Development of the Caspian Oil and Gas Sector

nurture of the Caspian anoint and swagger SectorCaspian petroleum swashRole of FDI in sparing Development of Azerbaijan, Kazakhstan and TurkmenistanAbstractThis paper under(a)lines the remote organise investiture schema formulation process in the three energy-rich countries of the Caspian tangiblem Azerbaijan, Kazakhstan and Turkmenistan. The study comparatively synopsis the enthronisation climate in three selected countries and to a greater termination specifically it examines the contrasted submit enthronement in anoint and splash application and its section in stinting reading of for each one rural. The research examines the enthronisation climate in Azerbaijan, Kazakhstan and Turkmenistan and factors influencing the unconnected investors decision-making in embrocate and flatulency firmament.The starting line gear sh argon of this paper everywhereviews the Caspian domain and its rock anele colour and shove along militia. More specifically this part summarises the role of oerseas speak enthronization in crude oil colour and hitman industry and how it promotes frugalal bugger offment of Caspian basin countries, namely Azerbaijan, Kazakhstan and Turkmenistan. The second part presents the theoretical framework of strange read investing funds.This part also reviews the previous empirical findings on types, determinants and motives of abroad head up investing. The part 3 comparatively analysis foreign occupy enthronisation performance in selected countries and factors which may influence the ability of a country to bring in foreign investment. This part also overviews the investment climates in Azerbaijan, Kazakhstan and Turkmenistan. Part 4 concludes. break Words FDI, Caspian ocean component part, oil colour and Gas, Azerbaijan, Kazakhstan, Turkmenistan.1 IntroductionThe Overview of the Caspian sea RegionIt is round-eyed recognized that foreign direct investment (FDI) can forge an important role in the outgrowth process of many countries and it is much required. Economies in passageway, such as those in primeval Asia and the Caucasus, are no exception as they satisfyingize the important role of FDI in strengthening their transition process. firearm some of them have sizable deposits of oil, tout and minerals which are major attractions to foreign investors, others, being less curioowed, have more difficulty to attract FDI to their fledgling industrial and service sectors. But in flush those countries which are well endowed with rude(a) resources, there is a thrust to diversify their economies away from over-dependence on those resources and to develop viable value-added manufacturing industries and services. FDI can play a major catalytic role in this process.Just a decade years ago the areas on each side of the Caspian sea primeval Asia to its eastern side and the Transcaucasia to its west were largely unknown. These orbits were provinces of the Soviet Empi re important to the outside military personnel neither politically nor economically. straightway its is well known that the Caspian Sea is largest land-locked corpse of water on Earth, bordered by Azerbaijan, Russia, Kazakhstan, Turkmenistan and Iran the Caspian basin countries (see Map 1). Amongst the five countries solitary(prenominal) Iran is a member of the physical composition of oil colour Exporting Countries. Kazakhstan, Azerbaijan and Turkmenistan became independent after stop of Soviet heart in 1991.Once a centimere of global commerce, the Caspian Sea region has languished in obscurity ever since the rise of the navigation ship rendered the Silk Road obsolete a half millennium ago (Olcott, 1998). After discovery of oil and triggerman resources in the Caspian offshore and shore areas, this region became very important oil and bumble sector in global context. Moreover, owing to energy security and geopolitical reasons, the Caspian region became very attractive fo r the West.Azerbaijan became sensation of the worlds first oil sectors after crude oil labor started in Baku in the middle of 19th century. The oil product in telephone exchange Asia started in the opening of the 20th century. Azerbaijan recorded about 70% of Soviet oil product by end of 1940. The fountain Soviet Union controlled almost all inhering resources in Soviet Republics. At the time of their independence, Soviet body politics were quasi- expresss (Olcott, 1998). Each republic has its own president and prime minister, topical anaesthetic and national legislatures. The political and economic liberalisation of the Soviet Union in the mid-1980s attracted foreign investors and oil and splash companies concerned in exploration and mathematical product prospects.The collapse of the Soviet Union gave further opportunities for the liberalisation of investment regulations. By the late 1990s the Caspian region was comparatively politically still region, and a number of co untries significantly betterd investment regimes to their oil and gas sectors.Historically, energy industry in Azerbaijan, Russia, Kazakhstan, Turkmenistan and Uzbekistan is very important sector for the frugality harvest-feast of these countries. However, poor management of natural resources and poor investment climate in these countries lead to disparities emergent between the countries in socio-economic terms. Nowadays, it is well recognized that foreign investment plays a vital role in the development of the oil and gas sector for such countries as Azerbaijan, Kazakhstan and Turkmenistan and significantly stimulates social and economic development of each of these countries.1.2 Research QuestionsThe presence of potentially vast oil and gas reserves is a part of the foreign investment attraction into the Caspian Sea region. On the other hand, it is important to note that bandage the quantity of proven reserves undoubtedly plays a significant role in estimating a regions prod uction and export potential, the other important factors for attraction foreign direct investment into this region are undeveloped securities industry, cheap labour and cheap inputs and unaccented competition.This paper focuses on foreign direct investment strategy formulation process in the three energy-rich countries of the Caspian Region Azerbaijan, Kazakhstan and Turkmenistan and on what foreign direct investment strategy in each country are based. The study comparatively analysis the investment climate in three selected countries and more specifically it examines the foreign direct investment in oil and gas industry and performance by each country.The significant number of researches in regard to foreign direct investment generally explains the investment strategy in the developed countries, when limited study has done on investment in less-developed countries or emerging countries. The selected countries Azerbaijan, Kazakhstan and Turkmenistan are transition countries an d to a certain extent new participants in the competition to attract foreign investment. These countries can offer many potential advantages to foreign investor, curiously in oil and gas sector of business. The research examines the investment climate in Azerbaijan, Kazakhstan and Turkmenistan and factors influencing the foreign investors decision-making in oil and gas sector.There is no much research which explores the determinants of investment in Azerbaijan, Kazakhstan and Turkmenistan, the stereotypes and perceptions that foreign investors have about these countries and what could be done to increase the foreign direct investment flow into these countries. This paper surveys these parts by investigating the transnational oil companies operating in Azerbaijan, Kazakhstan and Turkmenistan.The data from different energy agencies were gathered for comparative analysis of oil and gas data as well as foreign direct investment in different countries. This would not barely let one to have a picture of sundry(a) state strategies link to foreign investment, but could also provide the valuable outlook of the most advantageous approach for transition countries in doing business with foreign investors.1.3 The Legal spatial relation of Caspian SeaA large tract of oil and gas reserves in Central Asia and Caucasus are melodic theme to lie under he Caspian Sea. The drumhead of the ownership of those resources, including the right to license and tax their development, is being argued by the Caspian littoral zone countries. The legal debate over the Caspian Sea can be tracked spur to the 1921 Treaty to Moscow, reaffirmed in 1935, which declared that the inland Caspian Sea belonged to Russia (Kemp, 2000). Later Russia sent a note to the United Nations date from 5th October 1994, where Russian Ministry of immaterial personal business stated that the Caspian Sea should not be subject to the provisions of international maritime equity ( transnational Energy Agency, 1998).The grandeur of the application of international law is that a sea under the 1982 Law of the Sea Convention would be subject to separation into national zones for the development of its mineral resources. Russia stated that until all five of the Caspian littoral states (Azerbaijan, Russia, Kazakhstan, Turkmenistan, and Iran) came to a common decision on some other arrangement, the legal status of the Caspian Sea was subject only to the provisions of the more general (Treaty of companionship between Iran and the USSR of 26 February 1921 and Treaty between Iran and the USSR on divvy up and Maritime Navigation of 26 March 1940).Nevertheless, the current legal uncertainty does not wait considerably decreased foreign investment in the Caspian Sea region. Advantageous geological prospects, with potential of a major oil and gas resource base, manifest significant motivations for companies to invest in this important producing region, preferably from the beginning of its develop ment.1.4 Current takings and Proven Reserves in Caspian RegionCaspian oil presents a roach of opportunities for world oil markets and for the region itself (Energy Charter Secretariat, 2008)The appearance of new production sources would expand world oil supplies. study quantities of Caspian oil would ease the pressure on the Persian Gulf production capacity and provide an additional hedge against oil supply disruptionsProfits from oil exports could stimulate economic growth and improve the standard of living in the Caspian energy-rich counties. The availability of Caspian energy supplies in world markets will likewise improve the prospects for economic growth and political stability in the Caspian basin countries.Nowadays the Caspian Sea region is important, but not major supplier of crude oil to world markets, based upon estimates by British Petroleum (BP) and the Energy randomness political science (EIA). In 2005 the Caspian region produced 2.1 one thousand million put per day, or 2 per cent of totality world production (see Table 1). Kazakhstans production rapidly increased since the late 1990s, accounted for 67 per cent and Azerbaijan for 22 per cent of regional crude oil production in 2005.The Caspian Sea regions comparative contribution to world natural gas supplies is larger than that for oil. Gas production of 3.0 trillion brick-shaped feet per year in 2005 was 3 share of world production (Energy data Administration, 2006). Turkmenistan is the largest manufacturer with production of 2.0 trillion cubic feet per year, it accounts for almost two-thirds of the regions gas production. (see Figure 1). Unlike oil, the regions proven reserves of natural gas are a higher proportion of the world total than is its natural gas production. The estimate of proven reserves of natural gas in the Caspian Sea region for the end of 2006 published by Energy Information Administration is 232 trillion cubic feet per year, which represents 4 per cent of the world total (see Table 2).Table 1Oil Production in the Caspian Sea Region1. Proven reserves are defined by the EIA2. Possible reserves3. Other estimates (EIA/IEO 2006) 3.45 million barrels per day, (World Oil, 10 March 2004) 3 millionOnly Caspian area oil and gas productionSource Energy Information Administration (EIA) Caspian Sea Region Survey of Key Oil and Gas Statistics and Forecasts, July 2006.Table 2Gas Production in the Caspian Sea RegionOnly Caspian area gas productionSource Energy Information Administration (EIA) Caspian Sea Region Survey of Key Oil and Gas Statistics and Forecasts, July 2006.Figure 1 Gas Production in Caspian Sea region (1992-2004)Source Energy Information Administration (EIA) Caspian Sea Region Survey of Key Oil and Gas Statistics and Forecasts, July 2006.1.5 Role of Oil and Gas in the Economic Development of Caspian RegionThe development of oil and gas resources in the Caspian region is mostly important for the development of economies in the Central Asian and Transcaucasia. In 1995 the energy sectors share of staring(a) interior(prenominal) product (GDP) was an estimated 14.6 percent in Azerbaijan, 10.1 percent in Kazakhstan, 10.2 percent in Turkmenistan (International Energy Agency, 1998). Foreign investment attracted to the oil and gas sector in Caspian region could offer significant earnings for the regions establishments and stimulate investment in other economic sectors.The attract foreign investment the host Governments should take discreet measures to ensure the development of an sufficient legal and administrative infrastructure, including knowledgeableness building and personnel training, to maintain the inflow of oil related receiptss and to help ensure the countries efficient and equitable development.International Monetary entrepot (2003) expressed concerns that unless regional governing body activitys introduce further administrative reforms, they risk being overwhelmed by new oil wealth. Particularly, corrupti on is a peril. Economic development motivated by foreign investment in the oil and gas industry helps to guarantee the financial independence of the Central Asian and Transcaucasian states.The transition to the market economy and the economic dis placements originated by collapse of Soviet Union left Azerbaijan, Kazakhstan and Turkmenistan without adequate funds to develop oil and gas resources. Governments of these countries are look for private investment (mainly from foreign companies) that would play significant role in the development of oil and gas industry. Besides financial capital, a foreign investor brings a modern technology to local industry, including environmentally sound production techniques and modern management approaches.The Caspian Sea region countries are competing with each other for foreign investment. Oil and gas companies have a wide choice of where to make investment. The foreign investor considers the opportunities that offer the best financial returns. H owever, the investment climate is vital for companys decision on where to invest. As a result, Kazakhstan and Azerbaijan took considerable steps in creating attractive investment climates. Kazakhstan concentrated on building a clay of law applicable to all projects, while Azerbaijan centre primarily on modified production sharing agreements (International Monetary Fund, 2003).By the beginning of 1998, cumulative foreign direct investment in the oil and gas sectors of Central Asia and Transcaucasia had reached an estimated 3 billion of American dollars, nearly one third of which was placed in 1997. Future investment commitments in the region from contracts already sign-language(a) total over 40 billion of America dollars (International Energy Agency, 1998).So far most foreign investment has been in Kazakhstan and Azerbaijan. Gas-endowed Turkmenistan started to attract foreign investment later than the others overdue to Government dictatorship and poor investment climate.Caspian o il development has gained a great spread of political and commercial momentum since the first foreign companies came there at the end of 1980s (Ruseckas, 2000). Since then the most important external factor influencing Caspian oil development is the equipment casualty of oil. Principally if oil prices remain at present high level it is possible the more optimistic projects will be started. The Caspian Sea region could possibly produce virtually 4 million barrels per day by 2010. In any case, the Caspian Sea states require a stable legal regime to develop, produce, transport and market its natural resources.1.5.1 sum-up data on AzerbaijanOwing to extensive oil reserves, Azerbaijan is a major oil producer since the middle of the last century. Between 1990 and 1995 Azerbaijans blunt internal product dropped 58 percent (International Energy Agency, 1998). Oil production fell by only 25 percent mainly because of continue oil product exports to neighbouring countries and an increas e use of heavy fuel oil in domestic power post to alternative for imported gas. repayable to the alter of monetary and reckonary policies, the fiscal deficit dropped from 11.4 percent of gross domestic product in 1995 to less than 2 percent in 1996.In 2006 Azerbaijans palpable gross domestic product grew by 31 percent when the oil production in this region significantly increased. Azerbaijans anticipate for sustained economic growth is in its managing of large oil and natural gas resources in the Caspian Sea region, through effective management of the resulting revenue stream, and non-oil sector diversification (Energy Information Administration, 2006).During the beginning of transition most Azerbaijan onshore oil fields were in decline and required momentous new investment to develop large-scale offshore projects and to remake existing fields. Since independence Azerbaijan signed several agreements with foreign oil companies. While maintaining full state ownership over energy companies, Azerbaijan was quick to invite foreign investors to assume a direct role in the development of its hydrocarbon reserves (Thompson, 2004).In 1992 most of the Azerbaijan oil sector assets were merged in two state oil companies Azerineft and Azneftkimiya. The new merger was called the order Oil Company of the Azerbaijan Republic or SOCAR. While Government organizations handle production and exploration agreements with foreign companies, SOCAR is body to all international companies developing new oil and gas projects in Azerbaijan.After the first commercial oil flows through the Baku-Tbilisi-Ceyhan pipeline during summer 2006 and the increasing oil production from the Azeri-Chirag-Guneshli project, oil revenues are expected to contribute to a doubling of Azerbaijans gross domestic product by 2008 (Thompson, 2004). Energy Information Administration (2007) reports that though the oil sector represented around 10 percent of Azerbaijans gross domestic product in 2005, it is al ready intercommunicate to double to almost 20 percent of gross domestic product in 2007 (see Table 3).To manage the revenues, former President of Azerbaijan Heydar Aliyev formed a State Oil Fund in 1999, which is designed to use money obtained from oil-related foreign investment for poverty reduction, education and fostering rural living standards. As of the end of 2006, the State Oil Fund reported assets of almost 2 billion US dollars, but the funds assets are expected to increase to 36 billion US dollars by 2010 (Energy Information Administration, 2006).Table 3Azerbaijan Economy and Energy (in millions US dollars)200320042005200620072010Oil Production(thousand barrels per day)3203194416488601,300Oil Exports(thousand barrels per day)215204314521721N/AForeign Direct Investment3,2853,5561,680-219-4,750476FDI in Oil Sector3,2463,4611,459-573-5,198366Oil Sector Revenue8869461,3372,9215,27219,417As share of total rev (%)42%38%39%51%59%N/AAs share of total GDP (%)N/AN/A9.8%15%19.7%43.3 %Oil Fund Assets8169721,3941,9363,09336,387Source Energy Information Administration Short Term Energy Outlook, 2007 International Monetary Fund (IMF), Article IV Consultation, Staff Report, No 07/191, June 20071.5.2 Summary Data on KazakhstanAs it was the case in most other former Soviet Union countries, Kazakhstans first attempts at economic reform were effectively taken in response to Russias one-sided price reforms in 1992. After Kazak oil production had suddenly declined for two years in the end of 1993, inflation had out of control. The efforts to create an economic union with Russia and other former Soviet Union countries didnt meet expectations of the Kazakh Government. Looking at the impulsive Asian economies as a model, the Kazakh Government turned to market style policies.However, the government increased hard calculate constraints and counterpoiserictive monetary policies due to attempts to resolve non-payment problem through state financing. The remained net debts af ter netting out inter-industry arrears were financed from Government budget and the central bank.In 1993 International Monetary Fund (IMF) allow Kazakhstan a one-year standby package. To maintain IMF collaboration and to stop the decline in gross domestic product, the Kazakh government implemented a second stabilisation program in 1995. But this time hard budget constraints and monetary insurance policy were strengthened by excluding of government financing of net positions in inter-enterprise debts and retreating government guarantees for loans granted by foreign and domestic banks.In the middle of 1996, the International Monetary Fund approved an elongated Fund Facility (EFF) of 446 million US dollars for three years (IMF, 2003). According to International Monetary Fund (2003) the decision was made in light of a wide-ranging three-year reform programme submitted by the government, as well as the positive longer term prospects for production and exports of energy and non-ferrous metals. In 1996, Kazakhstan experienced its first positive economic growth since 1989.1.5.3 Summary Data on TurkmenistanPreceding the collapse of the Soviet Union approximately 8 percent Turkmenistans gross domestic product was generated by gas exports to the rest of the USSR mostly to Belarus, Ukraine and the Caucasus. Another 5 percent of gross domestic product was earned from cotton exports. Gas and cotton exports continue to be utilise to cover the import of considerable amounts of grain and capital equipment from other former Soviet Republics.While estimates for the fall of gross domestic product between 1990 and 1995 deepen depending on how adjustments to authoritative gross domestic product are made, International Monetary Fund and European brink of Reconstruction and Development agree on about -35 percent (IMF, 2003). This is much less than the 58 percent drop in Turkmen gas production. The rest of the economy is basically agricultural. The cotton industry has been less affected by the downfall of the Soviet Union.The government gradually liberalised some prices beginning in 1992. A presidential decree of 1995 removed price controls on all products except for about 50 items, including energy. The government introduced the manat as the national currency in 1993. In 1995 it unified the previously separate official and commercial exchange rates, which subsequently became determined by inter-bank auctions for foreign exchange.Between 1992 and 1995 the government compensated for the shortfall in revenue from taxes on gas production and exports by cutting expenditures and replacing subsidies to the economy with additional allocations of quote at largely negative interest rates.Controlled prices were familiarised repeatedly but declined in real terms for natural gas and for oil products through 1994. The share of gas related revenues in the central budget declined from 60 percent in 1992 to under 20 percent in 1995, which lowered the share of total budg etary revenue in GDP from 40 percent to 10 percent during this period. Due to drastic expenditure cuts in government wages and investment, including maintenance, the central budget deficit remained fairly stable over this period. It also helped that new excise taxes were introduced in 1995 on petrol (55 percent) and diesel (60 percent). This resulted in some recovery of government capital spending.The easy money policy was changed slowly in 1995 and 1996. During this time foreign exchange surrender requirements of state-owned enterprises to the Foreign Exchange Reserve Fund (FERF) were increased to 50 percent for gas and oil exports, and the money allocated directly to the central budget. preceding to that, this fund had been used to award credits to the economy, contributing to monetary expansion. In 1995 and 1996, bank credit allocation was reduced, real interest rates rose (due to credit auctions with deregulated interest rates), and reserve requirements for banks were increased . However, the pursuit of these policies was not smooth, in part due to the limited political autonomy of the Central Bank. Nevertheless, inflation decelerated by 50 percent towards the end of 1995 and is estimated to have been 445 percent in 1996, and 21 percent in 1997.Despite plummeting gas exports in youthful years, Turkmenistans current account was slightly positive in 1994 and 1995, as long as arrears owed to the country are not taken into account. If such arrears are counted the 1995 balance swings from an estimated surplus of 54 million US Dollars to a deficit of 289 million US Dollars. The situation has probably continued to deteriorate due to scant(p) gas exports.2 Theoretical Frameworks2.1 Overview of Foreign Direct Investment TheoriesThere is variety of empirical studies on theoretical models explaining foreign direct investment (FDI) and its determinants. The various approaches from different disciplines such as economics, international business, organisation and man agement explain numerous characteristics of this phenomenon. The following dissimilar methods, explaining foreign direct investment as the location decision of multinational enterprises are mostly acknowledged in empirical literature on FDIOwnership advantages as determinants of foreign direct investment (including monopolistic advantage and internalisation theory) based on imperfect competition models and the view that multinational enterprises (MNEs) are firms with market power (Hymer, 1960 Buckley and Casson, 1979 Kindleberger, 1969 Caves, 1971 for ownership advantages)Determinants according to the Neoclassical Trade Theory and the Heckscher-Ohlin model, where capital moves across countries due to differences in capital returns (for example Markusen et al, 1995,pp. 98-128 Aliber, 1970)Determinants of foreign direct investment in Dunnings ownership-location-internalization (OLI) framework, which brought together traditional stack economics, ownership advantages and internalisatio n theory (Dunning, 1977 1979)Determinants of foreign direct investment according to the horizontal FDI model or Proximity- Concentration Hypothesis (Krugman, 1983 Markusen, 1984 Ethier, 1986 Horstmann and Markusen, 1992 Brainard, 1993)Determinants of foreign direct investment according to the vertical FDI model, Factor-Proportions Hypothesis or the theoryDevelopment of the Caspian Oil and Gas SectorDevelopment of the Caspian Oil and Gas SectorCaspian Oil GasRole of FDI in Economic Development of Azerbaijan, Kazakhstan and TurkmenistanAbstractThis paper underlines the foreign direct investment strategy formulation process in the three energy-rich countries of the Caspian Region Azerbaijan, Kazakhstan and Turkmenistan. The study comparatively analysis the investment climate in three selected countries and more specifically it examines the foreign direct investment in oil and gas industry and its role in economic development of each country. The research examines the investment climate in Azerbaijan, Kazakhstan and Turkmenistan and factors influencing the foreign investors decision-making in oil and gas sector.The first part of this paper overviews the Caspian region and its oil and gas reserves. More specifically this part summarises the role of foreign direct investment in oil and gas industry and how it promotes economic development of Caspian basin countries, namely Azerbaijan, Kazakhstan and Turkmenistan. The second part presents the theoretical framework of foreign direct investment.This part also reviews the previous empirical findings on types, determinants and motives of foreign direct investment. The part 3 comparatively analysis foreign direct investment performance in selected countries and factors which may influence the ability of a country to attract foreign investment. This part also overviews the investment climates in Azerbaijan, Kazakhstan and Turkmenistan. Part 4 concludes.Key Words FDI, Caspian Sea region, Oil and Gas, Azerbaijan, Kazakhstan, Turkmenistan.1 IntroductionThe Overview of the Caspian Sea RegionIt is wide recognized that foreign direct investment (FDI) can play an important role in the development process of many countries and it is much required. Economies in transition, such as those in Central Asia and the Caucasus, are no exception as they realize the important role of FDI in strengthening their transition process. While some of them have sizable deposits of oil, gas and minerals which are major attractions to foreign investors, others, being less endowed, have more difficulty to attract FDI to their fledgling industrial and service sectors. But in even those countries which are well endowed with natural resources, there is a thrust to diversify their economies away from over-dependence on those resources and to develop viable value-added manufacturing industries and services. FDI can play a major catalytic role in this process.Just a decade years ago the areas on each side of the Caspian Sea Central As ia to its east side and the Transcaucasia to its west were largely unknown. These regions were provinces of the Soviet Empire important to the outside world neither politically nor economically. Now its is well known that the Caspian Sea is largest land-locked body of water on Earth, bordered by Azerbaijan, Russia, Kazakhstan, Turkmenistan and Iran the Caspian basin countries (see Map 1). Amongst the five countries only Iran is a member of the Organization of Petroleum Exporting Countries. Kazakhstan, Azerbaijan and Turkmenistan became independent after collapse of Soviet Union in 1991.Once a centre of global commerce, the Caspian Sea region has languished in obscurity ever since the rise of the sailing ship rendered the Silk Road obsolete a half millennium ago (Olcott, 1998). After discovery of oil and gas resources in the Caspian offshore and shore areas, this region became very important oil and gas sector in global context. Moreover, owing to energy security and geopolitical re asons, the Caspian region became very attractive for the West.Azerbaijan became one of the worlds first oil sectors after crude oil production started in Baku in the middle of 19th century. The oil production in Central Asia started in the beginning of the 20th century. Azerbaijan recorded about 70% of Soviet oil production by end of 1940. The former Soviet Union controlled almost all natural resources in Soviet Republics. At the time of their independence, Soviet republics were quasi-states (Olcott, 1998). Each republic has its own president and prime minister, local and national legislatures. The political and economic liberalisation of the Soviet Union in the mid-1980s attracted foreign investors and oil and gas companies interested in exploration and production prospects.The collapse of the Soviet Union gave further opportunities for the liberalisation of investment regulations. By the late 1990s the Caspian region was comparatively politically stable region, and a number of cou ntries significantly improved investment regimes to their oil and gas sectors.Historically, energy industry in Azerbaijan, Russia, Kazakhstan, Turkmenistan and Uzbekistan is very important sector for the economy growth of these countries. However, poor management of natural resources and poor investment climate in these countries lead to disparities emergent between the countries in socio-economic terms. Nowadays, it is well recognized that foreign investment plays a vital role in the development of the oil and gas sector for such countries as Azerbaijan, Kazakhstan and Turkmenistan and significantly stimulates social and economic development of each of these countries.1.2 Research QuestionsThe presence of potentially vast oil and gas reserves is a part of the foreign investment attraction into the Caspian Sea region. On the other hand, it is important to note that while the quantity of proven reserves undoubtedly plays a significant role in estimating a regions production and expor t potential, the other decisive factors for attraction foreign direct investment into this region are undeveloped market, cheap labour and cheap inputs and weak competition.This paper focuses on foreign direct investment strategy formulation process in the three energy-rich countries of the Caspian Region Azerbaijan, Kazakhstan and Turkmenistan and on what foreign direct investment strategy in each country are based. The study comparatively analysis the investment climate in three selected countries and more specifically it examines the foreign direct investment in oil and gas industry and performance by each country.The significant number of researches in regard to foreign direct investment mostly explains the investment strategy in the developed countries, when limited study has done on investment in less-developed countries or emerging countries. The selected countries Azerbaijan, Kazakhstan and Turkmenistan are transition countries and to a certain extent new participants in th e competition to attract foreign investment. These countries can offer many potential advantages to foreign investor, especially in oil and gas sector of business. The research examines the investment climate in Azerbaijan, Kazakhstan and Turkmenistan and factors influencing the foreign investors decision-making in oil and gas sector.There is no much research which explores the determinants of investment in Azerbaijan, Kazakhstan and Turkmenistan, the stereotypes and perceptions that foreign investors have about these countries and what could be done to increase the foreign direct investment flow into these countries. This paper surveys these parts by investigating the multinational oil companies operating in Azerbaijan, Kazakhstan and Turkmenistan.The data from different energy agencies were gathered for comparative analysis of oil and gas data as well as foreign direct investment in different countries. This would not only let one to have a picture of various state strategies rela ted to foreign investment, but could also provide the valuable outlook of the most advantageous approach for transition countries in doing business with foreign investors.1.3 The Legal Status of Caspian SeaA large share of oil and gas reserves in Central Asia and Caucasus are thought to lie under he Caspian Sea. The question of the ownership of those resources, including the right to license and tax their development, is being argued by the Caspian littoral countries. The legal debate over the Caspian Sea can be tracked back to the 1921 Treaty to Moscow, reaffirmed in 1935, which declared that the inland Caspian Sea belonged to Russia (Kemp, 2000). Later Russia sent a note to the United Nations dated from 5th October 1994, where Russian Ministry of Foreign Affairs stated that the Caspian Sea should not be subject to the provisions of international maritime law (International Energy Agency, 1998).The importance of the application of international law is that a sea under the 1982 Law of the Sea Convention would be subject to separation into national zones for the development of its mineral resources. Russia stated that until all five of the Caspian littoral states (Azerbaijan, Russia, Kazakhstan, Turkmenistan, and Iran) came to a common decision on some other arrangement, the legal status of the Caspian Sea was subject only to the provisions of the more general (Treaty of Friendship between Iran and the USSR of 26 February 1921 and Treaty between Iran and the USSR on Trade and Maritime Navigation of 26 March 1940).Nevertheless, the ongoing legal uncertainty does not seem considerably decreased foreign investment in the Caspian Sea region. Advantageous geological prospects, with potential of a major oil and gas resource base, show significant motivations for companies to invest in this important producing region, preferably from the beginning of its development.1.4 Current Production and Proven Reserves in Caspian RegionCaspian oil presents a lot of opportunities for world oil markets and for the region itself (Energy Charter Secretariat, 2008)The appearance of new production sources would expand world oil supplies. Major quantities of Caspian oil would ease the pressure on the Persian Gulf production capacity and provide an additional hedge against oil supply disruptionsProfits from oil exports could stimulate economic growth and improve the standard of living in the Caspian energy-rich counties. The availability of Caspian energy supplies in world markets will likewise improve the prospects for economic growth and political stability in the Caspian basin countries.Nowadays the Caspian Sea region is important, but not major supplier of crude oil to world markets, based upon estimates by British Petroleum (BP) and the Energy Information Administration (EIA). In 2005 the Caspian region produced 2.1 million barrels per day, or 2 per cent of total world production (see Table 1). Kazakhstans production rapidly increased since the late 1990s, ac counted for 67 per cent and Azerbaijan for 22 per cent of regional crude oil production in 2005.The Caspian Sea regions comparative contribution to world natural gas supplies is larger than that for oil. Gas production of 3.0 trillion cubic feet per year in 2005 was 3 percent of world production (Energy Information Administration, 2006). Turkmenistan is the largest producer with production of 2.0 trillion cubic feet per year, it accounts for almost two-thirds of the regions gas production. (see Figure 1). Unlike oil, the regions proven reserves of natural gas are a higher proportion of the world total than is its natural gas production. The estimate of proven reserves of natural gas in the Caspian Sea region for the end of 2006 published by Energy Information Administration is 232 trillion cubic feet per year, which represents 4 per cent of the world total (see Table 2).Table 1Oil Production in the Caspian Sea Region1. Proven reserves are defined by the EIA2. Possible reserves3. Oth er estimates (EIA/IEO 2006) 3.45 million barrels per day, (World Oil, 10 March 2004) 3 millionOnly Caspian area oil and gas productionSource Energy Information Administration (EIA) Caspian Sea Region Survey of Key Oil and Gas Statistics and Forecasts, July 2006.Table 2Gas Production in the Caspian Sea RegionOnly Caspian area gas productionSource Energy Information Administration (EIA) Caspian Sea Region Survey of Key Oil and Gas Statistics and Forecasts, July 2006.Figure 1 Gas Production in Caspian Sea region (1992-2004)Source Energy Information Administration (EIA) Caspian Sea Region Survey of Key Oil and Gas Statistics and Forecasts, July 2006.1.5 Role of Oil and Gas in the Economic Development of Caspian RegionThe development of oil and gas resources in the Caspian region is mostly important for the development of economies in the Central Asian and Transcaucasia. In 1995 the energy sectors share of gross domestic product (GDP) was an estimated 14.6 percent in Azerbaijan, 10.1 p ercent in Kazakhstan, 10.2 percent in Turkmenistan (International Energy Agency, 1998). Foreign investment attracted to the oil and gas sector in Caspian region could offer significant profits for the regions governments and stimulate investment in other economic sectors.The attract foreign investment the host Governments should take discreet measures to ensure the development of an sufficient legal and administrative infrastructure, including institution building and personnel training, to handle the inflow of oil related revenues and to help ensure the countries efficient and equitable development.International Monetary Fund (2003) expressed concerns that unless regional governments introduce further administrative reforms, they risk being overwhelmed by new oil wealth. Particularly, corruption is a peril. Economic development motivated by foreign investment in the oil and gas industry helps to guarantee the financial independence of the Central Asian and Transcaucasian states.The transition to the market economy and the economic dislocations originated by collapse of Soviet Union left Azerbaijan, Kazakhstan and Turkmenistan without adequate funds to develop oil and gas resources. Governments of these countries are looking for private investment (mainly from foreign companies) that would play significant role in the development of oil and gas industry. Besides financial capital, a foreign investor brings a modern technology to local industry, including environmentally sound production techniques and modern management approaches.The Caspian Sea region countries are competing with each other for foreign investment. Oil and gas companies have a wide choice of where to make investment. The foreign investor considers the opportunities that offer the best financial returns. However, the investment climate is vital for companys decision on where to invest. As a result, Kazakhstan and Azerbaijan took considerable steps in creating attractive investment climates. Kaz akhstan concentrated on building a body of law applicable to all projects, while Azerbaijan focused primarily on modified production sharing agreements (International Monetary Fund, 2003).By the beginning of 1998, cumulative foreign direct investment in the oil and gas sectors of Central Asia and Transcaucasia had reached an estimated 3 billion of American dollars, nearly one third of which was placed in 1997. Future investment commitments in the region from contracts already signed total over 40 billion of America dollars (International Energy Agency, 1998).So far most foreign investment has been in Kazakhstan and Azerbaijan. Gas-endowed Turkmenistan started to attract foreign investment later than the others due to Government dictatorship and poor investment climate.Caspian oil development has gained a great deal of political and commercial momentum since the first foreign companies came there at the end of 1980s (Ruseckas, 2000). Since then the most important external factor infl uencing Caspian oil development is the price of oil. Principally if oil prices remain at present high level it is possible the more optimistic projects will be started. The Caspian Sea region could possibly produce approximately 4 million barrels per day by 2010. In any case, the Caspian Sea states require a stable legal regime to develop, produce, transport and market its natural resources.1.5.1 Summary data on AzerbaijanOwing to extensive oil reserves, Azerbaijan is a major oil producer since the middle of the last century. Between 1990 and 1995 Azerbaijans gross domestic product dropped 58 percent (International Energy Agency, 1998). Oil production fell by only 25 percent mainly because of continuing oil product exports to neighbouring countries and an increasing use of heavy fuel oil in domestic power stations to alternative for imported gas. Due to the tightening of monetary and budgetary policies, the fiscal deficit dropped from 11.4 percent of gross domestic product in 1995 t o less than 2 percent in 1996.In 2006 Azerbaijans real gross domestic product grew by 31 percent when the oil production in this region significantly increased. Azerbaijans anticipate for sustained economic growth is in its managing of large oil and natural gas resources in the Caspian Sea region, through effective management of the resulting revenue stream, and non-oil sector diversification (Energy Information Administration, 2006).During the beginning of transition most Azerbaijan onshore oil fields were in decline and required momentous new investment to develop large-scale offshore projects and to reconstruct existing fields. Since independence Azerbaijan signed several agreements with foreign oil companies. While maintaining full state ownership over energy companies, Azerbaijan was quick to invite foreign investors to assume a direct role in the development of its hydrocarbon reserves (Thompson, 2004).In 1992 most of the Azerbaijan oil sector assets were merged in two state o il companies Azerineft and Azneftkimiya. The new merger was called the State Oil Company of the Azerbaijan Republic or SOCAR. While Government organizations handle production and exploration agreements with foreign companies, SOCAR is body to all international companies developing new oil and gas projects in Azerbaijan.After the first commercial oil flows through the Baku-Tbilisi-Ceyhan pipeline during summer 2006 and the increasing oil production from the Azeri-Chirag-Guneshli project, oil revenues are expected to contribute to a doubling of Azerbaijans gross domestic product by 2008 (Thompson, 2004). Energy Information Administration (2007) reports that though the oil sector represented around 10 percent of Azerbaijans gross domestic product in 2005, it is already projected to double to almost 20 percent of gross domestic product in 2007 (see Table 3).To manage the revenues, former President of Azerbaijan Heydar Aliyev formed a State Oil Fund in 1999, which is designed to use mon ey obtained from oil-related foreign investment for poverty reduction, education and raising rural living standards. As of the end of 2006, the State Oil Fund reported assets of almost 2 billion US dollars, but the funds assets are expected to increase to 36 billion US dollars by 2010 (Energy Information Administration, 2006).Table 3Azerbaijan Economy and Energy (in millions US dollars)200320042005200620072010Oil Production(thousand barrels per day)3203194416488601,300Oil Exports(thousand barrels per day)215204314521721N/AForeign Direct Investment3,2853,5561,680-219-4,750476FDI in Oil Sector3,2463,4611,459-573-5,198366Oil Sector Revenue8869461,3372,9215,27219,417As share of total rev (%)42%38%39%51%59%N/AAs share of total GDP (%)N/AN/A9.8%15%19.7%43.3%Oil Fund Assets8169721,3941,9363,09336,387Source Energy Information Administration Short Term Energy Outlook, 2007 International Monetary Fund (IMF), Article IV Consultation, Staff Report, No 07/191, June 20071.5.2 Summary Data on Kaza khstanAs it was the case in most other former Soviet Union countries, Kazakhstans first attempts at economic reform were effectively taken in response to Russias one-sided price reforms in 1992. After Kazak oil production had suddenly declined for two years in the end of 1993, inflation had out of control. The efforts to create an economic union with Russia and other former Soviet Union countries didnt meet expectations of the Kazakh Government. Looking at the dynamic Asian economies as a model, the Kazakh Government turned to market style policies.However, the government increased hard budget constraints and restrictive monetary policies due to attempts to solve non-payment problem through state financing. The remained net debts after netting out inter-industry arrears were financed from Government budget and the central bank.In 1993 International Monetary Fund (IMF) granted Kazakhstan a one-year standby package. To maintain IMF collaboration and to stop the decline in gross domest ic product, the Kazakh government implemented a second stabilisation program in 1995. But this time hard budget constraints and monetary policy were strengthened by excluding of government financing of net positions in inter-enterprise debts and retreating government guarantees for loans granted by foreign and domestic banks.In the middle of 1996, the International Monetary Fund approved an Extended Fund Facility (EFF) of 446 million US dollars for three years (IMF, 2003). According to International Monetary Fund (2003) the decision was made in light of a wide-ranging three-year reform programme submitted by the government, as well as the positive longer term prospects for production and exports of energy and non-ferrous metals. In 1996, Kazakhstan experienced its first positive economic growth since 1989.1.5.3 Summary Data on TurkmenistanPreceding the collapse of the Soviet Union approximately 8 percent Turkmenistans gross domestic product was generated by gas exports to the rest o f the USSR mostly to Belarus, Ukraine and the Caucasus. Another 5 percent of gross domestic product was earned from cotton exports. Gas and cotton exports continue to be used to cover the import of considerable amounts of grain and capital equipment from other former Soviet Republics.While estimates for the fall of gross domestic product between 1990 and 1995 vary depending on how adjustments to official gross domestic product are made, International Monetary Fund and European Bank of Reconstruction and Development agree on about -35 percent (IMF, 2003). This is much less than the 58 percent drop in Turkmen gas production. The rest of the economy is basically agricultural. The cotton industry has been less affected by the downfall of the Soviet Union.The government gradually liberalised some prices beginning in 1992. A presidential decree of 1995 removed price controls on all products except for about 50 items, including energy. The government introduced the manat as the national cu rrency in 1993. In 1995 it unified the previously separate official and commercial exchange rates, which subsequently became determined by inter-bank auctions for foreign exchange.Between 1992 and 1995 the government compensated for the shortfall in revenue from taxes on gas production and exports by cutting expenditures and replacing subsidies to the economy with additional allocations of credit at largely negative interest rates.Controlled prices were adjusted repeatedly but declined in real terms for natural gas and for oil products through 1994. The share of gas related revenues in the central budget declined from 60 percent in 1992 to under 20 percent in 1995, which lowered the share of total budgetary revenue in GDP from 40 percent to 10 percent during this period. Due to drastic expenditure cuts in government wages and investment, including maintenance, the central budget deficit remained fairly stable over this period. It also helped that new excise taxes were introduced in 1995 on petrol (55 percent) and diesel (60 percent). This resulted in some recovery of government capital spending.The easy money policy was changed slowly in 1995 and 1996. During this time foreign exchange surrender requirements of state-owned enterprises to the Foreign Exchange Reserve Fund (FERF) were increased to 50 percent for gas and oil exports, and the money allocated directly to the central budget. Prior to that, this fund had been used to award credits to the economy, contributing to monetary expansion. In 1995 and 1996, bank credit allocation was reduced, real interest rates rose (due to credit auctions with deregulated interest rates), and reserve requirements for banks were increased. However, the pursuit of these policies was not smooth, in part due to the limited political autonomy of the Central Bank. Nevertheless, inflation decelerated by 50 percent towards the end of 1995 and is estimated to have been 445 percent in 1996, and 21 percent in 1997.Despite plummeting gas exports in recent years, Turkmenistans current account was slightly positive in 1994 and 1995, as long as arrears owed to the country are not taken into account. If such arrears are counted the 1995 balance swings from an estimated surplus of 54 million US Dollars to a deficit of 289 million US Dollars. The situation has probably continued to deteriorate due to weak gas exports.2 Theoretical Frameworks2.1 Overview of Foreign Direct Investment TheoriesThere is variety of empirical studies on theoretical models explaining foreign direct investment (FDI) and its determinants. The various approaches from different disciplines such as economics, international business, organisation and management explain numerous characteristics of this phenomenon. The following dissimilar methods, explaining foreign direct investment as the location decision of multinational enterprises are mostly acknowledged in empirical literature on FDIOwnership advantages as determinants of foreign direct inves tment (including monopolistic advantage and internalisation theory) based on imperfect competition models and the view that multinational enterprises (MNEs) are firms with market power (Hymer, 1960 Buckley and Casson, 1979 Kindleberger, 1969 Caves, 1971 for ownership advantages)Determinants according to the Neoclassical Trade Theory and the Heckscher-Ohlin model, where capital moves across countries due to differences in capital returns (for example Markusen et al, 1995,pp. 98-128 Aliber, 1970)Determinants of foreign direct investment in Dunnings ownership-location-internalization (OLI) framework, which brought together traditional trade economics, ownership advantages and internalisation theory (Dunning, 1977 1979)Determinants of foreign direct investment according to the horizontal FDI model or Proximity- Concentration Hypothesis (Krugman, 1983 Markusen, 1984 Ethier, 1986 Horstmann and Markusen, 1992 Brainard, 1993)Determinants of foreign direct investment according to the vertica l FDI model, Factor-Proportions Hypothesis or the theory