Azerbaijan would also benefit from more dynamic, efficient, and environmentally and financially sustainable electricity and gas markets. The International Energy Agency (IEA) therefore strongly encourages the government to intensify efforts to unbundle monopoly operations, increase competition and attract private investment to build new infrastructure and modernize the existing system. Reforming the tariff system and phasing out gas subsidies to enable cost recovery and fair competition across all power and heat technologies is essential. To ensure that reforms are socially acceptable, this complex task requires careful action to protect vulnerable consumers. It also requires continuous education and training efforts to guarantee that enough people have the planning capabilities and skills necessary to deliver the reforms efficiently and effectively. A campaign to improve public awareness of the reasons for energy policy changes and the benefits of future reforms is also needed.
Electricity demand in Azerbaijan is set to grow in the years and decades ahead. The whole population has access to affordable electricity, and wider electrification is expected to raise demand considerably from the currently low 2 500 kilowatt-hours (kWh) per capita per year. The country needs a more dynamic electricity sector, and investments in new and more efficient generating capacity and electricity grids are essential. The IEA welcomes the government’s determination to reform the electricity system and gradually move from a state-dominated, vertically integrated system to a more dynamic, efficient, and environmentally sustainable one. The challenge now is to deliver it.
Azerbaijan’s 2016 Strategic Roadmap recognized the need for electricity reform, and several reform proposals have been drafted. These include the draft laws on electricity, the role of the regulator in energy and public utilities, and the use of renewable energy in electricity generation. The IEA urges the government to adopt the pending legislation and proceed to implement an ambitious electricity market reform for the benefit of the country and its economy.
The government should first focus on the issues of governance and financial viability. Tariffs and subsidies should be reformed to enable full cost recovery and encourage investments in power sector development, which should help reduce operating costs and improve generation, transmission, and distribution efficiency. To enable the energy sector to allocate resources more efficiently, the IEA furthermore urges the government to reform and gradually abolish subsidies for natural gas in electricity generation. The government should also focus at the outset on setting specific policy objectives for a secure, efficient, and clean electricity system. Although Azerbaijan has enough gas resources to generate all the electricity it needs for decades to come, it is also in the enviable position of having hydropower and significant solar and wind power potential. As solar and wind technology costs have declined dramatically in recent years, tapping into their potential would allow the country to save its natural gas for export at the same time as reducing domestic GHG emissions.
In this context, the IEA welcomes the government’s ambition to raise the share of renewable energy in total generating capacity from 16% in 2018 to 30% in 2030, and congratulates it on its first power purchase agreements (PPAs) for a 240‑megawatt (MW) wind farm, signed in late 2020, and 230 MW of solar power capacity, signed in early 2021. When the time comes for the government to consider renewable energy targets beyond 2030, it should take account of both the economic potential of renewable energy and the scope for other policies and measures to meet energy policy goals. Cost-effectiveness should be a key criterion for choosing among policy options: for example, it may be less costly to meet longer-term energy policy goals by increasing energy efficiency than by building new generating capacity.
To meet electricity market reform objectives, policies and measures must provide for unbundling, third-party access to grids, transparent wholesale markets, and partial privatization of monopolies. It follows that Azerenergy’s generating assets should be effectively unbundled from its transmission grid ownership and grid operations. At the same time, transmission and distribution tariffs should be separated from energy supply tariffs to enable the use of performance-based incentives, while electricity generation should be opened up to competition and wholesale and retail markets created. There is a strong case for undertaking such a broad and complex reform gradually. The first step should be to remove entry barriers for new participants and begin to institute unsubsidized cost-based economic dispatch of power plants to increase efficiency. This should be quite feasible, since – aside from auto producers – almost all generating capacity is owned by Azerenergy.
To increase competition, some of Azerenergy’s generating assets could be privatized. The emphasis should be on privatization as a means of increasing competition and operational efficiency rather than as an end in itself, with full privatization unlikely to be necessary to achieve the desired goals. For example, in many European countries, the state remains the majority shareholder in electricity generators that operate in competitive wholesale markets. New entrants could be entirely private or based on public-private partnerships, provided that barriers to market entry are removed. An important point to consider relates to raising the share of variable solar and wind power capacity. As the government plans to attract investment through long-term PPAs, a mechanism should be designed to integrate PPAs into the future wholesale market.
The establishment of the regulator in 2017 was a major step in electricity market reform. Since the Azerbaijan Energy Regulatory Agency (AERA) remains closely overseen by the Ministry of Energy, just like the electricity sector monopolies Azerenergy and Azerishiq, it will be essential to grant it the legal right to take binding decisions and issue recommendations. This also applies to its work in natural gas and district heating.