Azerbaijan is the oldest oil-producing country in the world. The country's name means "the land of fire," and chronicles from the 10th century refer to Azerbaijan's "eternal pillars of fire." Explorers' and other early travelers' references attest to the historic presence of oil in Azerbaijan. Onshore development coincided with Russia's annexation of the region at the beginning of the 19th century. Early oil extraction methods were extremely primitive: pits only several meters were dug by hand and oil simply bubbled to the surface. There were dozens of these oil holes reportedly 'in operation' by 1829, but their production was insignificant from a commercial perspective.

Azerbaijan also took an early lead in oil refining. As early as the 13th century, low-density oil fractions were produced from crude oil for home lighting, as mentioned by Marco Polo in his memoirs. Industrial refining started in the 1820s, when a distillation machine for obtaining kerosene was invented in Baku. In 1859, two local entrepreneurs erected the first factory to produce paraffin and kerosene near Surahani. In 1863, Javad Malikov, who resided in Baku, constructed the first industrial refinery. Within just 10 years, the number of refineries in Azerbaijan reached fifty. In 1875, the first lubricating oil in the world was produced in Azerbaijan, and in 1882, uninterrupted oil distillation began at refineries owned by the Nobel family.

The current refining capacity of Azerbaijan is approximately 20 mt per year, or 441 barrels in each calendar day(1), which is approximately double the country's oil production in 1997. There are two oil refineries in Azerbaijan, Azerneftyag and Azernefteyanajag, both located in the Baku area. Currently, State Oil Company of Azerbaijani Republic (SOCAR) runs both refineries.

Due to a significant decrease in crude oil production in 1970s and 1980s, large amounts of oil were imported from other USSR republics, primarily from Russia, in order to utilize Azerbaijan's refinery capacity. At that time approximately 40% of the oil proceed in Azerbaijan refineries was imported, with the products to other USSR republics.

According to recent press-reports, Azerbaijan refined 8.8 mt of crude oil or almost all of the country's production in 1997, as compared to 9.7 mt in 1992. Azerneftyag and Azernefteyanajag sold 4.7 million tons of oil products in 1999. That included 3999.2 thousand tons of black oil, 347.4 thousand tons of diesel fuel and 55.5 thousand tons of kerosene.

Much of the Azerneftyag refinery was constructed in the early 1930s, though the site dates back to the 19th century. Azerneftyag has a current throughput capacity of around of 235-238 barrels in each calendar day. It contains several crude and vacuum distillation units, though it lacks the reforming units necessary to produce marketable petrol. Currently, it is used mainly to produce lubricating oil and bitumen, with byproducts of diesel oil, fuel oils and straight run kerosene. It also sells naphtha to the Country Petrochemical Complex as food-stocks and is developing a lubricant-processing scheme. However, its existing facilities are using old technology unable to meet modern requirements for lubricants, which are characterized by a high viscosity index.

Baku's second oil refinery, Azerneftyanajag (former Novo-Bakinsky), was constructed in 1953 and substantially rebuilt in 1965. It contains a fluidized catalytic cracker, a coker and several light-end polymerization units. A reformer was installed in 1980, and a combination catalytic cracking unit was brought on-line in 1993 to improve the quality of high-octane petrol. Crude and vacuum distillation capacity was increased from 120 barrels in each calendar day to 160 barrels in each calendar day in 1976, and throughput capacity is currently around 202 barrels in each calendar day.

The low technical level of the current facilities and equipment plagues both refineries. The losses at the refineries are 4-5 times higher than at a modern refinery and consist of 2-2.5% of the processed oil. Refineries also consume 2.5-3 times more energy and 2-3 times more chemicals and reagents than a modern refinery of the same capacity. Even a low purchase price for crude oil cannot ensure an acceptable level of income for the refineries, especially for the older Azerneftyag.

The low technical level also significantly impacts the quality of the resulting products, most of which do not correspond to international standards.

With the recent increases in Azerbaijan's oil production, the refining sector becomes increasingly important in Azerbaijan. In 1998, Scientific Institute Azgyproneftekhim prepared a document entitled Concept of Development of Refinery Industry in Azerbaijan. The document described the main problems in the refinery sector and proposed potential investors' interests in reconstructing and modernizing the refineries. However, no real investments have been made as yet.

In August 1999, the US Trade and Development Agency ("TDA") and SOCAR signed an agreement granting $500,000 for a feasibility study of restoration of the facilities of the Azerneftyag refinery. The feasibility study is to be performed by Houston-based Merichem Refinery and Chemical LLC.

Legal Regime

Azerbaijani law governing the oil refinery sector is under-developed. The entry requirements for the sector are not entirely clear. Oil refining is not included among those activities listed as requiring a state license(2), however, refining is subject to the general safety, environmental and other requirements set forth in Azerbaijan's energy legislation.

State-owned oil refinery facilities can be privatized only based on a decision by the President of Azerbaijan(3). As of yet, there is no concrete indication that Azerbaijan's refining facilities will be slated for privatization.

As mentioned earlier, SOCAR plays a major role in the country's oil refinery sector. SOCAR is a state-affiliated company established in accordance with Presidential Decree of Azerbaijan No. 200 (September 13, 1992). It has the authority to manage the entire Azerbaijani oil industry, including "ensuring the activities of the oil refinery system" in Azerbaijan(4). SOCAR supervises the activity of all refineries on the territory of Azerbaijan through its Capital Construction and Refining Equipment Repair Department and its Production-Technical Department of Oil Refining.

In the absence of a clear legal framework governing the oil refinery sector, businesses wishing to enter the sector are left with two basic options. First, investors may participate in the privatization of state-owned refineries, provided that the President of Azerbaijan slates those facilities for privatization. Alternatively, investors may cooperate with SOCAR and the Government of Azerbaijan in order to start up a new oil refinery. The rules and procedures for both options, however, remain unclear.