Introduction

The EU membership referendum that was held in the UK on June 23, 2016, resulted with 51.9% of the population voting in favor of the withdrawal from the European Union. Taking into consideration the 43 years’ long membership of the U.K. in the EU, this event is bound to bring about certain consequences for all the remaining 27 Member-States as well as for countries outside the Union. In this particular paper, the author tries to determine the implications of Brexit for economic and energy policy of Azerbaijan.  

It is difficult to call the EU’s relations with Azerbaijan as strongly adjusted; however, Brexit’s impact on oil prices and reconsideration of the whole EU’s economic framework after the UK leaves, may have several unwelcome implications for Azerbaijan. Moreover, a number of changes in the EU domestic policy may lead to changes in the principles governing Azerbaijan’s participation in the Union’s economic programs. Hence, Azerbaijan should use its skills and experience in moderating the relations with the U.K. while trying to sustain its developing economic cooperation with the EU.

 

Background

Brexit and its implications for economic and energy policy of AzerbaijanAzerbaijan and the EU have had a long way of positive relationship for more than two decades. The Republic of Azerbaijan remains one of the most important EU’s partner countries, probably because of its strategically important location in the South Caucasus. Throughout many years, Azerbaijan was considered a bridge connecting Europe and Asia. Moreover, Brussels and Baku have common interests in the field of energy. With successful construction and operation of the Southern Gas Corridor, Azerbaijan is set to become a new additional gas supplier for Europe.

Throughout the last two decades, the Azerbaijani government has supported a positive integration of its economy into the European. In 2015, Azerbaijan`s trade turnover with the EU countries equaled $9.7 billion. Azerbaijan’s export and import shares falling to the EU account for 48.3 % and 27.7%, respectively. Overall, Azerbaijan views the EU as the main trading partner that holds 42.4% of Azerbaijan's total trade.

Talking about bilateral relations between Azerbaijan and the UK, it is necessary to highlight that these countries are not tied with strong geopolitical links; however, in the economic realm Azerbaijan is London’s biggest trading partner in the region of South Caucasus and Central Asia. Bilateral cooperation between the UK and Azerbaijan was established in the beginning of the 90s and since that time UK has become the third largest foreign direct investor in Azerbaijan after the United States and Japan. In 2014 only the UK’s export to Azerbaijan reached AZN 1.6 billion, while investment amounted to $153,3 million. Moreover, currently there are 473 companies with the British capital operating in Azerbaijan. Former Ambassador of Azerbaijan to the UK, Fakhraddin Gurbanov in his interview to Diplomat magazine claimed that stable and long operation of the British companies in Azerbaijan is the priority for both governments.

 

Analysis

At first glance, it seems difficult to claim about the implications of Brexit for Azerbaijan now. Little time has passed since the referendum yet, and what is observed at the moment is a high degree of uncertainty and turmoil. Fabian Zuleeg and Janis A. Emmanouilidis offer two possible scenarios as regards the economic effect of Brexit. The effect will be limited in case the UK remains in the Single Market. Otherwise, it will obviously affect the British and EU’s economy and will clod up the EU’s agenda for the coming months and years.

Energy sector is a key element in the bilateral relations of Azerbaijan with the UK. BP, one of the major oil companies operating in Azerbaijan since 1994, deals with the exploration and transportation of oil and natural gas from the Azerbaijani part of the Caspian Sea. BP`s North Sea operations Headquarters is based in Scotland, which may stay in the EU becoming independent from the UK, since a second independence referendum is "highly likely" according to the claim of Scotland's first minister, Nicola Sturgeon. If the UK would opt for the Swiss model with full access to the single market, the impact could be limited for Azerbaijan. For Britain, it will mean paying around the same amount of money to the EU, while abiding by all the EU standards applying in the single market without being able to influence them. If that would be the outcome, one wonders why the UK ever needed to initiate the withdrawal procedure. Another option is if London refuses from an access to the Single Market: it would reduce the UK transfers to the EU, and would be tantamount to an economic suicide with its own negative implications for BP, its shareholders and partner states. In any case, as it was claimed by a policy adviser at Bloomberg New Energy Finance, Dario Traum, ‘UK will work rapidly on free trade agreements with the EU but that would take some time.’

Energy partnership between the EU and Azerbaijan has already passed a long path; however all agreements still exist only on papers. For the first time, Azerbaijan got a real chance to gain an access to the European downstream gas business in 2013 when Nabucco-West lost its significance and gave a way to Trans-Adriatic Pipeline (TAP) that brought the idea of the Southern Gas Corridor (SGC) back into the spotlight. Southern Gas Corridor was launched in 2009 and the first gas from "Shah Deniz-2" supposed to be delivered to Turkey in 2018 and further to Europe in 2019. Despite the fact that construction is progressing, as of June 30, 2016, TANAP is built by over 26%, while TAP is just 19.5% complete.

The UK is not a shareholder in the Southern Gas Corridor project, but BP remains the key investor in engineering and an exporter of oil and gas-related equipment. The continuing fall of the British pound negatively affects euro that is not a good scenario for the Azerbaijani national currency (Manat) as well. Taking into consideration two devaluations that have already happened in Azerbaijan and a significant drop in oil prices, the Southern Gas Corridor becomes more expensive for the government than it is supposed to be.

Immediately after Brexit, many political analysts predicted a possible domino effect that will weaken Europe as a whole. According to the polls held in various European countries, more than 50% of the population in Italy, France, Germany, Sweden, the Netherlands, Czech Republic and Hungary are in favor of a referendum on leaving the Union. If such a movement happens in the EU, especially in Eastern Europe it will bear catastrophic implications for the Southern Gas Corridor. In the best case, this project will be postponed for some years until the EU re-stabilizes its economic framework and borders. In the worst scenario, SGC will be removed from the agenda because each state of the Union will prefer to pursue an independent energy policy with potential suppliers, such as Russia, Iran, Qatar and states in the Middle East.

Brexit and the fall of the British pound will definitely lead to the tax rises in the UK in the long term. Moreover, it will negatively affect the operation of small and medium companies as well as their investment capabilities. Financial markets do not like uncertainty. Therefore, the British companies operating in Azerbaijan will have to review their business conditions, or suffer from losses incurred by the rising costs of import. In the short term, Azerbaijani investors can even get some profit from that. Drop in property price in the UK as well as cheap pound will benefit not only private entrepreneurs but also some ordinary citizens who wish to purchase property there. Nevertheless, in the long term, investors from Azerbaijan will not invest in suffering EU’s economy that will lead to negative outcomes for the companies of both sides. Most probably, for the Azerbaijani government it will not be a collapse due to the appearance of new opportunities in Asia and increase power of dollar; however, individual private entrepreneurs in Azerbaijan will obviously suffer from it. In this case, Azerbaijan will also have to review and accept new prices offered by the British companies.

Certainly, Brexit is economically unsound and the depression that the UK will get immersed into as a consequence may have a mitigating effect on the already ailing and sluggish growth of the global economy which indeed may be bad news for oil prices. For Azerbaijan with its energy-based economy, long-term low oil prices seem to amount to an economic suicide. Immediately after Brexit the oil prices decreased from $47.64 to $46.70; however, already on June 29 it cost $50 again. Therefore, we can conclude that Brexit’s impact on oil prices is negative but only marginal. They mainly depend on the level of supply and demand but the UK`s withdrawal from the EU will not materially affect this balance.

Nevertheless, the exit of the UK, an overall decline in the European economy and ensuing uncertainty around financial markets will lead to, if not a decrease, but at least  sustenance of low oil prices, max $57, in the next five years. In addition, a decrease in investment into oil production is to be expected, probably because investors are fleeing risky assets and prefer redirecting funds to other markets, for example gold. Finally, Brexit and turmoil in European economy as well as devaluation of the British pound will obviously increase the cost of drilling downtime and increasing the number of drilling rigs.

 

Conclusion

To sum up, during just a little bit more than one month since Brexit, the situation on the global financial market does not seem clear yet.  In the medium to long term, a durable cooperation of Azerbaijan with the EU will not suffer from considerable setbacks. However, now that the level of uncertainty is high enough, it obviously has unfavorable implications for Azerbaijan. Both sides, the EU and Azerbaijan alike try to sustain the bilateral partnership in order to avoid any unpredictable outcomes.

Nevertheless, when it comes to investment policies, both sides prefer to avoid risky decisions. After Brexit and immediate fall of the pound and euro, British companies operating in Azerbaijan have to review the terms and conditions of doing business abroad. In addition, entrepreneurs from Azerbaijan prefer to make safe banking and financial transactions in dollars instead of euros or pounds.

Finally, currently, Brexit itself does not influence negatively on energy policy of Azerbaijan. U.K. is not among the major oil suppliers or consumers and therefore, it cannot affect world oil prices. However, in the long term, it may have several implications for stockholders and potential investors; due to the fact that British oil companies remain one of the major investors in various energy projects all around the world, including Azerbaijan.

 

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