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Domestic market overview
What is the extent of oil and gas production in your jurisdiction?
Azerbaijan, its capital Baku and, more generally, the Abseron Peninsula have long been known for oil and gas. At the beginning of the 20th century, approximately half of the world’s total oil output was sourced from the region.
The oil industry – upstream, midstream and downstream – is the driving force behind the Azerbaijani economy. Oil revenues accounted for 34.3% of Azerbaijan’s gross domestic product from January to August 2016 (up from 30.7% in 2015, but down from 56% in 2010).
Most current oil and gas production is based offshore in the Caspian Sea. In 2013 Azerbaijan produced 43.5 million tonnes of oil, although production has since fallen, with 41.9 million tonnes produced in 2014 and 41.6 million tonnes in 2015.
Unlike oil, gas production is on the rise. In 2013 Azerbaijan produced 17.9 billion cubic metres (m3) of gas, rising to 29.4 billion m3 in 2014 and 29.7 billion m3 in 2015.
How does domestic energy consumption break down with respect to oil and gas, as well as imports and exports?
In 2014 about 38% of Azerbaijan’s domestic energy consumption was met by oil products, while 42% was met by gas. The production of electricity depends mainly on natural gas. Azerbaijan exports both oil and gas – in 2015 imports of both commodities stood at 1.5% of the total.
What are the current trends and future prospects for oil and gas supply and demand in your jurisdiction, and what policies has the government adopted to address these?
Following recent falls in oil prices, the government is actively promoting non-oil sectors. However, domestic supply and demand for oil and gas are not expected to change dramatically. The government is stabilising oil production, which is expected to decline gradually after the peak production of 50.8 million tonnes (including condensate) in 2010. Gas production is expected to increase, mainly for exports, as two important gas export pipelines – the Trans-Adriatic Pipeline and the Trans-Anatolia Natural Gas Pipeline – are due to be commissioned in 2018.
What are the primary laws and regulations governing the oil and gas industry in your jurisdiction?
The primary laws and regulations governing oil and gas industry in Azerbaijan include the Subsoil Law (439-IQ/1998), the Energy Law (541-IQ/1998) and the Energy Resources Law (94-IQ/1996). On March 28 2000 the president of Azerbaijan issued the Decree on Measures to Improve the Issuance of Special Permits (310/2000), as subsequently amended.
The Subsoil Law governs the exploration, use, protection, safety and supervision of the use of subsoil resources, including oil located within Azerbaijan and on the Azerbaijani sector of the Caspian Sea’s continental shelf. Under the recent Law on Licenses and Permits (176-VQ/2016) the following require permits:
- production of gas and processing of natural gas;
- transportation of gas;
- distribution of gas;
- exploration of oil and gas fields;
- development and production from oil and gas fields;
- processing of oil and oil products; and
- transportation of oil and oil products by pipelines.
The Energy Law is intended to complete the legal framework for the use of subsoil resources, including oil and gas. It establishes the social, economic and legal bases of state policy for the energy sector.
Azerbaijan is a signatory and a contracting party to the Energy Charter Treaty and the Energy Charter Protocol on Energy Efficiency and Related Environmental Aspects, and is a member of the Energy Charter Conference.
What government bodies are charged with regulating the oil and gas industry and what are the extent of their powers?
Further to Presidential Decree 149/2014, the Ministry of Energy helps to implement state policy and to administer the fuel and energy sector. In addition, the State Oil Company of the Republic of Azerbaijan plays an important (in fact, on most issues a leading) role in such matters – especially in relation to the practical implementation of oil and gas projects. The State Oil Fund of the Republic of Azerbaijan was established in 1999 to manage Azerbaijani oil revenues.
Exploration and production
Who holds the rights to oil and gas reserves in your jurisdiction?
The exclusive rights to oil and gas reserves in Azerbaijan belong to the state.
Is there a distinction between surface and subsurface rights?
There is a legal distinction between surface rights and sub-surface mineral rights. Individuals and entities may have ownership rights in land; sub-surface rights, as stated, belong to the state.
What rules and procedures govern the grant of rights for exploration and production purposes (eg, through licences, leases, concessions, service contracts, production sharing agreements)?
Under the Subsoil Law, no person or legal entity may engage in oil or gas exploration and production without a licence (ie, an activity permit for a particular area). The law clarifies that a production licence must be issued for a particular subsoil block and is the ultimate deed granting subsoil use rights in that block.
An exploration licence can be issued for a term of up to five years and a production licence for up to 25 years. A combined exploration and production licence can be issued for up to 30 years. An extension can be granted for a term agreed between the subsoil user and the licensing authority.
Unlike the Subsoil Law, the Energy Law provides that production rights for a specified block are granted exclusively on the basis of an energy contract. Notwithstanding the regimes set out in the Subsoil and Energy Laws, and underlining the strategic importance of oil to the country, most major oil deals in Azerbaijan have been and are approved by the country’s legislature. In the absence of a production sharing agreement (PSA) law and a law on petroleum, every oil deal in the form of a PSA – the main form of oil agreement in Azerbaijan – is approved into law that prevails over any other conflicting Azerbaijani law (arguably, this is everything except for the Constitution, acts adopted by public referenda and international agreements).
What criteria are considered in awarding exploration and production rights (eg, are there any restrictions on the participation of foreign investors/companies)?
Under Decree 310/2000, the production and processing of oil and gas can be conducted only by state enterprises and joint stock companies in which the controlling stake belongs to the state. It is debatable whether this limitation contradicts the Subsoil Law; as neither the licensing regime set out in the Subsoil Law nor the contract regime established in the Energy Law has been implemented in practice, this contradiction has not been tested in court. The ownership limitation in the decree does not extend to PSAs.
Are there any special legal provisions applicable to joint ventures?
No, except that joint ventures are separate taxpayers and are formed as Azerbaijani legal entities – rather than pass-through entities, as investors might be used to. Historically, joint ventures must also include a foreign partner.
Joint ventures with foreign partners were popular in the Azerbaijani oil industry in the early and mid-1990s, when a total of four joint ventures were formed. Another upstream venture in the form of a local entity was formed in 2008 – principally to explore the Umid offshore structure.
Following the first approval of a PSA into law, most subsequent oil deals have been concluded as PSAs. One joint venture was subsequently converted into a PSA regime and the field united with a neighbouring field under a PSA regime. Some of the remaining joint ventures are also expected to be transferred to the PSA regime.
Can exploration and production rights be transferred to third parties?
Under the Energy Law, the transfer of rights under an energy contract to third parties and the signing of subsequent agreements require a special permit from the Ministry of Energy. Without such a permit, a contractor is liable – either solely or jointly with the successor – for its non-fulfilment of contractual obligations.
Under the Subsoil Law, the right to use subsoil is transferred to another party in the case of a change of legal-organisational form or reorganisation of the business entity using the subsoil. In case of a change of control by way of a company’s separation from or merger with another company, the new entity will be regarded as the new holder of the licence.
Under a production sharing agreement, a transfer of interest (except for internal reorganisation) typically requires approval from the government, represented by the State Oil Company of the Republic of Azerbaijan. Arguably, the company’s consent does not exclude the need for other regulatory consents and compliance, including anti-monopoly and tax, where applicable.
Is hydraulic fracturing (‘fracking’) permitted in your jurisdiction?
It is not regulated, although it does take place.
Transport and storage
What is the general legal framework governing the transportation and storage of oil and gas resources in your jurisdiction?
As with exploration and production, the transportation of oil and gas is governed by a general application regime, alongside other special regimes (eg, production sharing agreements (PSAs) and main export pipeline and host government agreements (HGAs)).
Under the Energy Law, the state has exclusive rights in the construction and management of major energy transportation systems, without prejudice to the rights of individuals and legal entities. Such systems can be used for the distribution of energy if so provided in the energy contracts. When contractors cannot use existing transportation systems, they may install and exploit transportation means at their own expense.
The transportation of gas resources is also regulated by the Gas Supply Law (513-IQ/1998), under which contractors must comply with the terms of energy contracts, as well as the relevant laws for installing, exploiting and maintaining gas transportation facilities.
Transportation by export pipelines developed with foreign partners is typically governed by agreements developed by partners in the relevant projects.
How is cross-border transportation of oil and gas resources regulated?
Cross-border transportation is typically regulated pursuant to agreements with operators of neighbouring states and can include HGA provisions as well as regulations of general application (eg, Customs).
Are there specific provisions governing marine and ground transportation of oil and gas resources?
There are no specific rules other than those relating to the transportation of hazardous goods. These include the Rules of Carriage of Hazardous Cargo by Marine Transport (approved by Resolution 75/2000) and the Rules on the Carriage of Hazardous Cargo by Automobile Transport (approved by Resolution 10/2000).
Construction and infrastructure
How are the construction and operation of pipelines, storage facilities and related infrastructure regulated?
The construction and operation of pipelines, storage facilities and related infrastructure are regulated by the Energy Law. Activities can be conducted through contractors entering into energy contracts with the Ministry of Energy (ie, the Republic). The law provides for different types of energy contract, including agreements on major energy transportation systems.
The construction and operation of export pipelines are regulated pursuant to agreements between governments (intergovernmental agreements) and with and among investors in those projects (eg, though HGAs).
What rules govern third-party access to pipelines and related infrastructure?
Third-party access to pipelines and related infrastructure is regulated by the Energy Law. When contracts on major energy transportation systems are exclusive, contractors must enable third parties to use the pipelines.
Trading and distribution
How are oil and gas resources traded in your jurisdiction and what (if any) regulations and procedures apply to oil and gas sales, distribution and marketing activities, both nationally and internationally?
Previously, the sale of oil and gas products required a licence from the Ministry of Energy. However, this was abolished by the Presidential Decree on Licensing (713/2015).
Offshore production sharing agreement partners normally export their sales independently, while smaller producers tend to utilise the marketing department of the State Oil Company of the Republic of Azerbaijan. Such arrangements are governed by commercial agreements.
Is oil and gas pricing regulated in your jurisdiction?
Yes. Pursuant to the Regulation on Prices of Crude Oil and Oil Products (Resolution 20/2003), wholesale and retail prices of oil products apply at rates determined by this resolution. This applies to domestic prices only – export prices are not regulated specifically.
Occupational health and safety and labour issues
Health and safety
What health and safety regulations and procedures apply to oil and gas operations (upstream, midstream and downstream)?
Most of the applicable regulations and procedures are of a general nature (ie, not specific to the oil and gas sector). They include:
- the Protection of Health Law (360-IQ/1997);
- the Sanitary-Epidemiology Safety Law (371-IQ/1992);
- the Fire Safety Law (313-IQ/1997);
- the Technical Safety Law (733-IQ/1999); and
- the Rules on Safety Measures and Safety Areas in Gas Supply (approved by Resolution 103/1999).
Technical facilities must be certified and anyone using them must comply with the applicable laws and regulations.
Are there any labour law provisions with specific relevance to the oil and gas industry (eg, with regard to use of native and foreign personnel)?
Employment in Azerbaijan is regulated by the Labour Code (effective July 1 1999) and the Migration Code (effective August 1 2013), along with other relevant laws and regulations. Foreign employees of enterprises operating in Azerbaijan are subject to Azerbaijani employment law, except for those working in Azerbaijan on the basis of employment contracts concluded with a foreign employer in a foreign state.
Foreign nationals wishing to work in Azerbaijan must register at their place of residence and obtain a work permit through their employers. Work permits are issued by the State Migration Service. They are not required if the foreign national is an individual entrepreneur or a sole proprietor and in certain other cases, such as for specific industries, including oil and gas.
What is the state of collective bargaining/organised labour in your jurisdiction’s oil and gas industry?
Currently, the State Oil Company of the Republic of Azerbaijan and its divisions enter into collective employment agreements with labour unions.
What preliminary environmental authorisations are required before commencing oil and gas-related activities?
Before issuing a licence or awarding an energy contract, the Ministry of Energy appoints experts to examine the relevant activity and its impact on the environment. Individuals and legal entities must submit information on the relevant measures they intend to take in order to mitigate any adverse effects that their activities might have on the environment. If they fail to do so, the ministry will not issue the permit or award the contract.
Further, the following approvals must be obtained from the Ministry of Ecology and Natural Resources:
- a passport for hazardous waste; and
- an environmental examination conducted by the Ministry of Ecology and Natural Resources and a positive opinion issued as a result of an environmental impact assessment.
What environmental protection requirements apply to the operation of oil and gas facilities?
Requirements apply pursuant to the following:
- the International Convention on Oil Pollution Preparedness, Response and Cooperation (implemented by Law 690-IIQ/2004);
- the Convention on the Protection and Use of Transboundary Watercourses and International Lakes (implemented by Law 830-IQ/2000) and the Protocol on Water and Health (implemented by Law 372-IIQ/2002);
- the Framework Convention for the Protection of the Marine Environment of the Caspian Sea (implemented by Law 89-IIQ/2006); and
- the Environment Protection Law (678-IQ/1999).
When engaged in energy production, cleaning installations must be used in order to reduce the amount of waste. These in turn must be equipped with devices which decontaminate the surroundings. Moreover, natural resources should be used effectively and efficiently.
Health, safety and environment protection programmes, as well as abandonment (sinking) funds, are established under production sharing agreements.
What are the consequences of failure to adhere to the relevant environmental regulations and to what extent can operators be held liable for environmental damage?
Penalties for violating the environmental regulations include administrative fines and criminal penalties, depending on the nature of the violation. The state is entitled to recover damages from a subsoil user which causes environmental pollution. Different standards of civil liability apply depending on whether the liability is to the state or to third parties.
Taxes and royalties
What taxes (direct and indirect) and/or royalties apply to oil and gas activities in your jurisdiction (including upstream, midstream and downstream activities)?
The Tax Code, which came into effect on January 1 2001, stipulates a three-level tax system, with state taxes levied at the first level, taxes of the Naxcivan Autonomous Republic within Azerbaijan at the second, and local and municipal taxes at the third. The taxes applicable to oil and gas exploration and production are mostly at the state level and include:
- profit (corporate income) tax at 20% (or simplified tax on proceeds);
- value added tax (VAT) at 18%;
- individual income tax;
- mining tax (royalties);
- highway tax (to a limited extent);
- property tax;
- land tax; and
- social taxes and charges.
The Tax Code provides for royalties of 26% to apply to crude oil production and of 20% to apply to natural gas production.
The tax regimes provided under production sharing agreements (PSAs) are different from the general tax regime and also differ from agreement to agreement. The tax on profits paid by oil contractors is normally included in the state’s share of the profit oil production under a PSA. Further, PSA tax regimes provide for lower withholding and income tax rates, exemption from VAT and simplified reporting and accounting procedures.
While most PSAs exempt contractors from having to pay mining tax, they can be obliged to make other tax-like payments in the form of bonus payments and acreage fees (depending on the capacities of each field and block granted under the PSA).
Imports and exports
What taxes and duties apply to oil and gas imports and exports?
Exports – including of oil, oil products and natural gas – are subject to 0% excise tax and VAT, while imports of the same are normally subject to 18% VAT and excise tax in accordance with the Resolution on the Approval of Excise Tax Rates of Excised Goods Imported into the Republic of Azerbaijan (20/2001). While there are no export duties, the import of oil and gas products is subject to customs duties ranging from 0% to 15% applicable to the import’s value.
How is the decommissioning of oil and gas facilities regulated?
Abandonment funds are typically established under production sharing agreements.
How are oil and gas disputes typically resolved in your jurisdiction?
Oil and gas disputes are usually resolved by arbitration.
Azerbaijan acceded to the United Nations Commission on International Trade Law Convention on the Recognition and Enforcement of Foreign Arbitral Awards on May 29 2000 without reservations.
It has also acceded to the Convention on Settlement of Investment Disputes between States and Nationals of Other States.
What regulations and procedures are in place to combat bribery, fraud, collusion and other dishonest practices in the oil and gas sector in your jurisdiction?
Azerbaijan was the first Extractive Industries Transparency Initiative (EITI)-compliant country in 2009. In March 2017 Azerbaijan withdrew from the EITI, and in April 2017 the country’s president formed the Extractive Industry Transparency Commission comprised of seven executives from each of the State Oil Fund of the Republic of Azerbaijan and involved state agencies.
Azerbaijani law prohibits the provision of any benefits of any nature to public and equal-status servants for any actions or inactions that fall under the scope of their duties. Pursuant to the Anti-corruption Law (580-IIQ), a public servant cannot accept a gift (or gifts) with a cumulative value exceeding Azn55 over the course of one year in relation to the discharge of his or her office. Any gift exceeding this threshold is deemed to belong to the office employing the servant.