil Fund operations, its role in Azerbaijan's development 
and the AJ-KZ intergovernmental agreement (IGA) negotiations. 
 In addition, Sharifov and Krasner discussed the role of the 
Oil Fund and the GOAJ in the Extractive Industries 
Transparency Initiative (EITI) (REF A).  The GOAJ is hosting 
the International Advisory Group of EITI this week for 
meetings. 
 
¶6. (C) Sharifov briefed Krasner and Bryza on the Oil Fund's 
history and future plans to adjust its asset allocation 
strategy.  Currently the Oil Fund invests in only highly 
secure U.S. treasuries and European government bonds. 
Sharifov explained that the Oil Fund is planning to shift to 
a three-portfolio asset allocation strategy with an 
"expenditure portfolio" for GOAJ budgetary requirements, an 
"emergency portfolio" and a "future generation portfolio," 
that would include more risky equity investments.  The new 
portfolio asset allocation, according to Sharifov, would 
increase the fund's annual return by five to six percent. 
Sharifov told Krasner that in 10 years the Oil Fund could 
have between USD 70 and 120 billion in assets depending on 
the price of oil. 
 
¶7. (C) Sharifov said that more than 80 percent of the Fund's 
revenues come from Production Sharing Arrangements (PSAs) 
with international energy companies.  Regarding SOCAR's 
contributions to the Oil Fund, Sharifov stated that SOCAR 
pays taxes to the Ministry of Taxes of which a certain 
percentage is allocated to the Oil Fund.  He noted that SOCAR 
uses some of its oil revenues to support its extensive 
"social activities" (i.e. corporate kindergartens and 
hospitals). 
 
¶8. (C) Sharifov also explained that the GOAJ was planning to 
submit new legislation formalizing the Oil Fund structure, 
compensation, asset allocation targets and other operational 
issues.  Sharifov noted that the GOAJ needed to perform an 
extensive public information campaign on the Oil Fund, its 
goals and its future operations.  He noted that many 
Azerbaijanis are not aware of its goals and operations and 
often have misconceptions about investing and its inherent 
risks. 
 
IGA with Kazakhstan 
------------------- 
 
¶9. (C) Turning to the IGA negotiations with Kazakhstan, 
Sharifov explained that President Aliyev was ready to sign 
the agreement in May 2005.  The Kazakhs balked and now 
Azerbaijan wanted to review several elements of the agreement 
and negotiate more specific language.  Sharifov stressed that 
the GOAJ remains committed to the East-West energy corridor 
and pledged that the GOAJ would work to ensure that Caspian 
and Central Asian energy resources reach European and world 
markets. 
 
Caspian Gas to Europe 
--------------------- 
 
¶10. (C) DAS Bryza suggested to Sharifov that if Azerbaijan 
wished to sell gas to Italy, it needed to begin discussions 
now with Rome and Athens, as well as Turkey, on lining up 
necessary commercial and legal agrements.  Sharifov agreed 
that Greece and Italy may be contemplating signing long-term 
gas contracts with Gazprom that may block GOAJ attempts to 
ship gas to Europe, and noted that Azerbaijan and Turkey 
would need to sign an agreement to facilitate the 
transshipment of gas to Europe.  Sharifov requested USG 
assistance and Bryza indicated that he would work to arrange 
a meeting between the governments of Azerbaijan and Italy. 
Sharifov highlighted that the GOAJ wanted to become the gas 
and oil transshipment hub for Caspian and Central Asian 
natural resource exporting countries. 
 
¶11. (U) S/P Director Krasner and EUR DAS Bryza cleared this 
message. 
HARNISH