AZERBAIJAN: From Boom to Bust and Back

Alfred Guliyev stands back to admire the new-look Villa Nobel, a mansion getting a make-over as this Caspian capital -- one of the world's oldest oil towns -- ramps up for another boom.

"Baku's reborn, and soon we'll be swimming in riches," says Mr. Guliyev, the house's caretaker.

Villa Nobel, built in 1885 during Baku's first oil bonanza, sums up Azerbaijan's shifting fortunes. Under the Soviets, when the town became a backwater, the mansion stood in ruins. Now, with Azerbaijan about to strike it rich again, Villa Nobel's $3 million face-lift reflects the hope sweeping the country.

A consortium led by BP PLC soon will be pumping one million barrels a day from a big offshore field, and sending the oil through a new $4 billion pipeline from Baku to Turkey's Mediterranean port of Ceyhan. From the moment the first cargoes are loaded early next year, Azerbaijan will face a wave of cash.

"By 2010, the revenues could be twice the country's current [gross domestic product]," says David Woodward, president of BP's Azeri unit. Azerbaijan's economy will grow 20% this year, according to most estimates.

But unlike most of today's emerging oil powers, Baku has seen it all before. Its landscape is littered with the detritus of past oil crazes: Along with faded gems like Villa Nobel are forests of Soviet derricks still standing by the Caspian, rusting amid pools of black sludge.

And there is concern that, if the imminent wave of oil wealth is mismanaged, Azerbaijan's latest boom could end in yet another bust.

Azerbaijan isn't the only state in the region hitting the jackpot as big oil and gas projects come onstream. Across the Caspian Sea, Kazakhstan, too, is reaping the rewards of years of foreign investment in its energy sector. But Western governments warn that unless these states clean up their corrupt political systems, the oil bonanza could turn out to be more of a curse than a blessing.

"We have the chance to create a new Norway, a democracy based on the rule of law. Or we'll just end up like Nigeria," says Eldar Namazov, a former Azeri presidential aide now in the opposition, comparing two nations whose oil riches have led them down starkly different paths.

Azerbaijan says it is making sure the money won't be squandered. A state oil fund has been created, which diplomats call Azerbaijan's best-run institution. It is externally audited every year, under the Extractive Industries Transparency Initiative, a British government program Azerbaijan signed up with in 2003.

But it still isn't clear what the country will do with the anticipated windfall. "The biggest issue is how much of this are they going to spend, and how sensibly are they going to spend it," says Basil Zavoico, the International Monetary Fund's representative in Baku. "That's where the gaps are."

Already, the government has alarmed economists by decreeing a massive 70% increase in next year's budget spending that could spur inflation.

The worries are compounded by Azerbaijan's reputation for corruption. It has been ruled for more than a decade by the same family -- first Heydar Aliyev, a former Soviet-era KGB boss, and by his son Ilham since 2003.

The economy is dominated by murky state monopolies run by the president's cronies. Transparency International ranks Azerbaijan 137th out of 158 countries in its Corruption Perceptions Index. Any big boosts in government spending, it is feared, will benefit only Mr. Aliyev's friends.

Hopes of greater public scrutiny of how the money is spent were pinned on parliamentary elections this month. But those hopes were dashed: Mr. Aliyev's YAP, or New Azerbaijan Party, won a comfortable victory, which according to Western observers was helped by massive vote-rigging.

"This parliament will not be able to control the oil revenues," says Ali Kerimli, a leader of the opposition Azadlik, or Freedom, bloc, which won only a handful of seats. "The president will decide everything."

The village of Nardaran, about 30 miles from Baku, shows how Azerbaijan's growing prosperity is failing to trickle down to the poor. A world away from Baku's luxury apartments, it is a grim place whose inhabitants seek solace in Islam. Koranic verses decorate the walls. Women in black chadors shuffle past a massive Shiite shrine.

Nardaran's farmers used to grow carnations and cucumbers and sell them to Russia. But oil revenue has strengthened the Azeri currency, making local industry and agriculture less competitive with imports. Nardaran's farmers now struggle to compete with imported food. Power cuts have forced many to shut down their greenhouses.

"My standard of living just keeps falling," says Eldar, a farmer who would give only his first name. "But no one in the government cares how I live."

Villa Nobel, despite its make-over, offers a cautionary tale for Baku's new boosters. The house dates back to the city's heyday in the late 19th century, when it produced half the world's crude.

The villa housed the expatriate staff of the Nobel family -- best known for the prestigious prize that bears their name -- who at that time controlled a big chunk of the Russian oil industry.

But from early on, the Nobels' interests were threatened by revolution. Radicals, including Josef Stalin, agitated oil workers and organized general strikes.

In 1905, Stalin-inspired rioters burned down hundreds of oil wells, and production never recovered. By 1914, the share of Russian oil in the global market dropped to 9%. Baku's oil boom was over.

Then in 1920, the Bolsheviks, who had taken control of Russia three years earlier, nationalized Azerbaijan's oil industry. The Nobel family fled and their villa was confiscated. For decades it was an orphanage, and since 1985 has stood empty. Mr. Guliyev boarded it up, and in time the roof collapsed.

Baku, too, languished. The Soviets lacked the expertise to exploit its massive offshore fields, and investment was funneled to easier projects in western Siberia.

Hope returned only in the mid-1990s, when a consortium of Western oil majors signed a deal widely hailed as the "contract of the century" with newly independent Azerbaijan to develop its oil riches.

Yet the country's poor don't expect the boom to improve their fortunes. "Ilham and his people will just put all the money in their pockets," says Ali Ismailov, an unemployed worker. "There'll be nothing left for us."

• 107 Energy