Investors and the State: Kazakh Content
The 20th session of the Foreign Investors’ Council (FIC), which is chaired by the Kazakh president, was held in Almaty on 5 December 2008. Increasing Kazakhstan’s share in the investment in and operational costs of the international mining companies operating in our country was the key issue on the agenda of the FIC’s anniversary meeting.
The Kazakh authorities have been discussing their intention to create their own industry to service extractive companies for a few years now. Priorities in this sphere were already specified in 2002 when the Strategy for Industrial and Innovative Development was developed. These are the development of Kazakh content in extractive projects, the creation of competitive scientific and high-tech productions with high added value for domestic service markets, the implementation of international quality standards for domestic products, the preparation of qualified personnel in order to replace foreign specialists with Kazakhs to the maximum extent possible. The Kazakh Contract Agency, an institutional structure aimed at implementing the policy, was also established in 2002.
The second stage started in March 2006, when the president said in his address to the nation that “each oil and gas field must be considered as a whole centre for developing entrepreneurship, ranging from modern personal services to advanced engineering and software products.” Following this, the Ministry of Industry and Trade and a group of extractive companies signed the Memorandum on the Development of the Local Content in the Service Market of Subsoil Use and the Memorandum on the Implementation of the Extractive Industries Transparency Initiative. Forty-one oil and gas companies, 21 mining enterprises and 74 domestic manufacturers supported these documents. Other agreements, including one with the Kazakhstan Petroleum Association, were also reached. In addition, the Ministry of Education and Science signed 18 agreements and memorandums with state bodies, foreign investors and companies on boosting cooperation in the training, retraining and advanced training of technical specialists.
Nevertheless, in his speech to the last FIC meeting, Kazakh President Nursultan Nazarbayev acknowledged that from the outset, comfortable and liberal conditions had been created for foreign companies to import goods, services and labour resources. At that moment, the country's leadership was aware that Kazakh companies were not ready to offer investors competitive goods and services. Therefore, it is no wonder that both sides approached the question of increasing Kazakh content rather formally. No one bothered foreign subsoil users for a while and other sectors of economy, especially the construction sector, were chosen as testing areas for increasing the competitiveness of domestic manufacturers.
However, the time has come. The economic crisis is changing the state of affairs. The global financial crisis has not only struck a blow on the real sector but also forced virtually all of the countries to rely on their domestic reserves. Kazakhstan is not an exception in this case. Having lost the powerful development source like the construction sector, our economy is in a dire need for new development drives. Being aware of this, the president demanded that the government, national companies and state bodies should ensure maximum contracts for Kazakh manufacturers: “From now on, each manager is responsible for increasing shares of domestic manufacturers in their contracts.”
The decision is quite logical. The state-run economic sector has lately grown considerably, and this is why it is one of the major consumers of goods and services. The chairman of the Samruk-Kazyna National Welfare Fund, Kairat Kelimbetov, reported that the purchase value of the fund's four major companies totalled $5.5bn in 2007. Following on from this, Samruk-Kazyna is drawing up a list of imported products that local enterprises could also be producing for national companies. This will be a single local content development programme that will focus on the following four sectors: subsoil use, the railway industry, telecommunications, and power engineering. Mr Kelimbetov said the programme would include products that Samruk-Kazyna would need in the medium-term future and a programme for new productions development in the above mentioned sectors. Moreover, the fund’s financial institutions will offer loans for the programme.
The government plans to use extractive sectors as the second source of support for domestic businesses because the extractive industry is Kazakhstan’s second largest service market in terms of investment. Oil and mining enterprises’ annual procurement has reached $18bn, including $8bn spent on goods and $10bn on services.
The government’s viewpoint…
Industry and Trade Minister Vladimir Shkolnik depicted the current situation surrounding Kazakh content. Today, he said, Kazakhstan has 575 extractive contracts, including 378 contracts for solid minerals and 197 for crude hydrocarbons. At the same time, the three contracts with Tengizchevroil, Agip KCO and Karachaganak Petroleum Operating, which account for 43.3% of the total procurement, do not include any rules regarding Kazakh content.
The remaining 572 contracts (56.6%) provide for this requirement to some extent. Thus, 500 contracts include general obligations with regard to Kazakh content without specifying their volume, and 72 envisage Kazakh content at 50%. At present, obligations are fully met only in two of the 72 contracts, partially in 45, and not fulfilled at all in 25 contracts. As a result, the average Kazakh content in goods supplies accounts for 8.4% of the procurement in the oil and gas industry and 22% of the mining sector.
Machines and equipment account for 39% of oil companies’ local procurement, metal and metal products 21%, chemical products 14%, and other goods 26%. Mining enterprises’ local procurement includes chemical products and other related products (42%), machines, equipment, transport facilities, devices and instruments (27%), metals and metal products (11%), and other goods (20%).
Mr Shkolnik said that the basic problems hampering Kazakh content were the absence of a single strategy in specifying the notion of ‘Kazakh content’ and incomplete information about goods, services and labour resources in demand for extractive companies. On the other hand, extractive companies do not have fully-fledged access to the basis of domestic manufacturers. Kazakh manufacturers put out a limited mix of products for the extractive sector and lack qualified personnel.
To resolve these problems, Mr Shkolnik believes, it is necessary to divide all of the goods and services which are in demand in the extractive industry into three groups. Instruments and mechanisms will be specified for each group. The first group includes local goods and services meeting fixed requirements.
State bodies’ key regulating mechanism will be the recently signed Law On State Procurement. For the companies with state stakes that are exempt from the law, requirements for mandatory procurement of Kazakh products will be fixed in the rules adopted by Samruk-Kazyna's Committee of Directors. For private extractive companies, including foreign ones, procurement must be made in line with memorandums signed in 2006. As for new extractive contracts, they must stipulate Kazakh content. The Ministry of Industry and Trade suggests, as a practical mechanism, that completing the list of domestic manufacturers, goods and services should reach its logical end.
The second group includes local goods and services that do not meet extractive companies’ requirements. It is necessary to analyse international standards, which have been registered in the country, with regard to each product and adopt them on a national level. In order to implement this, it is planned to create a register of extractive companies’ demands for short-term (current year) and long-term (three years and more) contracts, which will be available for domestic manufacturers. This will allow them to prepare their productions and to establish the output of goods in demand.
The third group includes goods and services that are not produced and offered in Kazakhstan. The Strategy for Industrial and Innovative Development and the 30 Corporate Leaders programme are expected to expand this group’s list. Mr Shkolnik believes that it is necessary to monitor needs constantly and conduct a comparative analysis of purchased goods and available offers in order to specify priority routes and increase the efficiency of transfers of technologies.
In conclusion, the Industry and Trade Minister noted that foreign companies would be stimulated to create joint ventures that will produce high-technology products through increasing Kazakh content in new extractive contracts. When major purchases of import equipment are made, state bodies will try to establish their production, maintenance and service in the country. Mr Shkolnik thinks that the so-called ‘offset policy’ must be adopted as a separate law.
The idea that the government and regional authorities have a mistaken belief that foreign operators are not interested in local goods, services and human resources, and this is why they did not want to increase the local content in their projects threaded through the speeches by the FIC's foreign members. In fact, investors are always interested in Kazakh content as long as it meets the appropriate quality and other business requirements. First of all, local specialists and suppliers better know the local peculiarities of running businesses. Secondly, this promotes a decrease in production cost and an increase in economic return.
Acknowledging the fact that it is still possible to increase Kazakh content, foreign investors at the same time depicted a whole range of problems hampering its full implementation. One of the problems, they said, was the insufficient development of the production sector, small domestic market, a low level of competition and limited technological and financial possibilities in aggregate.
ENRC stakeholder Alexander Mashkevich said that there was a dynamic growth in attracting contractors to the delivery of goods and service but, unfortunately, a similar growth was not observed in the delivery of materials and equipment. From year to year, the list of ENRC's purchases is limiting Kazakh content. The main reason is that the basic groups of goods include products that are not produced in Kazakhstan. Namely, these are mining transports, power engineering equipment, heavy duty electric motors, stainless steel pipes, section-shaped metal-roll, spare parts for mining and railway equipment etc.
Mr Mashkevich believes that it is necessary to attract innovative development institutions and national companies’ resources in order to stimulate a growth in the consumption of local goods. The government should become an accelerator of these processes because the schema ‘demand determines supply’ does not always work in Kazakhstan’s real production sector, unfortunately. For instance, he said, ENRC needs soda ash but Kazakh markets do not offer this product though there are raw materials available for its production. “If local businesses had financial, technological and human resources for the implementation of this project, we would become their long-term partners with much pleasure. In the meantime, we have to develop auxiliary productions independently.”
According to Mr Mashkevich, the Kazakh content reporting to various state bodies and measures to develop the local market require a special analysis and a more standardised approach. He backed his arguments with the same example, the soda ash plant that ENRC is building in Pavlodar Oblast. Although the plant will use local raw material and human resources, it will not be regarded as Kazakh content because it is a foreign investor’s project.
Therefore, members of the FIC believe, it is necessary to make the procedures for determining Kazakh origin of goods clearer, specifically to resolve issues related to the single determination, calculation and control of local content. Especially this applies to the regulation of contract and subcontract operations because the schema ‘Kazakh contractor – foreign subcontractor,’ which is often used at present, does not really contribute to Kazakh content’s growth.
The chairman and the chief executive of Arcelor MIttal, Lakshmi Mittal, also pointed out a number of difficulties and problems hindering the development of local entrepreneurship and the Kazakh content’s share. These are expensive electricity and the imminent energy crisis, high transport costs and the need to develop the transport network, a limited opportunity of receiving low-interest loans and, most of all, the low qualification of specialists.
At the same time, the president of Lukoil, Vagit Alekperov, said that Kazakhstan had virtually resolved the task of training high and medium level managers. High education quality in Kazakh universities and advanced education opportunities in Russia, Europe and the USA promoted this. He considers that the shortage of qualified workers, or the so-called blue collar workers, is indeed a serious problem. In his opinion, there is a need for special state programmes to train this type of specialists.
The investors also noted that extra protectionism might do more harm than good to the Kazakh business. The managing partner of Baker & McKenzie CIS, James T. Hitch, III, thinks that the existing Kazakh content development requirements do not stimulate local service companies to raise their competitiveness.
Today’s bidding rules for extractive companies’ procurement offer considerable advantages for Kazakh suppliers. Local suppliers' offer price is conditionally 20% cheaper. Thus, extractive companies will have to buy domestic products even if they are more expensive than similar imported products. Similar requirements are set for state-controlled enterprises and companies, including oil and gas companies. They are obligated to buy not less than 25% of certain goods and services from domestic suppliers. In addition, during the implementation of state purchases, local commodity producers’ offer price decreases by 15% conditionally.
All of these conditions allow Kazakh companies to fix higher prices for the application for bidding than their foreign competitors, and to win the tenders irrespective of this. Thereby, these conditions do not stimulate domestic producers to reduce costs, raise production efficiency and improve competitiveness in whole. With this approach, domestic companies will only be able to sell their goods and services in Kazakhstan until the country joins the WTO. “We do not consider that the Kazakh content requirements must be abolished. However, they must be changed in order to boost the competitiveness of oil and gas service companies in Kazakhstan,” said Mr Hitch.
To achieve this, he recommends that amendments should be introduced into the goods and services rules for purchasing goods and services for extractive operations. If a Kazakh oil and gas service company performs services for more than five years and its total sales exceeds 1.5 million of the monthly calculation index, then its offer price will not decrease by 20% conditionally but only by 10%. If the company has existed for more than ten years and its total annual sales exceeds 3 million monthly calculation indexes, the price decreases by 5% conditionally.
In conclusion, the foreign investors noted that not only international oil companies and the energy sector but the state and goods and service producers are also responsible for the local content development. Here the main guarantee is a long-term partnership and planning. Only this sort of approach will make it possible to determine realistic and stable objectives and specify proper actions. Therefore, Kazakhstan needs a nation-wide plan for the local content development, which will be a basis for various operators’ individual plans.
The president’s response
In keeping with tradition, the Kazakh president made the final speech at the FIC meeting. He said that our economy has developed and become stronger and more competitive over the 17 years of independence. Many of the local companies are now able to meet considerable needs of foreign investors. Following the first nine months of 2008, it is clear that Kazakh content do not exceed 10-15%. “It is obvious that this figure does not reflect the domestic manufacturers’ potential… The local content’s share ranges from 50% to 80% on average in Brazil, Malaysia, Norway, the Great Britain, 90% in Germany, and 77% in the USA. It even reached 30% in Nigeria!" Therefore, the president thinks that this kind of state of affairs does not satisfy the government, the extractive companies and Kazakh manufacturers. Moreover, all of the contracts provide for direct obligations with regard to Kazakh content.
Speaking to the FIC members, he noted that, as managers, they were not always aware of what was going on at lower levels. “However, your managers are often reluctant to cooperate in this issue, they do not want to change. I think that we will have enough will to make them address the needs of Kazakhstan.” Today Kazakh manufacturers do not have the information about the terms and conditions of biddings for goods and services, and about the future procurement plans. “If this information were available for us, we would have been preparing our companies for them. Moreover, these tenders for the use of our subsoil are held in London, for instance. It is simply a disgrace! We will not regard these tenders as fair. Our companies must have access to them. Only then we will achieve mutual understanding with you.”
The president also blamed foreign investors for their unjustified employment of foreign workforce. “Foreign workers like general workers, various builders, cooks and waiters are coming to Kazakhstan under quota. The country has enough of its own specialists of these kinds.”
Kazmunaigas also received its portion of criticism. The national company has the authority to work with extractive companies in major projects. Kazmunaigas is the company that must coordinate annual procurement plans and capital and operational costs. However, Kazmunaigas has not yet used its authority to increase Kazakh content in joint projects. In the president’s opinion, this situation should be changed immediately!
The president also said that the lack of progress in local content was, first of all, the result of the government’s unsatisfactory work. The government did not specify tasks and criteria. It did not develop and coordinated conditions and rules and did not undertake real measures to cooperate with domestic manufacturers. “For the government, the Kazak content development must be question number one. This is the actual development of the real sector that our economic diversification and industrialisation plans depend on.”
In this respect, the president instructed Deputy Prime Minister Umirzak Shukeyev personally to create a Kazakh content development group, which will include sectoral ministers and Samruk-Kazyna managers. This working group is expected to develop specific suggestions to resolve the following tasks.
Firstly, it is necessary to develop a single Kazakh content calculation method in coordination with extractive companies that will highlight the record of goods, services and human resources. A law should be adopted to uphold this method and ensured in all extractive contracts.
The government has been instructed to hold talks and reach agreements on Kazakh content with extractive companies within three months, and specify concrete conditions of their work in Kazakhstan.
Secondly, an efficient system of monitoring of the implementation of Kazakh content obligations should be set up. At the moment, only 135 of the 575 extractive companies are subjected to real monitoring. The accountability for the non-fulfilment of contractual obligations should be made stricter. The state system for the inspection of extractive companies’ activities needs to be set up. Energy and Mineral Resources Minister Sauat Mynbayev will personally be responsible for this work. Within its authorities provided for in production sharing agreements, Kazmunaigas must ensure an annual growth in Kazakh goods and services. President Nursultan Nazarbayev laid the responsibility for this on Kazmunaigas’ President Kairgeldy Kabyldin. The Ministry of Finance in the person of Minister Bolat Zhamishev will be responsible for the monitoring and control of Kazakh content in the purchases by the central and local state bodies and the state-run companies. The Chairman of Samruk-Kazyna, Kairat Kelimbetov, is responsible for increasing Kazakh content in the national companies’ purchases. The Ministry of Industry and Trade was assigned the task to develop domestic manufacturers and to improve their service’s quality up to international standards.
In whole, all the measures to make the state bodies and extractive companies more responsible for Kazakh content, conduct appropriate inspections and clarify the areas of responsibility should be fixed legally. “We will submit this issue to parliament so that everything is fixed clearly and accurately,” said the president.
Thirdly, the government and the working group needs to establish close cooperation with extractive companies over Kazakh content. As for the contracts that include quantitative obligations, it is necessary to draw up an agreed step-by-step plan to achieve those rates and to determine what manufacturers can be involved. In the contracts that do not provide for quantitative obligations, it is necessary to establish a Kazakh content level that is acceptable to both parties. All of these should be fixed in appropriate agreements between parties as part of talks with extractive companies. This task should be assigned immediately and be completed until July 2009.
Fourthly, a key component of Kazakh content is local labour resources. Therefore, the Ministry of Employment and Social Security was instructed to adjust the regional employment quota system and stiffen the monitoring of its quality improvement. In addition, it is necessary to invest in human capital. “I have assigned the working group and major extractive companies to determine jointly the need for specialists, to develop quality requirements for their training and, as part of this state programme, to ensure the creation or modernisation of the appropriate educational establishments. Also, similar work needs to be done with regard to geological and engineering specialities for the oil and gas, mining and other sectors.”
Fifthly, it is necessary to invest funds in the development of domestic enterprises that are able to offer their services and products of the required quality and safety. The president assigned the working group to develop and fund a special programme to boost Kazakh suppliers, considering extractive companies' requirements.
In conclusion, speaking to the foreign investors, the president stressed that joint efforts to increase Kazakh content should finally become a mutually beneficial project for all the parties. “With the government's purposeful work and support, you will get Kazakh goods and service suppliers producing qualitative and low-cost goods and services that you need. Moreover, as a result of this work, we will be able to make another contribution to the wellbeing of Kazakh citizens and the welfare of the country where you are working successfully. I am sure that this appeal corresponds to the corporate culture in your companies and in our mutual relations that have take shape over the years of cooperation.”
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