Oil and Investments. Risks and Оpportunities
Last February, Almaty hosted the oil and gas summit – The Kazakhstan Oil and Gas 2015 with participation of a number of eminent experts. One of the most discussed topics of the Forum were the trend of the global oil market, conditions for attracting new investors, as well as the measures to improve the investment climate in our country.
The Summit, organized by the British company Oliver Kinross, was attended by representatives of the oil and gas companies and State authorities of Kazakhstan, as well as by the reputable domestic and foreign oil&gas experts. The agenda proved to be quite diverse and rich, but we decided to focus only on the themes, that we found the most interesting. Above all, the facts that interferes with the arrival of new investors in the oil industry and generally, into the economy of Kazakhstan.
Production Is On Rise and Demand Falls
The presentation of Sam Berrows, Director of Marketing and Business Development , Max Petroleum, turned to be very interesting from the viewpoint of the global situation in the hydrocarbon market. The speaker emphasized the high volatility and the instability of the global oil prices seen over the past two decades.
For example, if in 1995 the average price of “black gold” was only $19 per barrel, then in 2012 it rose to $112, and this year it had dropped to $55. The peak value was observed in June 2008, when the oil prices reached a historic high of $140 per barrel.
It is interesting enough that in the period under review, the increase in oil prices was in line with the increasing demand. Only for the period from 1995 till 2004 the demand rose from 70 million to 80 million b/d, in 2012 it reached 90 million, and this year is projected to be at 93.3 million b/d. Nevertheless, the volume of deals has grown even faster: over the past 20 years, the oil&gas production has increased by 44% according to the expert opinion, and based on the results of 2015. it was equal to 94.3 million b/d. As a result, the present-time global oil market has an excess supply of hydrocarbons.
Speaking about the main players, Mr. Barrows particularly highlighted the OPEC countries, which increased their exports to 20% – from 25 million b/d from the current quota of 30 million bpd. However, the given quota is not always observed. So, in 2008, the cartel produced 32 million b/d, which largely led to price drop and reduced demand. As a result, in the next two years, OPEC production has been reduced to 29 million b/d.
Still, the main drivers of growth in the global oil supply during the past 20 years have been the countries outside OPEC. Only Russia increased its oil production last year up to 10.6 million b/d, which was a record for this country. Moreover, from 2010 to 2015, the production of liquid hydrocarbons in North America increased for 39% and for 35% in Africa, Asia and Latin America. In the case of removing the sanctions from Iran, the oil resource supplies to the global market will grow even higher.
The last twenty years has been very successful also for Kazakhstan, which was able to increase its oil production during that time in 4 times with 415 thousand up to 1.7 million b/d (or up to 82 million tons). At the same time, the half of the total production in our country is still produced from two largest fields – Tengiz and Karachaganak. If back in 1995, each field produced 2.5 million tons (with Republican production of 19 million tons), in 2012 Karachaganak reached 12 million tons, and Tengiz – 27 million tons.
However, as explained by the speaker, most recently there has been a negative trend in the industry development. During the period from 1995 to 2010 year, the average production growth rate in Kazakhstan amounted to 10%, but 2010–2014, it dropped to 1% and in 2015, according to Mr. Barrows, our petroleum industry will face a negative result.
In many ways this will be due to the expected imbalance of supply and demand on the global market. According to the expert, China, after increasing the volume of its hydrocarbons at the beginning of this year, will start to reduce the process by the middle of the year. Besides, the China and India increased taxes for the fuel transportation that will hold the Asian demand "at the bottom level". Japan can slightly increase its oil consumption, since its economy now looks "healthier". However, one can not expect a considerable increase in the supply of liquid hydrocarbons to North America and Europe, as demand in those regions remains almost unchanged. As a result, the balance of the global oil market does not give reasons for increasing the oil prices in 2015 above $55 per barrel.
Potential Is Under Threat
In his turn, Aydarkhan Kussainov, Director of consulting company Almagest, focused on the macroeconomic situation in Kazakhstan. "The economic growth has been declining over the past few years. If in the past decade, the average GDP growth rate was 10%, in the current year it is lower than 5%". The negative trends for the future of our economy are not encouraging. "Forecasts for this year remain conservative. Most recently, the GDP growth estimates for 2015 were reduced to 1.5%. The public investments and spending decrease due to these factors. The expenditure part of the budget was cut by 10%, and the investments of Samruk-Kazyna JSC – by 18%. The trade balance remains under pressure".
Mr. Kussainov also noted that after the crisis of 2008–2009, Kazakhstan's banking sector continues to face the difficulties; therefore, in the given circumstances our banks are not capable of playing "significant role as a financial intermediary this or next year".
He focused special attention to the functioning of the Eurasian Economic Union, describing the formation of the common market as a controversial factor in the background of a rapidly weakening rouble. The expert justified his position by the fact that in relation to the oil market of Kazakhstan, the devaluation of the Russian currency had a negative impact on domestic oil refineries, when higher quality and less expensive Russian fuel pushed the local products from the market.
Speaking about the relations of the oil business and the government, Mr. Kussainov said that nowadays the government is ready to dialogue with the companies to solve their urgent problems. The reason is the sharp decline in oil prices. "As far as I know, there is the issue of changing the tax regime for the extractive companies. It is especially true for the mature fields with high production costs. It means that the Government understood that it is not possible to support the subsoil users only through the reduction of export duties for oil producers alone".
Moreover, the Head of Almagest does not exclude that the Government might proceed with "mass field sales” to strengthen the income part of the budget. Therefore, as to revising the tax burden for oil companies, the reduced export duties and high probability of selling rights to develop new resources are implemented to create the favourable conditions for the access of new players to Kazakhstan’s oil and gas market. However, the speaker warned the investors about the potential risks of labour conflicts in the extractive companies. As a result, the issues of social responsibility in the industry remain highly relevant in the long term. "Disclosing the information, social stability, support for the SME are a mere economic or commercial tool. It becomes a tool for the social risk management. And this is very important for the operators in terms of cooperation with the State".
Vicious Circle of Problems
The arguments of Aydarkhan Kussainov about the prospect of the current situation for new investors is understandable. A crisis always means the new opportunities. However, by fighting for the new investors, Kazakhstan has to compete with a number of other oil-producing regions. In this regard, we found very interesting the information, provided by Robert Manson, Vice President, Geological Exploration of Petrotrans Company Ltd. His presentation is mainly based on the conclusions of the expert studies, ensured by the American Chamber of Commerce: "Improving Kazakhstan 's investment climate: top ten barriers for foreign investment", held in May of the last year. They recognize that since its independence, our country has significantly improved its business and investment climate. At the same time, there were a number of issues that have so far deterred the potential investors.
In this connection, the Government should improve the conditions for fair competition and to avoid taking the decisions administratively. "Advancing the specific goals of these reforms according to "top-down" principle, will create an environment of constantly changing rules, resulting in difficulties for the officials and the businessmen to follow the laws. This prevents the creation of a good investment climate".
According to the Chamber experts, whatever attractive the idea may appear to support a particular sector or political priority, some actions, albeit with good intentions, can reduce the predictability of the investment decisions and lead to a loss of investor confidence.
The paper stipulates top 10 barriers to improving the investment climate. The main obstacle remains the problem of an independent judiciary system. "Without resolving that issue, the investors don’t feel protected against incorrect action on the part of public authorities or the competitors".
According to the American Chamber of Commerce, the officials need to pay more attention to the issue of ensuring the rule of law and the independence of the courts to change the situation for the better, and they should not use its influence to make the right judgements.
Another obstacle is the legal uncertainty. "Investors are often seen that an unintentional mistake or an open divergence in opinion with the regulatory authorities could soon turn out to be the reason for individual criminal responsibility. This places a shadow on investors' confidence".
The third barrier to improve the investment climate is the corruption. To overcome this obstacle, the investors recommend to take the fight with the corruption from the scope of the exclusive competence of the financial police and to place it into the category of national objectives.
The environmental fines were listed among the harmful practices, since they are not defined in accordance with the potential or actual harm, and the proceeds are not purposed for the damage repair. "In this context, the investors they are perceived as symbolic or a short-term source of income, almost without any connections to the intended policy objective to protect the environment."
In this regard, the Chamber appealed to bring the system of fines in line with the stated political objective. For example, by allowing businesses to restore damage done independently by linking the compensation with environmental harm".
Another obstacle is the defficient tax system. "The taxes are justified in general, however, there are two issues of concern: VAT reimbursement and double taxation for the general and administrative expenses of a company’s head office".
As to the customs duties, the investors do not see any problems in this area. However, the American Chamber of Commerce consider them as "the areas of high volatility and possible corruption”. These risks can be reduced with “one contact” principle, as well as online filing.
The issue of work permit delivery seems much more worrying problem for the Chamber. “It's not enough transparent practice. For investors, it is a sign that they are not appreciated. The companies complain that in the case of denial of permission they are not given any explanation, that the requirements do not correspond to the necessary skills and that application and renewal processes for the existing permits remain too difficult".
The similar questions from investors raise the local content requirements, because in spite of years of practice, they do not see sufficient evidence that their compliance actually increases the competitiveness of local companies.
Another important area for the American Chamber of Commerce was an intervention to the business processes from the State. “The National Chamber of Entrepreneurs raises a number of concerns. Firstly, it is not clear how an authority, established by the Government, which has strong links with the public sector and governmental agencies, can be the voice of the business. Secondly, the mandatory membership and increasingly high membership fees are evaluated by the companies as an additional and unexpected tax".
The investors are not optimistic about the fact that half of the assets in Kazakhstan are owned by the Fund Samruk Kazyna and Baiterek Holding. This means that they virtually unreachable for the private investors. As a result, there is a lack of medium-sized companies, which remain a high-priority sector for investors. "The purpose of the State is to attract private funding for the infrastructure projects and it is likely to remain untouched, unless the laws on concessions will not be revised".
As mentioned by the experts of American Chamber of Commerce, while there will be no "significant progress" in addressing these barriers, the foreign consultants and representatives of the Chamber will not be able to recommend to invest in Kazakhstan ‘more confidently”.
With regard to the problems of doing business in the oil industry, they were listed by other speaker of the Summit – Thomas Quigley, General Manager of OMV Petrom Kazakhstan. Despite the many positive factors for the activities of their company, he noted the commitment of the State to increase the mandatory requirements for the supply of oil within Kazakhstan as a negative factor. "The contracts stipulate that quota to supply oil to the domestic market is 20% and the export quota is 80%. But increasingly, there is pressure on us to leave as much as possible export resources in the country". Among other important issues, the speaker highlighted the growth of tariffs for services of public monopolies, as well as the practice of government procurement.
Mr. Quigley reminded that the foreign companies have invested considerable funds into the economy, and they always considered the position of the State in matters of social stability and sustainable development with understanding related and therefore, were ready to cooperate in this area. And presently, when the global market environment does not allow companies to generate the sufficient cash flows, they expect a reciprocal support from the Government.