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Oiling the wheels

The first view on landing at Baku international airport is a building site - two tower cranes and a massive steel frame that will become the airport's new control tower. This project, started 12 years ago during the Soviet era but never finished due to lack of money, is a fitting symbol of Azerbaijan.

The country has been bankrupt since the collapse and break up of the Soviet Union. This removed Azerbaijan's main export market, and ageing factories now run at 10% capacity as they cry out for western technology. The lack of money has pushed Azerbaijan's infrastructure into ruin. The transport network is crumbling and there are electricity and water shortages. Pollution has reached unbearable proportions, with the industrial city of Sumgait across the Apsheron peninsula from Baku, described as 'the most dangerous place on earth'.

It was not always like this. A walk around Baku's centre reveals architectural wonders that rival anything found in the West. Grandiose buildings paid for by the great oil barons of the early 20th century serve as a reminder of a time when Azerbaijan produced half the world's oil. Names like Rockefeller, Rothschild, Siemens and Nobel made Baku one of the world's most important cities.

Those days might be about to return. Azerbaijan is at the start of an oil boom, with western companies pumping billions of pounds into developing the offshore oil fields in the Caspian Sea. The government is eagerly awaiting its share so that it can start spending money on rebuilding the country's decrepit infrastructure. And when this money feeds through, the Azeris will need western construction expertise because the local industry lacks modern skills and technology. This could produce a bonanza for British civil engineering contractors and consultants.

Fourteen oil consortia have signed production sharing agreements with the Azeri government to develop the Caspian's fields. The first, in 1994, was a pounds4.7bn, 30 year contract with Azerbaijan International Operating Company to develop three of the largest oil fields, hailed as 'the deal of the century'. It was seen as the catalyst for major economic expansion over the next 30 years, and has started delivering oil.

But the money has so far remained within the oil sector. The companies have concentrated on establishing an industrial base, pumping billions into refurbishing ageing Soviet facilities. The AIOC alone has spent pounds1bn. 'The overall development plan will cost about pounds6.5bn,' says AIOC vice president Stephen Back. But large quantities of oil have yet to be exported. It will be years before the oil companies recover their start up costs.

In 1997, a 75% increase in construction activity was directed at oil facilities and general building refurbishment. Much of the work was done by Turkish contractors who have strong geographic and cultural links with Azerbaijan - Azeri is a Turkic language.

But AIOC has now completed its initial facilities, bringing a mini recession in construction activity while the other oil consortia carry out their exploration work. The question now is when revenues from the newly refurbished oil facilities will spark much needed spending on the country's infrastructure.

'We have been there for four years and every year it is going to be the year,' says Ken Tallant, director of Morrison International. 'But the money is not there yet, so people are making do with the old Soviet facilities. The philosophy at the moment is make do and mend.'

Despite this, Tallant believes that setting up early was invaluable to Morrison. 'One of the reasons we get work is because we came out four years ago and stayed,' he says. The Scottish contractor recently won a pounds60M contract to build a five star Hilton hotel on Baku's sea front - the Azeri capital's largest ever non-oil related investment.

This point is underlined by quantity surveyor Currie & Brown. 'We have been here for four and a half years,' says director David Turner. 'It has been four and a half years of pain and aggravation. We have had to be very flexible. But it has been worth it. We are now the only fully registered QS out here.'

Depressed public spending means that virtually all non oil- related activity is financed by multinational financial institutions like the European Bank for Reconstruction & Development and the World Bank.

The World Bank recently announced a pounds24M credit for infrastructure work in Azerbaijan. 'We have a rolling three year investment programme,' says World Bank principal operations officer Peter Pollock. 'Our areas of interest do not overlap with the private sector. We look at projects to take the country forward. Most of the projects have an angle to improve living conditions.'

Deputy Prime Minister Abid Sharifov sees credit agreements with the world's financial institutions as the country's main source of revenue over the next few years. 'We are negotiating for EBRD and World Bank investment for road and railway reconstruction,' he says.

The EBRD is currently funding the country's largest infrastructure project - the pounds60M modernisation of Baku's water supply.

EBRD is also involved in the pounds50M upgrade of Baku's international airport. With Baku the hub for the oil and gas industries in the Caspian region, which includes Kazakhstan and Turkmenistan, airport expansion is needed to handle the expected increase in traffic. Funding comes from a consortium of international banks. Phase two of the project will be a cargo terminal, funded by an all British group of banks.

The other major transport development in the region is the European Union-sponsored Transport Corridor Europe Caucasus Asia project to develop road, rail and sea links along the ancient 'silk road' trading route between China and Europe.

But perhaps more important than reconstructing the country's infrastructure is cleaning up its legacy of serious pollution. 'Ecology is our biggest problem,' says Sharifov. 'The Apsheron peninsula is covered with oil left from the Soviet period. We have signed a pounds24M credit agreement with the World Bank to clean mercury from the ground in Sumgait (an industrial city north of Baku) and to build a fish farm for caviar. But we need help. It is not just a problem of pollution. The level of the Caspian has risen by 2.33m in the last few years. Hundreds of houses are underwater.'

Most of the money is lent on the basis of Azerbaijan's oil potential but it will be some time before the Azeri government can expect to receive actual oil revenues. The structuring of the production sharing agreements allows the oil companies to recover their production costs first and it could be well into the next century before the Azeri government receives its dividend.

'The contracts we have signed with the oil companies will not give us revenue for our budget for five to seven years,' explains Sharifov. 'The main short term benefit is that thousands of local people are provided with jobs.'

Geographical constraints are also hampering the country's export efforts. Oil has to be exported through Novorossiysk on Russia's Black Sea via northern Azerbaijan using small capacity pipeline. The key issue now is the construction of a main export pipeline able to carry up to 50Mt of oil a year via either Russia, Georgia, Iran or Turkey.

A route for the pipeline has yet to be agreed, with each option fraught with difficulties. Whichever route is selected it will be at least five years before large quantities of Caspian oil reaches the world's markets.

In the meantime, the country follows a strict fiscal regime designed to keep the International Monetary Fund happy and the Azeri economy stable. And borrowing against the small amount of oil that has left the country already, have been depressed by world oil prices.

'The slump in oil prices has affected us seriously,' says Sharifov. 'Some 50% of our budget comes from the sale of our own oil. We have not had to give up any major projects but we have had budget difficulties.'

This highlights a concern of many economists that the country risks becoming too dependent on the oil sector. 'The country has the potential to be like Nigeria or like Norway,' said one source. 'At the moment it is somewhere in the middle.'

And it is not clear how much oil there is in the Caspian. Only AIOC is producing oil, with other consortia still at the exploration stage. The news so far has not been good. Four exploratory wells drilled by the CIPCO and NAOC consortia have been dry.

A major obstacle to foreign companies in Azerbaijan is the complex tax and regulatory system. Everything from fire safety certificates to planning permission are at the discretion of civil servants. Minor tax errors can result in huge fines. It is a system open to abuse and in a country where the average wage is pounds12 a month, corruption is a problem.

A report on some of the environmental problems facing the industrial city of Sumgait will feature in NCE's water and environment issue in two weeks.

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