Turkmenistan: Eccentricities of a One-Man State April 15, 2005

C O N F I D E N T I A L

Turkmenistan: Eccentricities of a One-Man State

April 15, 2005
Introduction Turkmenistan is an arid country slightly larger than California and situated at the heart of Central Asia, bordered to the west by the landlocked Caspian Sea. The former Soviet republic gained its independence in 1991 after the Soviet Union dissolved and has been under the rule of one man ever since President Saparmurat Niyazov. First elected in October 1990, Niyazov was named president for life in December 1999. He also is founder and president of the Association of Turkmens of the World and holds the grand honorific Turkmenbashi, which means leader of all ethnic Turkmens. Under Niyazovs leadership, Turkmenistan has evolved into an authoritarian state that is as stable as it is sterile and brittle. Political repression is a fact of life; no opposition to the government is tolerated, and no legal framework exists to ensure guarantees for business. The country has extensive oil and, in particular, natural gas reserves, but its geographic isolation sandwiched as it is between Uzbekistan and Iran as well as territorial disputes in the Caspian Sea discourage foreign investment. However, it is possible to do business in this eccentric environment if expectations are managed and certain rules are followed. The key is in understanding the Turkmenbashi.

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Presidential Quirks The 65-year-old Niyazov is one of the most unusual national leaders in the world, and certainly the most colorful in the former Soviet Union (FSU) and Central Asia. While most of his exploits appear too farcical to be real, sources in the country both government and private lament that most of them are true. Niyazov has named a meteorite after himself as well as countless parts of the country, including the former Caspian port of Krasnowodsk (now Turkmenbashi). Golden statues of him populate Ashgabat; he has personalized lines of household goods, including Turkmenbashi vodka (the country is nominally Muslim); and the month of January in Turkmenistan is now known as Turkmenbashi. Politically, Turkmenistan has become one of the worlds most repressed societies since it achieved independence after the Soviet breakup. Niyazov-inspired security measures have succeeded in utterly stifling not merely political dissent but also political discussion. Civil society is an empty term in Turkmenistan, and Niyazov has doggedly worked to ensure that it remains that way. Internal travel is heavily restricted beyond ones own clan territories; tertiary education applicants are subject to a three generation-deep background check; and what remains of the countrys Russian minority once the intellectual backbone of the economy is being pressured to repatriate to Russia. Such peculiar policies also pervade broader economic planning. Two of Niyazovs most recent grandiose projects include a $4.5 billion reservoir under development in the Karakum desert to secure water supplies for Ashgabat, and tentative plans for an ice palace to rival the winter ice cities built annually in Astana, Kazakhstan and Harbin, China. (Winter temperatures do not consistently dip below freezing even in Turkmenistans higher latitudes.) Niyazov is largely discounted as a kook at best and an apostate at worst. Among Muslims, most people are not aware of Niyazov and could not care less because of Turkmenistans geographic remoteness, while those who are aware of him do not hold favorable opinions. As a rule, any Muslims with transnational feelings despise him since he is a former Communist masquerading as a Muslim. Niyazov uses Islam only in a superficial way as a means of retaining his hold on power. Contradicting traditional Muslim beliefs, he has written his own holy book, Ruhnama, to complement and, increasingly, informally supplant the various indigenous Islamic sects that are popular. Ruhnama is required reading at all levels in the Turkmen educational system. But eccentricity does not mean stupidity, and surprisingly to outsiders Niyazovs subjects do not consider him to be all that odd. Indeed, Niyazov is a creature of his countrys past. Before Soviet/Russian rule, Turkmenistan was a no-mans land between the major powers of Persia, Russia and, at times, British India. The political structure of the region before Russian conquest was that of isolated clans organized as de facto dictatorships. Essentially, Niyazov is a mixture of this traditional government with the cult of personalities that dominated during the Soviet period.

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Politics and the New Vulnerability Although Niyazov might take things a step further than most, there is nothing about him that does not also exist in the regions other former Soviet and ethnically Turkic republican leaderships. The political inexperience of the Turkmen populace and of Niyazov himself means that the country is unexpectedly stable, even if politically sterile and brittle. Repression is commonplace and political parties are banned, but unlike in many other parts of the world even the former Soviet Union repression in Turkmenistan is considered the normal state of affairs and political violence of any type is exceedingly rare. Turkmenistan is in the most literal definition of the term a one-man state. It is not so much that Niyazov has crushed the country under his boot but that he has never faced much resistance to begin with. And so Niyazov behaves as any strongman would: with paranoia. The Iraq war deeply impacted the Turkmen leaders psyche. Until Iraq, Niyazov firmly believed that he would rule from Ashgabat until the day he died. But the 2003 Iraq war was in Niyazovs mind about the United States going in to overthrow a very familiar-looking government. After Saddam Hussein was removed from power and particularly after Libyas Moammar Gadhafi reached a rapprochement with the United States Niyazov became convinced that he was the next target on Washingtons to-smite list. This led to his signing a rather comprehensive defense agreement with Moscow that abandoned Ashgabats previous policy of utter neutrality and placed Turkmenistan back under Moscows security umbrella. Combined with the countrys endemic political quiescence, Russias implicit security guarantee ensured that the country was stable. The one-man regime quite simply had no opponents of note. So as long as Niyazovs personal security was not challenged, there was no chance of political disintegration. Since the beginning of 2004, however, two things have changed. First, Russia became increasingly withdrawn as the government of Russian President Vladimir Putin sought to regenerate its economic and legal structure from within. The initial step in that process in Putins mind was to greatly centralize power so that his version of what Russia should be could be forced upon the country. That necessitated steady purges of officials at all levels who held divergent world or political views, followed by the redefinition of the powers of their posts so that bureaucrats and regional governors lacked the legal standing to challenge Putins program. The result was that Russian policy (particularly foreign policy) entered a deep freeze, except in those rare cases where Putin himself intervened. That left Turkmenistan like all of Russias nominal allies on its own. Second, there is the wave of velvet revolutions that began in Serbia in 2000 and then moved to Georgia in 2003 and finally reached Central Asia, specifically Kyrgyzstan, in March 2005. Unlike the previous velvet revolutions, in which people power and foreign assistance proved instrumental, the protest that upended Bishkek had neither. The group

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that stormed the presidential compound numbered at most only 500 people. Suddenly, the brittle regimes of Central Asia found themselves not only to be not natural outcomes of history but eminently disruptable. Already on April 1, 2005, Uzbekistan the most stable of the Central Asian republics suffered its first popular protest. Turkmenistan, with a far more brittle structure and far weaker security services, will not be far behind. Business in Turkmenistan As a one-man state, Turkmenistan lacks the legal framework for normal business practices. All contracts, for example, are subject quite literally to the whim of Niyazov. Any large project must have his personal approval to obtain even a middling chance of success and, should his thinking change, it will quickly be reflected in the terms of the deal (nothing there can be considered as chiseled in stone). A good example of just how far Niyazov will go involves his countrys relationship with Gazprom, Russias state-run natural gas monopoly. Gazprom currently faces a production shortage as natural gas fields first tapped during the Soviet era run dry. This makes it impossible for the firm to both supply all of Russias domestic demand and fulfill its export contracts for Europe. To fill the gap until it can bring new fields on-line, Gazprom has contracted with Turkmenistan to supply the difference. This has been the state of affairs for the bulk of the post-Soviet period. In 2005, however, Niyazov ordered the taps closed and the supply contracts renegotiated. Granted, the existing contract by which Gazprom had to pay Turkmenistan only $44 per 1,000 cubic meters of natural gas was not a good one for Niyazov. The rate of payment is barely one-third of the European retail price for natural gas, and fully half of the contract was filled by Gazprom with bartered goods not cash and such goods were of poor quality even by Russian standards. Niyazov feels that the disparity between Gazproms production capacity and supply commitments puts him in the drivers seat in relations with Gazprom since he feels that Turkmenistan can afford to wait Gazprom out. As such, Niyazov wants the contract renegotiated upward to $58 per 1000 cubic meters, all in hard currency. The case demonstrates Niyazovs one-track mind. While he might be correct in his assessment of the supply contract and, ultimately, of Gazproms weak position, Russia is the closest thing Turkmenistan has to a security guarantor, and Russia is also Turkmenistans largest trading partner with or without the natural gas flows. Moreover, Gazprom is the Russian governments largest taxpayer, so the natural gas cutoff affected not only the bottom line of the states largest asset but also of the state itself. Niyazov also ordered the taps closed in January. Winter is not friendly in Moscow. There is no doubt that the existing contract was in dire need of renegotiation. But the target and timing of Niyazovs move revealed an almost ruthless abandon. If he is willing to hit an entity so important as Russia so hard at such a weak moment in order to get his way, how will he treat any other country or people of less importance to his regime?

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Ultimately, the largest problem for investors is Turkmenistans utter lack of legal guarantees. Most laws related to interaction with foreign economic forces were adopted in 1993 and have barely been adjusted except by unilateral presidential decree since. The government, which accounts for approximately three-quarters of total economic activity, routinely manipulates (i.e., invents) economic statistics to demonstrate its excellent economic management. Officially, unemployment is zero and annual growth in gross domestic product is in excess of 15 percent. Independent estimates put those numbers closer to 50 percent and 7 percent respectively. Legislation and regulations, such as they are, are wildly inconsistent, designed to serve the states needs and regularly amended or overturned by Niyazov himself as the states wishes (i.e., Niyazovs wishes) evolve. Mediation and arbitration might be possible, but the state feels it is its right to ignore any decision that is not in its interests. There is not one example of such disputes resulting in rulings against the state in which the state has provided compensation. That attitude and the countrys remoteness was a key factor in ExxonMobils 2002 decision to halt all activity in the country ExxonMobil is hardly the only entity to pull out. The International Monetary Fund, the World Bank, the European Bank for Reconstruction and Development (EBRD) and the U.S. Agency for International Development have almost wholly suspended activities in Turkmenistan. None have plans to renew their relationships without drastic changes in Niyazovs policies. Total assistance from all these institutions to Turkmenistan in 2004 totaled under $10 million, most of which went toward programs not affiliated with the government-dominated economy such as civil society and health. The EBRD -- by far the most active international institution in Turkmenistan -- has a blanket ban barring any assistance to any project with even a modicum of government association or involving any petroleum-related activities. This ban will continue until there is a radical shift in the way Ashgabat views issues such as property rights, transparency and the private economy. The bank is not hopeful and believes the trend is toward further state economic consolidation. Still, many firms particularly agricultural firms do business in Turkmenistan regularly and express few complaints to their home governments. But most of these firms activities involve equipment sales or turnkey projects rather than financial investment. Such activities, carried out on an exclusively single-payment cash basis, have a very high record of success and regularly surpass success rates for similar work in other former Soviet states. Firms that carry out more involved projects frequently find their payments and currency exchanges suspended until they commit to additional deals of the states choosing or provide appropriate kickbacks. As of April 1, 2005, the U.S. Department of Commerce and U.S. State Department had no outstanding dispute resolution cases against the government of Turkmenistan. This, of course, does not necessarily indicate a lack of problems. When firms do have a run-in with the government, they swallow hard and adjust their practices to the new government-mandated reality instead of challenging the government and risking their assets. No foreign embassy has the leverage to offer any significant help to any firm operating in Turkmenistan.

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Despite a long list of operational irregularities that hobble economic development across the board (such as the strict monitoring of foreigners), the Turkmen government is not ideologically hostile toward foreign economic entities in general or investment in particular. It is just that there is one catch: the Turkmen government wants no catches, no strings attached. All investment must be on the governments terms, and so as a matter of course the phones of all foreign entities, whether of firms, embassies or multilateral institutions, are tapped to ensure compliance. The physical security of the country is in many respects superior to that of many Western countries. Organized crime is nearly unheard of, civil strife is nonexistent and personal safety is not an issue (though imported employees must brave perplexing, random and ever-changing visa requirements). Compared to Russia or even the United States Turkmenistan is a Shangra La from a security point of view. According to firms operating in the country, the trick to minimizing problems is sixfold: 1. Do your homework. Most firms operating in Turkmenistan report few problems because they had no illusions about the risks involved when they entered the country. Be sure to have your business well defined, contacts with the government arranged and expectations of the states cut clearly established. 2. If at all possible, do not take on a local partner. While most embassies offer extensive help in vetting potential partners, far and away the greatest problem investors face is the changing of terms once they get into the country. Legal guarantees are completely non-enforceable in Turkmenistan, and should your partner negotiate anything without you, expect to be negotiated out of your investment at your partners first opportunity. 3. Think brand. Niyazov is a sucker for brand names, as one source in the U.S. government put it. He is perfectly willing to pay top dollar and then some for a product or service that he considers prestigious. Make sure that you have something that he personally wants. 4. Think about the state. Niyazov believes that the state exists to serve him, so whatever is good for the state is good for him. This particularly applies to government revenues. Projects in energy and agriculture are more likely to meet with his approval than other projects because he views them as a reliable way to generate state income. 5. Be able to do something the Turkmen cannot do for themselves. The best way to ensure that Niyazov does not decree away your assets is to ensure that he or his people need them, but cannot operate or otherwise utilize the assets themselves. 6. Hammer out any currency exchange agreements before you invest. To do otherwise will leave you either holding a great deal of worthless manat (the local currency) or facing steep and unpredictably changing exchange rates and fees.

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Investors who follow these six guidelines constitute the bulk of active investors operating in Turkmenistan. They also report that for them corruption and bribery are minor problems. There are no independent power centers in the government outside of Niyazovs office. Everything of substance goes through him personally. Once Niyazov has given his blessing to a project, no one in the bureaucracy dares to challenge the word or desires of the Turkmenbashi. Of course, this has its down side. While bureaucrats are loathe to challenge their leader, they are also loathe to take any action that they are not positive will please him. As a result, government acquiescence for items such as permits can take inordinate amounts of time, since no one is quite sure what is going on in Niyazovs mind. There is one notable exception to all of the above. Foreign investors and operators have more latitude in those sectors that (in the governments view) boost state revenue and entrench state power mainly energy, agriculture and textiles although most foreign activities remain limited to facility construction and technology transfers. Ongoing investment projects of any type are exceedingly rare because of high legal risk. For example, the Argentine energy firm Bridas had a contract to develop natural gas fields in Turkmenistan for export via a yet-to-be-built pipeline that would cross Afghanistan and go into Pakistan. Niyazov unilaterally abrogated the agreement as soon as Unocal an American firm far more prestigious than Bridas expressed interest in the project. Niyazov, in effect, transferred control to Unocal. Bridas sought recourse from the International Court of Arbitration in Paris and won a $50 million settlement but has yet to collect anything from Ashgabat. Bridas currently has no commercial interests in Turkmenistan. The offshore oil and gas sector, in particular, is free from Niyazovs micromanagement. Here the state realizes that it lacks the technology to engage in exploration and production and so is more willing to allow foreigners to take up these operations. As such, Ashgabat had largely followed the letter and spirit of the law regarding offshore oil production in the Caspian Sea. Adopted in 1996, the law governs all production sharing agreements and provides a startlingly clear legal environment while transparently defining tax expectations and the rights of investors. All offshore operators in the Caspian Sea are reasonably satisfied with their government relations and consider the law to be the most liberal and appropriate of its kind on the books in Turkmenistan (although they still say that all the bureaucratic crap is still frustrating). Two of the three largest and longest lived foreign investments in Turkmenistan are such offshore projects. The two firms involved are Malaysias Petronas and the Irishincorporated (but United Arab Emirates [UAE]-owned) Dragon Oil. Collectively, the two have invested approximately $600 million in Turkmenistans Caspian sector, constituting the majority of foreign direct investment (FDI) into Turkmenistan. It is noteworthy that both of these companies are state-owned firms (Dragon Oil is owned by the UAE state oil firm Emirates National Oil Company). Such firms sport far higher risk tolerances than most other companies, and also benefited from direct government-to-government introductions to smooth the business process.

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Non-Governmental Barriers But even such favored and politically insulated firms must still cope with what are perhaps Turkmenistans most crippling obstacles to foreign investment: the countrys location and the legal status of the Caspian Sea. Both are largely beyond the ability of the government to address. The legal underpinnings of the Caspian Sea were first and most recently laid out in 1921 and 1940 treaties between the Soviet Union and Iran. When the Soviet Union disintegrated, the number of littoral states increased from two to five and the question became, how to divide the spoils? Azerbaijan and Kazakhstan immediately proposed and began acting upon a plan to split up the sea into national sectors based upon the length of their coastlines. Russia and Turkmenistan proposed that each player develop its immediate coastal region while a consortium plan would have all five states jointly develop the seas center. Iran insisted that standing treaties entitled it to fully half of the Caspians riches and that nothing should be touched until that was formalized. Working off of the theory that possession is nine-tenths of the law, Azerbaijan signed more than $20 billion in contracts and developed its section as it saw fit. Ultimately, Russia decided it was better to have all of something then something of nothing and joined the joint Azerbaijani-Kazakh position, leaving Turkmenistan and Iran in the cold. Both states reluctantly agreed to a sector split, but asserted that they should be entitled to a full 20 percent share of the Caspians area, as opposed to a sector whose size was determined by the length of their coastlines. (The two states sport the shortest coastlines of the five littoral states.) In July 2001, a BP survey vessel under contract from Azerbaijan that was mapping the 2.2 billion barrel Araz-Alov-Sharg fields was fired upon by Iranian warships claiming that the vessel was in the Iranian sector of the Caspian. The incident immediately froze all petroleum-related activities along the maritime borders that had not already been locked down by bilateral treaties namely, all maritime borders with the Turkmen and Iranian sectors. That is where things were left after a sharp arms buildup on all sides of the Caspian for the next four years. The various players simply decided to not develop anything near a contested border. This situation is beginning to change. The concern is over the disputed Kapaz/Sedar field, which depending upon whom you speak with lies on the extreme east side of the Azerbaijani claim or the west side of the Turkmen claim. For Azerbaijan, the field is the next piece of its Apsheron Sill, a geological feature that boasts a number of large fields including the Azeri-Chirag-Guneshli (ACG). In the latter half of 2005, Azerbaijani production from the ACG project will begin flowing west via the Baku-Tbilisi-Ceyhan (BTC) pipeline to the Mediterranean.

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The problem is that total Azerbaijani production is not enough to fill the BTC to its projected 1.0 million barrel per day (bpd) capacity; even full, the BTC line is already of questionable economic viability. Since the Kapaz/Sedar field is only 35 kilometers from the ACG project, it is a logical next step for Azerbaijani oil production with the BTC explicitly in mind. Turkmenistan which also lays claim to the Azeri and Chirag fields disagrees. The United States and the United Kingdom, the BTCs primary backers, will likely either support the Azerbaijani or a co-dominion position. However, most disinterested observers in the industry suspect Turkmenistans claim is the stronger, ergo Ashgabats recommendation to submit the case to binding arbitration (and Bakus refusal to do so). And, of course, even if the Caspian Seas legal status were fully resolved, the problem of Turkmenistans remoteness remains. 1. Even after the end of the Taliban regime, neighboring Afghanistan remains a country mired in civil conflict. What infrastructure exists is still primitive and is not conducive for building a trade relationship with Turkmenistan and countries beyond. 2. President Islam Karimov of Uzbekistan despises Niyazov and has irredentist desires toward northern Turkmenistan. That, combined with Uzbekistans status as an upstream state on the Amu Darya River

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Turkmenistans major supply of water makes Uzbek-Turkmen relations extremely hostile. Turkmenistans major oil and natural gas export routes were all built during the Soviet period, so they all transit Uzbekistan and Kazakhstan en route to Russia. That makes Turkmen exports subject to the Uzbeks and Kazakhs (who both plan to displace Turkmen exports with their own gradually growing petroleum exports) and the Russians (who think of Turkmenistan as at best a stopgap to supply them with extra oil and gas until Russian production increases to a point where Russia can fulfill all its energy contracts without Turkmen help). Bottom line: These export options are secure for now, although lack of maintenance has reduced their nameplate capacity from 90 billion cubic meters per year to only 50-55 billion cubic meters and they eventually will be denied completely. The Turkmen coast of the Caspian Sea lacks significant infrastructure of any type, including any undersea pipelines that would allow exports to go westward. Such infrastructure cannot be put into place until the legal status of the Caspian Sea is resolved. U.S. sanctions on Iran prevent any U.S. firm from participating in any southern export links. For all practical purposes, this has hobbled any Iranian-Turkmen cooperation despite the fact that the southern route would be the most economically viable by far. What options exist are limited to swap agreements by which Turkmen producers ship small amounts of oil to northern Irans Caspian ports for local consumption. Equal values of Iranian crude are then exported from southern Iran via the Persian Gulf in the Turkmen producers name. The landlocked nature of the Caspian Sea makes petroleum-related operations there extremely difficult, since rigs must be disassembled, shipped to a port on the Caspian and then reassembled. Only BP controls a meaningful number of rigs on the Caspian, so BP-led projects enjoy a near monopoly in tapping the regions maritime petroleum deposits. Consequently, production has yet to begin in any significant amounts in the Kazakh, Russian, Turkmen or Iranian sectors of the Caspian. A limited rig supply has coincided with the Kapaz/Sedar conflict in that Maersk Oil, a subsidiary of a Danish firm wanting to drill in the Caspian but lacking the in-country resources to do so, contracted with SOCAR, the Azerbaijani state oil firm, for a rig just before the Kapaz/Sedar issue came to the fore. The contract has been unilaterally suspended. Even if these issues were resolved, there is still the question of distance. The shortest export routes south to the Persian Gulf or west to the Black Sea are still some 1,000 kilometers away from current production sites in the Turkmen sector of the Caspian. The necessary capital investment is of such a high level that political risk enters heavily into any financial decision (thus forestalling any such investments). The total Turkmen population is only 5 million, nearly all of whom live along the countrys northwestern or southern borders. The combination of a small fragmented market and idiosyncratic economic policies make few firms interested in trudging out to this faraway corner of the earth.

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A Matter of Perspective The bottom line is that Turkmenistan is a hostile environment for foreigners in general, but in specific sectors and with certain preparations, investment is possible and can also be lucrative. While many (accurate) comparisons have been made to North Korea in terms of a personality cult, Niyazovs security state is not nearly as repugnant. Torture occurs but is neither common nor publicized and is most comparable to recent experiences in Turkey. Turkmenistan threatens none of its neighbors with war or instability, or vice versa, a claim that almost no states in South America or Africa can make. Terrorism is unheard of in Turkmenistan, and drug abuse, albeit rising due to the countrys proximity to Afghanistan, is nowhere near European levels. Public safety is the norm, and the overall political system is stable, albeit sterile. There is no need to worry about a new government coming in and altering terms of an agreement. There is only one person with whom a foreign business needs to have a relationship, and as long as that relationship is secured and nurtured, corruption is only a minor concern. In terms of property rights Turkmenistan is indeed at or near the bottom of the heap. The government has no respect for private property foreign or domestically held and is equally eccentric and absolute. Even worse, there is no recourse. Even in deepest, darkest Africa, countries such as the United States can pressure local governments into respecting at least some private business rights, but Turkmenistan is so remote and economically isolated that Ashgabat regularly ignores even Moscow. The exception, of course, is in the Caspian offshore. If this sizable obstacle can be negotiated, however, the picture brightens considerably.

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