State Oil Fund of Azerbaijan beefing up reserves Review by Caliber.Az

Stable returns from oil and gas exports, a still-existing trade surplus, and a sufficiently high level of balance of payments led to a boost of the country's "financial cushion" to more than $62.570 billion. In particular, the State Oil Fund of Azerbaijan (SOFAZ) has provided a 9% growth of international reserves in the first quarter of this year. 

SOFAZ is now pursuing quite a flexible policy in investing its assets, increasing its share in the North American region, including in the US government bonds. At the same time, the recent OPEC+ decision to reduce oil production by 1.7 million bpd (barrel per day) promises to improve the external environment by mid-2023, which will allow a high level of reserves to be maintained at year-end.

The past year has been marked by unprecedented tension in Eurasia's geopolitical and economic space since World War II due to the Russia-Ukraine conflict and subsequent anti-Russian sanctions. The European Union practically refused to buy Russian "blue" fuel, and the situation was similar with regard to oil supplies.

Nevertheless, it took quite a long period to diversify the supply of oil and LNG to Europe on a large scale from the US, Africa and the Persian Gulf. At the height of the crisis, the prices for natural gas in the European market were over $4,000 per 1,000 cubic meters/m and the price per barrel of Brent oil was over $120 - the last time such prices were recorded a little under a decade ago.

It is quite obvious that Azerbaijan, along with other extractive countries, has become a beneficiary of the fuel and raw materials crisis in the Old World. For example, long-term agreements have been signed with Southern European countries, as well as a Strategic Energy Partnership Memorandum with the European Union, which envisages a doubling of Azerbaijani natural gas exports to more than 20 bcm by the end of 2027.

And in the short term, the State Oil Company of Azerbaijan (SOCAR) has benefited from a sharp rise in the supply of gas, as well as oil, despite some reduction in liquid hydrocarbon production over the past year.

In particular, Azerbaijan increased gas exports in 2022 by 18% - to 22.3 bcm, and deliveries to Europe amounted to 11.4 bcm, an increase of 39%. In general, oil and gas exports amounted to $37.9 billion with a two-fold increase: oil exports amounted to $20.8 billion and gas exports to $16.4 billion.

The growth of oil and gas revenues was the main factor that ensured a current account surplus in Azerbaijan in 2022, which reached a record $23.478 billion or 23.5% of GDP. This positive move made it possible not only to ensure full fiscal revenues to the budget but also to significantly increase allocations to the country's reserve funds, first of all by increasing the assets of the State Oil Fund.

It should be noted that the fund established in December 1999 accumulates revenues from oil contracts, including the sale of the state's share of profitable oil and gas, transit tariffs for transportation of hydrocarbons through the country, leasing of state property, etc. In particular, last year SOFAZ revenue from sales of profitable oil and gas from block Azeri-Chirag-Guneshli (ACG) and gas condensate field Shah Deniz amounted to $11.332 billion, which rose by 65.4% compared to 2021.

Notably, since late last year the energy market saw a downward tendency due to a decline in industrial production in the European Union, and reduced energy consumption in emerging markets, in particular in the industrial regions of Asia, all of which were accompanied by high price volatility. This negative trend continued into 2023, with numerous forecasts of an expected severe recession and a downturn in the EU and US economies also weighing on oil futures prices and driving down gas prices.

Nevertheless, even despite downward trends in the global energy market, Azerbaijan's revenues from oil and gas agreements and other sources enabled to increase SOFAZ's income in the first quarter of this year: in particular, as of April 1, 2023, total assets of the State Oil Fund exceeded $53.437 billion, an increase of 9%.

Overall, the country's strategic foreign exchange reserves hit $62.570 billion at the beginning of April, of which the SOFAZ accounted for 85.4%, the rest being formed from the CBA reserves and treasury funds of the Ministry of Finance.

Nevertheless, the international expert community is upbeat about an early stabilisation of the oil and gas market, which is largely supported by the decision taken in early April by Saudi Arabia, Russia and nine other producing countries of the oil cartel and OPEC+ participating states to voluntarily reduce oil production by 1.7 million bpd in a coordinated manner.

According to the International Energy Agency (IEA), the pressure on the global energy market will also be exerted by the expected reduction of Russian oil production by about 1.4 million bpd in 2023.

An additional driver boosting demand in the global market will be the lifting of COVID-19 quarantine restrictions in China - the Middle Kingdom's economy will start to catch up with losses and demand for crude on the Chinese market is expected to reach 1.6 million bpd by the end of this year.

Bloomberg agency experts also assume that as a result of OPEC+ countries' production reduction and anti-Russian sanctions oil prices will increase since the second half of the year and Brent may approach $100 per barrel in the foreseeable future.

Meanwhile, analysts at US investment bank Goldman Sachs reviewed their earlier estimates, raising their forecasts for Brent from $90 to $95 for December 2023 and from $95 to $100 per barrel for December 2024. And some market specialists started talking about three-digit numbers, in particular, Rystad Energy said the cost of Brent may rise to $110 per barrel this summer.

Taking into account the expected trends the price of Azeri light oil will rise consistently, and allocations to state reserve funds will increase proportionally. Moreover, this year SOFAZ will be able to increase revenues from crude exports, taking into account the fact that the cut-off price is lower than in 2022: the forecast oil price in the Fund's budget for 2023 is taken at $50 per barrel.

It should also be borne in mind that in addition to revenues from oil and gas contracts and the sale of raw materials, a certain part of the State Oil Fund's income is generated through the management of the Fund's assets and funds, and in January-March 2023 these revenues exceeded 2.047 billion.

Here it should be noted that at the beginning of this year, bonds and monetary instruments were the main type of assets in the structure of the Fund's investment portfolio - 63%. Then follow shares - 18.7%, real estate - 6.3%, and also gold investments (101.8 tons) - about 12% of the portfolio's share.

As always, the State Oil Fund pursues a very prudent and balanced investment policy, and according to the credit rating, almost 70% of the bond and monetary instruments portfolio is invested in the most reliable instruments with a AAA rating. With regard to equity investments, the Fund has diversified its portfolio as much as possible in order to minimise risk, with investments covering over 1600 companies in 23 developed countries in 14 currencies.

At the same time, in the first quarter of this year, SOFAZ has slightly changed the structure of its investment portfolio by continent. According to the Fund, due to the observed 9% increase in total assets, the share of investments in the African continent decreased, and by early April it amounted to 0.04% of the total portfolio. For the same reason, the percentage of investments in the European and Asian continents and in assets of international organisations fell as well.

In contrast, the main investment growth in January-March this year was in the North American region, with investments in such assets increasing by 2.4%. This increase was driven by the fact that the bulk of income from profitable oil and gas sales was directed towards debt and equity sub-portfolios, with 60% of the share invested in equity sub-portfolios, according to the distribution of the index, falling on North America. In addition, this trend has been aided by the investment of part of the profitable oil and gas proceeds in US government bonds.

In turn, the increase is also due to higher prices due to changes in financial markets, which affects the value of the financial assets included in the portfolio - their share in the portfolio may change even without direct investment or sale of these assets.