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Oil property redistribution
Sergey Smirnov

At the beginning of 2010 the government of Kazakhstan, which earlier was affirming the investors about "inviolability" of the tax regime for oil contracts, said that it could revise their conditions and cancel the privileges. Apparently, these words will be followed by actions. At least, the evidence is in the number of inspections, fees and criminal charges, imposed onto a number of petroleum companies…

Since Kazakhstan gained its independence the implementation of the biggest and most promising projects in the oil and gas industry (specifically, the development of the fields of Tengiz, Kashagan and Karachaganak) was delegated to the consortiums of international oil companies. At the same time, the role of the oil and gas sector in the economic structure was constantly increasing in importance. In 2009 the sector’s share in GDP reached 20.8% while in the state revenues – 40.5% or 1,451.2 billion tenge. It is not surprising that in the last years the strengthening position of the state became the major trend in the balance of power in the oil fields of Kazakhstan. Thus, using the delayed terms of the Kashagan field development, the supply from which was expected to be launched in 2005, as well as the dramatic increase of implementation costs of the North Caspian project, the government demanded a share in this project for the KazMunayGas National Company. In 2008 the national company entered the structure of the leading consortium members, gaining 16.81% of shares (the same volume is held by ENI, Total, ExxonMobil and Shell).

In the last years KMG also became a large shareholder of such companies, as Kazgermunay (50% stake), Karazhanbasmunay (50%), Kazakhturkmunay (51%), PetroKazakhstan Inc (33%). Last year Kazakhstan took a loan from China in the amount of $10 billion and part of this loan was used to finance the purchase of 50%+2 shares of the Mangistaumunaygas Company – another big oil and gas producer, owning a number of promising fields.

It has to be mentioned that sometimes the government puts pressure through regulation and tax authorities with the purpose to acquire assets in this strategic sector of economy. This helps decrease the acquisition cost of assets and (or) compel the owners to sell them or reconsider the contract conditions.

Recent examples of such pressure on subsoil users, put by the state, was the situation with Tolkynneftegas LLP, Kazpolmunay LLP, Karachaganak Petroleum Operating B.V. (KPO) Consortium, and Tengizchevroil JV (TCO).

The arrested contract

Since July 21, 2010 the Oil and Gas Ministry terminated ahead of time the subsoil use contract of Tolkynneftegas LLP and Kazpolmunay LLP, owned by Moldavian businessman Anatol Stati. During the operations period these enterprises managed to increase annual production of liquid hydrocarbons from little over 100 thousand tons in 2002 to 365 thousand tons and 264 thousand tons in 2008 at the owned fields (which were considered non-commercial during the Soviet period).

Last year, it was "suddenly" revealed that the Moldavian investor exported raw material, without having the appropriate licenses for exploitation of the Kazakhstani trunk oil and gas pipelines. It is interesting to note that in the last 8 years the regulating authorities have not paid attention to this "illegal oil and gas traffic" during scheduled and unscheduled inspection of Tolkynneftegas and Kazpolmunay operations. In its turn, the management of these companies affirms that oil and gas pipelines, reflected in the book of Kazpolmunay LLP and Tolkynneftegas LLP, are the infield ones "which were perfectly known by the Oil and Gas Ministry since all project documents were endorsed by the competent authorities".

Nevertheless, turning the infield pipelines into trunk pipelines and identifying the blatant fact of the illegal export, the investigation estimated the damage, caused to the state by the foreign investors, in the amount of 147 billion tenge. In concern with "identified" illegal entrepreneurial operations, the authorities had initiated a tax inspection that revealed multiple violations of the tax payment schemes. As a result, criminal cases were filed against the managers of the company, the contracts were arrested, and the contract territories were transferred for trust management by KazMunayGas NC. The truth will be revealed by the Stockholm international arbitral court, where the affected party filed the lawsuit.

So far, according to the estimate of Fitch Ratings Agency, the situation with Kazpolmunay and Tolkynneftegas may lead to a change of control in the bond documentation while Tristan Oil Ltd, their parent company, is unable to perform the obligation on purchase of bonds due to a weak financial position.

“…and marked with red flags”

Today, the Oil and Gas Ministry is negotiating with Karachaganak Petroleum Operating B.V (KPO) on acquisition of up to a 10% of stake in the Karachaganak project – the only big oil and gas project in Kazakhstan that has 100% foreign capital. After such willingness of the government was announced by Prime-Minister Karim Masimov in December of the last year the consortium had to face a large number of inspections. As a result, KPO was marked with red flags of criminal charges and fees. Thus, the office of the Public Prosecutor of Western Kazakhstan Oblast penalized the company for $21 million for the violation of environmental laws that took place in 2008.

March was continued by pro-Prosecutor inspection of the consortium for observance of "labor and migration legislation application issues" and identification of large violations. The authorities revealed repeated tax evasion cases during 1999–2005, causing damage to the state in the amount of over 8 billion tenge. The supervisory body had questions on work authorizations and visas of 270 employees of the enterprise. In its turn, the financial police blamed the consortium in generation of illegal revenue from oil production in the amount of $700 million.

Additionally, the financial police filed criminal cases against KPO management for illegal production of petroleum (it was identified that in 2008 the consortium illegally produced 1.1 million tons and 94 thousand tons of condensate in addition to the annual work program, approved by the Ministry of Energy and Mineral Resources; as a result, the consortium gained illegal revenue for an amount over 104 billion tenge) as well as "the fact of embezzlement of 187 billion tenge through overestimation of costs on oil production in the above-mentioned amount during 2002–2007 and sale of oil to the customers for this amount". The number of revealed violations was increasing rapidly despite the fact that the BG Company, a British member of the concern, won the prize of "Best foreign investor in Kazakhstan – 2008".

However, after a few months of pressure the authorities decided to put away the cases, filed against the company, and started negotiations with its owners. "We expressed our readiness to acquire a 10% stake upon the availability of acceptable commercial conditions. The negotiations between the Oil and Gas Ministry of Kazakhstan and Karachaganak Petroleum Operating consortium on increased participation of the republic in the project of development of one of the biggest oil and gas condensate fields in the world are progressing in a constructive environment", Sauat Mynbayev, the Oil and Gas Minister, informed in July.

According to Reuters, 5% will be transferred to the state in exchange for cancelling (for KPO) the recently accepted export customs duties or reduction of lawsuit amount by Kazakhstan by $1.3 billion. Another 5% will be sold. Nevertheless, the final agreements have not been reached yet. The analysts believe that the obstacle was non-readiness of Chevron Company (owning 20% stake in KPO) to give up a part of its stake in the project. The reaction of the official government was prompt.

The Oil and Gas Minister blamed Tengizchevroil (where Chevron owns a 50% stake) in violation of the petroleum production contract conditions. The Prosecutor General’s Office and financial police immediately interfered in the case. The case against TCO was filed under article 190, RK Criminal Code, on "illegal entrepreneurship, conjugated with the generation of revenue on an especially large scale". The reason is illegal oil production by the company for total the amount of 212.4 billion tenge.

According to the financial police, the inspection identified that 41 wells at the Tengiz field were drilled below the set level – 5100 meters and "during September 1, 2002 – June 1, 2010 10 wells extracted over 3.4 billion tons of oil outside the borders, set by mining allotment". The company management immediately denied the charges, saying that it produces the oil in full compliance with the contract responsibilities. It has to be mentioned that between 1993 and beginning of 1996 TCO was producing oil without a mining allotment, but the regulating authorities never had any claims against this.

In mid-August Mr. Mynbayev disavowed his own statement, admitting that the claims on depth of production at Tengiz were not reasonable. "Indeed, the contract does not give specification (on the depth of allowed processing of oil), it needs to be discussed and we need to reach some agreement… I do not believe it will take long – we just need to put everything in order", he said. Nonetheless, the criminal case is still not closed and the investigation is still in progress.

TheTengizoilfieldwasdiscoveredin 1979. It is one of the deepest and biggest oil fields in the world. The total explored reserves of the Tengiz collector reaches 3 billion tons (26 billion barrels) and another 190 million tons (1.5 billion barrels) in the Korolevskoe field. Tengizchevroil LLP JV, the field developer, was established on April 6, 1993, based on an agreement between the Republic of Kazakhstan and the Chevron company. Today, the partner-owners of TCO are ChevronTexaco Overseas – 50%, KazMunayGas NC – 20%, ExxonMobil Kazakhstan Ventures Inc – 25% and LukArko JV – 5%.

In the first half of this year the company produced 12.5 million tons (99.5 million barrels) of crude oil. The volume of crude oil sales in this period reached 12.8 million tons (100.3 million barrels). TCO exported the Tengiz oil by several routes. About 8 million tons of oil was sent to Novorossiysk by CPC pipeline while the remaining volume was transported by railroad to Odessa, Feodosiya and Aktau, from where it was shipped to Batumi and Kulevi.

"Post flight" analysis

In the opinion of analysts, the aggressive approach to dialogue and putting pressure on foreign investors may evidence that the government of the republic is interested in gaining stakes in the company and, specifically, it wants to reconsider FPSA conditions on Karachaganak to the benefit of Kazakhstan. There is lucrative pie there.

The Karachaganak reserves are estimated at over 1.2 billion tons of oil and condensate and 1.35 trillion cubic meters of gas. Today, it annually produces almost 12 million tons of liquid hydrocarbons and about 15 billion cubic meters of gas, delivering about 18% of oil and condensate and over 45% of gas in total production volume to the republic. At the same time, the field is distinguished by a complex geological structure, significant fluctuations of pressure and bedded structure, high content of not only condensate but also toxic corrosion-active elements. The KazMunayGas National Company is not able to develop it independently, but it is strong enough to get a stake in the project. The best confirmation is in the scheme of such participation that was already worked out in a number of companies.

On the other hand, it is unlikely that the 10%, the government is looking for, will be enough for it to make a decision in KPO. The government would need the status of a big project participant and operator along with BG and Eni, but today such redistribution is not possible. The control is not only the purchase of a stake by the state. Here, the party needs to observe the environmental norms and solve the social problems in the region.

In respect to Karachaganak – it is the solution of the dwellers’ problems at the Berezovka village, located within the sanitary protection zone of the field that needs to be relocated from the dangerous zone. This is an old problem, constantly avoided by everyone – from the government to the consortium. As a result, the residents of Berezovka – citizens of the republic, owning the mineral resources – are in the role of natives, deprived of civil rights.

Undoubtedly, there is nothing wrong with the fact that, today, the government of Kazakhstan, correcting the previous mistakes, reconsiders and re-estimates the subsoil use contracts, signed in the middle of 1990s. The point is how it is implemented.

The absence of rules of the games in the oil market and strict administrative pressure on foreign investors, periodically put by the government, leads the oil industry to the process of permanent property redistribution, in "turbid water" of which often times more skilled officials are fishing for their own tables. Another negative side is that, in protecting the national interests, the government prefers to use the whip.

The Karachaganak oil and gas condensate field, located in the north-western part of Kazakhstan, was discovered in 1978. It is one of the most productive in the world in terms of oil and gas production. The roof bed of oil and gas bearing collector is located at the depth of 3,500 meters and reaches 1,600 meters in thickness. The development of the field was launched in 1984 and its reserves are estimated at over 1.2 billion tons of oil and condensate and 1.35 trillion cubic meters of gas. The field is distinguished by a complex geological structure, significant fluctuations of pressure and bedded structure, high content of condensate (490 to 1000 g/cubic meter) and toxic corrosion-active elements. About 80% of liquid hydrocarbons are exported to the world markets in the form of stabilized crude oil by the pipelines of CPC and Atyrau-Samara. The produced gas and unstable condensate are supplied to the Orenburg gas processing plant, located 130 kilometers away from the field.

After the collapse of USSR the republic had announced the international tender that was won in 1992 by British Gas and Italian Agip. Later on there were changes in the content of members: in the end of 1990s besides British and Italian companies the consortium accepted Russian LUKOIL and American Texaco, which was later on included in the Chevron Company. Today, in accordance with final PSA (FPSA), signed on November 18, 1997, the field development is implemented by Karachaganak Petroleum Operating B.V. international consortium (BG Group – 32,5%, ENI – 32,5%, Chevron – 20%, LUKOIL – 15%). According to the agreement conditions, the consortium will manage the Karachaganak project until 2038 and its members are subject to no new taxes and fees. 

At the moment, the project is at the second phase, the implementation of which allowed doubling the production volume thanks to reinjection of produced gas into the reservoir, reaching the volume of almost 12 million tons of oil and condensate and 14-15 billion cubic meters of gas per year. Therefore, Karachaganak delivers over 45% of the total gas production and 17% of the total liquid hydrocarbon production in the republic. At the same time, in the last several years its operators have been delaying the implementation of third phase events, assuming the growth of annual production volume of liquid hydrocarbons to 15 million tons. Earlier, the consortium reasoned it to the willingness to cover the costs first thanks to the export of raw material; later on, in 2009 to the "complex global economic situation, unstable raw material prices and new structures of capital expenditures that have not been adapted to today’s conditions yet".


Table of contents
Oil property redistribution  Sergey Smirnov 
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