TACR: Regional: Enabling Climate Change

Technical Assistance Consultant’s Report

Project Number: 42462 September 2009

R-CDTA 7274:Enabling Climate Change Interventions in Central and West Asia

Azerbaijan Alternative Energy Sector Analysis and Roadmap

Prepared by Dr. Randall Baker and Dr. Enver Safarzade Indiana University School of Public and Environmental Affairs, USA

For Asian Development Bank

This consultant’s report does not necessarily reflect the views of ADB or the Government concerned, and ADB and the Government cannot be held liable for its contents. (For project preparatory technical assistance: All the views expressed herein may not be incorporated into the proposed project’s design.

A Roadmap for Renewable Energy in Azerbaijan 2009.1

R-CDTA 7274: Azerbaijan Alternative Energy Sector Analysis and Roadmap

Dr. Randall Baker Professor Emeritus, Indiana University School of Public and Environmental Affairs, USA Distinguished Professor, New Bulgarian University, Sofia

And Dr. Enver Safarzade National Consultant

July – September 2009

Contents

Introduction. 4 Change. 7 Why a Roadmap? 10 The Policy Framework. 13 The Potential. 15 The Tariff Structure. 20 Costs, Returns and Benefits. 22 A Case Study of Costs, Returns and Benefits. 25 Azerenergy. 35 The Structural Issue. 39 Conclusion and Recommendations. 41 Annexes. 43 Principal Policy Statements. 44 List of Reports Consulted. 56 Officials Interviewed. 57 Simple SWOT Analysis. 58

Introduction

This report, by ADB to the Republic of Azerbaijan, is conducted under to rubric of a regional attempt to ameliorate the effects of climate change—in this case by addressing what is widely believed to be one of the principal causes: energy generation from non-renewable sources.

It is reassuring to find a country such as Azerbaijan, whose economy is so dependent on the exploitation and export of traditional hydrocarbon resources, so forward-looking as to envisage a transition to less damaging, and potentially inexhaustible supplies of energy. The continued use of natural gas and oil, the status quo as it is referred to in this report, is the ―easy option‖ though it will not always be an option since, by definition, this source of fuel is exhaustible and will become more expensive. Furthermore, it will continue to add to the global problem of carbon build-up, which the government is treaty-bound to address.

On the part of the government of Azerbaijan, the various policy statements (included in the annexes) reflect a strategic approach, rather than the default option, which eventually steers us into crisis management, possibly on a huge scale. The policy statements reflect an intent to steer toward a more sustainable, healthier and cleaner future.

However, having policy is one thing, and implementing it in the light of a huge existing status quo is another. The climate change question is one with very many, interlocked, components, whereas governments in most countries have a functional, or sectoral, structure that tends to disaggregate integrated problems of a high order. In the case of Azerbaijan, the various policy statements have taken the form of Presidential Decrees; something to which all arms of government must listen.

At the same time, during the preparation of this report, the consultants found report after report of a high technical order on the subject of Renewable and Alternative Energy (R&AE) in Azerbaijan, representing thousands of man-hours, and untold hundreds of thousands of dollars. And yet, there is little on the ground to show the realization of these many studies. So, there is a clear gap between intent and realization, and it is this that the present report addresses. It avoids repeating the voluminous literature on potential, and every aspect of current and potential energy generation. Instead, it addresses the perceived reasons why the transition to a greater reliance on R&AE has not occurred. It has nothing to do with political will—that has been clearly expressed. It has everything to do with the fact that there has not been, and in some cases still isn‘t, an administrative, legislative and economic framework to ―make this policy happen.‖ The various components do not come together, and there is no clear strategy on how to make the policy work.

But, this is not a negative view, simply an expository one. The report addresses, up-front, the enormous number of changes taking place globally and in the Republic, that address the need and modality for change. In fact, this complicates the report because so much is in transition as it is written, but the seeds of real, positive change are there and must be strengthened, with outside assistance where relevant and possible. However, this is a national initiative, best reflected in the creation, right in the middle of the report writing, of what was to be our central recommendation: the creation of a State Agency for Alternative and Renewable Energy in Azerbaijan. This mid-level between Policy and Implementation is key to integration, methodology and strategy design. It is, to a large extent, what has been missing previously, when the country had only a State Commission which, at best, was an

advisory group without any substantive existence in the administrative machine. Renewable energy in Azerbaijan was caught in an Administrative Trap, that without intent, made it well- nigh impossible to have a cohesive, intelligible and structured strategy. Once such a strategy is in place, and the various components have been brought on board (including tariffs, incentives, popular education and the like) then some real targets can be set and measured for the transition. There is no real ―obstruction‖ to this transition in place in Azerbaijan, just an inability to make it work to the benefit of all participants. Not least in this picture is the dramatic and costly refurbishment and efficiency-building of Azerenergy—the state monopoly, which has stated that its expanded capacity has ―the country covered.‖ We asked an Azerenergy spokesman this question directly, and we told, ―With its recent investments, Azerenergy now has the capacity to supply all the country‘s needs for electricity.‖ Does this mean that alternative energy, from which Azerenergy (apart from its aged larger hydro generating capacity) has been administratively excluded to favor the private sector, is left in a position of facing ―competition‖ rather than cooperation with the alternative sector?

At the same time, the private sector, often characterized as ―risk-averse‖ is reluctant to become involved (with one potentially significant exception). Perhaps an explanation that is closer to the truth is the fact that the private sector sees a world of few demonstrated pilot projects, enormous administrative and legislative impenetrability, questionable profitability, competition from a monolithic, monopolistic giant, and almost no suitable terms for raising capital locally. In these circumstances, they can hardly be blamed for being risk averse, for the risks seem incalculable, and the terms onerous.

Mention is made in many reports, and published articles on energy in Azerbaijan, of the phenomenon of ―Dutch Disease.‖ This is a condition that occurs when countries suddenly encounter an enormous increase in revenues—usually from hydrocarbon exploitation. It is not inevitable, and it sometimes seems unfair to label it with the example of the Netherlands, since there are many, much worse examples. Briefly, this rapid inflow of money is characterized, under the rubric of Dutch Disease, as follows:

The revenue, especially from hydrocarbons, accrues initially to the state sector in terms of royalties, including fees for the passage of energy via pipelines over the national territory. Some jobs are generated, but relatively few directly in the context of the size of the revenue. The government, then, has a major task of ―making the revenue work,‖ in terms of job creation, incentives, infrastructure creation and the like. This situation has an in-built tendency to favor the big and quick fix—huge highways and public buildings, grandiose improvement of facilities, and the generation of endless bureaucratic ―make-work‖ jobs. This works against more modest, and long- term options. The capacity to spend is the capacity to inflate, which is something that Azerbaijan has tried to control with the State Oil Fund that sets money aside for the future. Nevertheless, unless this flow of money is regulated, it can lead to inflated currency values, a limitless capacity to import rather than produce, and a rush of money into project with limited real returns. It discounts the future because of the simplicity of ―solving‖ problems here and now. This is critical because hydrocarbons are here and now, and ultimately do not have a future.

Some governments reveal a capacity to cope with this, such as Norway; others fall under its spell and show signs of extreme stress, such as Nigeria. In order to counter the temptations of Dutch Disease, governments in these situations need vision, and vision is a capacity to see how the future should be, not eventually get there by riding along with the present. The statements about alternative energy in a country afloat on hydrocarbons is a sign of vision, because, quite simply, Azerbaijan doesn’t have to do anything to change the present situation, especially in a world where politics is notoriously short-term.‖ If this vision does not seem to be becoming realized, it is possible to say that the government ―wasn‘t really serious, and it was only ‗window-dressing‘‖ or it can be that the policy is getting lost in an implementing (administrative, legal and economic) system that cannot address it. The case of Azerbaijan definitely appears to be the latter, and the policy is continually readdressed, and there is some sense of frustration that more progress is not being made.

So, the challenge is not technical, and that is why this report is not technical. The vision is there; the modalities are not, but they are being worked on and change is at hand. There is no doubt at all that the task of realizing the vision will fall, to a large extent, on the newly- created State Agency, which deserves all the support it can get in terms of being exposed to what other governments have done (particularly the carbon-budgeting dramatically announced by the UK in July, the Swedish Certificate system, the tradable permit proposal announced by Mr. Obama, also in July, and many more). It should also be given every opportunity, bilaterally and multilaterally, to achieve capacity-building to address its new, and very formidable, challenge.

Finally, this report has been kept deliberately brief to focus on the central issues that need to be addressed. Technical and scientific data is available in the reports listed at the end of this study. Furthermore, we have tried to make the report accessible to people in all branches and aspects of renewable energy.

Change

During the course of the fieldwork for this study, numerous very significant changes took place that are significant to the Roadmap exercise. Some of these may present problems, but mostly they indicate trends in the right direction toward R&AE, and give some encouragement. These changes include:

The major change in the price of natural gas in Azerbaijan, approved by the Tariff Council and implemented with effect from June 30th, 2009. This represents close to a 100% increase in the price to the consumer. However, gas remains subsidized to Azerenergy, which uses it—along with Diesel—as its principal component in generating electricity in its newly-refurbished plants. This change needs to be seen in the a broader context of (a) enormously expanded opportunities (Nabucco, for instance, as well as the new deal with Russia) for Azerbaijan to sell its gas into a wider regional market at global prices.1 This means that any gas deflected from this market, and into a locally subsidized market—as is the case with Azerenergy— carries a high opportunity cost. This could alter the cost and benefit analysis of the country‘s present system of electricity generation, depending on the market conditions for exported natural gas and oil. Should this opportunity cost work its way through the system in terms of higher prices to Azerenergy, and higher tariffs to the consumer, this will provide a considerable, and much-needed, incentive for the development of R&AE, especially in the private sector. It is not possible, at this stage, to say what will happen in regards to fuel prices for Azerenergy Perhaps most notable among changes, was the Presidential Decree on 17th July 2009 announcing the creation of a State Agency for Alternative and Renewable Energy. This agency will be based in the Ministry of Industry and Energy, and the Council of Ministers has been instructed to have the terms of reference ready for this initiative by mid-August. Previous policy initiatives in the R&AE field have suffered from the lack of any oversight body—being dispersed among many ministries and agencies with no coordination mechanism. Potentially, this State Agency affords the potential to overcome this problem and provide focus, coordination and direction. At this stage it is impossible to say anything specific as the Agency is in the process of being designed, but it offers the possibility of a substantial administrative improvement in achieving policy goals. This Agency would appear pivotal and would be a logical base for technical and other capacity-building assistance. Azerenergy, a joint-stock company wholly-owned by government, is in the process of major changes in the refurbishment of its generating basis, fee-collection through metering, coping with the collapse of the privatization of delivery through the collapse of the Barmek company (a leasing arrangement is in place now), redevelopment of the transmission and distribution system at considerable expense (+$1.5 bn), internal restructuring exercises, and eventually working out its relationship with the State Agency for Alternative and Renewable Energy, examination of tariffs, notable improvements in the efficiency of generation and (soon) delivery (where 18% losses prevailed). This will give Azerenergy the capacity to supply electricity to the country and even export to Georgia, Iran and others. This raises questions about the

1 Russia will start receiving Azerbaijani gas on the first day of 2010 and the amount will initially be a modest 500 million cubic meters per year. Current plans call for an initial 8 billion cubic meters of gas annually from Azerbaijan for Nabucco, an amount that should increase to 31 bcm as new suppliers join up, to be carried to Baumgarten, Austria. 7

monopoly situation, since alternative energy can be seen as in competition with the fossil-fuel based Azerenergy system which is in receipt of enormous subsidies in respect of its basic fuels. This could be a considerable disincentive to the alternative industry, and this is compounded by the tariff that Azerenergy pays for energy introduced into its system from alternatives. The private sector sees this as a major disincentive to any initiative on its part. This subsidy issue will be central to the development of alternative energy, and clearly Azerenergy wants to see clear returns on its considerable recent investments in the status quo of energy production in Azerbaijan. A great deal of investment has been put into improving efficiency on the basis of the present technology and fuel-source, which is commendable since waste is to be avoided wherever possible in burning fuels. Against this, however, the policy of the government has to set existing commitments to international agreements and its stated policy of encouraging alternatives, including climate change, social benefits, regional and poverty-alleviation programs etc. Again, Azerenergy‘s position vis-à-vis the new State Agency is critical in this respect. On the July 1, 2009, Azerigas was merged with SOCAR, and this could have consequences for the future of gas prices to Azerenergy, as SOCAR has a broader view of the resource than does Azerigas, perhaps especially in respect of the opportunity cost of subsidies. Based on the cooperation of the German company Energy Competence Centre GmbH (ECC) from Berlin and the Azerbaijan company Caspian Technology Company, the operation of the first wind energy turbine started in March 2009. In Yani Yashma, Khizi Region, the pilot project consisting of two VESTAS V52 with each 850 kW power was connected to the grid. Thus, Azerbaijan has a modest, but functioning wind-turbine system, and the company has large plans for expansion, not only in the coastal area, but in developing up to 30 mini-hydro units in Sheki region capable of producing 45 mw. So, change has started. The prospect of a 105 mw wind-turbine project on the Caspian Coast is in the process of advanced negotiations with a German company, and a local private venture. Parliament (Milli Majlis) is discussing a new law on renewable energy, which might be presented in September of 2009, and that could alter the basis for private investment, which has been very cautious and nervous up to now. A major initiative is under way, under the aegis of the Ministry of Ecology and Natural resources to provide clean drinking-water to up to 400, smaller, rural communities, as well as units to purify water entering the Caspian Sea, especially at popular resorts such as Bilgah. This project has substantial, not least basic health, benefits, but is prevented from achieving full efficiency by the irregularity of the electricity supplies in these areas. This seems like a model pilot effort for solar energy but finance remains a problem. The country now benefits from potential payments from the CDM (carbon offset fund) facility that should enter the calculation of costs and returns for renewable energy. However, the system is extremely complicated and not sufficiently understood nationally. Tariffs are under review, and this is crucial to the development of R&AE. They were raised in 2007, but are seen by the private sector as prohibitively low, as are the prices paid for accepting R&AE by Azerenergy. We should take note, too, of enormous changes that are going on globally in the assessment of the contribution of R&AE. For instance, 2009 was the first year that expenditure on renewable energy exceeded that on conventional energy, and marks a turning point. During the research for this study, the UK announced that by 2020 8

40% of its electricity would be generated by renewable sources, which is a huge transformation, and is a response to climate change. Just as important is the fact that the UK introduced the system of Carbon Budgeting for the government, which is the means by which this transformational policy will be achieved. Furthermore, the government will take a major role through taxes, incentives, and public-private cooperation in achieving this. In the USA, the Obama Administration announced a program for carbon limits and trading, though this has yet to be endorsed by the legislative system. Sweden has a system of certificates to allow R&AE to competed with established fossil-fuel systems. There is a surge of government-led initiatives in this transformative process, recognizing that the private sector alone cannot turn around 120 years of dependence on fossil fuels. Among the public, too, ideas are changing, especially as a result of the remarkable volatility of the oil market, uncertainties in the delivery of natural gas (though sometimes this is emphasizing a move to nuclear power, as in Bulgaria, and nuclear is not a renewable).But, the public is more ready to consider change, rather than ―business as usual‖ which was the traditional response to, for instance, oil crises in the USA. Lastly, there is the change in the continuation of fossil-fuel resources in Azerbaijan itself. Projections of oil and gas reserves are notoriously unreliable, but the fact is that, over time, supplies become more expensive to extract and are, ultimately, expendable. Thus Azerbaijan cannot rely on the windfall profits of, particularly, the last five years, and has set aside funds in this regard. The World Bank, among others, refers to ―Peak Oil‖ in 2010, after which supplies diminish. Others are now quoting 2020, but it is evident that the implication here is to use windfall resources, in part, to facilitate the transition to alternatives. Some of these windfalls will come from transition fees for pipelines (possibly including Turkmenian gas, new gas sales to Europe and Russia—offset by the unpredictable volatility in oil and gas prices, and the demand response to recent crises. It is a wise and commendable move to be thinking of the future now in terms of positioning the country for a very different world.

It is evident that this climate of change is necessary, but it is impossible at this stage to envisage how the various elements will eventually play out. Everything, it seems, is in a state of flux, but a necessary flux. It is hoped that the new State Agency will be able to coordinate the various components into a viable program with set goals and targets from R&AE in the near future. Action is needed now to set the process of R&AE development on a secure footing.

Why A Roadmap?

The term ―Roadmap‖ has achieved some popularity, but in the case of this report it is useful to start by examining the value of this analogy to the examination of the future of Renewable and Alternative Energy (R&AE) in the Republic of Azerbaijan, since it has considerable operational and logistical value.

It is useful to start by realizing that a Roadmap is not an end in itself, but a means to an end: how to get from A to B.

A Roadmap has, as its main utility, the means of arriving at a destination, and in this case the destination is a place defined—or, perhaps in some elements, needing to be defined—in terms of a stated place in the economic and social development of the country for R&AE. This destination is expressed in various policy statements from the government, and especially, the Executive Arm. Policy will, therefore, be taken as the definition of where the country intends to go in this particular journey, and this has been spelled out on more than one occasion in terms of intent, if not always in terms of scheduled targets. So, we know where the country wants to go on this journey. The journey itself is based on solid knowledge about the reason for traveling—the consequences of continuing with the existing situation, the potential for R&AE in scientifically proven terms, costs, revenue and benefits, and environmental consequences, especially if nothing is done. The need for the journey is not just in terms of internal policy decisions, but also to abide by the international agreements (Kyoto, IRENA and others) to which Azerbaijan is a signatory, and has therefore undertaken to initiate and sustain change.

In terms of the starting point, this comprises the present mix, efficiency and consequences (economic, social, environmental, etc) in terms of the country‘s means of generating, transmitting and distributing energy at the present time. This point of origin has been defined, for well over one hundred years, by the presence of abundant resources of fossil energy, both on land, and more recently, in the development of offshore resources in the Caspian Sea. This starting point has also been recalibrated, particularly in the last two decades by the construction of major gas and oil pipelines to Turkey and Western Europe, as well as the recent revitalization of the pipeline to Russia—dating back to Soviet times— following an Agreement to supply gas to Dagestan with effect from January 1, 2010.

The Roadmap should show a clear route from here to there. The route should be clear, and impediments to progress need to be cleared, rebuilt and modified to make the journey possible and achievable. At present, the journey contains many hazards in the form of uncertain legislation, sunk costs in the status quo, tariff problems, public interest levels, private uncertainty about investment, improvements and associated costs undertaken in modernizing the existing fossil-fuel based electricity generating system, and others. In other words, the journey requires a well-defined and integrated route with clear signs, markers to show progress and with all elements brought together in a clear strategy to enable the journey to take place efficiently and without periodic breakdowns and loss of direction.

However, as is often the case with conventional Roadmaps, the information quickly becomes revised, and is undergoing reconstruction, review and modification. In the case of R&AE in Azerbaijan this is particularly the case, as the timing of this study coincides with a picture of considerably change. New policy, new administrative structures, reviews of legislation and tariffs, enormous variations in the world price for gas and oil, rebuilding of the

entire electricity infrastructure, private initiatives and proposals, new regional and international infrastructure for the sale and distribution of gas and oil—especially to the EU, changing emphasis by developed countries into the future energy mix, the global financial crisis, and other factors are all operating to provide a pattern of considerable local, regional and global change—all of which will have to figure into the realignment and nature of the road itself. In addition, these changes constantly modify the importance, urgency and relative place of R&AE options for Azerbaijan.

It is also important to consider why make the journey, as ―staying where we are‖ is an alluring alternative. After all, Azerbaijan is fortunate among countries in having abundant fossil fuel resources that provide a considerable proportion of its wealth and could, as has happened in other oil-producing countries, deflect it from serious considerations about the future and set it on a road of unsustainable expenditure. This phenomenon is sometimes termed ―Dutch Disease,‖ though the Netherlands is by no means the prime example of the pitfalls of sudden energy wealth. The comparative scale of ―Dutch Disease‖ runs from sound management of such resources toward a sustainable future, as in Norway, and a damaging effect on both the future and present, as is the case in Nigeria. Azerbaijan has done much to prevent this supercharging of the economy, with attendant inflation and unsustainable spending, and, indeed, the very presence of a policy and institutional framework for renewable energy is a tribute to foresight in the country. Indeed, one of the reasons for making this journey in the first place, thus requiring the roadmap, is because our starting point is an unsustainable place. Making this journey is a strategic decision that will, if undertaken properly, avoid the crisis management of breakdown if the journey is delayed.

One aspect of traveling is the weather, and this analogy holds good for a serious consideration of taking the R&AE Highway. This study is being undertaken under the general umbrella of Climate Change within the ADB. Throughout the world, in the new administration in the USA, throughout Europe, and particularly in the UK, major efforts are underway to modify the way in which our use of energy may be altering the climate through changes in atmospheric chemistry. Azerbaijan has its part to play in this global effort to reduce carbon emissions, and indeed the CDM mechanism provides incentives for making this transition at many levels, public and private. Projects are being designed now with carbon offsets as a substantial part of their benefits, and justification for their costs. It is now recognized, throughout most of the world, that the cost of doing nothing, continuing with a comfortable status quo is likely to be unsustainable and, indeed, damaging to future generations and this generation too.

Taking this journey, we hope to pick up people who are stranded along the way by remoteness, failure of the existing energy system, poverty or displacement. Indeed, if this journey is to be successful, it is necessary to carry with us all those needing to get to the designated destination. It is a journey for everyone and not simply to reinforce what is. Thus, getting there is not just a question of the cost of the journey, but the benefits—not all of them easily identifiable in terms of immediate return on the cost of the journey, but of making the journey an improving experience for society in general, and even for contributing to a global effort.

So, the roadmap is a sort of practical analogy helping to piece together all the different components of the journey. More particularly it shows us how to get there in the shortest and most efficacious way. So far, the journey has been intermittent, stalled here and there, littered with broken-down vehicles and sprinkled with contradictory roadsigns. But, that is changing—though much remains to be done. What we need to address in this Roadmap is 11

a clear set of directions, a set of provisions to sustain us on the journey and some indicator of how we are doing along the way to measure progress. Sometimes the elements are there, but not comprehensively working together; in some cases pieces are missing; and in yet others there are contradictory signals and even roadblocks.

In many ways this Roadmap is familiar, and contains mostly things that we know. But its purpose is to design the route so it works, is understandable, has everyone working together along the way, and stands a good chance, finally, of getting us to where we want to be. So far, the journey has remained largely in the ―vacation planning‖ category of effort with little substantial mileage on the clock. However, as will be a recurring theme of this report, major change is underway already, and must be incorporated into our planning. Indeed, while preparing this Roadmap, we had constantly to modify our ideas as substantial restructuring and policy change appeared. This could be seen as disruptive, but is not, for it shows intent at the policy level, and in one case, the creation of a new body to oversee the whole journey—something lacking until now. The ideas were there, but the highway authority was lacking to implement them. The creation of a new State Agency for Renewable and Alternative Energy offers the potential for pulling the effort together and making it happen.

Finally, an examination of the journey offers opportunities to see where gaps remain that might be usefully filled by initiatives by, for instance, agencies such as the Asian Development Bank. Increasingly, Azerbaijan has accumulated the resources to make its own investment provisions, but there remain technical, economic opportunities for making this highway more efficient and speeding its completion.

In this Roadmap, the focus will not be on repeating the large amount of technical and economic data that already resides in many existing studies, but to focus on the key issues, especially those of realizing policy, that need to be addressed in order to make those, often non-operational, reports useful in shaping the future. It seems clear, and very commendable, where Azerbaijan wants to go. The whole purpose of this report is to enable that journey to be made, and made soon.

The Policy Framework

There are, already, many policy statements and decrees that, directly or indirectly, touch upon the role of R&AE in Azerbaijan. In effect, these are a statement of ―where the country wishes to be,‖ though, not always, how it will get there.

In brief, the main policy statements relative to this study (other than those reproduced in detail in the annex) are:

Law on Energy Utilization; Law on Power Engineering; Law on Energy; Law on Electric and Thermal Power Plants; State Program on Poverty reduction and Economic Development for 2003-2005 approved with Presidential Decree N854 dated February 20, 2003; Measures on Strengthening Financial Discipline in Energy and Water Sectors approved with Ordinance N893 dated March 25, 2002; Presidential Decree N4 on Furtherance of Socio-Economic Development in Azerbaijan Republic dated November 24, 2003; State Program on Socio-Economic Development of Regions of Azerbaijan Republic for 2004-2008 approved with Presidential Decree N24 dated February 11, 2004; Presidential Decree N458 on Establishment of Ministry of Fuel and Energy dated April 18, 2001; and other normative-legal acts.

In summary, it may be said that ―The objective of State Program is to promote the power generation from renewable and environmentally sound sources and to more efficiently utilize hydrocarbon energy sources.‖ The desire of the country‘s leadership to focus more attention and importance on R&AE seems clear and unequivocal.

Putting together the various policy statements, the main aims may be summarized as follows:

The major tasks of State Program include:

- define the potential of alternative (renewable) energy sources for electric power generation (the technical aspects of this are largely completed); - raise the efficiency of utilization of country‘s energy sources by developing renewable energy sources; - ensure the opening of additional jobs with creation of new energy production sites; - Given the existing total capacity of traditional energy sources in Azerbaijan, increase the energy capacities at the expense of alternative energy sources and therefore, achieve the country‘s energy security.

In addition to setting the domestic agenda, there is an international dimension of obligations, including: The commitment of the Government of Azerbaijan (GOA) to the development of environment-friendly energy sources reflected in the UN Framework Convention on Climate Change, the National Environmental Action Plan, the State Programme on Poverty Reduction and Economic Development (SPPRED) and the State Program on Use of Alternative and Renewable Energy Sources (October 2004).

In terms of the ADB‘s involvement in this policy framework, it has stated that the Development of renewable and clean energy sources to provide direct benefits to the rural poor is a priority of the energy policy of the Asian Development Bank (ADB). Accordingly, ADB supports the Government‘s initiative to develop a priority renewable energy project with the overall goal to

reduce the regional imbalance in economic growth with reliable and environmentally clean energy supply. As part of its report on renewable energy in Azerbaijan in 2007, Entec outlined the basic requirements, as it saw them, for a sound policy framework in this respect. These included: A tariff regime: that acknowledges that the true social costs of fossil energy generation are not captured by wholesale market prices, and which therefore justifies a higher price to compensate for this market failure. An effective regulator to oversee the tariff and its annual recalculation The development of a set of technical and legal documents (power purchase agreement, grid code) that ensure a level playing field by avoiding ad hoc negotiations over tariffs, terms and conditions. This is particularly important where the buyer is a still a vertically integrated monopoly, but which is itself active in renewable energy as a developer (through wholly owned subsidiaries). An outreach activity to promote renewable energy, and in particular to attract private investors into the sector (e.g. develop a website for renewable energy, prepare prospectuses on potential opportunities targeted expressly at developers) Working with the Designated National Authority (under UNFCCC) to establish the procedures for developers to obtain carbon finance for renewable energy projects The setting of renewable energy targets (this is not an immediate priority for Azerbaijan, but if the Government wishes to go beyond the first set of projects funded by ADB, nonetheless an important step). Such efforts have been agreed in a number of similar renewable energy projects in Asia as a condition for loan support from multilateral agencies (e.g., Sri Lanka, Vietnam). They should be part of the agreed activities in Azerbaijan as well.

Many, if not most, of these elements are still absent, though progress is being made. The creation of the State Agency for Alternative and Renewable Energy, in July 2009, provides a locus for bringing these disparate, but essential, elements together. These provisions remain as essential to the successful implementation of R&AE policy as they ever were, and should be addressed.

It seems as though, given the establishment of the State Agency,2 which will be based in the Ministry of Industry and Energy—at least initially—that the role of the Ministry/Agency is the basis for the successful strategic operationalizing of policy—though not necessarily all the implementation, of course. We shall discuss some of the necessary functions of the Ministry/Agency in the recommendations section at the end of this report, but it is reassuring to see a structure in place that has the capacity to move policy, think strategically, and coordinate the many elements of this equation. It is, it seems, the missing link that policy has needed in this area for so long. Without it, much study, research and report-writing has been neutralized, but may now be activated.

2 One of the requirements of joining the International Renewable Energy Agency (EU) on June 10th 2009. 14

The Potential

Numerous studies have been conducted since about 2004 into the potential for R&AE in Azerbaijan. What is evident is that the potential is very considerable, especially for wind, hydro and solar, with some elements of biogas and thermal energy entering the picture as well. Indeed, Azerbaijan is, in many ways, better endowed than many countries that have made remarkable advances in R&AE, such as Denmark and Germany. Realizing this potential is a matter of policy and government incentive, not just leaving the pace to the private sector—almost no government in the Developed World takes this laissez-faire position. Positions, in different consultant reports, vary on the prime contender for R&AE in Azerbaijan, but in this section, we will summarize the technical assessments.3

Wind

Wind power is the most preferable energy source compared to solar, hydro, geothermal and biomass for its cost, environmental soundness and unlimited availability.

Practice shows that many of regions in Azerbaijan have great perspective for an application of wind power facilities. Calculations suggest that Azerbaijan Republic has about 800 MW annual wind power capacities due to its geographical location, nature and economic infrastructure. This reserve means 2.4 billion kWh of electricity, according to rough calculations. This would imply the saving up 1 million tons of conventional fuel, more importantly, the prevention of emitting a large quantity of wastes, including ozone-cracking carbon dioxide.

Long-term surveys have determined that convenient windy conditions prevail in the Absheron Peninsula, and along the Caspian seashore and islands in the north-west of Caspian basin. It is feasible to use medium capacity wind power facilities in Ganja- Dahskesen zone and Sharur-Julfa area of the Nakhchevan Autonomous Republic because the annual average speed of wind in those regions is 3-5 m/sec.

A Japanese company, Tomen, together with Azerbaijan Scientific-Research Energy and Power Design Institute, installed two wind towers of 30 m and 40 m heights and determined that annual average wind speed is 7.9-8.1 m/sec in Absheron. The company had also prepared a Feasibility Study for the installation of a 30 MW wind power plant in the Gorbustan region—this is now under serious consideration as an Azerbaijan-German joint venture.

An Assessment of Azerbaijan‘s renewable energy sources was conducted in 2002 and it was determined that Absheron Peninsula has large-scale wind power capacity. The average speed of long-lasting wind is more than 6 m/sec, which shows the technical-economic potential for using wind power. The statistical data on wind power gathered in Shimal DRES area have once again justified the above indicators. Based on conducted researches, the presented indicators on Gobustan area have been included into 4th class of wind energy potential, which is considered as high potential.

3 Most of the technical data derived from the Prefeasibility Study for a New Project to Promote Renewable Energy in Azerbaijan. Kreditanstalt für Wiederaufbau, for Ministry of Economic Development, conducted by Environmental Resource Management (ERM), 2004, and Preparation of Energy Sector Road Map, ADB TA: RSC – C60114 (AZE), 2006. 15

The present involvement in wind-energy power generation is represented by the two wind turbines, run by Caspian Technology at Yani Yashma on the Caspian Coast north of Baku, with a capacity of 1.75 mw. However, plans are already in advanced stage for this to expand, in the form of a German joint- venture, with partial funding from a German bank and guarantees from the International Bank of Azerbaijan, to expand this facility to a wind park of 40 mw capacity. This would mainly serve the Sumgait area under a special tariff negotiated with the tariff authority. Eventually, the holding company envisages this park expanding to a possible 250 mw capacity (Sumgait uses about 500 mw daily). There are also plans, mentioned by the Ministry of Industry and Energy, for developing offshore wind generating capacity to serve rigs in the Caspian Sea, and a decision on this is expected in September 2009. Earlier involvement by the Korean company STX, to get into the wind-turbine generation of electricity failed over the low level of the tariff that it was able to offer, and negotiations broke off after two years. Apart from having high and reliable winds, the Caspian coast has little alternative land use because of salt-contamination, so land is available.

Solar

The climate condition of Azerbaijan opens great opportunities for production of electric and heat energy using solar power. The annual number of sunshine hours in USA and Central Asia is 2500-3000 hours, 500-2000 hours in Russia and 2400-3200 hours in Azerbaijan.

Development of solar power can partially solve energy problem in many regions of Azerbaijan. Several developed countries have recently started to widely apply Photovoltaic Program (PVP). Involvement of Azerbaijan in this Program can have important role in application of such type of energy systems.

It should be noted that the efficiency of solar stations depends on country‘s natural climate condition and geographical location. The solar power that comes down to earth totals 1500-2000 kWh/m2 annually in USA, 800-1600 kWh/m2 in Russia, 1200-1400 kWh/m2 in France, 1800-2000 kWh/m2 in China and 1500-2000 kWh/m2 in Azerbaijan. It is obviously clear that the quantity of solar intensity in Azerbaijan stands up very well in comparison with other countries, which might be regarded as one of the efficiency factors for attracting investments in solar power.

The full potential for solar is easier to calculate than the demand. The wind energy prospects are favored in the coastal locations where the breeze is strong and steady. Solar, on the other hand, is better-suited to the central river valleys and the north and northwest. If the Ministry of Ecology and Natural Resources‘ water-purification program were to switch to solar energy, then there would be the capacity to generate 100 mw, (or more) in mostly rural 16

areas. What is not clear is how many people (and communities) remain underserved even after Azerenergy‘s large recent expansion. There was a substantial reduction in energy use after effective metering was introduced, and it is not clear whether people economized or dropped out of the system. Many were using electricity to compensate for the basic collapse of the rural natural-gas distribution system—even though this is an inefficient way to use electricity. These people could now be using wood. However, if they were priced out of the market, even at today‘s low rates for electric power, it is hard to say that they would be any more of a market for a solar-produced alternative. This remains a major unknown.

The Ministry of Industry and Energy informed us that in 1 to 2 years, they would prepare solar stations so that by 2012, some 250 mw would be produced that would help light schools, traffic signals etc., and that they were preparing a project to encourage a joint venture on the domestic production of solar batteries. In addition, a 5 mw pilot project was envisaged in conjunction with the Caspian Technology operation at the Yani Yashma wind farm.

Hydro

The weight of generation capacity of hydro power plants within Azerbaijan‘s overall power system is presently 17.8 percent. 2.4 billion kWh of total electricity generated in 2003 was produced by hydro power plants, which constituted 11.4 percent of overall electricity generation, making hydro, by far the largest renewable contributor to the country‘s energy needs at present.

There are some hydropower potentials in the country that are still undeveloped up to date. The researches related to this area showed that overall hydropower potential of rivers in Azerbaijan Republic equals 40 billion kWh. The technically feasible potential totals 16 billion kWh, 5 billion kWh of which is related to small hydro power plants.

Construction of hydro power plants has an important role in the resolution of country- level issues such as regulation of flood waters, environmentally sound electricity generation and the creation of new irrigation systems. It is possible to locate dozens of small hydro power plants on rivers and water facilities and these plants can generate up to 3.2 billion kWh annually. In the near-term perspective, it would be expedient to install 61 small HPPs. These HPPs can be located on irrigation canals, rivers with unregulated flow and water reservoirs that are under-construction. Use of micro HPPs in electricity supply of objects and settlements that are remote from transmission lines and substations of countrywide grid system can resolve electricity problems, as well social problems.

Given that power system of Nakhchevan Autonomous Republic has no connection with mainland (countrywide) power system, construction of medium, small and micro hydro power plants would be more expedient primarily for Nakhchevan Autonomous Republic.

The picture for hydro, both large and small, is difficult to pin down. EDRB, Norwegian Aid, the UNDP, and the ADB have all had some recent involvement. In the ADB‘s case this resulted in the substantial study of hydro-potential by the Entec consulting company. There was a difficulty with the government over the requirement for government guarantees for project development, and the dialog lapsed and the findings of the report remain inert. Plans exist on paper to add more than 500 mw from two new dams in the Talus and Fizuli regions.

A three-year project is underway with UNDP support to examine small-hydro development and to produce a guidebook on the legal framework for power generation from 17

this source. There has been minimal private interest in refurbishing the 5 or so small hydro stations that date from the 1050s, but the holding company of the Yani Yashma wind farm project have expressed their interest in developing thirty or so such units in the Sheki area generating about 45 mw.

Biomass power

Rapid development of industry, agriculture and social service in Azerbaijan Republic opens new opportunities for electricity generation from biomass. The sources of bio- substances in the country include followings:

Studies suggest that much of the composition of production wastes in all industrial sites is biomass substances. It is feasible to produce biogas, bio-liquid and solid bio-substance that can be used for electricity generation. More than 2.0 million tons of solid domestic and production wastes are annually thrown into waste treatment sites in the Azerbaijan Republic. Utilization (processing) of solid domestic and production wastes would partially resolve the problems in heating public buildings in Baku and other large industrial cities.

Many European countries have already found ways to solve these problems. That is, waste combustion plants are built in densely populated areas and domestic wastes are fired in those plants. The nearby residential settlements are then provided with electricity and heat at the expense of energy produced from waste combustion. The remains of fired wastes are widely used as a manure to increase fertility of soil. Therefore, construction of such plants having complex importance would be significant for Azerbaijan, too.

The Norwegian government has provided some assistance in developing prototype biogas projects, mainly in the Ismaili area. Research on site is being conducted by the Academy of Sciences into this field of energy generation, and one local company, Solaris, actually has installed some biogas digesters. But, the industry remains in its infancy in the county.

Geothermal power

The heat of earth depth is widely used in industry, agriculture, domestic, communal and health sector in many countries. The advantage of using geothermal power in energy production and consumption is that its application doesn‘t require large amount of funding.

Azerbaijan is rich with thermal waters. They are usually found in the Great and Small Caucasus, the Absheron Peninsula, Talish mountain zone, Kur lowland and Caspian-Guba area. Exploitation of thermal waters in these areas would partially cover the domestic and other heat energy needs. In addition, the potential exists for using thermal energy to heat extensive greenhouses.

There is no doubt of the considerable potential for R&AE in Azerbaijan, but the realization of that potential has little to do with technical considerations—and everything to do with economic, legislative, administrative and confidence issues. In overcoming these, the government of Azerbaijan will have the leading role to play, even if privatization is a main consideration of energy policy in the R&AE sector. This would put Azerbaijan in the same position as the governments of almost all Developed Countries moving toward the alternative option. Most of those, however, do not have to deal with the established structure of a large, and historically dominant, local fuel alternative, which can complicate the picture enormously. However, the key to the realization of R&AE ambitions is (a) to see this as a necessary transition for economic and environmental reasons, (b) to see the present oil/gas wealth as a means to an end, (c) to take account of the full range of benefits of making this transition—which may not show up in the financial books of the companies engaged in conventional energy supply as well as those who may enter the alternative field. The role of the government will be critical in realizing this potential, and enabling the private sector to participate effectively.

The Tariff Structure

The tariff issue emerges immediately in discussions with the private sector with respect to investment in R&AE in Azerbaijan. The whole process of tariff calculation and setting has been thoroughly studied in earlier reports (Entec for ADB for example) and is the subject of further study by an ADB mission at the time of writing. In addition, the tariff issue, including that for renewables is under review by Parliament at the moment. The new State Agency for Alternative and Renewable Energy in Azerbaijan is unlikely to house the tariff-setting function, which will likely remain with the Tariff Commission in the Ministry of Economic Development.

The tariff structure is a key instrument in making policy work in this sector with regard to R&AE. Furthermore, tariff-setting requires a clear methodology, which is far from being universal, as policy aims vary from country to country. In Germany, for instance, the tariff structure discriminates strongly in favor of wind energy (and other renewables) which is why that ―In the absence of an country is a leader in the use of this technology. independent regulator, the task Likewise, there are other examples, such as of setting tariffs falls on the Sweden. The methodology for tariff-setting is MED. Obviously, there needs currently under review with the assistance of the to be an agreement among EDRB. It is not possible, at this stage, to predict stakeholders on the the outcome of those deliberations. methodology of setting the tariff, or how the tariff is At present, the tariff structure in Azerbaijan updated from time to time to strongly favors the domestic consumer, who is the keep pace with changes in principal customer for Azernergy‘s electricity cost, and on the schedule of production. Rates to industrial and commercial implementation. To give consumers are considerably higher. In addition, the comfort to lenders, updates to tariff rates are low, when compared internationally, the tariffs should be published and the rate paid for purchasing renewable energy on a specific date each year into the grid system—around 6q—are way below the 24q or so paid in Germany (and other parts of The desire to promote and Europe) to encourage production and help make develop a wind energy the industry viable. The tariff also has to reflect the technology was a key fact that the fuel costs of Azerenergy are heavily consideration in granting subsidized at present, though this could change. generous feed-in tariffs in The rates for electricity were last increased in Germany and Denmark. These 2007, and face the distinct possibility of substantial countries are now leaders in rises, such as were seen (x100%) in June of 2009 the global wind-turbine for gas (though not to Azerenergy).4 industry, the successful development of which has The greatest single problem in the tariff area at brought a gradual lowering of present is the lack of a comprehensive tariff unit costs.‖ methodology reflecting a clearly stated strategy on the nature of energy production. There are very Entec, ADB, 1994.

4 The price negotiated for the alternative energy purchase in the Sumgait area was in accordance with the US$0.06c rate recommended by Entec, though this is way below the incentive levels offered in Europe, and does not reflect the subsidized nature, and opportunity-cost element of producing conventional energy using subsidized gas. 20

few examples to quote, other than the Yani Yashma wind turbine project on the coast north of Baku, and they negotiated a special rate for feeding power into the Sumgait area. Still, the holding company in charge of this project considers this tariff level too low to be a real incentive for investment. As mentioned, a methodology is under consideration, and it will be a key component of the State Agency‘s overall plan for R&AE, though it falls outside the Agency‘s projected area of competence.

Several key questions need to be addressed. First of these is the incorporation of CDM savings in the generation of alternative energy, and whether these can be realized directly by the power producer. The formula is, at present, very complex and incompletely understood. Nevertheless, since the producers are creating the savings, they should benefit from them in terms of returns on their investment. These savings are real in cash terms and should feature in the investment plans of private companies. Secondly, the tariff structure should, but does not, recognize the contribution of R&AE to stated government policies, which again, it does not. As mentioned earlier, companies cannot be expected to deliver non-profitable benefits to segments of the population, or the country at large, as that is not their function—nor should it be. A modified tariff structure could incorporate these benefits as a real return to the social and broadly economic climate of the country. Unless this is spelled out in a methodology, it is unlikely to happen. The present structure does not really do this.

The cost of renewable wind technology, and small hydro, has risen over the last few years quite substantially, and this has been a reflection of excess demand over supply, rather than any other factor. However, the growth in demand is now producing, especially in the solar industry, big price reductions for solar technology, A special renewable energy tariff especially from Japan, as a result of large is the first prerequisite for increases in the volume of production to meet successful renewable energy soaring demand. Savings are possible in the local project development. However, manufacture of solar components—though the renewable energy tariffs, like all margins are diminishing, but it is unlikely that the tariffs, reflect a balance of often technology, locally manufactured, (rather than conflicting objectives. Therefore assembled) could bring the unit price down, any discussion of how the especially given the strong manat. Government should approach the question of the type, structure, and In many parts of the world, tariffs are structured to implementation of a tariff must reflect major differences in consumption patterns, begin with an understanding of the particularly between day and night. There is no objectives. such pattern in Azerbaijan, and it needs consideration. It is often the case, in other countries, that the market-based prices for setting renewable energy tariffs work only where there is a system of mandatory quotas, which make a market for renewable energy certificates that can be bought or sold for production companies to meet their quotas.

Clearly, capacity-building and the development of a methodology are the key areas for the tariff authority to play a fully integrated part in the transition to R&AE in Azerbaijan. Right now, the tariff structure and levels do not vigorously support an alternative energy strategy, and favor the status quo. But, work is in progress that can change that.

Costs, Returns and Benefits

One of the biggest barriers to the expansion of R&AE is the difference between returns and benefits. Returns are those elements of revenue which accrue to the bearer of the development and maintenance costs of the provision of R&AE, whereas benefits may be positive gains accruing in the social, general economic, and equity circumstances of the country as a whole. While considerable benefits might prevail, they do not necessarily help the bearer of the costs to balance his books. Profits and benefits are not the same, and this is critical in a situation, such as the policy environment in Azerbaijan, which favors looking to the private sector to lead the transition. In almost all Developed Countries, government takes an active role in creating the circumstances for private investment to flourish. Right now, the administrative, legal, fiscal and other public-policy areas do not encourage private investment, which is marginal at best.

At the same time, benefits are important to government because they often relate to the realization of stated policy, and so the government, and public sector in general, has a leading role in creating the conditions for private investment, and this has to come first. The list of benefits associated with the transition to R&AE include:

Improving the reliability of supply in regional areas currently experiencing rationing and blackouts. Clarifying and simplifying the CDM, or carbon-offset rewards, so that those who actually make the carbon savings receive the benefits in a real way, and can include them in their book-keeping. Reducing the environmental consequences of using wood for heat, and the inefficient use of electricity for heat (in the absence of natural gas supplies from a redundant network). The country has a policy to protect, and expand, its forest resources, but this is difficult to enforce where rural people have little alternative to wood for absent supplies of energy. This problem will be likely to increase as tariffs, as

they inevitable will, rise. Ameliorating the equity situation of the regions away from the capital. It is true that the level of people living in poverty has dropped dramatically in the last five years from over 40% to around 15%, but there is still a sharp contrast between the capital region and the outlying regions, which helps to fuel migration and depress regional participation in the national economy. Playing its part in achieving the targets of international conventions to which Azerbaijan is a signatory, such as the Kyoto Treaty. Agreeing to targets, and working out the precise methodology by which those targets will be achieved, are often two different things. 22

It is a fact of life that, while business might applaud many of these benefits, they cannot stay solvent on benefits, but need to see a profitable return on their investments. Government can help in this through a package of incentives, tax breaks, tariff adjustments, legislative clarity and loans.

The private sector, even if it wishes to participate, faces a problem of the terms of capital. The current local banking system—and the international banks are largely absent in Azerbaijan—is simply not geared to the realities of alternative energy development. In the current risk-averse climate, the repayment period is short (5 years) and the interest rate is punitive (28%). The banks are not, themselves, averse to participation in the R&AE field, as they all affirmed at interviews, but they are reluctant to involve themselves in projects that cannot easily be contained in their terms. GTZ, the German aid agency, and KfW, a banking arm, have considered the possibility of a dedicated line of credit specifically reserved for R&AE investment. The terms would be longer (say 15 years), and the interest rate would be somewhere around 8%. This would provide banks with a revolving line of credit to allow them to participate actively in this field, without compromising their perceived level of risk exposure. Government could add to this a more favorable investment climate through administrative, legal and economic reform, as well as clarifying a mechanism whereby CDM returns found their way to those actually reducing the carbon emissions, directly or indirectly. The system is complex and murky at the moment.

The government must also consider ways of transforming the benefits (achievement of policy goals) into rewards if it wishes to secure private-sector involvement in the transition. Some possibilities, other than those already stated, include:

Certificates for offsetting the costs of competing with the existing sunk costs and infrastructure of the existing, fossil-fuel based, energy system (the Swedish model) Financial incentives for realizing policy targets through R&AE, such as regional and income equity, environmental protection and conservation, job-creation in the non-oil sector, and the development of local manufacturing capacity. Creating a strategy for the transition, including all the above as well as a clearly- stated package of incentives, some firm orders for R&AE for government property, cost-sharing where advisable (including the availability of low interest, long-term dedicated loans for R&AE).

The private sector cannot, realistically, be expected to bear the costs of producing the benefits. It has to focus on the revenue stream of its investment, and that could include tax breaks for initiatives involving R&AE.

It is important to make this distinction, because many of the government‘s stated policy objectives can, in part, be facilitated by R&AE, but not by the private sector alone. Some basic conditions for domestic and international investment still remain uncertain and off- putting at the moment, and indeed, the story of R&AE in Azerbaijan is littered with the remains of failed attempts, such as the experience of the Koreans, Swedes, Norwegians, British and others who have pulled out of R&AE ventures in the country. This memory needs to be erased by a clear strategy for the transition which incorporates the whole package of needed reforms, many of which fall outside the energy sector per se. The role of the new State Agency for Alternative and Renewable Energy will be crucial in bringing these together, even though they are not directly responsible for many of them.

There is another dimension to the cost/benefit/return equation. A key element of the argument for a larger contribution by R&AE is sustainability. This is, essentially, a long-term concept incorporating the principle of balance. However, experience with long-term policies is that they excite little interest among the electorate, which is why it has been so difficult to operationalize sustainability—a problem not adequately addressed in the Brundtlant Report, (―Our Common Future, 1988) which popularized the concept. There are current costs involved in achieving future benefits, and the pressure is on the political system, in most countries, to produce immediate solutions to current crises. Not least of these, at the moment, is the Global Financial Crisis, which has created an atmosphere of caution in the area of investment, unless it has immediate and clear short-term returns. Increasingly, governments have taken this initiative, often without demonstrated popular support because they feel this has to be done strategically, otherwise the problem will be dealt with entirely in the framework of crisis management, where the options are few, costly, and sometimes unpleasant. It is probably fair to say that there is no ―groundswell of popular support‖ for R&AE in Azerbaijan at the moment, and it is, therefore, reassuring to see the government taking independent initiatives to secure the future of Azerbaijan, and playing its part in the global climate-change struggle. So, to the lack of demonstrated private interest (and, indeed some serious failed initiatives), as well as the lack of public momentum for new and renewable energy sources, the government must maintain a leadership profile if progress is to be made. It comes down to the word vision, which leadership must have if the country is to have a clear idea of where it is headed, and where it does not want to be. The policy statements issued so far do contain this vision, but the mechanisms to bring this policy to fruition have been the obstacles to progress along the road to realizing the policy. The journey has been chosen, the car is unreliable.

This transition has to be strategic and integrated or it is unlikely to succeed. Indeed, the archives of many ministries are filled with costly and laborious studies relating to R&AE, which, sadly, have produced almost no concrete results. This is because this strategic, integrated approach, reforming the investment climate, simplifying the legislation, creating realistic tariffs and incentives, reconciling the positions of R&AE and the monopoly electricity provider, and working out benefits and revenues remains to be done. It has been addressed piecemeal so far, and that has been a fundamental problem because there has been no administrative cohesion or oversight in this field—that is why the State Agency is so crucial to making the process work. It must be assured of the capacity to undertake this task realistically, and this needs an agreed strategic approach with targets and deadlines, means and structure. The creation of this Agency is a fundamental step forward in the process of transition, and its role is pivotal.

A Case Study of Costs, Returns and Benefits

Recently, in June, the Ministry of Ecology and Natural Resources (MENR) opened a mobile water-purification unit in Qarabagli in the agricultural basin of the Kura River (20 districts with 500 villages) southwest of Baku. It embodies many of the key questions needing to be resolved in the application of alternative energy in Azerbaijan.

This unit is one of 122 put in place so far, and there is an assessed potential for 300 units in 447 rural settlements eventually. The program began in 2007 and introduced units in 50 villages serving approximately 55,000 rural people with clean and reliable drinking water. It is estimated (MENR) that about 500,000 benefit from the project at present.

Prior to the introduction of these units, the population had to draw its water from rivers and irrigation canals, which are plentiful in this central region, but this water is heavily polluted from adjacent agricultural use, from being shared with animals, and from pollution introduced from beyond the borders of Azerbaijan on its way to the Caspian Sea. The villagers had, basically, two options (a) take the water from the canal, let it settle and then boil it, or, (b) buy bottled water at extravagantly expensive “Improving access to safe prices, with the attendant plastic, non-degradable drinking water is another key priority for public investment. Unsafe drinking water is a threat to the lives of those infants who are fed milk formula mixed with water (at present only 32.6% of infants are exclusively breastfed up to three months). Child mortality and morbidity are caused by the diarrhea that results from use of unsafe water, which also contributes to the spread of parasitic diseases. According to a recent study residue which litters so much of the country. To give by the WFP and the Ministry some impression of the nature of the problem, of Health, 31% of primary compare these two water containers—one drawn school children were straight from the canal behind the purification unit (which is the source of the unit‘s water), and the infected with intestinal other, containing water from the standpipe parasites.” delivering the product of the purification-unit to the State Program on Poverty local population. Continued use of the untreated Reduction and Sustainable water by the people in this area had led to high Development levels of liver parasite infections. Clearly, the Republic of Azerbaijan introduction of pure water in these circumstances 2008-2015 represents a basic transformation of one of the dire consequences of poverty.

The Kur and Araz rivers provide about 70% of the potable water in Azerbaijan, but for many this potability has been a myth.

The purification units, which come from Korea (67), Turkey (53) and Israel (2) are essentially mobile units which run at 6, 8, 10 and 13 kw, depending on their capacity, so the system is very flexible and modular. Taking water from the canal, and exposing it to a reverse osmosis process, the unit is able—in the case of Carabagli—to produce about 100 tons per day of clean water distributed to the local population of 5,000 via a series of 20 standpipes at different locations.

The installation is provided by the MENR, and for two years the Ministry provides maintenance, but from the outset, the unit is the possession of the local municipality or appropriate legal, civic entity that prevails in the area.5 The power for the unit—13.5 kw/hour in this case—is taken from the Azerenergy grid system.

In this area, as in many rural areas, electricity may be available from the national system, but it is not available all the time. This is clearly demonstrated by the notice attached to the front of the unit. This indicates the times at which electricity is predictably available at this location: a situation common in many rural areas and not restricted to Qarabagli. In addition there are periodic, unexpected blackouts due to the advanced age of the electric infrastructure.

The problem here is that the machines are designed to be run continually to work at their most efficient. Where there are predictable shut-downs, fairly normal in rural areas, then it is possible to anticipate these and shut down the machines This, however, requires an attendant to be present at these times and adds to the cost of maintaining the facility at each location. Unpredicted blackouts cause the machines to stop in mid-process and resetting and backwash problems result. Shortened life-expectancy of the machine, higher maintenance and the need for an attendant are all additional costs in the provision of this clean water.

In addition, the water is not distributed to the homes, for that would produce problems in terms of existing legislation based around the national water provider. Since the water is delivered through standpipes there is no effective way of measuring individual consumer use, and thus no way of charging for this service. Essentially, the water is provided free to those served by the standpipes. But, the local government authority has to pay for the electricity, and if this payment is not made promptly and in full, the delivery of electricity is

5 The principal constraint emerging from this program is the capacity of the MENR to install and maintain so many units, with many more planned. Indeed capacity may become a more significant problem than funding. 26

terminated and the service stops working completely. The local government has no revenue stream from the provision of this service, though some are ―selling‖ the water to surrounding areas, but this is not strictly legal. Though the social and medical benefits are evident and basic, this does not solve the problem of the local government in paying this additional cost.

One way of overcoming the irregularity of power supply would be to equip the units with solar-voltaic cells. These would have an initial start-up cost of purchase and installation, which would be beyond the capacity of many rural authorities. But, it would make the machines more efficient and dependable, and would obviate the need for the attendant. The units themselves were provided by a capital grant from Presidential discretionary funds, and have proven to be politically very positive with the recipients of the clean water for obvious reasons, and they have expressed their gratitude.

To overcome some of these problems, the MENR has constructed a project proposal entitled ―The use of solar energy to generate electricity for water-purifying equipment in the regions of the Republic of Azerbaijan. 2008.‖ The total cost for this project, covering the full extent of the planned expansion of the provision of these units, is 12.65 million manat.6 Raising this money is difficult because there is no projected revenue stream, as we have observed without metered distribution.

However, when assessing this project, a range of non-revenue (direct) producing benefits are identified, including:

Basic improvements in the health and well-being of the population of the rural regions of the country (in line with the policy on regional development). Cost-saving and maintenance reduction, as well as a reduction in staffing requirements, for the water-purification units. Reduction in dependence on waste-producing bottled water. Water could be produced this way for about 4c rather than the 40c equivalent purchased in bottled form. In compliance with the State‘s ―Programme for the Use of Alternative and Renewable Energy in the Republic of Azerbaijan.‖ The additional energy could also be used to heat schools, provide light and provide reliable supplies to health centers. It is estimated by the MENR that the project, if fully realized, would produce 150-200 m/w of alternatively produced energy. As a result of the full development of the project, it will be possible to reduce about 2,190 tons of carbon dioxide, and the return from this—though not directly to those incurring the costs as things stand at present—would be redeemed under CDM to the extent that the project could ―cover its costs‖ in a little over 5 years (MENR calculation).

None of this, however, helps the local authority balance its books, as most of these benefits are social. Up to now, Presidential funds have covered the cost of the units, and have offered 50% of capex for the next phase. But, the problem remains where to find the remainder. A proposal for the government to run the energy side of these enterprises (MENR) was resisted by the Ministry of Finance since that would go against the government priority for privatization.

6 The manat currently exchanges at 1:$0.80. 27

On the other hand, there is a case to be made that the government can step in, cover the cost and produce clear evidence of the benefits of regional renewable initiatives, and the whole ensemble of projects could be sold to a private investor as a going concern, though the problem will still remain as to where to find the revenue (profit) to make this worthwhile. If the local authorities take over the electrical, as well as the water, side of this venture, then they face the problem of selling electricity against the established monopoly of Azerenergy at tariffs that remain unattractive. This monopoly status stands in the way of development, unless the local authorities were to have their own independent ―island‖ system of distribution, which seems very unlikely as things stand now. This is a clear example of the problems of privatizing something, however in-line it is with numerous government policies, that does not have an assured profit. The private sector is already very risk-averse in this renewable initiative because of the many opaque areas of legislation and administration, as well as the absence of any demonstrable pilot projects.

At some point, the government may decide that its leading role in making policy work necessitates initiating projects of this sort, but this is far from the case at the moment. The poorer element of the population, the regions outside of Baku, those served by inadequate schools and medical centers etc, would all see an immediate benefit. They may not have any demonstrated interest in renewable energy at present, but the benefits of a project like this are easy to see, provide evidence of government concern and solve many basic problems. However, policy in the near future must have a clearer idea of how this is to be done, what exactly is the role of the government in kick-starting the transition to renewables, and how to provide a level playing-field in a situation with large monopolies. It is normal, now, for government to take a leading role in the transition process, and it is unlikely that any immediate private-sector solution to the funding needs of this project will be found.

Bilgah.

At this location, on the north coast of the Absheron Peninsula, ―The Absheron are located two more examples of intervention by the MENR in Peninsula is one, water-quality issues. and the most At Bilgah itself, a important, of the popular recreation five ecologically center for nearby stressed areas of Baku, the Ministry Azerbaijan. It has established, contains 30% of the within the framework population, more of the country‘s ―State than 60% of Program on the industrial capacity, Environment,‖ a as well as most of purification unit the oil- (similar to the one processing—which described above) but has been polluting with the purpose of the area for more cleaning the water than 160 years. leaving the shore— The seas have particularly from been afloat with some of the very sewage effluent.‖ large sanatoria—and entering the Caspian Ministry of Ecology Sea. This is one of 16 and Natural 28 Resources, 2008. such stations developed along the coast so far with various aims.

This 3-stage process7 cleans the water before it is piped 300 meters out into the sea, and released to international standards of purity, including biological treatment with chlorine. It replaces an old, Soviet-era mechanical unit that did nothing to treat the biological problems (shown here).

The unit is tied into the national electricity supply and rarely experiences blackouts, but here, as in the other purification cases, the cost of energy falls on the local authority. This has problems, from time to time, paying its electricity bill, and then the whole system closes down because the state monopoly turns off the power until the bill is paid. This causes serious problems of backup, and deflection to a reservoir, beyond the control of those managing the unit. Interestingly, given the considerable amount of substantial property investment in the area, the municipality clearly has problems covering this cost, which may well indicate the need for reforms in municipal finance and collection, but that is beyond the scope of this report. However, that problem will be endemic to whatever options are implemented in this, and probably many other locations.

Interestingly, if we consider the benefits of this project, they do indicate the potential for improvements in revenue to the authority bearing the cost. Since this town relies heavily on the domestic tourism and recreation industry, and that industry is directly based on the seaside and bathing, notable improvements in water quality—and they are evident—should make the location much more attractive to visitors, who generate revenue locally. However, this still seems to be a very ―loose‖ connection and the payment of utility bills—particularly in the winter—is undependable.

The MENR is now considering tying their nine coastal water-purification units, which have varied purposes, into a dedicated network of wind turbines. This would be in accordance with the provisions of the 2004 ―State Program for the use of alternative and renewable energy in the Republic of Azerbaijan.‖ At this location on the north shore of the Peninsula, this seems logical given the reliability and strength of the wind:

The average monthly and annual wind velocity (meters/sec)

I 2 3 4 5 6 7 8 9 10 11 12 Ann.

6.9 7.1 7.2 6.4 5.9 6.2 6.6 6.5 6.5 6.7 6.6 6.6 6.6

MENR

The Ministry‘s calculation is that by liberating themselves (or more correctly, the local authority) from the grid, it will be possible to reduce carbon emissions by 700 tons, and the CDM revenue would help to make this project able to ―recover its expenditures‖ in 3.6 years.

Of course, again, the problem remains that, while this development is in fulfillment of more than one national policy initiative, there still remains the question of who will pay for it, and how will it be maintained. Naturally, once the turbine is up and running, then the issue of electricity bills will be removed, but other costs apply, especially if the local authority, which will own these machines, will have a possible of option of selling additional power, but at the present very low tariff for renewable purchases operated by Azerenergy. Insofar as the

7 Settling, biological treatment, and then chlorination. 29

turbine is powering the purification unit, this issue does not arise. However, move beyond this and the relationship with the state monopoly arises. The municipality, clearly, if it is to share in the construction cost, will need to see some revenue, and not just benefits. In this case, the clarification of bathing water should produce an improved revenue stream from business and taxes. But, how effective this will be depends on the recovery rate for those obligations from those resident, conducting business, or owning property in the area. But, that could be a decisive factor in making this proposition work—even if the wind turbines are privatized, this issue will not go away. Water purification is not something that can, or should, be done occasionally.

Buzovna

Close to Bilgah is Buzovna, which demonstrates another aspect of the water purification initiative. In this case it is used to drain stagnant water from a shoreside location rendering it useful as a site for recreational purposes (or building). There are about 30-40 hectares of inundated land, and this is already in an advanced state of drainage and leveling. Once this one-time job is completed, the unit—which is mobile—may be moved to perform some other function in some other place. The problem remains, the payment of electricity bills, without which the unit stops and it is not advisable to pump stagnant water into the sea. Here, the wind option may be more questionable because of the fixed nature of the capital (turbine) and the essentially one-time function of the unit. However, if such a unit was provided with equally mobile solar panels, this problem would be obviated.

Lessons

1. Financing is the key to the introduction of alternative energy, and this problem includes revenue streams for the eventual owners—if they are municipal, how do they translate benefits into revenue? If they are private, does the tariff structure and state monopoly encourage investment. Indeed, the country‘s only private initiative in wind energy is not far from Bilgah at Yani Yashma, and the progress of this unit in terms of profitability will be watched very closely—though its operating holding company says that opaque legislation and very low tariffs are a serious impediment to progress—though both are under review, and the findings are eagerly awaited by this industry pioneer.

2. Creating the conditions for alternative energy is not so much a technical as a legislative, economic and administrative one, including such seemingly remote areas as municipal fiscal reform.

3. The benefits from these, actually rather modest, projects are very considerable, and this may be a reason for closer government direct involvement at this stage to kick- start the transition, and create the conditions for private investment.

PRIVATE-SECTOR INVOLVEMENT IN MANUFACTURING AND INSTALLING R&AE.

―Solaris‖ is a locally-owned and run company that, for eight years, has been importing components for solar energy units—some photovoltaic, most for heating water. Its experience illustrates many of the barriers on the road to transition to a more balanced fossil-fuel: R&AE energy economy.

Solaris has built 48 3.6 kw solar units along a pipeline route to provide water purification for facilities related to the route of the pipeline; it has provided hot water bathrooms in refugee/IDP under Norwegian assistance and has provided solar heating units to a number of private buyers. Its major projects, to date, have been to provide the ―Atlant‖ resort area with 452 collectors giving 12,000 liters of hot water to a facility of 122 rooms, and the fitting of solar heaters to the Police Academy, which eliminated a $20,000 per annum bill for diesel. To prove a point, Despite these Solaris left this two successful basic unit without projects, the care and demand for solar maintenance for three years, and it energy (and still produces hot biogas, which water with over Solaris also 95% efficiency. installs) has been very modest, discontinuous, and insufficient to promote the local manufacturing of basic equipment, which would reduce the unit cost and make the solar alternative much more cost-attractive in Azerbaijan.

The main attraction of the solar option for local customers is that it:

Isolates the buyer from the vicissitudes of tariffs, and this argument should be stronger in the present climate of rising energy costs and tariffs. The owner of the ―Atlant‖ resort8 stated that he paid for the capital cost of transferring to solar in a little over five years, and after that—apart from maintenance, which has been minimal— he is independent of tariffs from Azerenergy. It is also significant to note that heat had, in this area, previously been provided from natural gas, but the superannuated nature of the distribution system has cut off many regions from supplies of gas. Using electrical energy for heating water—the only option—is inefficient and costly, and it is in this context that the introduction of solar energy must be seen. Refurbishing the gas distribution network, in this environment, could be seen as impeding the development of the renewable alternative.

A second benefit identified by ―Atlant‖ is the isolation of, at least this part, of the system from the downtimes and blackouts of regional electricity supply. The costs associated with irregular supply are not borne by the producer of the power, but are passed on as ―costs‖ to the consumer. Indeed, there is a form of ―Catch 22‖ situation

8 Situated in the vacation area of Nabran in the northeast of the country. 31

here because the inability to receive gas supplies puts much of the heating burden onto the electricity supply, helping to induce the various rationing and blackout circumstances.

The ―Atlant‖ resort in Nabran is one of the few private ventures to use solar power—in this case to provide hot water to its 80+ units.

In this region, as in many regions, where the gas network is moribund, the ―alternative‖ for many people is to cut down trees in the surrounding forests and woodland to provide heat. However, one solar collector compensates for 16 kw per day, or 30 liters of fuel for generators, or 1 cubic meter of wood—all three of which alternatives, in the conditions of energy in Azerbaijan at present, carry negative environmental impact consequences—whereas solar is neutral and everlasting.

The Solaris company would like to move to manufacturing solar (photo-voltaic and heating) units in Baku, and has acquired a site with basic workshops for this purpose, and employs 17 people—though much of the time they are working on other projects because the volume of demand for solar energy facilities is just too small and intermittent. This is not a viable stand-alone business venture at the present time for several reasons—despite the success of the Atlant and Police Academy projects, which are now independent producers and consumers of, at least one aspect of, energy. The major business constraints are:

The public, in general, in not aware of the ―solar option.‖ It may become so as tariffs rise, but with the country so abundantly supplied with fossil fuels, and so much investment being made in the distribution and transmission networks, the ―immediate‖ problems may retreat (irregularity or breakdown of supply), easing the advantages of switching to renewables. In both the Atlant and Police Academy ventures, they arose from a personal interest by a leading figure in the management 32

or ownership structure; something not widely replicated so far, despite these ventures being reported in the press and on television, and the boom in new building over the last five years. R&AE exists in an awareness vacuum. Solaris, for instance, did not receive one order following any of the television reports on alternative energy.

Given the low volume of sales, the company cannot import in bulk (i.e. fill a truck) from its suppliers in Russia, Turkey, Austria, Germany and Sweden. This greatly increases the unit cost, Recently, the firm was contacted by an Austrian manufacturer who offered a 50% discount, but, given a sufficient local market, the Solaris company could manufacture the units for less than half the discounted price. Solaris could buy units in Turkey for $75, which rises to $100 with delivery and customs charges, given sufficient bulk orders (300+ units). Instead, assembling units now costs $200 Manufacturers, also, do not generally distribute component parts, but only the entire unit, further reducing the opportunity for local companies to ―finish‖ production. There have been talks about a joint venture with a Swedish company, but these failed because of the low volume of market demand at present.

In order to get into the manufacturing business, the company would require to raise capital, and at present the 5-year repayment period and the 28% interest quoted by local banks do not make this capital competitive, and this has been a major constraint and would be a major additional cost component in the early years, making the local product less competitive. Furthermore, the same problem applies to potential consumers of the company‘s product, since their investment capital would be obtained at the same rate.9 Solaris has, in fact, invented a scheme by which it would ―guarantee‖ loans for village consumers of its technologies, but this has not been accepted by any lenders to date.

The major constraint identified by this, and other companies, is the volume of orders/level of interest. In all cases, companies said that the industry needs to be ―kick-started,‖ and only the government has the capacity to do that. If, for instance, the government ordered all rural schools, or health facilities, to be equipped with R&AE, then the economics would change radically, and costs would come down. Jobs would be created by local manufacturing instead of importing and assembling. Rural communities would benefit and manufacturers would have some resources to raise their profile and public awareness. The government, too, could show its practical commitment to the transition to R&AE. In addition, local companies stated that government could offer incentives, amend taxes, adjust customs and make other elements of the transition ―easier‖ for local business. In the main, local business now focuses on single users (where the producer of R&AE and the consumer are the same) where the tariff issue is avoided or eliminated. A housing subdivision, a poultry farm, an apartment block or resort, for instance—or equipping the regional water purification facilities, mentioned above.

9 Caspian Technologies, which operates the country‘s only wind farm, is raising its capital abroad with the assistance of its German joint-venture partners. This option is not available to any but the largest potential investors, and the local sources of funding are constraining the transition to R&AE at present because of their very cautious, and risk-averse lending, which makes potential entrepreneurs risk- averse also. 33

At present, local participation in R&AE remains, at best, peripheral, expensive and uncertain. Job-creation potential is lost, and the substitution of local manufactures for imports is constrained. Only the government, it seems, can break this cycle as part of a unified strategy for enabling the transition. This could be a priority for the new State Agency for Alternative and Renewable Energy in its future involvement with this sector. The government, too, alone has the capacity to raise the profile of this sector of the economy.

Azerenergy

The role of Azerenergy is pivotal to the development of R&AE in Azerbaijan, but it is often seen as obstructive and contradictory to the implementation of stated national policy, as monolithic in structure—and becoming more so, and is being reinforced in its present position by massive investment. While this may be, de facto, the situation, it is not because of any conscious decision by the organization to occupy any of these positions; resulting instead from a visible national strategy, diffusion of what should be integrated components in the energy plan for the country, and a need to overcome serious incapacities arising from an aged and inefficient infrastructure. However, Azerenergy is the key player in paving the way for R&AE to play its part in the nation‘s energy development.

Azerenergy is a wholly-owned Joint-Stock company which has a monopoly over the provision of electricity in Azerbaijan. It arose from the previous Soviet infrastructure that had to be refocused on a national territory after the break-up of the USSR in 1991. As a result, and because of a long lack of investment in an infrastructure that is 50 to 60 years old, the company has, necessarily, had to focus on keeping the system running, coping with huge losses in transit, overcoming serious non-payment problems from people using their product, and dealing with severe overload problems resulting in rationing and blackouts. In this context, fixing the system was the #1 priority, and broader implications about the origins of the electricity have had to be sidelined. On the other hand, initiatives proposed by Azerenergy to participate in R&AE have been set aside by the prevailing view in government that such initiatives should originate with the private sector—and Azerenergy is not part of the private sector, strictly speaking. However, to proceed along a transition to R&AE without Azerenergy is to deny the needed integrative nature of a national strategy.

The position of Azerenergy has changed rapidly in the last five, or so, years. These changes may be summarized as follows:

An attempt at privatizing the distribution network proved to be unsuccessful based on alleged irregularities in the operations of the major concessionaire, and as a result the distribution network had to be ―re-integrated‖ though parts of it are leased at present—principally in the Baku area. This was a serious setback to the privatization process. Azerenergy has been the locus of huge investments, especially from the World Bank, EDRB, ADB and others, in rebuilding the generating capacity (Phase 1), the transmission, and the distribution networks (Phase 2). Phase 1 is essentially complete, and new generating plants are the basis of electricity provision throughout the country. These facilities need to be paid for over time, and so the revenue stream is critical. However, it tends to reinforce the status quo of how energy is produced in this sector. In the words of a company spokesman, ―Azerenergy now has the country covered.‖ This is an important issue and we will return to it below. Internally, the company has been the subject of much restructuring (ongoing) and a focus on efficiency. The new distribution net, for instance, will eliminate losses of 18%+ encountered in earlier years. As part of this efficiency drive, the company is embarked on a nationwide program of metering.10 Prior to this there was no effective monitoring of demand, no effective payment-on-use, and widespread theft of power. This was one of the reasons for the blackouts and the need for rationing, especially

10 With assistance, possibly, from ADB. 35

in rural areas. Insulated cables and meters, when introduced, took the collection rate up to 100% from 30% and strikingly reduced illegal extraction of electricity. At the same time, it reduced consumption, in some areas, to one-third of what it had been (Ganja area). Azerenergy continues to rely heavily on supplies of natural gas, provided by Azergas at 50% of the industrial cost, and about 33% of the price that the same gas can realize if it is exported through the fast-expanding network of pipelines connecting Azerbaijan to Russia,11 and via the Nabucco system, to Turkey, the Balkans and EU countries. Thus, there is a considerable subsidy built into the Azerenergy operation through the preferential price of its basic fuel. This distorts the market for those wishing to enter it on a non-subsidized basis using R&AE. The private sector is very aware of this and made this clear during our interviews. Frequently, this is seen by potential investors, as influencing what they feel are the very low tariffs offered by the monopoly when buying power into the grid system (2.5q kw/h for hydro power, 4.5q for wind,12 and 6.5q for solar—Azerenergy retails energy for 7.5q).13 These figures are under review, as are all tariffs, at present. The current ―rule of thumb‖ is that tariffs rise with minimum wage. Azerenergy is, already, in the renewable energy business since it derives about 11% of its capacity from hydropower—though the units are old. It had plans to develop a full-size (500 mw) new unit in the Tolus Region, and a smaller one in the Fizuli area. In terms of alternative energy, it should be remembered, this is the largest single functioning initiative in the country. Azerenergy stated that it is ―not profitable‖ for it to operate and maintain small hydro generators at present, but it is willing to refurbish or develop them and sell them into the private sector

With the major investments in generating capacity, and the similarly large investments under way on transmission and distribution, with their attendant reduction in losses and efficiencies in generating, as well as the huge rise in payment recoveries, Azerenergy considers, as a spokesman said, that it ―has the country covered.‖ The implications of this are considerable and are central to any strategy for R&AE in Azerbaijan.

First of all, with the 5 gw capacity rising to 7.75 gw, Azerenergy sees itself as looking for demand, not in filling gaps in demand. Indeed, it is now in the business of exporting electricity to Georgia, and in the future to other neighboring countries such as Iran. In these circumstances, the question arises ―What place is there for R&AE power generation in Azerbaijan since current electricity production meets the needs?‖ In other words, additional generating capacity would be in competition with Azerenergy (apart from its own hydro capacity of course). The business community sees this as providing Azerenergy with a reason to ―resist‖ initiatives from the private sector in transforming the energy base of the country. In addition, Azerenergy has just incurred large debts in modernizing its existing basis of production. This may emerge as the central strategic question in achieving Azerbaijan‘s stated policy goal of encouraging R&AE.

11 Actually, the pipeline to Russia already exists and dates back to Soviet times. However, under the new agreement to take effect from January 1, 2010, this pipeline to Dagestan will be refurbished and will deliver gas to that area. 12 This is specific to the Sumgayit wind project that puts power into the grid, and is the only supplier of this type at present. 13 Azerenergy is interested in buying in quantities of 200 kw/h and above. 36

As noted, however, the introduction of metering led to a dramatic drop in demand among domestic consumers—especially in the regions. This could mean that domestic consumers are dropping out of the system, or that they are wasting less. The former has more serious implications. Azerenergy stated that it used to cost around 30q a day to heat the typical rural home with gas. The assumption was, from income surveys, that it was not possible to spend more than 30q, and now the metered price is twice that. So, metering may have driven down effective demand, and most of Azerbaijan‘s electricity is consumed in a domestic, rather than industrial, environment. It is true that official figures record a very considerable drop in poverty in the country over that past five years, (>40% poor to <15%) which could offset the implications of metering. But, it would take research to discover what proportion of the population are effectively beyond electricity in terms of price. The surplus of energy at Azerenergy now may result from unmet domestic needs, and here the role of R&AE could emerge in terms of fulfilling several policy areas, though it, too, would have to be paid for.

The major uncertainty with respect to Azerenergy is probably the cost of its raw material—gas (and diesel to some extent). As the opportunity cost of selling this commodity on the world market increases, and the opportunities for its distribution proliferate (pipelines), then the implications of the huge 2/3rds subsidy for the 14 billion m3 of gas consumed by Azerenergy annually will become more significant. Indeed, in developing an integrated strategy for the country‘s energy policy, the whole rationale of the subsidy comes into question where poverty is falling fast, the country‘s wealth is booming, there is a focus on meeting environmental carbon targets and so forth. Subsidies are, of course, a political and not an economic issue, and their basis needs to be reassessed politically as circumstances change. Should the rationale for the subsidy be seen as passed, then Azerenergy would be faced with a dramatic rise in fuel cost, which—to some extent offset by improved revenue collection and reduced distribution losses—has to be translated into higher tariffs.14 This, in turn, could lead to depressed demand, especially in poorer communities, but it could also provide a major initiative to alternative-energy providers. Given the recent merger of Azergas and SOCAL, there may be a different perspective on selling gas nationally at discounted prices. This, in turn, could encourage Azerenergy‘s interest in expanding its hydropower base according to existing proposals.

Azerenergy has not resisted alternative energy, and indeed proposed its participation in a three wind farm projects some years ago because, as a spokesman put it, ―it is our duty to be seen to be doing something in this area.‖ However, this was rejected by the Ministry of Energy as it was not in accord with the stated policy of encouraging this area of development in the ―private sector.‖ The same objection could apply to the hydro projects. So, the claim raised by some that Azerenergy is obstructive in the field of alternative energy is not really fair, but it does have strong incentives to protect its recent huge investments. The picture is one of considerable uncertainty in terms of fuel cost, subsidy, extent of delivery etc. The tariff it pays to suppliers of R&AE are not under its direct control, but under that of the Tariff Council in the Ministry of Economic Development.

14 As recommended by the IMF. 37

During discussions at the Ministry of Industry and Energy, we were informed that a possibility exists to bring Azerenergy into to orbit of the new State Agency for Alternative and Renewable Energy. This is no more than a possibility at the time of writing this report, but it would encourage the institutional incorporation of the country‘s largest player in the energy field into the strategic process of attaining some balance in the Azerenergy is not operationally basis of how energy is produced and involved, other than its hydro supplied. generating capacity, in R&AE. Again, there remains the difficulty of knowing Writing in 2007, Entec, reporting what proportion of the existing regional poor on renewable energy for the ADB (and indeed some of the urban poor) remain commented: priced-out of the energy system at present, ―This option (Azerenergy taking encouraging them, since they have no the leading role) has the key alternative, to cut into the country‘s forest advantage that Azerenergy has all resources etc. There is also the question of the necessary expertise to build, whether gas and diesel-burning, albeit new, own and operate the projects, and facilities provide a barrier to Azerbaijan‘s therefore has the smallest achievement of Kyoto targets. Whatever the completion risk. If domestic situation, the solution has to be planned over loans were required to time on an integrated basis involving costs, complement ADB finance, its returns and benefits, and Azerenergy is the balance sheet would pose few key to this. It needs to be fully integrated difficulties for lenders. into, not marginalized from, this process. However, the government has stated that it does not wish Azerenergy to be the implementing agency for renewable energy projects. Indeed there are few countries in Asia where a vertically integrated utility has successfully implemented large-scale renewable energy development.

The Structural Issue

Almost every report devotes lengthy discussion to the central question of ―who is the end- user‖ of this alternative energy, and who should oversee and manage its operation. There are several alternatives, and this consideration will have to be part of the formulation of a national strategy.

The main alternatives usually offered are:

1. Azerenergy, since it is already in the central position in the energy industry in Azerbaijan, and has the experience and expertise to absorb such a role. This runs into complications under present arrangements for several reasons: (a) the policy of the government is that the principal initiative in the R&AE sector development should be in private hands, and Azerenergy is not private, but a wholly-owned joint-stock company in which the government holds 100% of the stock; (b) in terms of its recent, and planned, expansion of capacity for generating electricity from hydrocarbon sources, it can be seen as having a ―vested interest‖ in the status quo—whether this is true or not. It would, in effect, be competing against itself for a national demand that, it states, is already covered by massive investments in conventional generation. The distribution network, reabsorbed into state ownership and leased in some cases, can, of course, deliver electricity from any type of source. Initiatives in the R&AE area previously suggested by Azerenergy were already rebuffed on the grounds that it should leave this initiative to the private sector. The crucial question then is how much interest is there in the private sector? Who, also, in the private sector has Azerenergy‘s experience, and it should be recognized that 11% or so of its energy already comes from renewable sources, e.g. Water. 2. A private company, or companies, that could take on, for instance, installation and maintenance of solar energy production, overseeing many units that are, at present, possibly beyond the technical and financial competence of small, rural authorities. The holding company of Caspian Technologies is already planning expansion into different regions, though in their case the vehicle in mini-hydro. The problem here is the profitability—and the Caspian case will help to test this, and they already negotiated a special rate for their wind-powered electricity in the Sumgait area. However, interest by banks, foreign corporations and aid agencies have been compromised by the legislative and administrative uncertainties, and the private sector—with the one notable exception mentioned—is reluctant, or unable to participate at the present time. However, this could change, given the revisions being made to tariffs, tariff methodology, legislation on renewable tariffs, legislation on investment in general, potential new lines of credit for local financial institutions dedicated to R&AE development, the new State Agency, and more. If there is to be real private involvement in this area, it is certain that it will need strong institutional support, concessions and incentives from the government to bring it in. Over time, this may be diminished as the technology and its context become established. This is normal in most countries attempting to reinforce the national role of renewable energy, and is increasing. Carbon trading and trading offsets would be one supportive mechanism for the private sector, but it requires a major government initiative, as does the true compensation for the rewards of CDM savings. 3. Local authorities was one of the suggestions for providing solar power to the water- purification plants in rural areas. While this might provide them with a possible source of revenue—selling the power (the water is not sold at present)—it does raise 39

questions about capacity, and if this power is to be distributed, the tariff question with the monopoly provider (almost exclusively so in rural areas)—Azerenergy. This also goes against the general principle of the private sector having the initiative in this field.

It would be very useful for Azerbaijan to look at some of the models prevailing in other countries, such as Germany, Denmark, Sweden, and the UK, and consider what seems appropriate to the goals and realities of Azerbaijan. There are many ways of ―making R&AE happen,‖ and this country will need to develop its own hybrid based on its own circumstances and realities. However, comparative management studies of national initiatives is a good incubator or alternatives that countries would be pleased to share. This might also encourage a more radical and new vision of what to do than trying to piece together the existing patchwork.

Conclusions and Recommendations

1. The country needs to develop, as soon as possible, an integrated strategy for the role and incorporating of R&AE into the nation‘s development. The new State Agency for Alternative and Renewable Energy should be the locus for this, and the Ministry of Industry and Energy has already stated, to us, that this is one of the urgent needs. 2. As part of this strategy, a timetable with objectives, goals and targets should be clearly stated, so that it will be possible to monitor and evaluate the implementation of this strategy. This will impose discipline, and cause attention to be focused on progress, or the lack of progress. This is an iterative process, in which the regular review mechanism is coupled with the possibility to modify the strategy in the light of experience and changing circumstances. 3. The capacity of the new State Agency is absolutely central to the task in hand of promoting R&AE. Technical cooperation, bilateral and multilateral, should see this as a priority in offering assistance to Azerbaijan. The problem is unlikely to be money, and is more likely to be expanding capacity and the necessary skills. At the Academy of Sciences, for instance, not one of the post-graduate students focusing on renewable energy research is from Azerbaijan (mostly from Iran). Research funding should reflect the priority of R&AE in the national program of development. 4. A real effort is needed to build confidence in the R&AE sector for investment. At present, people in Azerbaijan are barely aware of its existence—which is not too surprising when you consider that the country is floating on oil and gas. The initiative (policy) in this field, so far, has come from the government. The public has to be brought into the policy of emphasizing R&AE and, more important, why. This is an issue of vision, and the government, through the media, needs to bring the public into this vision as a component of its leadership. Part of the R&AE strategy must focus on public education and information. 5. The government will have to take a leading role in creating a climate for domestic and foreign investment in R&AE that is a form of partnership with, for the moment, the government in the leading role in ―kick-starting‖ the transformation. This has been the case in many Developed countries. Initiatives here include: (a) a program of R&AE-based incentives; (b) the stimulation of the field in general, and local manufacturing in particular, through the issuing of substantial contracts in the area of alternative energy (such as, for instance, was done in the case of the Police Academy, though not replicated); (c) consider the rapid implementation of tax and, possibly customs, reform to encourage participation and, particularly, provide tariff incentives for participation (much of this is in the system already, but needs to be tied together strategically). 6. The position vis-à-vis Azerenergy and A&RE needs to be resolved and clearly stated. Having invested so much in efficiency, renewing its generating, transmission and distribution capacity. A situation of potential rivalry and obstruction needs to be avoided from the start. Indeed, ―excess capacity‖ is providing Azerbaijan with a new, and valuable, export. 7. A study needs to be made of the situation among consumers of energy in regional areas. The dramatic drop in consumption following metering could reflect an excision of part of the market (most of which is domestic consumption) and this is a problem for those people. Though poverty reduction has been dramatic in Azerbaijan, the

writers of this report constantly heard about an ―inability to pay‖ for energy in some poorer parts and communities of the nation. 8. The whole question of the continuing fuel subsidy to Azerenergy needs to be addressed as a fundamental part of the strategy for R&AE. There is now a high opportunity cost in deflecting this resource to Azerenergy in the context of expanding new markets, delivery systems to Russia, Turkey, Europe etc. What is the rationale for this strategy now? Why is the country bearing this cost? What would be the effect on domestic demand of a sudden increase in tariffs arising from Azerenergy being charged the ―going rate‖ for, for instance, natural gas? 9. In economic and financial terms, there should be a dedicated longer-term, lower interest rate of commercial lending in the R&AE area. At present, banks are not providing the sorts of loans that development in this field needs. They are happy to do so if they have a line of credit for this purpose on appropriate terms. The German Technical Assistance (GTZ/KfW) have already proposed this idea. Right now, it is one of the key bottlenecks to the involvement of private-sector investment. 10. The Ministry of Industry and Energy stipulated several measures for the stimulation of the Renewable Energy sector as long ago as the mid 2000s.These measures are:

- A subsidy of up to 30% to the private sector on the initial investment. (This is in effect now according to the Ministry of Industry and Energy, though several private sector potential investors informed us they had never come across this fact)

- A state guarantee that each kWh can be sold at a cost covering tariff (we could find no confirmation of this provision having been applied)

- Unconditional guarantee that all produced energy by IPP‘s is purchased (is said to be operational, though there is a de facto volume [>200kw] for purchases they make from the R&AE sector)

- Producers of renewable energy are released from the custom charges stipulated in the republic and from the VAT (This is stated as being operational, but this was not known to at least one producer we interviewed.)

- Real estate is given free to Renewable Energy Producers (Not confirmed)

- Soft loans on construction and purchase of equipment are given to Renewable Energy producers (Not confirmed)

Annexes

Principal Policy Statements

(Unofficial English Translation)

Decree of President Ilham Aliyev to set up the State Agency of Alternative and Renewable Energy Resources at the Ministry of Industry and Energy.

With the purpose of more effective using of Alternative and Renewable Energy in Azerbaijan, and subsequent to my regulation of the 21st of October 2004 entitled: "State Program for the Mobilization of Alternative and Renewable Energy Resources", I have decreed as follows:

1. To set up at the Ministry of Industry and Energy.

2. That the staff of the State Agency of Alternative and Renewable Energy Resources at the Ministry of Industry and Energy should consist 25 persons.

3. That conformable changes in the structure and charter of Ministry of Industry and Energy be made

4. That the Cabinet of Ministers is instructed to prepare draft regulations for the State Agency and to submit them to the President within a month

5. To set up any upcoming issues related this Decree.

Ilham Aliyev,

President of the Republic of Azerbaijan.

Baku, 16 July, 2009

Ordinance of President of Azerbaijan Republic on approval of “The State Program on Use of Alternative and Renewable Energy Sources in Azerbaijan Republic”

The limited availability of traditional hydrocarbon resources and preventing pollution of environment necessitate increasing the volume of produced energy at the expense of alternative and renewable energy sources. Positive trend in this area already exists and utilization of solar, wind and other sound and renewable energy sources widely expand year-by-year.

Azerbaijan has sufficient alternative and renewable energy potential with its convenient natural environment. This potential, however, is not developed yet. Thus, to secure the creation of new energy capacities at the at the expense of alternative and renewable energy sources of the country with wide employment of world practice, I decide:

1. ―The State Program on Use of Alternative and Renewable Energy Sources In Azerbaijan Republic‖ (enclosed) shall be approved. 2. The Ministry of Fuel and Energy of Azerbaijan Republic shall be identified as coordinator for the activities envisaged in State Program. 3. The Cabinet of Ministers of Azerbaijan shall solve the matters arising from this Ordinance. 4. The Ministry of Fuel and Energy of Azerbaijan Republic shall undertake necessary measures to ensure the implementation of State Program. 5. This Ordinance shall become effective since the issuance date.

Ilham Aliyev

President of Azerbaijan Republic

October 21, 2004

Unofficial translation

Presidential Decree on Approval of the State Program for Development of the Fuel and Energy Sector of the Azerbaijan Republic (2005-2015)

With an aim to ensuring further development of the fuel and energy sector, which plays a crucial role in the economic and social life of the Azerbaijan Republic, as well as improving the supply of energy resources to the economy and population and more efficient usage of energy carriers, I hereby decree:

1. To approve the ‗State Program for the Development of the Fuel and Energy Sector of the Azerbaijan Republic (2005-2015)‘ (attached hereto). 2. To designate the Ministry of Industry and Energy of the Azerbaijan Republic as the coordinating agency for the purposes of the activities outlined in the State Program. 3. The Ministry of Industry and Energy of the Azerbaijan Republic, the State Oil Company of the Azerbaijan Republic, Azerenergy and Azerigaz Joint-Stock Companies, as well as other relevant central and local governmental authorities shall take appropriate actions, within their respective competences, to ensure and support implementation of the State Program. 4. The Cabinet of Ministers of the Azerbaijan Republic and the Ministry of Industry and Energy of the Azerbaijan Republic shall address the issues arising from this Decree. 5. This Decree shall take effect as of the date of publication.

Ilham Aliyev,

President of the Azerbaijan Republic

Baku, February 14, 2005

Unofficial translation

Approved with Presidential Decree N462 dated October 21, 2004

The State Program on Use of Alternative and Renewable Energy Sources in Azerbaijan Republic

Introduction

Because of gradual shortfall of traditional energy sources and vast hazards to environment yielded by their utilization, developed countries widely use environmentally sound alternative (renewable) energy sources (solar and wind power, small HPPs, thermal waters, biomass power). USA, Canada, Germany, Finland, Norway, Denmark, pain, Japan and China have leading positions in this area. According to statistics, renewable energy sources (including hydro power plants) constitute 13.5 percent of overall power generation in developed countries.

Wind power has much importance among renewable energy sources. Germany holds the leadership in the world for use of wind power. Adoption of Law on Renewable Energy Sources in this country strongly encouraged the application of wind power installations. More than 35 thousand employees are currently involved in production, installation and operation of wind power facilities in Germany.

Potential energy of water is environmentally pure source in electric power generation. Power generation from this source has had growing trend since 1990. Some countries of Latin America, Asia and Africa as well Northern European countries (which have large hydro resources) have set as a priority to utilize this energy source in the line with other alternative sources.

Direct conversion of thermal power into electric power is widely practiced throughout the world and it is regarded as one of the main areas of energy sector in developed countries. European Union countries and USA have commenced the construction of large- scale power plants to utilize alternative energy sources based on Kyoto Protocol of 1997. The volume of heat energy generated from solar power is significantly higher than in terms of electric power equivalent. That is, this factor is 600 MW in USA, 100 MW in France, 100 MW in Israel, 50 MW in Turkey and so forth.

The USA, Germany, Japan and China employ high-efficiency technologies for development of main working element (photo element) of solar stations which directly converts solar power into electric power. The efficiency factor of these photo elements equals 12-14 percent. The stations developed with such photo elements covers 2 hectares per 1 MW. A number of scientific researches are presently conducted in develop countries to reduce area coverage of photo elements.

Convenient geographical location and climate condition allows for wide utilization of environmentally sound alternative (renewable) energy sources in Azerbaijan. This would save large amount of fuel combusted in thermal power plants, as well significantly reduce hazardous substances. Production of electric and heat energy using alternative energy sources would be incentive for progressive changes in future development of energy sector.

Institute of Physics of National Academy of Sciences, Institute of Radiation Problems, Scientific-Research and Power Design Institute and Baku Hydro Design Institute have undertaken expedient scientific activities towards utilization of renewable energy sources.

This State Program have been prepared based on Law on Energy Utilization; Law on Power Engineering; Law on Energy; Law on Electric and Thermal Power Plants; State Program on Poverty reduction and Economic Development for 2003-2005 approved with Presidential Decree N854 dated February 20, 2003; Measures on Strengthening Financial Discipline in Energy and Water Sectors approved with Ordinance N893 dated March 25, 2002; Presidential Decree N4 on Furtherance of Socio-Economic Development in Azerbaijan Republic dated November 24, 2003; State Program on Socio-Economic Development of Regions of Azerbaijan Republic for 2004-2008 approved with Presidential Decree N24 dated February 11, 2004; Presidential Decree N458 on Establishment of Ministry of Fuel and Energy dated April 18, 2001; and other normative-legal acts.

1. The objective and major tasks of State Program

The objective of State Program is to promote the power generation from renewable and environmentally sound sources and to more efficiently utilize hydrocarbon energy sources.

The major tasks of State Program include:

- define the potential of alternative (renewable) energy sources for electric power generation; - raise the efficiency of utilization of country‘s energy sources by developing renewable energy sources; - ensure the opening of additional jobs with creation of new energy production sites; - Given the existing total capacity of traditional energy sources in Azerbaijan, increase the energy capacities at the expense of alternative energy sources and therefore, achieve the country‘s energy security.

2. Alternative (renewable) energy potential of Azerbaijan

Wind power is the more preferable energy source than solar, hydro, geothermal and biomass for its cost, environmental soundness and unlimited availability.

Practice shows that many of regions in Azerbaijan have great perspective for application of wind power facilities. Calculations suggest that Azerbaijan Republic has about 800 MW annual wind power capacities due to its geographical location, nature and economic infrastructure. This reserve means 2.4 billion kWh of electricity, according to rough calculations. This would imply the saving up 1 million tons of conditional fuel, more 48

importantly, prevention of emitting large quantity of wastes including ozone-cracking carbon dioxide.

Long-term surveys have determined that convenient windy condition prevails in Absheron Peninsula, Caspian seashore and islands in the north-west of Caspian basin. It is feasible to use medium capacity wind power facilities in Ganja-Dahskesen zone and Sharur- Julfa area of Nakhchevan Autonomous Republic because the annual average speed of wind in those regions is 3-5 m/sec.

Japanese company Tomen, together with Azerbaijan Scientific-Research Energy and Power Design Institute, had installed two wind towers of 30 m and 40 m heights and determined that annual average wind speed is 7.9-8.1 m/sec in Absheron. The company had also prepared a Feasibility Study for installment of 30 MW wind power plant in Gobustan region.

Assessment of Azerbaijan‘s renewable energy sources have been conducted in 2002 and it was determined that Absheron Peninsula has large-scale wind power capacity. The average speed of long-lasting wind is more than 6 m/sec which shows the convenient technical-economic potential for using wind power. The statistical data on wind power gathered in Shimal DRES area have once again justified the above indicators. Based on conducted researches, the presented indicators on Gobustan area have been included into 4th class of wind energy potential, which is considered as a high potential.

2.2 Solar power

It should be noted that the efficiency of solar stations depends on country‘s natural climate condition and geographical location. The solar power that comes down to earth totals 1500-2000 kWh/m2 annually in USA, 800-1600 kWh/m2 in Russia, 1200-1400 kWh/m2 in France, 1800-2000 kWh/m2 in China and 1500-2000 kWh/m2 in Azerbaijan. It is obviously clear that the quantity of solar rays in Azerbaijan prevails in comparison with other countries, which might be regarded as one of the efficiency factors for attracting investments to utilization of solar power.

2.3 Small hydro power plants

Construction of hydro power plants has important role in resolution of country-level issues such as regulation of flood waters, environmentally sound electricity generation and creation of new irrigation systems. It is possible to locate dozens of small hydro power plants on rivers and water facilities and these plants can generate up to 3.2 billion kWh annually. For near-term perspective, it would be expedient to install 61 small HPPs. These HPPs can be located on irrigation canals, rives with unregulated flow and water reservoirs that are under-construction. Use of micro HPPs in electricity supply of objects and settlements that are remote from transmission lines and substations of countrywide grid system can resolve electricity problems, as well social problems.

2.4 Biomass power

- combustive industrial wastes; - wastes of forestry and wood-working; - agricultural and organic wastes; - domestic and communal wastes; - wastes processed from areas polluted with oil and petroleum products. Studies suggest that much of composition of production wastes in all industrial sites is biomass substances. It is feasible to produce biogas, bio-liquid and solid bio-substance that can be used for electricity generation. More than 2.0 million tons of solid domestic and production wastes are annually thrown to waste treatment sites in Azerbaijan Republic. Utilization (processing) of solid domestic and production wastes would partially resolve the problems in heating public buildings in Baku and other large industrial cities.

Many of European countries have already found the ways to solve these problems. That is, waste combustion plants are built in densely populated areas and domestic wastes are fired in those plants. The nearby residential settlements are then provided with electricity and heat at the expense of energy produced from waste combustion. The remains of fired wastes are widely used as a manure to increase fertility of soil. Therefore, construction of such plants having complex importance would be significant for Azerbaijan, too.

2.2 Geothermal power

The heat of earth depth is widely used in industry, agriculture, domestic, communal and health sector in many countries. The advantage of using geothermal power in energy production and consumption is that their application doesn‘t require large amount of funding.

Azerbaijan Republic is rich with thermal waters. They are usually found in Great and Small Caucasus, Absheron Peninsula, Talish mountain-row zone, Kur lowland and Caspian- Guba area. Exploitation of thermal waters in noted areas would partially cover the domestic and other heat energy needs.

Attracting private investments in connection with implementation of actions envisaged under State Program and maximum use of alternative (renewable) energy sources can be conductive for connection additional capacities to power system.

Actions on utilization of alternative (renewable) energy sources

N Action Major executors Period (years)

1 Prepare proposals on improvement of MFE, MED, MENR, 2005-2007 legislative framework in order to further SCAC, MJ the utilization of alternative (renewable) energy sources

2 Study and application of international MFE, MENR, MED, regularly experience on utilization of alternative ANAS (renewable) energy sources

3 Undertake actions towards the MFE, MED, MF, regularly encouragement of utilization of MT, MJ, SCC, alternative (renewable) energy sources SGMC, local executive authorities

4 Undertake actions on training ME, MFE, ANAS, regularly specialists for utilization of alternative MENR (renewable) energy sources and education of consumers

5 Development of single scientific- MFE, ANAS 2004-2006 methodic coordinating center and database for efficient utilization of alternative (renewable)

6 Conduct scientific researches to ANAS, MFE, MED regularly determine the potential of alternative

(renewable)

7 Undertake actions towards the MED, MFE, local 2004-2006 furtherance of privatization of existing executive small hydro power plants (―Guba‖, authorities ―Gusar‖, ―Chichakly‖, ―Zeykhur‖, ―Nugedi‖, ―Chinarly‖)

8 Undertake actions towards the MFE, MED, MWEC, 2005-2007 reconstruction of Varvara Hydro Power Azerenerji JSC Plant

9 Design and construction of hydro power MFE, MED, MWEC, 2005-2007 plant on Vaykhyr River Azerenerji JSC

1 Carry out the construction of small MFE, MED, MWEC, 2005-2013 0 hydro power plants on mountain rivers SGMC and irrigation canals in order to use their potential

1 Wide application of wind power plants in MFE, MED, SGMC, 2004-2013 1 accordance with wind power potential in ANAS, local Azerbaijan executive authorities and municipalities

1 Study the wind power potential in MFE, MED, ANAS, 2006-2008 2 electricity supply in Nakhchevan MENR, SGMC, CM Autonomous Republic and secure its NAR utilization

1 Application of solar collectors for MFE, MED, SCAC, 2005-2007 3 heating in Absheron Peninsula, Mil- ANAS, Baku CEA, Mugan flatland and Nakhchevan CM NAR, local Autonomous Republic executive authorities

1 Using local scientific-technical potential MFE, MED, ANAS 2005-2007 4 and raw materials, Increase the efficiency rate of photo elements used in production of solar power and start their production

1 Provide heat to residential, institutional MFE, MED, MENR, 2005-2013 5 and other buildings by using the thermal SCAC, ANAS, local energy of geothermal waters executive authorities

1 Application of plastic pipes with lower MFE, MENR, MED, 2006-2013 6 heat transfer capacity in order to ANAS efficiently utilize thermal energy of geothermal waters

1 Use of geothermal waters for heating Local executive regularly 7 greenhouses in fall-winter seasons authorities, MA,

MFE, MENR, ANAS

1 Conduct scientific-research works ANAS, MFE 2005-2010 8 towards the conversion of power of sea high and low tide into electric power

1 Develop modern technologies for MFE, ANAS, 2005-2013 9 production of bio-substances from MENR, MED, Baku industrial, agricultural and domestic CEA, Sumgayit wastes; undertake works towards CEA local executive construction of small biomass-firing authorities power plants

2 Develop technologies for getting coke MFE, ANAS, 2005-2008 0 brick from oil refinery wastes at refinery MENR, SOCAR plants in order to produce heat energy

Acronyms

MFE – Ministry of Fuel and Energy

MED – Ministry of Economic Development

MENR – Ministry of Ecology and Natural Resources

MF – Ministry of Finance

MT – Ministry of Taxes

ME – Ministry of Education

MJ – Ministry of Justice

MA – Ministry of Agriculture

SCC – State Customs Committee

ANAS – Azerbaijan National Academy of Sciences

SCAC – State Construction and Architecture Committee

SGMC – State Geodesy and Mapping Committee

MWEC – Melioration and Water Economy Committee under auspices of Cabinet of Ministers

SOCAR – State Oil Company of Azerbaijan Republic

CM NAR – Cabinet of Ministers, Nakchevan Autonomous Republic

Baku CEA – Baku City Executive Authority

Sumgayit CEA – Sumgayit City Executive Authority 53

Approved by Decree #3043 of the President of the Republic of Azerbaijan

dated September 15, 2008

State Program on Poverty Reduction and Sustainable Development Republic of Azerbaijan 15 2008-2015

Chapter 1 Introduction

In order to tackle poverty on a global level, the heads of 147 world nations joined together at the United Nations (UN) Millennium Summit in New York in September 2000 to sign the Millennium Declaration. In that document, they committed to achieving a set of eight Millennium Development Goals (MDGs) with 18 targets and 48 indicators. The first of these goals is to halve the number of the world’s population living in extreme poverty and hunger by 2015. National leader Heydar Aliyev signed the Millennium Declaration on behalf of the Republic of Azerbaijan.

In order to honor this commitment in line with local conditions, the President approved by Decree #854 of February 20, 2003, the State Program on Poverty Reduction and Economic Development (SPPRED) in the Republic of Azerbaijan for 2003-2005.

Implementation of that State Program resulted in maintaining overall macroeconomic stability, ensuring dynamic economic growth and upholding inflation and national exchange rates at appropriate levels. These achievements made possible the implementation of major activities aimed at solving existing social problems and tackling poverty. The percentage of Azerbaijanis living in poverty fell from 46.7% in 2002 to 29.3% by 2005.

This document, the State Program on Poverty Reduction and Sustainable Development (SPPRSD) 2008-2015, was prepared in order to continue with this improvement in the welfare of the citizens of the Republic of Azerbaijan.

4.3.6. Industry and Energy Policy A state programme outlining the government’s medium-term activities will be adopted under the SPPRSD in order to ensure comprehensive development of industry, including the non-oil sectors. Also, in accordance with the “State Programme on Development of the Fuel-Energy Sector of the Republic of Azerbaijan (2005-2015)”, which was approved by Presidential Decree #635 on February 14, 2005 for the purpose of development of the fuel-power complex, planned activities will establish a sound competitive environment in the sector, improve the structure of the sector, attract investment, provide environmental safety, and ensure that full payment is received for the consumption of fuel and energy resources.

15 This is an extract of a much monger document, highlighting the energy component only. 54

The provision of meters to the population will be finalized to ensure efficient use of power and to strengthen financial discipline, and public awareness activities will be conducted to promote the thrifty and efficient use of power resources.

In order to increase efficiency in the power sector and to create a more competitive environment, the increase of the private sector involvement in the area will be supported, and the activity of the newly established Azerbaijan Investment Company will be strengthened. These steps will help meet the investment needs of the non-oil sector, introduce new technology and knowledge in the area, and promote strategic cooperation with foreign investors.

New generation capacity will be developed relying on alternative and renewable energy sources including small hydrological power stations and wind farms. Regular monitoring will be conducted and financial sanctions will be applied where necessary to minimize any negative impact on the environment from the development of the fuel-energy complex.

Annex 2.

List of Reports Reviewed.

The Project for the use of modular type waste-water treatment facilities on the Absheron Peninsula using wind energy. Ministry of Ecology and Natural Resources, 2008. The use of solar energy to generate electricity for water-purifying equipment in the regions of Azerbaijan. Ministry of Ecology and Natural Resources. TA: RSC – C60114 (AZE). PREPARATION OF ENERGY SECTOR ROAD MAP. First Draft. April 25, 2006. ADB. State Program for the development of fuel and energy sector in Azerbaijan (2005— 2015), Approved by Presidential Decree February 14, 2005. State Program on poverty reduction and sustainable development in the Republic of Azerbaijan, 2008-2015, Approved by Presidential Decree, September 15, 2008. State Program on the socio-economic development of the regions of the Republic of Azerbaijan 2009—2013. Approved by Presidential Decree, April 14th, 2009. World Bank CPS for Azerbaijan, current. State Program on the use of alternative and renewable energy sources in Azerbaijan Republic. Approved by Presidential Decree, October 21st, 2004. Rapid assessment of the energy sector in Azerbaijan. ADB. 2005. Preparing the renewable energy development project. Technical Assistance Project with Government of Finland. 2005. Renewable energy development project. Ministry of Industry and Energy. Entech Consulting, (ADB), 2007. Ordinance of President of Azerbaijan Republic on approval of ―The State Program on Use of Alternative and Renewable Energy Sources in Azerbaijan Republic‖ October 21, 2004. Presidential Decree on Approval of the State Program for Development of the Fuel and Energy Sector of the Azerbaijan Republic (2005-2015) TA:RSC—C60114 (AZE) Preparation of energy sector road map. April 25, 2006.

Annex 3 Officials interviewed

Institution Responsible Person

Fariz Mammadov Azerbaijan Energy Engineering and Consulting

Arvid Kruze Elictricaql Utility and Regulatory Specialist (Consultant)

Nijat Valiyev Infrastructure Specialist, World Bank Office, Baku.

Ali. N. Kamalov Principal Banker, European Bank for Recon & Dev.

Aliya Azimova Country Officer, IFC Azerbaijan.

Fegan Aliyev President, International EcoEnergy Academy.

Islam Rafibeyli Head, Foreign Economic Relations, AzerEnergy.

Aslan Abasov Dep. Chairman of Executive Board, Bank Respublika.

Rasim Sattar-zada Head, Env. Policy Division, Min. Ecology and Nat. Res.

Emin Garabaghli Ag. Head, Int. Cooperation Division, Min. Ec. & N.R.

Anar Ahmedov General Director, OAO Mikron Alt. Energy.

Gussein Baguirov Minister, Ministry of Ecology and Natural Resources.

Islam Mustafaev RUGAR Alternative Energy, Academy of Sciences.

Fuad Islamov Director, Corporate Banking, Int. Bank of Azerbaijan.

Karim Ramazanov Advisor to Minister, Ministry of Economic Development

Zakir Sadigov Solaris Ltd. Manufacturer of Solar Technology

Mikayil J. Jabbarov Chief Deputy, Caspian Ecology Monitoring Unit, MENR

Chingiz Zeynalov Project Manager, UNDP TA for Small Hydropower.

Anar Ahmadov Chief Director, Mikron SST, alternative energy company.

Dunyamin Khalilov Chairman of the Supervisory Board, General Construction

Mehdi Seyidov Head of Renewable Energy & Env Dept. M of I & E

Consulate of Sweden

Zeynalov Telman Pres. National Center for Environmental Forecasting.

Islam Rafibeyli Head, Foreign Economic Relations, Azerenergy

Taek Yeon Cho Commercial Attaché, Embassy of Korea

Nabat Mammadova Energy Officer, Embassy of the UK.

Economic Officer, U. S. Embassy

Simple SWOT Analysis Matrix Strengths Weaknesses

.Replacing fossil fuels by Renewable Low feed-in tariff for independent Energies would allow for significant power producers income generation through export .No promotion of Renewable Energies earnings from oil since the latter is .Responsibilities and institutional setup presently the main energy source of for the promotion of Renewable electricity producers in Azerbaijan. Energies / IPP‘s is not yet clearly The present subsidisation of fuel defined would be made redundant or can be .Purchase of all produced energy is not diverted into promotion of yet guaranteed Renewables. Every gallon not burned .lack of long-term security for investors in Azerbeijan can be sold on the .Responsibilities within the Renewable worldmarket for 3 to 4 times higher Energy sector are not yet clearly prices than optioned back home. defined .Introduction and dissemination of .weak private sector, few competitors Renewables is facilitated through: .Only very limited industry for a) the existence and operability of an production of hydropower equipment in institutional setup allowing CDM Azerbaijan, high dependency from projects foreign countries b) the Renewable Energy decree .Risk of inefficient cooperation and which is under development complex administrative procedures c) the increasing availability of between the different institutions investment capital with low interest rates d) interest of a first private investor who already started implementation of a project Opportunities Threats

High RE potential, especially for Azerbaijan has its own oil resources hydropower and wind energy, often in and therewith very low fuel costs. If the close vicinity of the grid oil price falls it is difficult for Renewable .Interesting market through growing Energies to compete electricity demand .Lack of capacities in the private sector .Oil as a main energy source has to be (most of the available human resources replaced within the next 20 to 30 with an academic degree is absorbed years by the government) .Technical assistance available .Excellent position to profit from the CDM market .Investors for RE projects exist