KAZAKHSTAN: A/S BOUCHER DISCUSSES BUSINESS

C O N F I D E N T I A L SECTION 01 OF 03 ALMATY 001456

SIPDIS

SIPDIS

DEPT FOR EB/ESC; SCA/PO (MANN); SCA/CACEN (MUDGE)

E.O. 12958: DECL: 04/19/2015
TAGS: ENRG EPET KZ AF PK
SUBJECT: KAZAKHSTAN: A/S BOUCHER DISCUSSES BUSINESS
CLIMATE, REGIONAL INTEGRATION WITH BUSINESS LEADERS


Classified By: AMBASSADOR JOHN ORDWAY FOR REASONS 1.4(B) and (D)


1. (C) Summary: SCA Assistant Secretary Boucher discussed
Kazakhstan's business climate, regional economic integration,
and oil and gas infrastructure projects on April 10 with
representatives of American companies operating in
Kazakhstan. While acknowledging that their companies were
thriving in Kazakhstan, especially in the retail and banking
sectors, the executives pointed out obstacles to doing
business in Kazakhstan, including widespread corruption; a
lack of transparency, particularly in tax law and collection;
the Government of Kazakhstan's growing tendency to
"criminalize" civil disputes; and a shortage of technically
skilled Kazakhstani workers. A/S Boucher described the U.S.
Government's vision for regional infrastructure integration,
identifying the electricity sector as the most promising in
the short-run, and pointing out the eventual benefit to
Central Asian countries of tapping the "near-infinite" Indian
market. AES representative Dale Perry told A/S Boucher that
it was "entirely economic" to sell Central Asian electricity
to Pakistan, and described AES's involvement in generation
and transmission projects to that end. A/S Boucher and oil
executives also discussed current and next-generation oil and
gas pipeline projects. End Summary.


2. (U) Meeting Participants: SCA A/S Boucher, Senior Advisor
Caitlin Hayden, Ambassador Ordway, Commercial Officer Mitch
Auerbach, Energy Officer Jim Loveland (Notetaker),Gil
Ankenbauer (Chevron),Dan Connelly (Citibank),Paul Dennard
(ExxonMobil),Courtney Fowler (PriceWaterhouseCooper),Hakim
Janah (ConocoPhillips),Ken Mack (AmCham),Meltem Metin (Coca
Cola),Dale Perry (AES),Andy Peterson (Proctor & Gamble),
Marla Valdez (DentonWildeSapte).

Weaknesses in the Business Climate
--------------


3. (C) While acknowledging that their businesses were
thriving, especially in the banking and retail sectors, the
business leaders used their meeting with A/S Boucher to
describe challenges to doing business in Kazakhstan. There
was widespread agreement, for example, that Kazakhstan
suffered from "endemic" corruption. However, different types
of corruption could be distinguished: at low-levels,
business owners often faced direct appeals for payoffs from
local officials. At higher levels, however, corruption often
took the form of using connections to Nazarbayev's family as
a virtual exemption from regulation and taxation; to not have
those connections meant suffering a comparative disadvantage.
A/S Boucher asked if American companies were exempted from
most bribery demands. The local Coca-Cola representative,
Meltim Metin, acknowledged that the Foreign Corrupt Practices
Act did help shelter American companies somewhat, but noted
that Coca Cola was still "tested" when it expanded its
business into new markets.


4. (C) The executives then described a second set of problems
related to a lack of transparency in tax law and collection.
The Proctor & Gamble representative explained that his
company had suffered several "nasty tax audits" over the
years, but had ultimately won all the cases in court.
Smaller enterprises, however, often did not have the means to
engage in prolonged legal battles -- many of which would drag
on for years, without resolution. The executives identified
several factors which invited the abuse of tax audits,
including hastily-drafted tax law which even the Ministry of
Finance could not definitively explain; the fact that local
tax collection offices were assigned revenue collection
"targets" which had no basis in law; and the fact that no
effective check -- other than the Presidency -- existed to
limit the power of the Financial Police and the Procuracy.


5. (C) Several business leaders expressed alarm over the
Government of Kazakhstan's growing tendency to "criminalize"
civil disputes. DentonWildeSapte's Valdez explained that,
according to Kazakhstani law, the head of a company or the
company's lead accountant could be held criminally liable for

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audit assessments exceeding $12,000. Only recently, however,
had the government begun to use this law as leverage against
companies embroiled in unrelated disputes with the
government. Several executives noted that the Government of
Kazakhstan's tendency to criminalize civil wrongs had
affected their day-to-day operations, as many local employees
were now afraid to sign documents or make critical accounting
decisions, for fear of future criminal liability.

Institutional Issues: Judiciary, Education
--------------


6. (C) DentonWildeSapte's Valdez described Kazakhstan's
judicial system as being of "mixed" quality. Lower-level
judges, especially those outside of Almaty, often accepted
bribes or succumbed to pressures from local officials, she
said. On the other hand, the Supreme Court (which functions
as a general appellate court in Kazakhstan) often issued
well-founded rulings. Valdez characterized Kazakhstani
society as increasingly litigious, as the volume of
commercial transactions increased. Few contracts allowed for
either local or international arbitration, she noted, so most
day-to-day problems were resolved either via negotiation or
in court.


7. (C) The business leaders identified education and training
as another issue of concern, describing their difficulty in
hiring and retaining technically skilled employees.
Employees who were sent abroad on assignment often did not
want to return; when technical employees did return they
often wanted top management jobs. Valdez warned that
Kazakhstani university students were flocking to jobs in
business or real estate, rather than the technical
professions. Due to low salaries, the teaching profession
was attracting even fewer students, she said -- a trend which
would lead to serious long-term problems.

Banking: A Kazakhstani Strength
--------------


8. (C) Citibank Kazakhstan President Dan Connelly told A/S
Boucher that Kazakhstan's banking system was "good," unlike
most of the Former Soviet Union. Kazakhstan's 34 banks
operated on a "pretty level playing field," with rapid rates
of growth. Asked whether certain banks were privileged by
virtue of having close ties to the regime, Connelly
acknowledged that, of the top ten banks, all were owned and
managed by well-connected people. However, Nazarbayev's
family owned only two of the top-ten banks, and of the top
three banks, two were associated more with the opposition
than with the government. Connelly pointed out that the top
three banks held 60% of the system's assets. Their size, he
concluded, gave them a measure of freedom to criticize the
government.

Diversifying the Economy
--------------


9. (C) The meeting participants discussed prospects for
diversifying Kazakhstan's economy away from oil. The
ConocoPhillips representative identified Kazakhstan's push
for a domestic petrochemical industry as one attempt at
diversification. PriceWaterhouseCooper's Fowler remarked that
the draft 2007 tax cuts, if passed as drafted, would create
important incentives for investment beyond the oil sector.
Ambassador Ordway added the field of agricultural processing
held potential, and later observed that the Kazakhstani
Government intended to use the National Oil Fund as an
instrument of diversification, by investing its funds in
high-tech firms abroad. These firms, in turn, could be used
as a base from which to develop a domestic high-tech
industry.

Regional Economic Integration
--------------


10. (C) Asked to describe his vision of regional integration,

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A/S Boucher told the invitees that he was convinced that
"eventually, it has to happen." Governments were already
envisioning the connections; companies would eventually
follow. While stability in Afghanistan was a key, A/S Boucher
acknowledged, it wasn't as big an obstacle as many thought.
Pipelines, for example, "exist in many other unstable
places." A/S Boucher remarked that the "most viable" project
at the moment appeared to be the generation of electricity in
the North for transmission South. Improving road linkages
was also important, though made difficult by the terrain and
Uzbekistan's central location. The real benefits of
integration would be realized, he concluded, when area
countries were able to access the "almost infinite" Indian
market.


11. (C) AES Country Manager Dale Perry told A/S Boucher that,
with power prices in Pakistan five times higher than in
Kazakhstan, the economics were favorable for generating
electricity in Central Asia for export south. To that end,
AES was interested not only in hydropower projects in
Tajikistan, but also in the repair and construction of
transmission lines linking the Tajik grid to Afghanistan and,
eventually, to Pakistan. Ultimately, Perry said, he foresaw
the construction of a North-South direct current transmission
line which would allow coal-generated electricity from
Kazakhstani to offset seasonal shortages in Tajik and Krygyz
hydroelectricity, and vice versa. However, Perry added,
"power should first flow South." To that end, the USG could
help by ceasing to subsidize diesel fuel consumption in
Afghanistan; with the subsidies, imported electricity was not
competitive. Perry noted that the Kazakhstanis, as well, had
expressed interest in investing in regional electricity
projects.

Oil and Gas Pipelines
--------------


12. (C) A/S Boucher asked the oil executives what proportion
of Kazakhstani hydrocarbons transited Russia, and what could
be done to lessen that dependence. Chevron's Ankenbauer
acknowledged that dependence on Russia was a serious problem,
pointing out that, with Tengiz "second-generation" production
volumes coming on-line, and CPC expansion negotiations still
blocked by the Russians, Chevron would be forced in the
short-run to export large volumes of Tengiz oil by rail.
ConocoPhillips' Janah noted that early Kashagan oil would be
barged across the Caspian to the BTC pipeline -- provided
ongoing Kazakhstani-Azeri negotiations over Kazakhstani
access to the pipeline were resolved. A Trans-Caspian oil
pipeline would be a better solution, he added, but had been
blocked by Russian opposition and unresolved Caspian
delimitation issues. The group then discussed other,
less-attractive export options: the second of three stages
of an oil pipeline to China had recently been completed, but
that export route provided the Kazakhstanis with only a
single, monopsonistic buyer. Total and Shell were still
exploring a possible pipeline to Iran; however, U.S.
opposition and questionable economics would likely keep the
project from being realized. Finally, the oil executives
voiced doubt that an oil pipeline could be constructed
directly from Kazakhstan to Pakistan or Afghanistan, due to
the challenging terrain.


13. (U) A/S Boucher has cleared this message.
ORDWAY