Volatile mixture in the Caspian

Where the tectonic plates of the old Russian, Persian and Ottoman empires collided, there was bound to be some residual volatility. That restlessness is seen throughout the Caucasus, but perhaps nowhere better than in modern-day Azerbaijan. Last week in the Azeri capital, Baku, those cultures were standing in sharp contrast. The city has been designated the Capital of Islamic Culture for 2009, and ministers of the Organisation of Islamic Conferences gathered in one of the bigger hotels to discuss OIC matters.

An Emirati delegation were being briefed on Azeri affairs by their hosts, who explained, in English, that the country had a booming oil industry, that it was almost bilingual in Russian and the Turkic native language, and that it was a rare Shia Muslim state, but secular on the Turkish model. The men in dishdashas nodded at the information, but seemed puzzled - how many such idiosyncrasies could one country, population 9 million, combine?

There are others. For a few years of the 21st century, Azerbaijan reported the highest rate of GDP growth in the world, reaching 30 per cent plus in 2007. Yet there is still a glaring "infrastructure deficit" in transport, public services and telecommunications. Soaring inflation meant living standards for most Azeris were well down the global charts. Oil has always been at the centre of life in Azerbaijan. Marco Polo passed through the Baku region on his way to China, and said the oil was "no good for food, but good to burn". It had already been burning for thousands of years before he arrived - the region is the origin of the pyrocentric Zoroastrian religion - and it has continued to be exploited ever since.

By 1900 the Caspian region produced around half the world's crude, and Baku was a kind of late-Victorian Dubai. Extravagant palaces built by the Baku oil barons, who included foreign entrepreneurs like the Rothschilds and Nobels, still dominate the city's downtown today. The city's industrial infrastructure was so advanced, by the standards of the day, that it was targeted by a young Marxist revolutionary called Josef Djugashvilli (aka Stalin) as a base for his proletarian agitation.

Stalin's ambitions were fulfilled in the aftermath of the Russian Revolution, when the Soviets took power in Baku and proceeded to rape the country's natural resources for the next 70 years. Baku's oil supplied 75 per cent of the Red Army's needs during the Second World War, and Hitler was on his way there in 1942 when he was stopped at Stalingrad. The Russians "rewarded" Azerbaijan by pushing through a rapid industrialisation programme centred on oil, which made it one of the more prosperous parts of the Soviet Union, but at a huge price. Sumgait, the largely abandoned petro-chemicals port a few kilometres from Baku, is one of the most polluted places on Earth. When the Soviets left in 1991 they bequeathed another problem to the Azeris. Russia's primitive energy technology had depleted almost all the easily accessible reserves, though there were still billions of barrels of oil and cubic feet of gas in more difficult, and expensive, locations. The Azeris turned to the West for help, and found it readily available via the multinational oil companies eager to get their hands on new fields previously blocked by the Soviets.

The "deal of the century" was signed between the Azeri government and consortia of western oil companies determined to get to new reserves in the Caspian, and get it out of Azerbaijan without Russian interference. The first goal has proved more easily achievable. Beneath the Caspian seabed is another sea, of oil, and the relatively shallow waters were no problem for the western majors. On the eastern shore of the Caspian there were other vast reserves - in Kazakhstan and Turkmenistan - and the western plan seemed comparatively simple: join all the rigs and pipelines in a network and pump the oil ashore at the Absheron peninsula, on which Baku stands. Then it could be relatively easily transported, preferably by pipeline, but by train and tanker if necessary, across the southern Caucasus and into Turkey, for on-shipment to Europe.

These ambitious plans crystallised in two strategic energy initiatives - the Baku-Tiblisi-Ceyhan (BTC) oil pipeline and the Nabucco gas pipeline. Both bypassed Russia, and, just as important for the Azeris, also avoided entering Armenian territory; Azerbaijan and Armenia have been in a state of on-off war for more than a century. Added into this volatile geopolitical mix are the ambitions of a resurgent Russia. Influence over Europe's energy sources has become a central part of Russian foreign policy, and Presidents Vladimir Putin and Dmitry Medvedev certainly do not want western oil companies interfering with this strategy.

If the BTC pipeline runs smoothly for the next 30 years it could be worth an estimated $160 billion (Dh590bn) to Azerbaijan. But the Russians do not want to see so much oil reaching Europe outside their control. During last year's war with Georgia, Russian bombs fell ominously close to the BTC - not near enough to cause damage, but near enough to close it down. It is uncertain how much oil is passing through the BTC, and low prices will not hasten the process of getting it up and running at full speed again.

The Nabucco project is on the verge of being clinched, with EU financial participation, but last month the Russians pulled of a minor coup. In a Moscow meeting between President Medvedev and his Azeri counterpart, Ilham Aliyev, the two countries announced a deal for Azerbaijan to also supply Russia with gas, some of which would be re-exported to Europe. Nabucco had been neatly sidestepped, it seemed.

Azerbaijan has to get the best price for its oil and gas. The global financial recession is beginning to hit the country, with the World Bank forecasting less than one per cent growth this year. The Baku construction boom, which sustained the economy as the oil price fell, has petered out, with many big projects mothballed. A healthy current account surplus of nearly $17 billion last year is forecast to fall to just over $1bn in 2009. But its future as an oil-rich producer is being held back by its past as an imperial playground. [e-mail]