C O N F I D E N T I A L ALMATY 003857

SIPDIS


DEPT FOR EB/ESC; EUR/SNEC (MANN); EUR/CACEN (MUDGE)

E.O. 12958: DECL: 10/19/2015
TAGS: ENRG CH EPET IN KZ ECONOMIC
SUBJECT: KAZAKHSTAN: NEW SUBSOIL AMENDMENTS BROADEN STATE'S
PREEMPTIVE RIGHTS

REF: A. ALMATY 3075

B. ALMATY 3143

C. ALMATY 3296

D. 04 ALMATY 4843

Classified By: POEC Chief Deborah Mennuti, reasons 1.4(B) and (D).


1. (C) Summary: On October 15, President Nazarbayev signed
into law a series of amendments which expand the scope of the
GOK's "preemptive rights" to cover the case of the sale of a
company whose subsidiary conducts subsoil operations in
Kazakhstan. The new amendments appear to have been
tailor-made to apply in the PetroKazakhstan (PK) case (refs
A-C), and rushed into law in advance of the PK shareholders'
October 18 vote approving the company's sale to CNPC
subsidiary PetroChina. Many analysts here believe the
amendments were intended to increase GOK leverage in
negotiations with CNPC over the disposition and pricing of PK
assets, including the Shymkent refinery. While this law will
be ignored by Western courts and financial regulators signing
off on the sale of publicly-held companies, or shares
thereof, the penalty prescribed for non-compliance --
termination of a buyer's subsoil use license -- is real, and
will likely serve the amendments' intended purpose of forcing
prospective buyers to seek GOK approval, and give first right
to the government to purchase "strategic" assets, prior to
concluding a deal. The GOK justified the new amendments on
the basis of "national security." Energy Minister Shkolnik
drew a parallel between the new law and the 1950 U.S.
"Defense Production Act," which, as amended, provided the
legal basis for the "national security" objections to CNPC's
recent bid to purchase UNOCAL.


2. (C) Summary continued. Whatever the GOK's motives in
rushing the package into force, the lasting effect of the
amendments is a tightening of government control over the oil
sector. Furthermore, at least one prominent energy lawyer
here believes that the hastily-written amendments go much
further in altering the legal landscape than the GOK likely
intended. Interestingly, the sale of Nelson Resources --
owned primarily by GOK insiders -- to Lukoil appears to have
beat the implementation of the new law by hours. O

n the
positive side, the amendments relax the complete ban on gas
flaring in effect since January 2005, granting companies
until July 2006 to submit plans for disposing of associated
gas. End Summary.

New Amendments Rushed Into Law
--------------


3. (U) President Nazarbayev signed a package of amendments
related to subsoil use and petroleum operations into law on
October 15, capping a rapid approval process that began on
September 8 when the draft law was first submitted to the
Lower House (Mazhilis). The new amendments modify three
existing laws: the "Law on Oil," the "Law on Subsurface
Resources and Subsurface Use," and the "Law on National
Security." The amendments are logically seen as an extension
of the December 2004 preemption law (ref D), which applied
only to an entity selling an interest in a contract or a
subsurface use right in Kazakhstan. The new law reaches
upward in an oil company's customary chain of parent and
subsidiary companies, extending the GOK's preemptive right
"to any legal entity which may influence, indirectly or
directly, the decisions made by the subsoil user." In the
words (reported in the press) of First Deputy Minister of
Energy and Mineral Resources Baktykozha Izmukhambetov, the
amendments were drafted to confront "...cases of access to
the republic's resources not by way of transaction with the
subsurface user, but through indirect transactions with the
parent company of the subsurface user."



4. (U) The key passage (Article 71.3) on preemptive rights
amends the "Law on Subsurface Resources and Subsurface Use"
(unofficial translation): "In order to preserve and
reinforce the resource and energy basis of the country's
economy in newly concluded, as well as in earlier concluded,
subsoil use contracts, exclusive of contracts of subsurface
water and common minerals, the state has a preemptive right
before the other party to the contract, or members of a legal
entity that has the right for subsoil use, and other persons,
to purchase the alienable right for subsoil use (its portion)


and/or an interest (stock holding) in a legal entity that has
the right for subsoil use, as well as in a legal entity which
may, directly or indirectly, make decisions for and/or
influence the decisions made by the subsoil user, provided
such legal entity's activities are related to subsoil use in
the Republic of Kazakhstan, on the terms none the worse than
those offered by other buyers..."


5. (U) The penalty for noncompliance is defined in Article
45.2, clause 1. As amended, the relevant portion of the
article will read: "(The) competent body has a right to
cancel a contract in a unilateral way in...case of
non-fulfillment of part 3 of Article 71 of the present Law
regarding a state's preemptive right."


6. (SBU) According to press quotes, Energy and Mineral
Resources Minister Vladimir Shkolnik told the Parliament's
Lower House that the GOK "developed the bill after intensive
study of U.S. legislation," and cited a U.S. "law of 1950
that stipulates a federal commission to consider all the
issues of transfer to title of large assets." (Note:
Shkolnik is likely referring to Section 7 of the Defense
Production Act of 1950 -- which, as amended in 1988, provides
for inter-agency USG review of prospective Foreign Direct
Investment which may threaten national security. This
process became news during CNPC's attempted purchase of
UNOCAL. End Note.)

Putting Pressure on CNPC?
--------------


7. (C) Western courts ruling on the sale of shares in
publicly-traded companies (such as the Alberta court
currently considering PK's sale to CNPC) will, by legal
necessity, ignore the GOK's presumption of preemptive rights.
However, the penalty for non-compliance envisioned by the
new law -- potential suspension of exploration and/or
operating licenses -- will presumably be sufficient to drive
any future buyers to seek prior GOK approval, and to give the
GOK an opportunity to purchase desired assets in the name of
"national security."


8. (C) The consensus here is that the law -- first submitted
to the Lower House on September 8, 17 days after the August
22 announced sale of PK to CNPC -- was timed to increase GOK
leverage in negotiations with the Chinese over disposition of
PK's assets, and rushed into law in order to predate PK's
official sale to CNPC. According to one variation of this
argument, the intended pressure may have already borne fruit:
on October 19 the official government paper,
"Kazakhstanskaya Pravda," published a joint CNPC-KMG
(KazMunaiGaz, the state-owned oil company) statement
announcing the October 15 signature of a Memorandum of
Understanding (MOU) governing KMG's "participation in the
purchase of PK shares." The statement announces that KMG
will receive "a right of joint management of the Shymkent
refinery and a right to sell oil products on parity terms
with equal shares from each side." (Comment: Experts here
uniformly agree that, of all PK's assets, KMG most prizes the
refinery. See Ref C. However, skeptics of the theory that
the GOK and CNPC have already reached agreement point out
that if the details of "joint management" of the refinery
have not been agreed-upon behind the scenes - not to mention
the price of KMG's share - the most contentious negotiations
likely lie ahead, and thus the new amendments' effectiveness
as leverage remains to be seen. End comment.)


9. (C) Tom Dvorak, President of PK's "Kumkol" Joint Venture
(with LUKOIL), offered an alternative interpretation of
events. While the announced KMG-CNPC MOU was promising, he
wasn't ready to abandon the hypothesis that the GOK's real
goal was, in partnership with Lukoil, to scuttle PK's sale to
CNPC in order buy PK later at a deep discount. As evidence
of Lukoil's intent, Dvorak pointed to its lawsuit in Canadian
court to stall finalization of PK's sale until after Lukoil's
claim to a preemptive right to the Kumkol field had been
subjected to international arbitration. Such a delay, Dvorak
worried, would surely induce CNPC to rescind its purchase
offer. If the MOU was really a sign of GOK-CNPC agreement,
Dvorak concluded, why hadn't Lukoil dropped its case in
Canadian courts? (Comment: One answer, of course, is that
Lukoil is using its own leverage in negotiations with CNPC to
buy-out the latter's 50% (PK) share of the Kumkol field. End


Comment.) According to Dvorak, yet another possible
scenario, which Energy Minister Shkolnik's recent comments to
the press have reinforced, was that KMG and the Ministry of
Energy were at odds over the sale -- in which case KMG's MOU
with the Chinese represented less than it appeared.

The Law with Unintended Consequences
--------------


10. (C) Legal analysts here fear that the hastily-written law
may have many unintended consequences. DentonWildeSapte's
Marla Valdez identified two: first, the operative definition
of the entities over which the GOK exerts its new preemptive
rights (paragraph 4) was much too broad, and "probably will
apply in more instances than not." Second, the amendments to
the National Security Law appear to obligate the GOK to
consider numerous routine administrative acts, including
"concluding and monitoring (subsurface) contracts," as issues
of "national security." However, according to previously
existing GOK legislation, fundamental provisions of subsoil
contracts, including contract "stability," do not apply when
questions of national security arise. This conclusion --
which Valdez speculates was unintended -- not only
contradicts other fundamental Kazakhstani laws (the January
2005 tax code, for example, grants tax stability to PSA
contracts entered into after January 2004), but, if
implemented, would alter the fundamental operating principles
of Kazakhstani subsoil contracts. The authors of the
amendments, Valdez concluded, "were either really stupid or
really devious."

Nelson: In Under the Wire
--------------


11. (C) Kazakhstan's other headline oil deal -- the sale of
Nelson Resources, a Bermuda-based and Toronto stock exchange
listed company, to Lukoil -- would also appear, at first
glance, to fall within the purview of the new legislation.
Outgoing Nelson Chief Operating Officer Simon Gill told
Econoff, however, that Nelson's well-connected majority
owners (which include the President's son-in-law) managed to
finalize sale of their shares to Lukoil on October 14,
thereby narrowly escaping application of the new law.

Relief on Gas Flaring
--------------


12. (SBU) One provision of the new amendments which will be
welcomed by oil companies is the relaxation of the GOK's
strict ban on gas flaring, enacted in January 2005. The oil
companies had made adoption of a grace period, or
implementation phase, a priority in their 2005 lobbying
efforts.


13. (C) Comment. Many important aspects of this law --
including its intended or effective scope -- are not yet
clear. Nor do we have a reliable sense of how the law is
affecting the closed-door negotiations between the GOK, CNPC,
and Lukoil. We are left with the impression that the GOK is
once again tightening its control over the oil sector,
leaving less and less to the workings of the free market.
Finally, the fact that these amendments appear to have been
cobbled together and rushed to beat an October 18 deadline
only strengthens the perception -- already ingrained due to
the see-saw tax changes of 2004 and 2005 -- that the GOK
lacks a coherent, overarching policy toward energy
investment. End Comment.
ORDWAY


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