by Jody LaPorte*
The 2024 meeting of the UN Climate Change Conference—known as COP29—will be held in Baku on November 11–22. Azerbaijan’s hosting of the summit has come under considerable scrutiny—both because of the country’s human rights record, which many view as incompatible with the open dialogue and civil society input needed to formulate and enact climate policy, and because a petrostate has again been selected to host a climate conference.
Azerbaijan’s economy has long been centered on its hydrocarbon sector. The world’s first industrial oil well was drilled in 1847 at Bibi-Heybat on the outskirts of Baku; by the turn of the twentieth century, Azerbaijan was producing over half of the world’s oil. In the Soviet period, Baku continued to be a major supplier of oil—though production declined in later years. Since gaining independence in 1991, Azerbaijan has discovered new oil and natural gas fields under the Caspian Sea and, with the help of international companies, focused its economy even more strongly on hydrocarbons, which today account for a large portion of the country’s economic output and an outsize percentage of state revenue.
This situation has created a rentier model of political economy in Azerbaijan with two characteristics: first, an economic dependence on external rents derived from the extraction and export of natural resources; and second, the capture of political and economic power by a narrow set of elites. There are challenges that naturally arise from this arrangement. Resource production is capital intensive, rather than labor intensive: both the upfront investments and the downstream profits tend to be tightly centralized. The jobs that are available in the sector are often highly technical, offering little in the way of widespread employment opportunities for the population. In addition, world commodity prices are notoriously fickle. As prices rise and fall, government revenue in oil-dependent states can fluctuate in unpredictable ways.
More recently, these long-standing challenges to resource-dependent development have been aggravated by climate change. As global consumers shift from fossil fuels to renewable energy, resource-reliant states must plan for a long-term decline in global demand and seek new sources of economic stability.
While Azerbaijan has begun to diversify its economy, for example by investing in the development of renewable energy, Baku also remains committed to hydrocarbon production. At least for the time being, it appears that the government intends to pursue these two trajectories in parallel, rather than seek to use renewables to wean itself off fossil fuels. Looking ahead, this strategy will create opportunities for Europe to push for increased transparency in Azerbaijan’s energy sector and greater openness in the country’s political and economic institutions.
Managing Azerbaijan’s Oil Profits
The day-to-day operations of Azerbaijan’s oil and natural gas deposits are overseen by the State Oil Company of Azerbaijan (SOCAR), which was established in 1992 as a state-owned monopoly. SOCAR is involved in the exploration, extraction, transportation, and sale of Azerbaijan’s oil and gas, both domestically and internationally. SOCAR also manages a small number of the country’s older oil fields. More importantly, it holds a joint stake in all of Azerbaijan’s production-sharing agreements, which lay out arrangements between SOCAR and foreign oil companies to explore and develop the country’s largest fields. The company’s far-reaching operations have made it not only Azerbaijan’s largest employer but also the country’s biggest single source of state revenue. In 2024, payments from SOCAR alone are expected to constitute 7 percent of the government’s total revenue.
Azerbaijan’s oil industry and political structures are intimately linked. President Ilham Aliyev served as vice president of SOCAR from 1994 to 2003. More formally, the head of SOCAR reports directly to the country’s president, who holds the power to appoint and dismiss members of the company’s governing bodies, including the supervisory and management boards. All of SOCAR’s production-sharing agreements require the president’s approval. While Azerbaijan’s parliament also has the power to scrutinize these deals, in practice it does not exercise a significant oversight role. The government has excluded other stakeholders, such as opposition parties and civil society organizations, from its resource governance processes—a move that caused Azerbaijan’s 2017 withdrawal from the Extractive Industries Transparency Initiative, an organization that promotes good governance of natural resources.
Similarly, the State Oil Fund of Azerbaijan (SOFAZ) functions under the direction of the president. Set up in 1999, this sovereign wealth fund is designed to ensure the country’s oil profits are invested and fairly distributed across social groups and generations. In reality, it has been used in part to cover short-term budget shortfalls and fund massive public infrastructure projects.
Currently managing $57 billion in reserves, SOFAZ is legally separate from Azerbaijan’s government and central bank. However, the president appoints—and can dismiss—the fund’s executive director and approves appointments to its supervisory board as well as the independent auditor that investigates SOFAZ’s accounts. Aliyev also controls the fund’s strategic direction and expenditure, including transfers from the fund to the state budget. SOFAZ thus functions as a key link in distributing oil rents and funding the regime’s patronage networks.
Opportunities for Elite Enrichment
Besides the state itself, the primary beneficiaries of Azerbaijan’s oil boom have been the country’s ruling elites. Allegations of corruption in Azerbaijan’s oil industry date back to the original investment deals in the 1990s. One aspiring investor described making large payments that were destined for “the family,” allegedly in exchange for the right to buy a stake in SOCAR. In sworn testimony, he noted that former president Heydar Aliyev, the incumbent’s father, “directed that we wire transfer sums of money into bank accounts held for the benefit of relatives of Heydar Aliyev” and “instructed that money be sent to members of Heydar Aliyev’s family for ‘shopping sprees.’ Typically the amount of money requested was $1 million.”
More recently, investigators have suggested that oil rents have been captured through shell companies and state-owned subsidiaries operating in this sector. For example, in 2013, international NGO Global Witness examined the ownership structures behind a series of firms that were doing business with SOCAR. Among these companies was SOCAR International DMCC, which appeared in 2011, ostensibly to serve an oil-trading subsidiary of SOCAR. The company generated millions of dollars of annual sales for its owners, who included private investors whose identities could not be traced. Curiously, much of the oil sold by SOCAR International DMCC was bought by SOCAR-owned firms, raising questions about the purpose of this new company beyond extracting rents.
A similar set of circumstances arose in Azerbaijan’s natural gas industry, where the Organized Crime and Corruption Reporting Project reported that “using fake charges and padded contracts, two companies owned by Azerbaijan’s state oil company looted the expansion of BP’s operations” related to the Shah Deniz gas field in the Caspian Sea. Records show that the director of these companies and his wife made several large real-estate purchases in the same period, paying $8 million in cash for two apartments in a luxury beachside complex in Miami and purchasing a $2 million property in Fort Lauderdale.
While these schemes have targeted oil profits before they accrue to the state, elites have also profited from public projects funded by the state. Azerbaijan’s ostensibly private sector has been structured around a series of large-scale holding companies, which stand out for the depth and breadth of their holdings as well as their close ties to political elites. For example, Pasha Holding—associated with First Lady Mehriban Aliyeva’s family, the Pashayevs—has investments across the travel, insurance, banking, retail, real estate, and construction industries. Gilan Holding, founded by Kemaleddin Heydarov, is another of Azerbaijan’s biggest and most successful conglomerates, with major stakes in the banking industry, luxury hotels, a soccer club, and a construction company. Heydarov served as chairman of the State Customs Committee and has been minister of emergency situations since 2006.
Other major holding companies have included Ata Holding, founded in 2003 by Fazil Mammadov, the tax minister at the time; ZQAN Holding, linked to Zia Mammadov, the minister of transportation until 2017; and Silk Way Holdings, co-owned by the president’s daughters.
At the same time, there has been an increasing centralization of political and economic life around the ruling family. Ilham Aliyev has served five consecutive terms in office. In the February 2024 presidential election, he was reelected with 92 percent of the vote. A 2016 referendum extended presidential terms from five to seven years and created the post of vice president. First Lady Aliyeva has held this role since its inception. Other elites have been sidelined in recent years. Some powerful political figures have lost their ministerial posts as the government has grown increasingly technocratic, while many of the country’s commercial assets have been absorbed into the Aliyev and Pashayev business portfolios.
Reports suggest that conglomerates linked to the Aliyevs and their close associates have benefited from privileged access to state contracts. Through Azerbaijan’s oil boom, these firms have won rights to carry out major construction and infrastructure projects—often through opaque bidding processes, without independent oversight, and amid allegations of inflated costs and rent-seeking intentions. In the early 2010s, for example, several contracts were awarded to the Azenco construction company, including the $134 million Crystal Hall concert hall, which opened in 2012 to host the Eurovision Song Contest, and the $38 million State Flag Square, whose flagpole, at 162 meters (531 feet), was briefly the world’s tallest. A 2012 investigation indicated that the Aliyevs were majority owners of Azenco at the time of these projects, noting that this “looks like a clear example of a scheme to ‘misappropriate’ some of the country’s oil wealth.”
Proximity to the state’s windfall oil rents has generated enormous wealth for Azerbaijan’s political leaders and helped protect them against political instability. The concentration of economic resources has ensured that powerful elites have every incentive to stay loyal to the regime while allowing the state to cut off access to funding and other resources for opposition groups, civil society organizations, and independent media. And, when all else fails, the resources at the regime’s disposal fund an extensive repressive apparatus that is willing to crack down on dissent.
Azerbaijan’s Oil Boom and the Broader Population
By contrast, Azerbaijani citizens’ experiences of the oil boom have been more varied. As the World Bank has observed, “Azerbaijan’s labor market is dominated by employment in the agricultural and service sectors, while most of the GDP is produced in oil-dependent sectors.” On the one hand, levels of poverty and unemployment have declined since the late 1990s, and living standards have improved. On the other hand, the country’s aggregate GDP per capita is $7,640—significantly lower than the average across Central Asia and the South Caucasus ($9,480) and below the levels in neighboring Georgia ($8,830) and Armenia ($8,580).
The economic benefits of Azerbaijan’s oil boom have been spread unevenly. Rural areas, in particular, have continued to suffer from higher levels of poverty, stagnant wages, and underemployment. Agriculture’s contributions to GDP have plummeted from 32 percent in 1994 to under 5 percent in 2022. Consequently, there has been substantial internal migration from rural to urban areas: by early 2024, Azerbaijan’s urban population stood at 54.5 percent of the country’s total. This rural emigration has led to “a concomitant process of stagnation and recession in the countryside,” according to one researcher.
Oil profits have fueled these socioeconomic shifts. These revenues also play an important role in underwriting popular support for the regime. The state’s hydrocarbon profits have financed a sizable public sector: since 2020, state employment has accounted for 22 percent of the country’s jobs. Azerbaijan’s authorities draw on this constituency and the mechanisms of workplace mobilization to secure votes in elections. More broadly, researchers have found evidence that the government increases public spending in the run-up to elections as a means of boosting popular support.
The Drivers of Economic Change
The use of oil rents to ensure elite loyalty and distribute popular patronage has been central to Azerbaijan’s autocratic stability over recent decades. But challenges remain. Perhaps most important is the fact that with an estimated 7 billion barrels of extractable oil, Azerbaijan’s hydrocarbon fields are considerably smaller than those of many other oil-reliant countries. By comparison, Russia’s reserves have been estimated at 80 billion barrels and Kazakhstan’s at 30 billion.
In the mid-2000s, it was expected that Azerbaijan’s oil fields would be exhausted by 2025. Advances in extractive technology and the discovery of new fields have extended this time horizon: Azerbaijan’s current reserves are now projected to last another twenty-five years. Nonetheless, Azerbaijan’s oil production peaked in the early 2010s and has been slowly in decline since then. Thus, the trajectory of Azerbaijan’s oil rents is likely to be one of gradual decrease over the next several decades, rather than an abrupt cliff edge.
The reduction in oil exports has been somewhat offset by the increasing production of natural gas. The Shah Deniz deposit has proved to be one of the largest gas fields ever discovered—and when production began in 2007, Azerbaijan became a net exporter of natural gas for the first time. This status has taken on added importance in the wake of Russia’s 2022 invasion of Ukraine. As Western countries have sought to protect their energy security and diversify their supply chains away from Russia, Azerbaijan has pledged to double its gas supplies to Europe.
This trend is likely to continue. Forecasts suggest that global energy companies are set to spend over $40 billion developing Azerbaijan’s gas fields over the next decade, which would boost gas production by a third from current levels. However, gas generates smaller rents than oil does, and Azerbaijan’s exports face competition on world markets from other sources of natural gas, including U.S. producers.
Besides its ability to supply global oil and gas markets, Azerbaijan’s economic model will also be affected by the long-term decline in global demand for fossil fuels. As countries move to renewable energy sources to cut carbon emissions, the hydrocarbon rents that have filled public coffers, enriched elites, and bought popular support are likely to decline. This trend is likely to jeopardize the political, economic, and social equilibrium that has prevailed in Azerbaijan since the 1990s—unless an alternative source of rents is found.
Taken together, these factors create potentially competing incentives for Azerbaijan’s leadership in the short to medium term. It is not clear how these incentives will affect the regime’s urgency in addressing the country’s dependence on hydrocarbons. Aliyev’s speech at the April 2024 Petersberg Climate Dialogue underscored this point. The president noted that “having oil and gas deposits is not our fault. It’s a gift from God. We must not be judged by that [but by] how we use these reserves for the development of the country . . . and on what our targets are with respect to the green agenda.” Nonetheless, he added, “our oil and gas will be needed for many more years, including in European markets.”
The Government’s Response to Energy Trends
In a set of strategic road maps, Azerbaijani government officials have outlined plans for economic diversification. Baku has been discussing the need to move away from hydrocarbon reliance since the early 2000s, but the first concrete proposals to develop Azerbaijan’s broader economy were approved by the president in 2016 and subsequently updated in 2021. These road maps identified several sectors for investment. In practice, significant progress has been made in defining Azerbaijan as, first, a major destination for international conferences and events and, second, a shipping and transit point between Europe, Russia, the Middle East, and Asia.
These efforts have driven a boom in building and infrastructure development in and around Baku. Notably, the Aliyev family and other elites have been heavily invested in these sectors—with private holdings not only in construction firms but also in airport services, cargo companies, high-end hotels, and transportation infrastructure. To this end, one Azerbaijani economist has suggested that the country’s enthusiastic bids to host major international proceedings, such as COP29, are best understood as “corrupt and flashy events disguised as modernization.”
The government has also announced plans to invest in the country’s green energy potential, particularly its wind and solar power resources. Research and development in the green energy sector is funded through the public budget, the state science fund, and SOCAR as well as by private investors. However, these intentions have been slow to materialize. State spending in this area is low, at the equivalent of 0.2 percent of GDP, which is a lower percentage than for any member of the Organisation for Economic Co-operation and Development. And the International Energy Agency reported in 2023 that “Azerbaijan’s research, development and deployment . . . system and governance remain incohesive.” The report continued that despite a January 2019 presidential order on innovative development, “the policy and funding appear fragmentary and only partially co?ordinated.”
In October 2023, Azerbaijan inaugurated its first large-scale solar plant in partnership with Masdar, an Emirati company. Officials have projected that the plant’s 570,000 solar panels will generate enough electricity to meet the energy needs of 110,000 homes and cut 200,000 tons of emissions annually. The joint initiative between SOCAR and Masdar broke ground on three further wind and solar plants in June 2024.
But, as much as the government has billed these projects as evidence of a shift to green energy production, these outputs are not intended to substitute for Azerbaijan’s hydrocarbon production. Calling this a “win-win situation,” Aliyev has noted that the natural gas that Azerbaijan saves by moving domestic energy consumption to renewable sources will be sold on the export market. Thus, rather than a transition away from hydrocarbons, this plan may be a way to sustain resource rents, at least for the foreseeable future.
Many observers have suggested that climate change—and the global shift to renewables—will undermine the rentier structures associated with authoritarian petrostates. Yet, rentierism may well prove to be a resilient political economic model even in the absence of hydrocarbon rents. Like hydrocarbons, renewables are a highly technical and capital-intensive industry. Given that Azerbaijan’s shift to solar and wind production has involved significant state-directed investment, there remains the potential for profits to be captured by the state—and, by extension, the ruling elites.
Scenarios for Azerbaijan’s Future Trajectory
Azerbaijan has taken steps toward diversifying its economy, including by investing in developing the country’s considerable wind and solar energy potential. But the regime has also continued its commitment to hydrocarbon production. For the foreseeable future, the government is treating these ventures as complementary, rather than as two ends of a transition from one form of energy to the other.
In the longer term, questions arise about the political economy effects of this trajectory. On the one hand, Azerbaijan’s shift to renewables—and pursuit of economic diversification more broadly—could create opportunities for meaningful changes to the country’s political and economic structures. Hydrocarbon revenues are already substantially lower than they were a decade ago, and the rental income available from natural gas, renewable energy, and other assets is likely to be much slimmer than during the oil boom. On the other hand, these investments may serve to sustain the networks of rent seeking and patronage that have underpinned the regime’s stability for the past thirty years. After all, the people who have benefited from the existing institutional arrangements are ultimately the ones who would be empowered to pursue potential reforms.
Which scenario prevails will depend, to a large degree, on the incentives that Azerbaijan’s leaders perceive for institutional change versus continuity. Two possible impulses for reform stand out. The first could arise from the prospect of political instability. In the face of declining oil production and associated rents, Azerbaijan’s rulers may find the financial resources available to them insufficient to maintain elite cohesion and mass support. In this scenario, the regime may find it more palatable to liberalize the country’s political and economic structures—by distributing and protecting private property rights while opening up to political competition—than to potentially lose power altogether.
Indeed, the distribution of property rights plays an important role in Azerbaijan’s political stability. Incumbent elites have major stakes across various sectors, and they have been careful to pursue economic policies that seem designed to preserve, rather than undermine, control over the country’s most productive sectors. As long as access to economic opportunities remains conditional on political support, many Azerbaijanis are likely to consider that the benefits of remaining loyal to the government outweigh the costs of expressing dissent.
A second source of leverage comes from Europe, which is a key strategic partner in the development of Azerbaijan’s energy sector. The EU has signed several agreements to strengthen the supply of Azerbaijani energy to Europe, including a July 2022 memorandum of understanding to double the capacity of the Southern Gas Corridor. Meanwhile, a joint venture launched in September 2024 to install an electricity supply line under the Black Sea will bring Azerbaijan’s renewable energy to EU markets. These projects come with pledges to deepen infrastructure investments, technology transfers, and regulatory alignment between the two parties. Leaders on both sides have emphasized that these projects will strengthen the EU’s energy security, support Azerbaijan as it shifts away from oil reliance, and increase Europe’s access to renewable energy.
In pursuing this partnership, Europe must not fall into the trap of turning a blind eye to Azerbaijan’s governance challenges. It is crucial that work to diversify and decentralize Azerbaijan’s economy be accompanied by reforms that ensure that all citizens share in the benefits. To this end, the EU needs to insist on international standards for open, transparent tendering for joint infrastructure projects, accompanied by appropriate monitoring of accounts and investments. It is crucial that monitoring focus not only on the entities involved in the downstream provision of Azerbaijan’s energy but also on the companies engaged in the production side.
In the longer term, the EU should make further cooperation conditional on governance reforms in Azerbaijan. The country needs Western partnerships if it is to meet its climate commitments while remaining a major energy producer. Europe can use this leverage to call for increased transparency in Azerbaijan’s energy sector in exchange for technical assistance, continued joint ventures, and further access to EU markets.
*Gonticas fellow in politics and international relations at Lincoln College, University of Oxford
**first published in: Carnegieendowment.org
By: N. Peter Kramer
