KAZAKHSTAN: PETROKAZAKHSTAN LEGAL CASE WINDS DOWN

C O N F I D E N T I A L SECTION 01 OF 03 ASTANA 000817

SIPDIS

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SIPDIS

DEPT FOR EB/ESC; SCA/CEN (O'MARA)

E.O. 12958: DECL: 12/11/2015
TAGS: ENRG EPET KZ CASC
SUBJECT: KAZAKHSTAN: PETROKAZAKHSTAN LEGAL CASE WINDS DOWN

REF: A. 05 ALMATY 3150


B. 05 ALMATY 3857

C. ASTANA 90

Classified By: Pol-Econ Chief Deborah Mennuti; reasons 1.5 (b) and (d).


1. (C) Summary: On November 14, an Almaty district court
convicted three expatriate former executives (two AmCits) of
PetroKazakhstan (PK) of criminal violations of Kazakhstan's
anti-monopoly law. The judge simultaneously granted the
defendants amnesty and lifted a travel ban that had been in
place since the criminal charges were filed in April 2005.
The only AmCit defendant remaining in Kazakhstan, Tom Dvorak,
plans to depart Kazakhstan on December 17.


2. (C) Summary (continued): PK's controversial October 2005
sale to the Chinese National Petroleum Company (CNPC)
recently came two steps closer to closure, as Kazakhstan's
national oil and gas company, KazMunaiGaz (KMG),finalized a
deal on November 16 to purchase 50% of PK's Shymkent
refinery; and Lukoil won an October 30 arbitration ruling
granting it a preemptive right to acquire PK's half of the
Turgai oil field (at the price paid by CNPC). An argument
can be made that the legal case of the PK executives was
manipulated to enhance the GOK's leverage in its post-sale
negotiations with CNPC to acquire a share of the PK assets.
While PK's ten-year experience in Kazakhstan has arguably
been unique, it nevertheless offers several perspectives from
which to evaluate Kazakhstan's investment climate. End
summary.

PK Executives Convicted -- and Amnestied
--------------


3. (C) On November 14, after an intermittent 8-month trial,
an Almaty district court convicted three former expatriate
executives of the Canadian oil company PetroKazakhstan (PK)
of criminal violations of the anti-monopoly law, sentencing
them to three years' imprisonment. (In addition to the two
American citizens, Tom Dvorak and Robert Goldsmith, and a
Canadian, Clayton Clift, the court also convicted twelve
Kazakhstani PK employees.) All the PK employees were then
granted amnesty under a January 2006 "Independence Day"
Amnesty Law, and the court lifted a travel ban in place since
April 2005. (Note: Of the three expatriates, only Dvorak
remained in Kazakhstan through the trial's end. Dvorak told
Econoff on November 29 that he plans to leave Kazakhstan on
December 17. End note.) The defendants have appealed the
conviction.


4. (SBU) Note: Another AmCit PK employee, Dan Hermann, was
granted amnesty in January 2006 in what was, legally, an
unrelated case. Hermann was charged with violating the terms
of PK's exploration license (Ref A).

Origin of the Criminal Charges
--------------


5. (SBU) The criminal charges stem from activities PK
undertook, beginning in 2002, to sell refined products from
PK's Shymkent refinery at prices higher than those
established by Kazakhstan's Agency for the Regulation of
Natural Monopolies. PK executives attempted to avoid the
application of the Monopoly Law by dividing the sales of its
refined products, previously undertaken by a single business
entity, among seven newly-created companies. Each of the
seven companies allegedly managed the volumes of its regional
sales, selling into one another's respective regions, to
avoid establishing the 35% market share required to apply the
monopoly price ceilings.


6. (C) Dvorak told Econoff on November 29 that,
notwithstanding the conviction, the Procurator's case "was
full of holes." One example, he explained, was the fact that
he, Dvorak, did not even begin working for PK until August
2003, and thus could hardly have contributed to the alleged
"conspiracy" begun in 2002 to evade the law. Further, he
argued, the refinery's privatization agreement, drafted in
the late 1990's when the State first sold its interest in the
refinery, guaranteed that the refinery's products would not
be subject to future price controls. And finally, Dvorak
said, the Procurator had never established in court that PK's
distribution scheme had resulted in higher prices for the
refined products.


7. (C/NF) However, Dvorak admitted, in retrospect PK "clearly
should have done things differently." The defendants' case

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had been undermined, he noted, by the exposure of an internal
memo, written by PK's lawyers, warning that creating the new
distribution companies would make the company vulnerable to
charges of anti-monopoly violations.

"Why Us?" -- Making Sense of the Past
--------------


8. (C/NF) In seeking to explain the cause ("why us?") of
their legal problems, the PK executives have favored
different hypotheses at different times. Prior to the
company's announced sale to CNPC, Dvorak and Goldsmith often
defended the thesis that PK's legal problems were the result
of a GOK plot (perhaps in collusion with Lukoil) to drive
down PK's share price prior to a planned bid to buy the
company. According to this theory, KMG had long coveted the
Shymkent refinery. Dvorak and Goldsmith tended to see most
of the company's legal problems in this light, including
several legal disputes with its joint venture partner Lukoil,
and the GOK's enforcement of gas flaring restrictions which
forced a 30% cut in PK's 2005 oil production.


9. (C/NF) Following the announcement of PK's sale to CNPC,
Goldsmith and Dvorak found hope that the legal case against
them would be dropped -- after all, as they argued at the
time, there was no further reason for the GOK to target PK's
stock price. As the legal case against them moved forward,
however, they adopted a different hypothesis: that the GOK,
taken by surprise by the sale, was using the legal case as
leverage in post-sale negotiations to acquire key PK assets
from the Chinese. (Note: Much evidence points to the fact
that the GOK was caught unprepared by the sale, the most
dramatic of which was a series of amendments which the GOK
rushed into law before the deal was finalized (Ref B),which
extended the GOK's "preemptive rights" and thus strengthened
its negotiating position with CNPC. A KazMunaiGaz (KMG)
contact told us at the time that the GOK had been
unpleasantly surprised by the high price paid by CNPC -- a
price KMG would have to match, under the preemptive right
legislation, to acquire the PK assets. End note.)

Refusing Amnesty and Other Legal Oddities
--------------


10. (C) The guilt or innocence of the executives aside, the
anti-monopoly case took more than one questionable turn in
the Winter and Spring of 2005-06, which fed the executives'
sense that they were pawns in a bigger game. The most curious
of these was the Procurator's refusal to apply the Amnesty
Law in January and February 2006, before the case went to
trial, despite PK's repeated legal appeals and Embassy
requests for close consideration. (The Embassy also voiced
concern about the tendency, present both in this case and in
recent AES disputes, of the authorities to file criminal
charges in what are essentially civil cases.) In Spring
2006, the trial judge also refused, during pre-trial motions,
to dismiss the case on the basis of the amnesty -- only to do
so at trial's end.


11. (C/NF) As further evidence that his case was being
manipulated for larger purposes, Dvorak cites the fact that
the list of alleged victims of PK's "monopolistic" activities
-- companies which allegedly overpaid for refined products --
grew in apparent synchrony with the reported intensity of the
GOK's negotiations with CNPC. (The dollar amount of these
alleged damages reached, at one point, approximately $750
million, before shrinking throughout the summer of 2006,
under examination of the court, to approximately $55 million.
These damages represent PK liabilities which CNPC legally
assumed upon purchasing the company. Dvorak, who remained on
PK's payroll even after the company's sale to CNPC, told
Econoff that this (inflated) dollar figure was being used as
a bargaining chip in the GOK-CNPC negotiations.) Dvorak also
asserts that the list of alleged victims of the crime was
populated by numerous brand-new companies created,
presumably, in order to file claims and make a buck from PK's
legal problems. PK's lawyers, Dvorak claims, were able to
establish that fourteen of the allegedly unrelated victimized
companies, in fact, shared a single bank account. Dvorak
believes that the courts may have refused to grant amnesty in
January 2006 in order to allow these "victimized" companies
the opportunity to collect in court. (In denying application
of the Amnesty Law, the Procurator's office cited a need to
gain the consent of all injured parties before applying the
amnesty.) And, finally, Dvorak believes that his own
conviction may have been "necessary" as evidence in the
ongoing legal case to collect the $55 million from CNPC.

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12. (C/NF) Comment: While it is easy to blame Kazakhstan's
weak judicial system for many of the recent legal cases
involving Western investors -- and we readily do so, here, in
the instance of the non-applied amnesty -- it is worth
pointing out that companies take on different level of "legal
risk," by virtue of adopting conservative or aggressive legal
and accounting practices, just as they take on differing
levels of financial risk in making their investments.
PetroKazakhstan, it appears to us, may have pushed the legal
envelope. Even without taking a hard position on the justice
of the anti-monopoly verdict, however, we clearly decry one
of the more insidious aspects of the current investment
climate in Kazakhstan -- the discretion of authorities to
file criminal charges in cases which are essentially civil in
nature, without meeting Western standards for establishing
criminal intent.


13. (C) Comment (continued): With the recent sale of PK and
Nelson Resources, the ongoing CITIC bid to buy NationsEnergy
(Ref C),and growing rumors of a Chinese bid for
MangistauMunaiGas, we may be witnessing the end of the
ownership of Kazakhstan's mid-sized oil fields by private
investors and mid-sized foreign companies. As these
investors move out, cashing in on high oil prices, KMG is
likely to exercise its preemptive rights to take a share of
the assets, thus expanding its onshore presence in parallel
with its legislatively-prescribed requirement to take part in
all offshore projects. Perhaps paradoxically, KMG's growing
presence is likely to improve the investment climate for
project partners. As KMG's Kashagan partners tell us, having
KMG as a partner is helpful when addressing legal or fiscal
issues raised by the GOK. While KMG's new role, onshore and
off, is usually seen as a means to develop the national
company, and gradually expand State ownership and control
over Kazakhstan's hydrocarbon reserves, it may also serve as
means to institutionalize, and thus tame, the "Wild West"
characteristics of Kazakhstan's oil patch. End comment.
MILAS