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Oil and Gas Industry in Azerbaijan: History and Prospects, 1999
Khoschbakht Yusifzade


Historical Overview of Azerbaijani Oil
Daniel Yergin
President, Cambridge Energy Research Associates

For Azerbaijan, the end and the beginning of the 20th century are about to come together. Azerbaijan is poised to regain a position of prominence in the world oil industry. Indeed, there was a time at the turn of the century when it was the world's number one source of oil. While the oil and gas resources of the Absheron peninsula did not become part of a global industry until the late nineteenth century, they were known to the area's inhabitants long before that. Historical references to this oil date back to the fifth century; in the thirteenth century Marco Polo reported hearing of a substance which came from the ground near Baku that was "good to burn." Natural gas too left its mark on the culture and religion of the area. Gas was known in some places to escape from the earth and at times to ignite; these fiery displays played a central role in the evolution of Zoroastrian belief. The Zoroastrian temple in Surakhany still stands today.

But it was oil rather than gas that was useful for lighting homes, and by the early nineteenth century a small oil industry had developed in the Baku region. Pits only several meters deep were dug by hand in areas of oil seepage, and buckets and pulleys were used to extract the oil. However, with the industry's growth was constrained by the heavy-handed oversight of Tsarist administrators through an inefficient system of state concessions. In 1872, Baku's real oil rush began when the concession system was abolished in favor of an outright auction of the oil-bearing lands around Baku. This led to Baku's first full-fledged oil boom - the boom that was to make it the world's most productive oil province by the turn of the century.

By then, drilling had become the norm on the Absheron peninsula as the new system of private ownership provided more powerful incentives for technological advancement. Oil production began to grow rapidly but steadily, increasing from only hundreds of barrels per day in 1871 to nearly 200,000 barrels per day [bd] by 1901. A large refining industry also sprung up to turn crude oil into kerosene. Great fortunes were made during this time, most famously by the Nobel Brothers company, which by 1883 was responsible for half of Baku's petroleum exports. Local oil barons such as Zeynalabdin Taghiyev and Musa Naghiyev also prospered, and their philanthropy played an important role in strengthening Azerbaijani culture and art during this formative period.

The key to unlocking the wealth of these oil fields - then as now - was transportation. The first pipeline in the area, made of wood, was built to link Baku's refineries with the Balakhany fields in 1878. In that same year, the world's first oil tanker made its maiden voyage on the Caspian Sea. But the development that truly opened the door for Baku's oil to reach world markets in large quantities was the completion of the Baku-Batumi railroad in 1883. In that same year, entrepreneurs and oilmen began to submit proposals for the construction of a pipeline along that same route, a step which would dramatically reduce transportation costs. A 42 mile pipeline was completed in 1889, using Alfred Nobel's dynamite, to eliminate a bottleneck on the railroad at the peak. Despite the benefits such a pipeline would bring, the opposition of railway interests along with the indecision of the Tsarist bureaucracy kept the pipeline plan on the drawing board for two decades. It was not until 1903 that the pipeline was finally built.

By this time, oil production had begun to decline, slightly at first. This decline became a collapse in the revolutionary year of 1905, when strikes, ethnic conflict, and general chaos engulfed Baku. Exports were temporarily cut off, and when the smoke cleared much of the local oil industry was close to ruin. Between 1904 and 1913, the Absheron Peninsula went from supplying 31 percent of the world's petroleum exports to less than 8 percent. That was still more than enough to make Baku a prize much coveted by Germany during World War I. Although the Germans did land in the Georgian port of Batumi in June 1918, the war ended before they could begin a march on Baku.

After a brief period of Azerbaijani independence, Soviet power was established in 1920. With the Bolshevik victory came the nationalization of the entire oil industry, which was at that point producing about 60,000 bd - less than one third of its 1901 peak. The Soviet government, however, knew that Baku's oil was crucial to fueling economic growth and earning foreign exchange, and it made the reinvigoration of the oil industry in what was then the Azerbaijani Soviet Socialist Republic a top priority. The output of what was then the Azerbaijani Soviet Socialist Republic had increased to near 200,000 bd once again by 1930, much of it exported to the West via a new pipeline to Batumi which was completed in 1925.

With Stalin's ascent to power in Moscow, joint ventures with foreign companies came to an end, but the development of the Azerbaijani oil industry continued. Oil production grew steadily, reaching nearly 450,000 bd by 1940, representing nearly three quarters of total Soviet oil production. Baku maintained its traditional role as a center for oil refining during this time, and it also became the center for the production of oil equipment in the USSR. World War II again put Baku at center stage, as Hitler was preoccupied with gaining control of its oil fields. Indeed, the ill-fated German push to the south that ended in the Soviet defeat of German troops at Stalingrad - the turning point of the war - was motivated primarily by a desire to take Baku. There still exists bizarre film footage of Hitler being presented with a birthday cake during World War II. The icing depicted the Caspian Sea. Baku was in chocolate. The film shows Hitler engorging it. In reality, he came close-but not close enough. And shortage of oil was one of the reasons the Nazi war machine failed.Ironically, despite the fact that the German armies never reached Baku, the war resulted in the ravaging of Azerbaijan's oil industry all the same. Fearing a German victory in the Caucasus, Moscow had ordered much of the region's oil infrastructure to be disassembled and sent north and east to the more secure Volga-Urals region, which geologists had identified as a promising oil province. Thus equipment, factories, skilled personnel, and even the Baku-Batumi pipeline were moved to Tatarstan and Bashkiria, where they provided the basis for a postwar oil boom.

Azerbaijani oil production collapsed for the second time in a half-century. Slow and steady growth which was to last for about 20 years began again in 1947, but Azerbaijani oil production has never again matched its 1940 peak (although it appears likely to do so again soon after 2000).

Azerbaijani oil production took its first step offshore with the discovery in 1949 of the shallow-water Oily Rocks field, which had reserves of over one billion barrels. By the time Oily Rocks reached its peak in 1970 it was producing 140,000 bd. Since the late 1960s offshore fields in the Caspian Sea have provided the bulk of new Azerbaijani oil production, reaching total production as high as 258,000 bd. The final major offshore field brought into production during the Soviet era was known as the 28th of April field, which is today called Guneshli. Having come on line in 1981, this field was producing 120,000 bd from nine offshore platforms at the time of the USSR's collapse. Full development of the field was constrained, however, by the deficiencies of Soviet offshore technology. Part of the field lay in deep water, but available technology allowed production only in depths of less than about 125 meters.

Oilpipes

A new era in Azerbaijani oil began with the coming of independence in the autumn of 1991. Discussions between Baku's offshore company Kaspmorneftegaz and a handful of foreign companies had already begun in the closing years of Soviet rule, focusing primarily on two deep-water fields, Azeri and Chirag, as well as Guneshli. (All three fields are now thought to be part of a single geological megastructure.) After signing letters of intent with three different groups of companies, the Azerbaijani government decided to unitize the project in 1992, creating the consortium that eventually created the Azerbaijani International Operating Company (AIOC). The signing of the AIOC contract in September 1994 represented a major turning point for Azerbaijan's oil industry, and for the country as a whole. This project produced its first oil in October 1997 after investing more than $1 billion; meanwhile nearly a dozen offshore exploration contracts have followed in its wake. Ceremonies marking the flow of "early oil" were held in November 1997. They signified the opening of a new chapter for Azerbaijan, and a reopening for Azeri oil into the world market.