Azerbaijan has been known as the country with rich oil and gas resources. The country made an important and strategic decision in 1994 by opening its oil and gas reserves for development by multinational energy companies. Since then, number of production sharing agreements relating to Azerbaijan’s oil and gas reserves have been signed between multinational energy companies and Azerbaijan’s State Oil Company (SOCAR). Shah Deniz Stage 2 project is continuation of an established and successful cooperation between Azerbaijan and multinational energy companies.
Production Sharing Agreements
There are few laws in Azerbaijan regulating exploration, development and use of natural resources, including oil and gas (please see below). When it comes to oil and gas, however, production sharing agreements (PSA) are the major instruments. PSAs are entered into between number of large and multinational energy companies. SOCAR is a party to these agreements. Typically, PSAs are signed with respect to a particular oil and/or gas reservoir. For instance, currently there is one PSA in effect with respect to Shah Deniz filed: it is called the Agreement on the Exploration, Development and Production Sharing for the Shah Deniz Prospective Area in the Azerbaijan Sector of the Caspian Sea and governs the Shah Deniz Stage 1 project. The terms of this PSA have been extended until 2048.
Azerbaijan has developed a legal tradition of approving important and strategic PSAs into laws – i.e., the Azerbaijani Parliament approves those agreements and they obtain the status of law. Azerbaijan views this tradition as a factor that helps to attract foreign investment for the development of Azerbaijan’s strategic assets and resources.
PSAs govern relationship of parties, their rights and obligations. Azerbaijan participates in oil and gas related PSAs through SOCAR. Most PSAs contain provisions governing in detail, among other things, each party’s interest (or share) in the project, the procedure for exploration of oil and gas reserves, formation of decision-making committees, procedure and criteria for making decisions in those committees, formation and functioning of operating companies. Besides regulating these contractual matters, PSAs also regulate issues of taxation of proceeds from oil and gas operations in the context of PSAs as well as import and exports of products. PSAs also regulate other matters that are normally within the ambit of regulations of general application (as opposed to contracts). Number of regulations, such as the Azerbaijani Tax Code and Customs Code, do acknowledge the priority of PSAs with the status of law over other legal acts including the Tax Code and the Customs Code.
Azerbaijani Regulations of Energy Resources
Azerbaijani Law On Use of Energy Resources (Energy Resources Law), the Law On Subsoil (Subsoil Law) and the Law On Energy (Energy Law) are three main laws on the development, use and disposal of sources of energy, including oil and gas. Most provisions of the Energy Resources Law are of declaratory nature – they do not contain specific requirements with respect to the development of reservoirs. In particular, the Energy Law proclaims the government’s intention to achieve the efficient use of natural resources.
The Energy Law contains more specific provisions. The Energy Law governs “energy contracts”. Energy contracts are entered into between contractors and the respective government authority of Azerbaijan. The agreements on exploration, development and use of natural resources, such as oil and gas, are considered energy contracts. Under the Energy Law, energy contracts are awarded on competitive basis or as a result of negotiations.
The Subsoil Law defines “subsoil” as part of the land, which is located below the surface and consists of, among other things, natural and energy resources (such as oil and gas). The Subsoil Law provides that the Republic of Azerbaijan (acting through its government) owns the subsoil. This implies that any natural resources below the surface of land belong to the government of Azerbaijan. The Subsoil Law defines “use” of subsoil. In particular, extraction of mineral resources is considered the use of subsoil. In order to use subsoil a legal or natural person must obtain a license from the government. The Subsoil Law allows for allocation of subsoil through negotiations with the government, although the law does not set out the procedure in more detail.
Special Economic Regime for Oil and Gas Operations
On February 2, 2009 the Azerbaijani Parliament adopted the Law On Application of Special Economic Regime to Export Oriented Oil and Gas Operations (Special Regime Law). The law provides tax benefits to contractors and sub-contractors, who are engaged in certain oil and gas operations.
The Special Regime Law applies to any transactions or operations relating to the exploration, development and processing of oil and gas outside Azerbaijan. More specifically, to benefit from the special regime, a contractor’s business in Azerbaijan must be related to oil and gas operations conducted outside Azerbaijan. The Special Regime Law further provides that it does not apply to supply of goods or services in connection with development of oil and gas reservoirs located in
Azerbaijan (including the Azerbaijani sector of the Caspian Sea). This implies that businesses that can benefit from the special regime would likely be those that provide products and services, which are auxiliary or aim to support the major oil and gas operations outside Azerbaijan.
The Special Regime Law defines “contractors”: any legal person (i) registered in Azerbaijan, (ii) with the necessary capacity, expertise and knowledge of working in the oil and gas industry, (iii) engaged in the oil and gas related operations outside Azerbaijan, and (iv) which has entered into agreement with the foreign owner is considered a contractor. While contractors must be registered in Azerbaijan, foreign persons may participate and be 100 percent owner of contractors. The law also defines subcontractors – those are legal persons and individuals who provide goods and services to contractors. Contractors and subcontractors must apply for and receive from the Azerbaijani government a certificate confirming their status.
The Special Regime Law allows contractors to elect one of two income (profit) tax regimes: they may either (1) elect to pay corporate profit tax effective at the time they obtained the certificate confirming their right to benefit from the special economic regime; any subsequent rise in tax rates would not apply to those contractors, or (2) pay tax at 5 percent from the gross amount of payments they receive. Foreign subcontractors are liable for the 5 percent tax from their gross income. Similar tax benefits do not apply to local subcontractors. “0” percent value added tax (VAT) applies to a contractor’s export of operations.
The Special Regime Law exempts all import and export operations of contractors subcontractors from customs duties39, provided those operations relate to “export oriented oil and gas operations” as defined in the law. Further, the Special Regime Law provides free movement of currency in connection with such operations.