annual report 2005 State Oil Fund of the Republic of Azerbaijan

Transcription

1 State Oil Fund of the Republic of Azerbaijan

2 Table of Contents State Oil Fund of the Republic of Azer bai jan INTRODUCTION 3 OIL FUND S FINANCIAL ACTIVITIES IN 7 Cash flow 8 Oil Contract Revenues 9 Income of the State Oil Fund from Asset Management in 15 Oil Fund s expenditures in 23 State Oil Fund s administration expenses in 29 OIL FUND S BUDGET EXECUTION 31 OIL FUND S MANAGEMENT SYSTEM 37 IMPROVEMENT OF THE STATE OIL FUND S INSTITUTIONAL STRUCTURE 39 OIL FUND S INTERNATIONAL RELATIONS 41 HUMAN RESOURCE DEVELOPMENT 45 REPORTING SYSTEM 47 AUDIT REPORT ON THE STATE OIL FUND S FINANCIAL STATEMENTS 49 Report of independent auditors 50 Financial statements 51 Notes to the financial statements 55 Introduction

3 4 5 The economic policy pursued during under the direction of the President of the Republic of Azerbaijan Mr. Ilham Aliyev was distinguished by great accomplishments. The economic and social programs implemented during the reported year resulted in creation of opportunities for revitalization of domestic production in the country, creation of thousands of jobs across the economic sectors and improvement of the financial and social welfare of the public. Indicators showed impressive performance across virtually the whole spectrum of the economy in. Azerbaijan became the world s leading country in terms of growth in Gross Domestic Product, a key macroeconomic indicator. It is hardly surprising, therefore, that the Republic of is recognized as the most dynamically developing country among transition economies in numerous reports published by international financial institutions; indeed, the report of the UN Trade and Development Conference claimed Azerbaijan as the of the most attractive countries of the world to investment in. In GDP reached AZN11.87 billion - a year on year growth of 26.4%. Personal income increased by 27% and reached AZN7.79 billion. The year of was also notable from the point of view of macroeconomic development. Azerbaijan was creating growth in the environment of limited public investments and low inflation. The country has to catch up because of the underinvestment in the public infrastructure in the previous year. However, greater possibilities for public financing arose from successful implementation of the National Oil Strategy, resulting in broader opportunities for the effective tackling of country-wide, socio-economic problems as well as rehabilitating and reconstructing both technical and social infrastructure. Furthermore, the country s economy moved into a new stage of development marked by a dynamic macroeconomic environment. Implementation of numerous investment and socially-oriented programs resulted in increased public expenditure that in turn led to expansion of money supply and generated related macroeconomic pressures, including inflationary trends and a strengthening of the national currency. However, the government instigated a range of effective measures to control the new macroeconomic environment and developed the financial market s ability to counter the challenges posed by both increased money supply and the threat of rising inflation. During, the issuance of government securities improved in terms of both volume and yield helping banking and insurance institutions to further develop their operations. The State Oil Fund has, year on year, expanded its support to promoting the country s economic development, tackling significant socio-economic problems, as well as financing strategically important state programs and projects; the Oil Fund s has also been enhancing its role in respect of sterilizing the foreign currency flows resulting increasing oil revenues. The Fund made a significant contribution towards domestic investment in the country s economy during. Pursuant to Presidential Decrees and under the Fund s approved budget, in the reporting year the State Oil Fund disbursed AZM201.9 billion (AZN40.4 million) in line with the arrangements for improvement of social and housing conditions of refugees and internally displaced persons, and AZM205.0 million (AZN41.0 million) to finance Azerbaijan s share in the Heydar Aliyev Baku-Tbilisi- Ceyhan (BTC) Main Export Pipeline project, as per related Presidential Decrees and within the Fund s approved budget. Furthermore, the Fund transferred AZM750.0 billion (AZN150.0 million) to the state budget in accordance with the Fund s budget. Total amount of fund allocated by the Oil Fund during the reporting year for the above mentioned purposes totaled AZM1,156.9 billion (AZN231.4 million). In addition, a total of AZM17.4 billion (AZN3.5 million) was transferred to the state budget in the form of profit tax and other taxes during. will also be remembered as the year when the first reports under the Extractive Industries Transparency Initiative (EITI) were published in Azerbaijan. The EITI Commission, established by the Cabinet of Ministers Resolution of November 13, 2003 and chaired by the State Oil Fund s Executive Director, submitted reports on the Government s revenues resulting from activities of Extractive Industries and opinion of international auditors on these reports. The reports covered year 2003 and the first quarter of 2004 and thereafter the whole year of Those reports declared the total revenues of the Extractive Industries and were first such reports published by any government under the Transparency Initiative. They demonstrated Azerbaijan s total fulfillment of its Initiative-related obligations. Azerbaijan s accomplishments in this field have caught worldwide attention and became an example for other countries to follow. Consistently high prices for crude oil can be regarded as a main long-term economic event that affected the world economy in. The high oil price is explained, on the one hand, by greater demand for hydrocarbon fuels due to the global growth rate of the world economy, and, on the other hand, by a substantial reduction in strategic domestic oil reserves in a number of major oil consuming countries. The high rate of economic development in Asian countries, especially China, as well as the actions taken to establish public emergency reserves of fuel in China, India, South Korea and Taiwan, led to the growth in energy consumption in this region and, hence provided an impetus to increasing oil prices worldwide. Increased prices for energy resources as well as the political, economical and even natural events taking place in the USA, the world s leading economy, had a direct impact on the international financial markets. As military and peacemaking efforts continued, especially in Iraq and Afghanistan, defense expenditure by the USA increased, as did other expenditures such as those associated with the aftermath of the devastating storm that struck the Mexican Gulf. This increase in expenditure further widened the country s budget deficit and this posed the risk of higher inflation creating tension across the global economy and especially in the world s financial markets. High energy prices also reduced growth rates in Euro zone as well. Introduction

4 State Oil Fund of the Republic of Azer bai jan was difficult year for investing in fixed income. Federal Reserve of US was continuing tightening policy at each meeting of FOMC. ECB increased its target rate once. Increase in yields both in US and Eurozone had adverse effect on fixed income portfolios in terms of capital losses. At the same time during there was a considerable appreciation of US dollar against other currencies, namely Euro and British pound. State Oil Fund s Investment Policy approved by Presidential Decree mandated diversification of Fund s assets into Euros and British pounds; the environment of appreciating US dollar caused decrease of nominal value of the portfolio expressed in US dollars. In addition The State Oil Fund pursued very conservative position and those facts combined resulted in low returns from asset management activities. Oil Fund s Financial Activities in

5 8 9 Cash Flow As of January 1, the State Oil Fund accumulated AZM4.73 trillion (945.2 million AZN or USD964.0 million) worth of assets. Year revenues of the Fund generated from implementation of oil contracts and management of financial assets totaled AZM3.3 trillion (AZN660 million). Year expenditures were AZM1.6 trillion (AZN million). As of 31 December the Fund s total assets reached AZM6.4* trillion (AZN1.28 billion) an equivalent of USD1.39 billion. Table 1 presents the breakdown of the Oil Fund s cash flow during the reporting year. During the reporting year the Oil Fund s primary source of income was the revenues from the implementation of the Production Sharing Agreements signed by Republic of Azerbaijan with the foreign investors. Oil Contract Revenues The State Oil Fund s revenues from oil contracts during the reported year included the proceeds from the sale of the Republic of Azerbaijan s share of crude oil (profit oil), bonus payments, acreage fees, revenues from traffic of oil through Azerbaijan (transit fees) and proceeds from sales of assets delivered by investors to Azerbaijani party. Chart 1 below describes the structure of the oil and gas contract revenues. Chart 1 Oil Fund s Revenues in from Oil Contracts 95.4% Sales of profit oil Transit fee Oil Fund s Financial Activities in Table 1 Oil Fund s cash flow spreadsheet Revenues ASSETS ACCUMULATED as of January 1, Amount AZM trillion AZN million USD million % 0.2% 1.4% 0.3% Bonus payments Acreage fees Revenues from sale of assets handed over by investors (Asset sales) TOTAL REVENUES: including: Oil contract revenues Fund s asset management revenues Transfers from the Ministry of Finance TOTAL EXPENDITURES: As Chart 1 above shows, revenues from sale of profit oil accounted for 95.4% of the total oil contract revenues, bonus payments 0.2%, acreage fees 1.4%, revenues from transit over Azerbaijan s territory (transit fees) 2.8% and sales of assets handed over by the investors to the Fund 0.3%. including: Financial asset revaluation expenses Balance of the Fund s assets as of December 31, , ,394.3 Proceeds from sales of profit oil. In, proceeds from sale of the Republic of Azerbaijan s share of profit oil under the oil contracts entered into with foreign oil companies constituted the principal source of inflow to the Oil Fund and were a major portion of the Fund s total revenues. A total of AZM2.7 trillion (AZN542.6 million) or USD579.9 million of revenues were gained during the reporting year from sale of the State Oil Fund s share of profit oil. These revenues constituted 82.2% of the Oil Fund s total revenues in the reporting year. * The discrepancy between assets as per auditors report (Ernst&Young) and SOFAZ numbers is due to the difference between the calculation methodology prescribed by the international standards and Fund s calculations. Auditors made several adjustments to the accounts balance. Thus fixed and intangible assets were increased (AzM 11 bln), adjustments to reflect transits fees due in and paid in 2006 (AzM 6.4bln) as well as adjustments to reflect prepayments and adjustments to other current assets were made (AzM 3.4bln). Approximately 1.2 million barrels of profit oil out of Republic of Azerbaijan s share were used to fill the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline in. The process of filling the pipeline with crude oil began following the commissioning of the Azeri section of the Main Export Pipeline. The ceremony was attended by the presidents of Azerbaijan, Georgia and Turkey on May 25,.

6 10 11 Presidential Decree of July 30, 2002 On financing the share of the State Oil Company of Azerbaijan Republic in the Baku-Tbilisi-Ceyhan Main Export Pipeline Project regulates assumptions and fulfillment of obligations of Azerbaijan Republic in connection with the project as well as provision of counter-guarantees for funds borrowed from foreign financial institutions, and allocation of crude oil in accordance with Azerbaijan share of profit oil. The price of crude oil ranged between USD50-60 per barrel throughout resulted in Fund s inflows being higher than budgeted for the year. Number of factors contributed to the crude oil elevated price levels. The high rate of development in Asian countries, particularly in China, and the associated increase in demand of hydrocarbon fuels is considered one of the reasons. In addition China, India, South Korea and Taiwan established public emergency fuel deposits thus boosting demand even higher. Another reason is that the number of oil exporting countries decreases year by year. China exported oil 10 years ago. Now she is the second biggest oil importer in the world. Indonesia, an OPEC member, turned from an exporter into an importer in. Despite some short-term downward movements the average annual oil price remained high. While the average price of one barrel of oil was USD45.87 early during the year, this figure rose to USD54.85 in June, and was USD58.87 in December. Over, the average price of Brent oil was USD54.1 per barrel. Chart 3 Monthly revenues of SOFAZ from sale of profit oil in (USD and barrels) brl February brl March brl April brl May brl June brl july brl August brl September brl November brl December Oil Fund s Financial Activities in In year, the average annual price of profit oil consignments sold by the State Oil Company of Azerbaijan Republic (SOCAR) was approximately USD51.6 per barrel. As a result of high oil prices, as well as increased production, the Oil Fund gained more revenues from sale of profit oil in than in the previous years. The year on year comparison of the Oil Fund s revenues from sale of profit oil throughout shows the annual upward trend of this source of the Fund s income. Chart 4 describes the annualized dynamics of the revenues generated by this source. Chart 2 Comparative dynamics of world market Brent oil price and sale prices of profit oil consignments sold by SOCAR in Chart 4 Revenues from sale of profit oil in áàõõæï/usd USD million Average monthly Brent oil prices at world markets in Sale price of profit oil consignments sold by SOCAR in SOCAR deducted oil transportation, banking, customs clearance, independent surveyor, marketing and insurance costs from the proceeds from sale of profit oil transferred to the Oil Fund.

7 12 13 Bonus payment revenues. Another source of the State Oil Fund s revenues during the reporting year was bonus payments made by foreign investors to the State Oil Company of Azerbaijan Republic or other relevant authorities in association with signature or implementation of oil and gas contracts. In, bonus payments received by the Oil Fund totaled AZM4.6 billion (AZN0.9 million) or USD1.0 million. Bonus payment revenues constituted 0.1% of the Oil Fund s total income. Table 2 below presents sources of bonus payments. Table 2 Revenues of State Oil Fund from bonus payments Transferor Date Amount AZM billion AZN million USD million AZEN Oil Chart 5 SOFAZ s acreage fee revenues in 69% Transit fees. 10% 15% 6% Lukoil BP Exploration Exxon Mobil Exxon Mobil Oil Fund s Financial Activities in Bonus payments presented in Table 2 were paid to the State Oil Fund by a single company - AZEN Oil. Another significant source of the Oil Fund s oil contract revenues was the proceeds from transportation of oil and gas through the Republic of Azerbaijan (transit fees). The Oil Fund s total revenues from this source amounted to AZM78 billion (AZN15.6 million) or about USD16.5 million. Transit fees accounted for 2.4% of the Oil Fund s total revenues. Acreage fee revenues. Chart 6 presents the monthly flow pattern of the State Oil Fund transit fee revenues in. Another source of the Oil Fund s revenues in was the acreage fees paid by foreign investors for use of contract areas in connection with the development of hydrocarbon resources. Acreage fees received by the Oil Fund in totaled AZM40.8 billion (AZN8.2 million) or approximately USD8.8 million. These revenues accounted for 1.2% of the Oil Fund s total income. Table 3 presents the acreage fee revenues of the Oil Fund during the reporting year. Chart 6 State Oil Fund s transit fee revenues in December November 1, ,335.3 Table 3 Revenues of State Oil Fund from acreage fees payments Amount Transferor Oilfield Date AZM billion AZN million USD million Exxon Mobil Zafar-Mashal 05/ Exxon Mobil Nakhchivan 11/ ÏØKoil Å / BP Exploration Inam 12/ Total Revenues in USD thousands October September August July June May April March February January January 1, , , , , , , , , ,257.6** 1,291.1* A major portion of the acreage fees was paid by Lukoil (69%); 25% by Exxon Azerbaijan and 10% by BP Exploration. Chart 5 presents the percentage-based structure of the acreage fees * and **: USD1.26 million indicated in the chart was paid for November 2004 and USD1.3 million for December 2004, however, they were actually received by the Oil Fund in January.

8 14 15 Revenues from the disposal of assets delivered by foreign investors under oil and gas contracts. Pursuant to the legal and regulatory framework governing the State Oil Fund s operations, another source of the Fund s revenues is the proceeds from assets delivered by investors to the State Oil Company of Azerbaijan Republic or the relevant government authority under the oil and gas contracts. Under trilateral agreements entered into between the State Oil Company, State Oil Fund and foreign oil companies operating under Production Sharing Agreements (PSA s), assets used under such agreements are to be delivered and handed over to the State Oil Fund. A trilateral agreement signed among the State Oil Company, State Oil Fund and Azerbaijan International Operating Company on December 24, 2002 governs all issues related to asset delivery and handover under the Azeri-Chirag-Guneshly Production Sharing Agreement. The agreement also defines asset delivery mechanisms and appropriate documentation requirements. The State Oil Company, State Oil Fund and Chevron Overseas Exploration Limited signed trilateral agreements on May 15 and October 27, 2004 to govern exploration, development of the Absheron offshore block in Azerbaijan s sector of the Caspian sea and delivery of assets by the Azeri party as per Article 14.1 of the PSA, and to identify the procedures, mechanisms and appropriate formalization rules for asset delivery. A portion of assets held by that foreign company was accepted under the agreement. Negotiations were continued between Chevron Overseas Exploration Limited and State Oil Fund in order to accept the remaining assets and resulted in signing of a trilateral agreement between the State Oil Company, State Oil Fund and Chevron Overseas Exploration Limited on June 30,. During the reporting year, negotiations were conducted with Exxon Azerbaijan Limited regarding exploration, development of the Nakhchivan prospective structure as well Zafar and Mashal prospective structures in Azerbaijan s sector of the Caspian sea and asset delivery and handover under Article 9.3 of PSA and as a result an appropriate trilateral agreement BALL-1388 was signed between the State Oil Company, State Oil Fund and Exxon Azerbaijan Limited on September 19, and the Oil Fund accepted the assets subsequently delivered. Negotiations were conducted in with Total E&P Azerbaijan and Devon Energy Caspian Corporation regarding asset delivery and handover, and continued into Arrangements were made to sell the assets received from the foreign oil companies in the reporting year under PSA s, and the Fund s revenues from this source totaled to AZM7.6 billion (AZN1.5 million) or 0.2% of the Fund s total revenues. between the sale price of oil exported before June 1, and the price stipulated for use in budgetary estimations. This amount was 9.6% of the Fund s total revenues. Income of the State Oil Fund from Asset Management in Income produced by asset management activity is considered another significant source of the State Oil Fund s total revenues. Pursuant to the State Oil Fund s legal framework, these revenues include revenues from the Oil Fund s asset management, including interest income, dividends, capital and foreign exchange gains/losses, and other income. The Fund s revenues from this source totaled AZM139.6 billion (AZN27.9 million) in the reporting year. These revenues amounted to 4.2% of the Oil Fund s total revenues. Table 4 Oil Fund s asset management revenues in Sources of revenue AZM billion Amount AZN million Interest income and dividends Total Effectiveness of investment of the Oil Fund s financial assets depends on the situation in global financial markets and economic conditions. Increased energy resource prices in as well as the political, economical and even natural events taking place in the USA, the world s leading economy, had a direct impact on the international financial markets. The military and peacemaking efforts continued in Iraq and Afghanistan, as well as the increased defense and other expenditures of the USA in line with the removal of consequences of the devastating storm that impacted the Mexican Gulf led to further expansion of the country s budget deficit and thus posed the risk of higher inflation and the economic situation caused the tensions grow in the world economy, especially financial markets. The continued growth of energy resource prices also caused tensions to grow in the economy of the European zone as well as the financial markets of these countries. In, the risk of inflation grew further in the USA, forcing the Federal Reserve Bank to increase interest rates to 4.25% by the end of the year as part of its policy to restrain inflationary pressure. In addition, affected by the US Federal Reserve Bank s policy of increasing target interest rates, the US dollar appreciated against the Euro and other leading currencies. In the second half of the Euro zone displayed signs of economic recovery with associated risk of higher inflation. As a result, in December the European Central Bank, for the first time in the past five years, increased its discount rate to 2.25%. Oil Fund s Financial Activities in Other revenues of State Oil Fund. Another revenue of the Oil Fund in the reporting year was the amount of AZM316.4 billion (AZN63.3 million) transferred to the State Oil Fund from the State Treasury. The Law passed by the Parliament of the Republic of Azerbaijan on June 21, on amendments and revisions to the Law of the Republic of Azerbaijan On state budget provided for the transfer to the State Oil Fund of the amount received by the state budget, and held in a special treasury account, originating from the difference

9 16 17 Chart 7 presents the change pattern of US Federal Reserve Bank and European Central Bank rates in. Chart 7 Change pattern of US Federal Reserve (Fed Funds) and European Central Banks target rates in % 3 months USD LIBOR 3.58% SOFAZ s annual rate of return of USD portfolio 2.79% USD inflation rate 2.02% 2.5% 2.75% 3.00% 3.25% % 3.75% 4.00% 4.25% 2.25 December 21, 2001 and # 202 dated March 1,. At the same time, the Fund s investment policy related to asset management followed the Investment Program for The approved by the Presidential Resolution # 652 dated March 1,. This program sets the return benchmark on the Oil Fund s assets to be 3 month LIBOR in the respective currency. Bank deposits, money market (liquidity) funds, securities, including bonds were the primary investment instruments used by Oil Fund. At the same time, the Fund continued to engage two external managers, Clariden (Switzerland) of Credit Swiss Group, and Deutsche Asset Management GmbH (Germany) of the Deutsche Bank Group to manage a portion of its assets. Scheme 1 indicates the Oil Fund s investment structure. Sƒheme1 Oil Fund s investments Oil Fund s Financial Activities in months EURO LIBOR 2.22% SOFAZ s annul rate of return of Euro portfolio 2.20% Euro inflation rate 1.30% liquid assets Securities External managers Bank deposits Money market funds Sovereign debt securities Agencies Clariden Deutsche AsM European Central Bank s target rate US Federal Reserve Bank s target rate Clearing accounts Bank and financial bonds Equities All this factors caused the returns from management of the Fund s assets in to be low. Thus, during the year, the State Oil Fund retained a very conservative position due to US Dollar and Euro-denominated price declines of securities as a result of the countereffect of the target rate increases by the US Federal Reserve Bank. On the other hand, investment of the Fund s investment assets in three major currencies (US Dollar, Euro and British Pound) diversified as per the State Oil Fund s Investment Policy (that is up to 40% of funds transformed into non-dollar assets) approved by the Presidential Decree, as well as the continued decline of Euro and British Pound against the US Dollar during the year; the Fund s proceeds from management of US Dollar-denominated assets were low. In parallel, as the Oil Fund switched to International Accounting Standards in, financial assets in the Fund s portfolio were valued based on their fair market value rather than their historic cost. As a result Fund recorded capital losses which further depressed earnings. During the year local currency, Manat significantly strengthening against the US Dollar (by 6.3%) which negatively affected results reported in local currency. The return in the Fund s reporting currency (Azeri manat) was negative 5.69%, with 2.68% on the currency basket in. The investment portfolio of the Oil Fund was managed in accordance with the Asset Management Guidelines for the approved by the Presidential Decree as of June 19, 2001 as amended by Decree #607 dated A major portion (74.6%) of the Oil Fund s assets in year had up to 1 year maturity. The maturity profile of the Fund s remaining financial assets was as follows: 1 to 3 years maturity 13.1%; 3 to 5 years 8.8%; 5 to 7 years 0.52%; 7 to 10 years 3% (Table 5). Table 5 Maturities of the Oil Fund s financial assets (as of ) Maturity Investment amount (USD million) (years) SOFAZ Clariden Deutsche AsM % % % % 4 0.3% % % % % % % % 3 0.2% % Total % % % Grand Total 1 394

10 18 19 As of December 31,, USD836.1 million, or 59.9% of the Oil Fund s assets, were liquid, including USD522.3 million, or 37.4%, in bank deposits, USD296.5 million, or 21.3%, in money market funds, and USD17.3 million, or 1.2%, in clearing accounts. USD558.2 million, or 40.1% of the Fund s assets were invested in securities, including USD553.9 million, or 39.8%, in sovereign debt securities, agency securities, bank and financial bonds, and USD4.2 million, or 0.3%, were invested in equities. Table 6 presents the structure of the Oil Fund s investment portfolio by asset class. Table 6 Oil Fund s financial assets breakdown (as of ) USD million SOFAZ Clariden Deutsche AsM Securities: ,9% % % Sovereign debt securities % % Agency securities % % Breakdown of the securities portfolio by credit rating is presented in Chart 8. Chart 8 Breakdown of the securities portfolio by credit rating 10.5% 30.2% 38.5% 20.8% AAA AA A BBB Oil Fund s Financial Activities in Bank and financial securities % % % Equities % Cash: % % % Bank deposits % % Money market funds % % Clearing accounts % % % Total 1, % % % Grand Total As noted above, in a portion of the Fund s assets was allocated to two external managers - Clariden (Switzerland), a member of Credit Swiss group, and Deutsche Asset Management GmbH (Germany), a member of Deutsche Bank Group. As of December 31, total assets under external management were USD118.8 million, or 8.5% of the Fund s total assets. Assets managed by Clariden and Deutsche Asset Management GmbH comprised 3.2% and 5.3% of the Oil Fund s assets respectively. Chart 9 below presents the weight of assets managed by external managers as total assets of SOFAZ. Current asset management guidelines of the Fund allow investments only in investment grade securities and issuers. This rule also applies to investments made by the external asset managers of the Fund. Table 7 Breakdown of the investment assets of SOFAZ by credit rating (as of ) USD million Moody/S&P s ratings SOFAZ Clariden Åeutsche AsM AAA (Aaa) % % AA+, AA, AA- Aa1, Aa2, Aa3 A+, A, A- A1, A2, A3 BBB+, BBB, BBB- Baa1, Baa2, Baa % 2 0.4% % % % % % % Total % % % Grand Total 554 Chart 9 Percentage of assets managed by external managers within SOFAZ S total assets 91.5% 5.3% 3.2% Other assets Deutsche AsM Clariden

11 20 21 External managers accomplished different levels of return in. Dynamics of return of both external managers can be compared from Chart 10 and Chart 11. Chart 10 Actual rates of return provided by Deutsche AsM in (by months) 0.5% 0.4% 0.3% 0.2% 0.1% 3 months $ ÏIÁOÕ Chart 12 Actual annual rates of return of external managers in rate of return, % Clariden 4.24% Deutsche AsM 2.82% As the Chart shows, Clariden s actual annual rate of return was 4.24% and Deutsche AsM s was 2.82% in. Clariden s actual annualized return since inception was 2.94% and that of Deutsche AsM s was 2.40%. 3 months $ ÏÊÁOÕ 3.58% Oil Fund s Financial Activities in 0.0% During the reporting year, the annualized return of the SOFAZ currencies portfolio was 2.79% on US Dollar, 2.20% on Euro and 4.71% on British Pound. Chart 13 presents the annual rates of return of the currencies portfolios. Chart 11 Actual rates of return provided by Clariden in (by months) Chart 13 Annualized return of SOFAZ S currency portfolios in 5.0% 4.71% 4.88% 4.5% 0.9% 4.0% 3.5% 3.58% 0.7% 3.0% 2.79% 0.5% 0.3% 3 months $ ÏIÁOÕ 2.5% 2.0% 1.5% 1.0% 2.20% 2.22% 0.1% 0.5% -0.1% % $ PORTFOLIO BENCHMARK Æ Chart 12 shows the actual annual rates of return of external managers for the year in comparison with the benchmark. Chart 14 shows the rates of return of the currency portfolios in terms of real rates of return (inflation adjusted rate of return) in year.

12 22 23 Chart 14 The real rate of return on SOFAZ currency portfolio in year 5.0% 4.0% 3.0% 2,0% 1.0% 0.0% INFLATION 2.79% 0.77% 2.02% $ REAL RATE OF RETURN The annualized return of all SOFAZ s assets denominated in the base currency (US Dollar) during the years was 2.58%. 2.20% 0.90% 1.30% 4.71% 2.59% 2.12% Æ Oil Fund s expenditures in Pursuant to the Fund s budget approved by Presidential Decree No.201 of March 1,, the State Oil Fund continued to finance two major projects during the reporting year -improvement of social and housing conditions and settlement of refugees and internally displaced persons, and the financing of Azerbaijan s share in the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline Project. In addition, a part of the Fund s resources was transferred to the state budget. Chart 16 presents the structure of the State Oil Fund s budget expenditures in. Chart 16 State Oil Fund s budget expenditures in (AZM mil and AZN thousand) billlion AZM 750 million AZN 150 billlion AZM 7.8 million AZN 1.6 Transfer to the state budget Oil Fund s Financial Activities in The Investment Policy of the State Oil Fund for as approved by Resolution #202 of the President of the Republic of Azerbaijan dated March 1,, specified requirements for the currency basket of the Fund s portfolio for. In accordance with these requirements, in, 55% of the total amount of the investment portfolio of the Fund was to be invested in assets denominated in US Dollars, 35% in assets denominated in Euros, 5% in assets denominated in British Pounds, whereas 5% of the total amount of the investment portfolio of the Fund was to be invested in assets denominated either in currencies of countries with a long-term country ratings (sovereign debt) of not less than credit rating A (Standard & Poor s, Fitch) or A2 (Moody s), in US Dollars or in US Dollars, Euros and British Pounds based on their percentage in the weight. As at December 31,, 53.4% of the Fund s investment portfolio (less the expenditures portfolio) was denominated in US Dollars, 41% in Euros and 5.6% in British Pounds (Chart 15). Chart 15 Currency structure of the SOFAZ s investment portfolio (as of ) 53,4% 5,6% 41,0% $ Æ billlion AZM 202 million AZN 40.4 billlion AZM 205 million AZN 41 Fund s administration costs Financing of improvement of the social and economic conditions of refugees and internally displaced persons Financing of Azerbaijan Republic s share of the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline project Financing of the improvement of the social and economic conditions of refugees and internally displaced persons. As per its budget, the Oil Fund allocated AZM202 billion (AZN40.4 million) during the reporting year to finance improvements in the social and economic conditions of refugees and internally displaced persons. AZM8.3 billion (AZN1.7 million) of that amount was allocated to support under Presidential Decree No.562, dated on Addressing problems of settling Azerbaijanis displaced from their historic lands on the territory of Armenia as a result of the ethnic cleansing by the Armenian nationalists ; Presidential Decree No.577, dated , On measures to settle a portion of internally displaced persons from the regions of Agdam and Fizuli, forced out as a result of the occupation of Azerbaijan s lands by the Armenian armed forces and temporarily residing in tented camps, in the mentioned regions ; and Presidential Decree No. 700, dated on Measures aimed at improving the social and living conditions of internally displaced persons settled in five tented camps in Bilesuvar district. It should be noted that the State Oil Fund was to allocate AZM359 billion to support actions to implement the three aforementioned Decrees. About AZM343 billion

13 24 25 (AZN68 million) have been disbursed and spent as per the intentions of the said Decrees in In parallel, in AZM193 billion (AZN38.6 million) were allocated to finance measures stipulated by Directive No.80 of February 4, 2004 on Actions to improve the social, housing and economic conditions and employment of 3,860 internally displaced persons from Agdam and other regions forced from their native lands as a result of occupation by the Armenian armed forces, and temporarily residing in tented camps in Barda and Agdjabedi regions, as well as in cargo railway cars on railroads in Barda region, as well as to finance construction of 100 private houses for internally displaced persons families in Nakhchivan Autonomous Republic as per Presidential Decree No.132 of October 1, In addition, in the State Oil Fund allocated AZM633.7 million (AZN126.8 thousand) to finance design works for construction of new settlements for families consisting of 4,179 internally displaced persons in Bilesuvar, Fizuli, Agdam, Agjabedi under the State Program approved by Presidential Directive No.298 of July 1, 2004, for Improvement of Housing Conditions and Employment of Refugees and Internally Displaced Persons. Table 8 provides the structure of investments for the efforts stipulated under the above mentioned Decrees. Table 8 Breakdown of expenses of SOFAZ incurred for improvement of social and economic conditions of refugees and internally displaced persons Disbursed (AZM billion) Az per Az per Az per Az per Az per Az per Presidential Presidential Presidential Presidential Presidential Presidential Decree Decree Decree Directive Decree Directive No.562 No.577 No.700 No.80 No.132 No.298 of of of of of of Oil Fund s Financial Activities in Construction of residential * houses Construction of 4.10 infrastructure and cocial and cultural facilities Design/Project works * Views of the settlement built for internally displaced persons in Agdam district Implementing agencies office 1.40 management costs Total * These amounts include treasury service fees. Resources allocated for the above mentioned projects were transferred by the State Oil Fund to the state treasury accounts of the State Committee for Refugees and Internally Displaced Persons, as well as the Social Development Fund for Internally Displaced Persons based on their written, substantiated requests and subsequently disbursed to the contractors by the implementing agencies. The Social Development Fund for Internally Displaced Persons under the Cabinet of Ministers of the Republic of Azerbaijan is the executing agency for projects associated with resolution of settling

14 26 27 problems of internally displaced persons from the districts of Agdam and Fizuli. The executing agency functions for issues related to 3,860 internally displaced persons settled in Bilesuvar is the Agency for Rehabilitation and Reconstruction of Liberated Areas responsible for construction of settlements in Harami district of Fizuli region, and the Development Fund for Internally Displaced Persons is the executing agency bearing overall responsibility for construction of settlements in Bilesuvar. The Agency for Rehabilitation and Reconstruction of Liberated Areas is the executing agency for projects concerning settlement of Azerbaijanis displaced from the territory of Armenia. The executing agency for construction of unfinished housing under this project is the Directorate of Construction Enterprises under the State Committee for Refugees. The executing agency functions for the issues related to internally displaced persons settled in Bilesuvar is the Agency for Rehabilitation and Reconstruction of Liberated Areas responsible for construction of settlements in Harami district of Fizuli region, and the Development Fund for Internally Displaced Persons is the executing agency bearing the overall responsibility for construction of settlements in Bilesuva. These executing agencies are responsible for overall supervision of project implementation, carrying out bidding processes and other relevant proceedings, organization and coordination of works through site offices. Chart 17 categorizes the State Oil Fund s project financing costs in. Financing Azerbaijan s share in the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline Project A portion of the State Oil Fund s resources was directed in towards financing Azerbaijan s share in the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline Project in accordance with the State Oil Fund s budget as well as Presidential Decree No.739, dated July 30, 2002 on Financing the Share of the State Oil Company of Azerbaijan Republic in the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline Project. The State Oil Fund started financing the said project in October The State Oil Fund s expenses in this context in totaled AZM205 billion (AZN41million) or USD44.1 thousand. These costs amounted to 17.6% of the Fund s total budget expenditures. Chart 18 presents the yearly flow pattern of the Oil Fund s payments designated to finance Azerbaijan s share in the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline (BTC) project. Chart 18 Payments executed by the Oil Fund in to finance the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline Project Oil Fund s Financial Activities in Chart 17 Amounts allocated in to finance the projects of improving social and housing conditions of refugees and internally displaced persons (AZM and AZN mil) / / / / / / / / / / January February March April May June July August September October November December USD milion Oil Fund s expenses related to financing efforts designed to improve the social and economic conditions of refugees and internally displaced persons in amounted to 17.3% of the Fund s total budget expenditures. A total of USD229 million has been allocated by the State Oil Fund from 2002 to, under its approved budgets, to finance the Republic of Azerbaijan s share in the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline Project. That amount also includes financing of interest payments on bridging loans by the project s sponsor

15 28 29 group of companies extended to Azerbaijan BTC Ltd. to finance its equity contribution in the BTC project and proportionate financing of the administrative costs of Azerbaijan BTC Ltd. Construction works on the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline reached their concluding stage in. On May 25 of the Azeri section of the pipeline was put into operation, followed by the Georgian section on October 12. Public ceremony of commissioning the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline attended by the Presidents of Azerbaijan, Georgia and Turkey The funds were transferred to the Finance Ministry s account at the Central Treasury. These expenses amounted to 64.4% of the Fund s approved budgeted expenditures. Chart 19 presents the monthly breakdown of state budget transfers by the Oil Fund in. Chart 19 Allocations for transfers to the state budget of Azerbaijan Republic in (monthly) AZM billion Oil Fund s Financial Activities in March April July September October November December Commissioning of the Azeri part of the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline (pipeline opening ceremony, May 25,, Baku, Sangachal terminal) Transfers to the state budget of Azerbaijan Republic in. As in the previous years, transfers to the state budget constituted a significant portion of the State Oil Fund s budgeted expenditures in. Pursuant to Presidential Decree of March 1, on the Budget of the State Oil Fund of Azerbaijan Republic, and the Investment Guidelines for for the State Oil Fund of Azerbaijan Republic, approved by Presidential Decree No.652 of March 1,, on Certain Measures regarding execution of the State Oil Fund s budget, the State Oil Fund transferred a total of AZM750 billion (AZN150 million) to the state budget during the reporting year. The Oil Fund s transfers to the state budget during totaled AZM1.9 trillion (AZN380 million). AZM500 billion was transferred in 2003, AZM650 billion in 2004 and AZM750 billion in. State Oil Fund s administration expenses in Pursuant to the State Oil Fund s Regulations, the Oil Fund s budget for operating costs is subject to presentation by the Fund s Executive Director to the President of the Republic of Azerbaijan for approval. The Oil Fund s operating budget was approved by Presidential Decree No.652 of March 1,. In the Oil Fund s administration and operating expenditures were executed only to the extent of AZM7.8 billion (AZN1.6 million) or 49.4% of the Fund s approved budget (AZM15.9 billion), savings AZM8 billion(azn1.6 million). The breakdown of the Oil Fund s administrative costs was as follows: remuneration to personnel - AZM955.1 million (AZN191 thousand) (12.2%); payments to the State Social Protection Fund - AZM209.5 million (AZN41.9 thousand) (2.67%); acquisition of goods and services (stationery, business trips, transportation, commercial, external audit, security, communications, utilities, banking, conversion, external audit, etc.), combined - AZM million (AZN thousand) (80.0%); acquisition of fixed assets - AZM123.0

16 State Oil Fund of the Republic of Azer bai jan million (AZN24.6 thousand) (1.56%); acquisition of intangible assets - AZM277.3 million (AZN55.5 thousand) (3.54%). Asset management fees assessed by external managers were charged directly to the investment portfolio that they managed. In the two external asset managers charged a total of USD289.7 thousands in asset management fees. In addition, revaluation costs with respect to securities in the Fund s investment portfolio amounted to AZM442 billion (AZN88.4 million). Bulk of the Fund s financial assets is denominated in US Dollars, Euros and British Pounds and is reported in Azeri Manats. As the Manat exchange rate fluctuated, accounting gains and losses arise. In the periods when the Manat appreciated, the value of the Fund s portfolio expressed in Manats reduces and accounting losses are recognized. These accounting gains and losses, however, do not affect the international purchasing power of the Fund s assets. In the State Oil Fund paid AZM17.4 billion (AZN3.5 million) in profit tax and other taxes to the state budget. Oil Fund s Budget Execution

17 32 33 The State Oil Fund s annual budget was approved by Presidential Decree No.201 dated March 1,. Revenues. The Oil Fund s actual revenues in exceeded the budgeted amount (AZM1.1 trillion) by around 206%, and totaled AZM3.3 trillion (AZN660 million). The breakdown of the revenues by source is presented in Table 9. Revenues from sale of profit oil in exceeded the budgeted amount (AZM849.6 billion) by AZM1.9 trillion, or 219%. The excess revenues versus projections are mostly attributable to substantially higher actual oil prices compared with the budgeted price. The Fund s budget projected oil price was USD25 per barrel for, while, in reality, the average weighted net price was USD49.5 per barrel (less transportation and marketing costs). In addition, considering that the commissioning of the Baku- Tbilisi-Ceyhan Main Export Pipeline was scheduled for, the proceeds from sale of profit oil included in the Fund s budget were reduced to allow for the profit oil to be used for both filling the pipeline (2.5 million barrels) payment of guarantees for completion works (2 million barrels) - overall 4.5 million barrels. The Presidential Decree of July 30, 2002 On financing the share of the State Oil Company of Azerbaijan Republic in the Baku-Tbilisi-Ceyhan Main Export Pipeline Project identifies the procedures for performance of Azerbaijan Republic s obligations following commissioning of the pipeline, including filling the pipeline with crude oil, as well as providing counter-guarantees on loans granted by foreign financial institutions and granting of Azerbaijan s share of profit oil. Given the fact that complete commissioning of the pipeline was delayed into 2006 and that the filling of the pipeline with crude oil was not completed during the reporting year, the proceeds from sale of profit oil earmarked for this purpose (1.3 million barrels left from pipeline filling and 2 million barrels for completion guarantee) constituted unplanned additional revenues of the State Oil Fund. Table 9 The breakdown of revenues by source Revenue items Revenue amounts Budgeted Actual Execution AZM AZN AZM AZN percentage million thousand million thousand 1. Net flows from sales of Azerbaijan s share of hydrocarbon resources (less hydrocarbon transportation costs, banking, customs clearance, independent supervision (surveyor), 849, , ,713, , marketing and insurance costs, as well as revenues of the State Oil Company as investor, shareholder or countepart in relevant projects it participates) 2. Acreage fees paid by investors on a contractual basis to the State Oil Company or relevant government authority for development of hydrocarbon resources 43, , , , Revenues from transporting oil and gas in the territory of 73, , , , Azerbaijan Republic 4. Revenues from investment and management 110, , , , of the Fund s assets 5. Other income and revenues , , ,545.8 Oil Fund s Budget Execution Acreage fees paid by foreign investors for using contract areas for development of hydrocarbon resources reached 93.8% of the budgeted amount (AZM million) and totaled AZM40.8 billion (AZN8.2 million). Revenues from this source were lower than projections because the average annual exchange rate of the Azeri Manat against the US Dollar was set at AZM4925 in the budget, yet during the year the average annual exchange rate was approximately AZM4729 (AZN0.9458). Revenues from transporting oil and gas through the territory of the Republic of Azerbaijan exceeded the budgeted amount (AZM73.9 billion) by AZM4.3 billion, or 5.9%. The income of the Fund in produced by asset management exceeded the budgeted amount (AZM110.7 billion), by 26.1%, and totaled AZM139.6 billion (AZN27.9 million). 6. The revenues generated due to the difference between sales oil price and budgeted oil price. Those funds were kept at special 316, ,294.8 treasury accounts of the Ministry of Finance and were eventually transferred to State Oil Fund 7. Bonuses paid by investors to the State Oil Company or relevant government authority in 4, connection with signing or execution of oil and gas contracts Total 1,078, , ,300, ,

18 34 35 Furthermore, arrangements were made by the State Oil Fund to sell assets (old or unused metal scrap, pipes etc.) handed over by foreign oil companies under oil and gas contracts, and a total of AZM7.6 billion (AZN1.5 million) was gained from the sale of such assets (the budgeted amount was AZM492.5 million). These revenues were recorded as other income and revenues. Also during the year State Oil Fund received inflows which were not budgeted in budget of the Fund. Another revenue of the Fund in was the amount of AZM316.5 billion (AZN63.3 million) transferred to the State Oil Fund by the state treasury. The Law passed by the Parliament of Azerbaijan Republic on June 21, on amendments and revisions to the Law of Azerbaijan Republic On state budget provided for the transfer to the State Oil Fund of the amount received by the state budget, and accumulated in a special treasury account, originating from the difference between the actual sale price of oil exported before June 1, and the price allowed for in the budget. Another source of the State Oil Fund s income in the reporting year was AZM4.6 billion (AZN918.4 thousand) in bonuses paid by investors to the State Oil Company or relevant government authority arising from the signature or execution of the oil and gas contracts. Expenditures. Year expenses of State Oil Fund were 99.3% of the budgeted expenses (AzM1.172 billion budgeted versus AzM1.164 actual expenses). The breakdown of the Fund s budget is given in Table 10. Pursuant to appropriate Presidential Decrees, as well as the Fund s approved budget, the expenditures for financing efforts to improve the social and economic conditions and residential problems of refugees and internally displaced persons were virtually fully executed in accordance with the budgeted amount (AZM202 billion), and totaled AZM201.9 billion (AZN40.4 million). In, the Fund s budgeted expenses for transfer to the state budget (AZM750 billion) was also executed in full (100%). The Oil Fund s administrative costs in were AZM7.8 billion (AZN1.57 million) or 49.4% against the budgeted figure of AZM15.8 billion saving AZM8 billion (AZN1.6 million). Table 10 presents the levels of execution of the Fund s budgeted expenditures in. The Fund s extra budgetary expenses in the reporting year totaled AZM459.6 billion (AZN91.2 million). Table 10 Expense amounts Expense items Budgeted Actual Execution AZM AZN AZM AZN percentage million thousand million thousand 1. Expenses related to financing efforts to address the social and economic conditions and settlement problems of refugees and internally displaced persons Budget expenses 202, , , , Expenses related to financing Azerbaijan Republic s share in the Heydar Aliyev 205, , , , Baku-Tbilisi-Ceyhan Main Export Pipeline Project 3. Transfer to the state budget of Azerbaijan Republic 750, , , , Oil Fund s Budget Execution The Fund s budgeted expenses for financing Azerbaijan s share in the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline Project (AZM205 billion) were executed in full (100%). It should be noted that the Fund s expenses under this item were set at AZM105 billion as per the Oil Fund s budget approved by Presidential Decree No.201 of March 1,. During the reporting year Presidential Decree of December 28, made amendments to the State Oil Fund s budget, which took into consideration the increase in expenses associated with construction of the Heydar Aliyev Baku-Tbilisi- Ceyhan Main Export Pipeline and, in accordance with which, the Fund s budgeted expenses for financing the Baku-Tbilisi-Ceyhan Main Export Pipeline Project were raised from AZM105 billion to AZM205 billion. 4. State Oil Fund s administration / operating costs 15, , , , Total 1,172, , ,164, , Fund s financial asset revaluation costs Extra budgetary costs and payments 442, ,411.8 Profit tax and other taxes 17, ,490.2 Total extra budgetary expenses 459, ,902.0

19 State Oil Fund of the Republic of Azer bai jan In addition, revaluation costs with respect to the financial assets in the Fund s investment portfolio amounted to AZM442 billion (AZN88.4 million). The bulk of the Fund s financial assets were denominated in US Dollars, Euros and British pounds and reported in Azeri Manats. As the Manat exchange rate fluctuated, accounting gains and losses arose. In the periods when the Manat appreciated, the value of Fund s portfolio expressed in Manats reduces and accounting losses are recognized. These accounting gains and losses however do not affect the purchasing power of the Fund s investment portfolio. Also, the Fund paid AZM17.5 billion (AZN3.5 million) in profit tax and other taxes to the state budget. Oil Fund s Management System

20 State Oil Fund of the Republic of Azer bai jan The supervision of the Fund s activities is discharged by the Supervisory Board representing the government and general public. The Supervisory Board held several meetings in the reporting year. The Oil Fund s Supervisory Board meeting of January 5, reviewed the Fund s draft budget, provision of the currency structure of the Fund s investment portfolio and tax status-related issues. The Board meeting reviewed the Fund s draft budget, including the Fund s investment program (including the investment policy), and the annual expense budget for the Oil Fund s administration. It also accepted the draft budget and submitted it to the President of the Republic of Azerbaijan for approval. In addition, the Supervisory Board considered it appropriate to treat the Oil Fund s financial asset revaluation costs as extra budgetary costs and recommended introducing appropriate changes to the Fund s legal framework in this respect. The board members exchanged opinions regarding the currency makeup of the Oil Fund s investment portfolio that led to decisions being taken the portfolio s structure. The Board s next meeting, on November 19,, reviewed and approved the Fund s financial performance report and budget outturn report, taking into account the independent auditor s report (Ernst Young) for the Oil Fund s 2004 financial performance. Another decision was to approve the Fund s 2004 budget outturn report and to recommend submission of this report to the President of the Republic of Azerbaijan for approval. The meeting also considered the expected increase in the costs of construction of the Heydar Aliyev Baku-Tbilisi-Ceyhan Main Export Pipeline and the State Oil Fund s anticipated financing of Azerbaijan s share in the project, with the Board deciding to suggest increasing the State Oil Fund s budgetary expenses and making appropriate recommendations to the President regarding introduction of relevant changes to the Fund s budget in this context. The Board meeting also reviewed the Fund s 2006 draft budget, including the Fund s investment program (including the investment policy) and the annual expense budget for the Oil Fund s administration. It accepted the draft budget and submitted it to the President of Azerbaijan Republic for approval. Improvement of the State Oil Fund s institutional structure Close coordination and division of authority among the Fund s relevant departments was ensured and performance, discipline and internal controls were strengthened in the reported year. The Fund s budget outturn was executed as planned, in accordance with the Oil Fund s budget rules and procedures. During the reporting year departments within the State Oil Fund carried out their responsibilities in accordance with the applicable laws and regulations.

21 State Oil Fund of the Republic of Azer bai jan With the aim of improving the State Oil Fund s legal and regulatory framework in, a number of legal documents were revised and amended in accordance with Presidential Decree No.202 of March 1, On amendments and revisions to some legislative acts governing the State Oil Fund of Azerbaijan Republic. The Decree provided for revision and amendment of the following regulatory acts regulating the Fund s operations: Presidential Decree No.240 of December 29, 1999 On establishment of the State Oil Fund of Azerbaijan Republic ; Regulations of the State Oil Fund of Azerbaijan Republic approved by Presidential Decree No.434 of December 29, 2000; Asset Management Guidelines for the State Oil Fund of Azerbaijan Republic approved by Presidential Decree No.511 of June 19, 2001; Regulation for development and implementation of the annual income and expense program of the State Oil Fund of Azerbaijan Republic approved by Presidential Decree No.579 of September 12, Based on the changes to the documents listed above, the categorization of the Fund s revenue sources was expanded, and the Oil Fund s currency holding, investment and management procedures were improved (including definition of a special regulatory mechanism for regulating the weight of each currency within the Oil Fund s investment portfolio with an aim to promote the currency diversification policy of the Fund). Furthermore, the revisions eliminated the principle related to preventing an excess of annual budgeted expenses over revenues. Oil Fund s International Relations

22 42 43 The State Oil Fund s international relations were further promoted during and in this respect the year was distinguished by numerous meetings, business trips and presentations. The Fund constantly seeks to promote and expand its partnership relations with different international financial and banking institutions in the context of managing the Oil Fund s foreign exchange assets, and building contacts and controlling business relations with such institutions is among the Fund s top priorities. Major efforts and important trips were taken in with an aim to build business relations and learn from experiences of financial institutions that discharge functions and pursue objectives similar to those of SOFAZ. An important step in this context was the study tour to the US Alaskan Fund by a SOFAZ delegation headed by Executive Director Samir Sharifov, under the US Trade and Development Agency-funded Oil Fund s Institutional Framework Improvement project, at the invitation of Overture Financial Services LLC, who was responsible for implementing this project. During the study tour SOFAZ and the Alaskan Fund exchanged information on their backgrounds, history and operating principles, and there was opportunity to review the professional experience of the various business units within the Alaskan Fund. Accomplishments in implementation of the Extractive Industries Transparency Initiative. brought major breakthrough within the Extractive Industries Transparency Initiative (EITI) in Azerbaijan. During the reporting year the EITI Commission, established by the Cabinet of Ministers Resolution of November 13, 2003 and chaired by the State Oil Fund s Executive Director, disclosed reports on the Government s total Extractive Industries revenues and an international auditor s opinion on these reports. The initial Transparency Initiative reports covered 2003 and the first quarter of The reports for these periods were audited and reconciled by Deloitte&Touche. The second stage - Transparency Initiative reports were presented covering the year The reports for that period were also audited and reconciled by Deloitte&Touche. The reports published at the third stage covered H1 and were audited and reconciled by AGN MAK. The Government s reports on the extractive industry s total revenues, along with the auditor s report, were posted on the State Oil Fund s web-site ( the web-site of the UK s Department for International Development, which acts as the EITI Secretariat ( and on the website of Coalition for Increasing Transparency in Extractive Industries, which represents NGOs ( Oil Fund s International Relations In the Oil Fund also established ties with various financial institutions. The Oil Fund conducted a tender, in accordance with the Law of Azerbaijan Republic On public procurements, in order to select a financial and banking institution to provide the Oil Fund with depository services. The primary objective of the tender was to select a financial institution capable of providing international custodial services to SOFAZ. The Bank of New York was selected as a result of competitive bidding. The published reports contained aggregated information about revenues paid to the budget by the extractive industry. It was the first report of its kind ever published by any Government. This report also satisfies, in full, obligations assumed by the Government of Azerbaijan in respect of EITI. Thus, at the second international conference on the Transparency Initiative, on Extractive Industries Transparency Initiative held in London, Great Britain on March 17, and attended by representatives from up to 40 countries, international financial institutions (including the World Bank, International Monetary Fund, European Bank for Reconstruction and Development, reputable nongovernmental institutions, and transnational extractive industries companies), Azerbaijan s efforts and accomplishments in this field, as a pilot country, were particularly praised. Another major area of the Oil Fund s international relations during was the enhancement of cooperation with foreign oil companies operating in Azerbaijan, in particular the companies functioning in the consortium that created the Azerbaijan International Operating Company. Numerous meetings and discussions were held to this end with the representatives of these companies. The meetings focused on a variety of issues, including delivery of assets to the State Oil Fund by foreign investors and future oil revenue forecasts. The Oil Fund also had a number of meetings in with foreign oil companies operating in Azerbaijan, and the international financial and banking institutions regarding financing of the Baku-Tbilisi-Ceyhan Main Export Pipeline Project, given that the construction work neared completion in the reporting year. In addition, the State Oil Fund s management traveled to Great Britain within government delegations dispatched to discuss the financing of the Baku-Tbilisi-Ceyhan Pipeline Project with the sponsor group. Azerbaijan s actions and achievements in the context of the Transparency Initiative have turned into an example for other countries to follow, and a number of countries have already referred to Azerbaijan for Initiative-related training in order to apply Azerbaijan s experience, with Kazakhstan being the first to decide to use Azerbaijan s experience in the context of the Transparency Initiative. In response to that request, at the order of President of Azerbaijan Mr. Ilham Aliyev, and the at the invitation of the government of Kazakhstan, the EITI Commission Chairman, Executive Director of the State Oil Fund, Mr. Samir Sharifov, traveled to Kazakhstan in and shared Azerbaijan s

23 Transparency Initiative experience with Kazakh officials and rendered advisory assistance. State Oil Fund of the Republic of Azer bai jan Another important achievement in the context of its international activity is Azerbaijan s membership of the Transparency Initiative International Advisory Group. The 2nd EITI International Conference resolved to establish an International Advisory Group (IAG) in order to provide assistance to member-countries and promote new memberships; Azerbaijan s inclusion in the IAG was approved. Based on instructions issued by the President, Azerbaijan is represented in this group by the EITI State Commission s Chairman. During the reporting year the group had two meetings, in London and Washington. Human Resource Development

24 As in the previous years, the Oil Fund implemented a number of important measures in aimed at developing its human capital and staffing its office. State Oil Fund of the Republic of Azer bai jan During the reporting year, personnel of the Oil Fund s appropriate business units attended a number of training seminars and courses organized by the Fund s partner investment banks. By attending the said seminars and training courses the Fund s personnel improved their skills and knowledge in understanding financial markets, management risks, and other related subjects. Another event that served the purpose of developing the skills of the Oil Fund s personnel was the study tour to Alaska Permanent Fund Corporation. As noted in the Oil Fund s international relations section of this report, a study tour was organized to Alaska Permanent Fund Corporation by a delegation headed by the State Oil Fund s Executive Director Samir Sharifov, under the US Trade and Development Agency-funded Oil Fund s Institutional Framework Improvement project., at the invitation of Overture Financial Services LLC. responsible for implementing this project. During the study tour, SOFAZ and Alaska Permanent Fund Corporation exchanged information on their backgrounds, history and operating principles, professional experience of different business units of t Alaska Permanent Fund Corporation were reviewed. Reporting System

25 State Oil Fund of the Republic of Azer bai jan As the State Oil Fund s assets have been growing impressively under the National Oil Strategy, and with the Oil Fund s increasingly important role in making domestically-funded investment in the country s economy, SOFAZ has been the subject of ever closer interest for both the domestic and international communities. Given this, the Fund has paid special attention to improving and increasing the transparency of its operations and accurate and timely communication to all constituencies. As in previous years, a significant safeguard for the transparency of the Oil Fund s operations and the reporting system is a regular audit of the Fund s financial statements by an independent auditor. The State Oil Fund s financial performance was audited by Ernst Young, appointed by means of a tender in 2003 to secure an auditor of the Oil Fund s 2004,, and 2006 (separate audit for each year) financial statements in accordance with the applicable public procurement laws of Azerbaijan. Following evaluation of bids submitted by several reputable audit firms, the Azerbaijan office of Ernst Young was selected as the winner and according to the Oil Fund s Regulations and the Presidential Consent of January 6,, Ernst Young was appointed to audit the Fund s financial activities for three years , and In addition, the State Oil Fund regularly publishes quarterly reports relating to its operations, as well as information concerning any changes to its legal framework and decisions made by the Fund s Supervisory Board, both in the press and on the Fund s web-site. During the Fund s web-site ( published information, in both Azerbaijani and English. In addition, it also displayed information about the actions taken by the EITI Commission under the Extractive Industries Transparency Initiative (EITI) and the reports published by the Government of Azerbaijan regarding the Extractive Industries total income, as well as international auditor s opinion and disclosures on those reports. It also published information on meetings and business trips, and other significant news related to the Oil Fund. Audit Report on the State Oil Fund s Financial Statements A number of press conferences were organized for mass media during the reporting year to make publicly available information about the Fund s operations and its Transparency Initiative activities.

26 50 51 Report of Independent Auditors To the : We have audited the accompanying statement of financial position of the State Oil Fund of the Republic of Azerbaijan (the Fund ) as of December 31, and the related statements of financial performance, changes in net assets, and cash flows for the year then ended. These financial statements are the responsibility of the Fund s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. Financial Statements Statement of Financial Position (Amounts presented are in millions of Azerbaijani Manats, unless otherwise stated) Note December 31, 2004 ASSETS Current assets Cash and cash equivalents 3 3,837,208 2,360,251 Investments in securities at fair value through profit or loss 4 2,520,278 2,346,625 Interest receivable 46,393 20,205 Contributions receivable 6,397 12,492 Advance payments and current assets 3,425 Other current assets 5 15 Total current assets 6,413,706 4,739,588 Non-current assets Property and equipment, net 6 10,073 10,635 Intangible assets, net Other assets Total non-current assets 10,956 11,798 Total Assets 6,424,662 4,751,386 Audit Report on State Oil Fund s Financial Statements In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Fund at December 31,, and the results of its financial performance and its cash flows for the year then ended in conformity with International Public Sector Accounting Standards. LIABILITIES Current liabilities Payable to the State Budget 15,832 Other current liabilities 1, Total Liabilities 1,590 16,644 Net Assets 6,423,072 4,734,742 NET ASSETS / EQUITY Contributed capital 6,291,820 4,294,713 Accumulated surplus 131, ,029 April 10, 2006 Total Net Assets / Equity 6,423,072 4,734,742 The accompanying notes form an integral part of these financial statements.