RESOURCE NATIONALISM IN KAZAKHSTAN: SOME

C O N F I D E N T I A L SECTION 01 OF 03 ASTANA 003379

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E.O. 12958: DECL: 12/27/2017
TAGS: PREL PGOV EPET ECON KZ
SUBJECT: RESOURCE NATIONALISM IN KAZAKHSTAN: SOME
DISTRESSING SIGNS, BUT INVESTORS STILL WAITING IN LINE

REF: A. STATE 150999 B. ASTANA 2931 C. ASTANA 3226 D.
ASTANA 2586 E. ASTANA 1240

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


1. (C) Summary: With a burgeoning self-confidence fostered
by impressive economic growth, Kazakhstan is exercising
tighter control over the exploitation of its natural
resources. New laws,including an amendment to the law on
subsoil use which allows for the termination of a subsoil use
contract if the contractor's actions violate Kazakhstan's
economic security interests, impact foreign investors.
Kazakhstan is placing additional pressure on international
energy companies by aggressively pursuing environmental and
tax claims. Nevertheless, Kazakhstan is unlikely to foresake
its international partners because it cannot exploit its
largest oil and gas fields on its own. Moreover, Kazakhstani
officials have thus far demonstrated an understanding that an
overly nationalistic approach in the energy sector will
negatively affect the country's effort to diversify its
economy. End Summary.


The Legal Framework: Changes Strengthen Kazakhstan's Hand
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2. (C) Claiming that the conditions of previously signed
contracts are too favorable to foreign partners, Kazakhstan
has made several changes to its subsoil use laws to
strengthen its position and that of the national oil and gas
company, KazMunayGas (KMG). In October, President Nazarbayev
signed into law an amendment to the "Law on Subsoil and
Subsoil Use" which gives the Government of Kazakhstan (GOK)
the power to terminate a subsoil use contract if it
determines that the contractor's actions violate the national
economic security interests of the country (Reftel B). The
GOK has stated that only a "limited list of strategic
objects" will be subject to the amendment, but has not yet
publicly declared which projects will be defined as strategic
objects. The Ambassador has received high-level assurances
that the amendment will not be used against the consortium
developing the Kashagan field. On November 30, Deputy
Finance Minister Daulet Yergozhin told Charge that the
amendments will not be used against any American company. He
added, however, that the amendment will be used. (Ref C)
(Comment: Post believes that the GOK introduced the amemdment
primarily as protection against the perceived dangers of
Chinese and Russian over-investment.)


3. (C) The GOK has also introduced several other laws in
recent years to increase its control over Kazakhstan's
natural resource sector. New laws on production sharing
agreements (PSAs) and subsoil use, passed in 2004, stipulate
that KMG must have at least a 50% stake in all new projects
and act as a contractor in all new offshore PSAs. A January
2007 amendment to the "Subsoil Use Law" prohibits the
assignment of subsoil use rights within the initial two years
of the contract's effective date. The amendment also further
tightens the GOK's application of local content requirements,
mandating that companies meet local content benchmarks
annually, rather than on the average over the lifetime of a
project. Subsoil user entities are now required to submit an
annual procurement program and to maintain a national
register of goods, works and services consumed or supplied
for subsoil use operations.

Future Production: A Bigger Role for KMG, Leveraged Deals
-------------- --------------


4. (C) Kazakhstan has been increasingly assertive in pushing
for an enhanced role for KMG in both existing and potential
projects. The latest delays and cost overruns on the huge
Kashagan project, the world's fifth largest field in terms of
reserves, led Kazakhstani authorities in August to demand new
PSA terms. Among the chief demands they have made to the

ASTANA 00003379 002 OF 003

SUBJECT: RESOURCE NATIONALISM IN KAZAKHSTAN: SOME
DISTRERRING SIGNS U INVESTORS STILL WAITI I`QinE**kaSHqWqn so~soj|qum m$an mjcrcgqg`"wv`hd"elr!LF)LGQQelQThe Ministry of Finance has indicated that it intends
to increase its scrutiny of foreign oil companies. During an
October bilateral meeting between the IRS and the Ministry of
Finance's Tax Committee on a tax treaty issue, two Ministry
of Finance officials appeared and introduced themselves as
members of a "special unit" created to investigate foreign
subsoil use companies. They asked the IRS for detailed
information on Chevron. When the IRS refused, the "special
unit" representatives responded that they intend to pursue
Chevron aggressively and shift the burden to the company to
prove that it adheres to all of Kazakhstan's tax regulations.
The Ministry of Finance is also currently completing an
inspection of Agip KCO's (Kashagan) compliance with Kazakh
tax law. Deputy Minister of Finance Daulet Yergozhin told
the media in November that the Ministry of Finance has
several concerns about Agip activities.


7. (C) Kazakhstan's environmental authorities have also been
more active in bringing claims against subsoil users. In
2006, the Ministry of Environmental Protection threatened to
revoke Tengizchevroil's (TCO) operating license, claiming
that TCO "violates the enviromental law regularly." In
August 2007, the Atyrau regional environmental prosecutor's
office made a claim against TCO for 74.4 billion tenge ($575
million) for alleged "systematic failure to comply with the
requirements of safe sulfur recovery." The court reviewing
the claim affirmed the violations but reduced the fine to 37
billion tenge. The Environmental Ministry has also waded into
the Kashagan dispute. On November 5, Minister of
Environmental Protection Nurlan Iskakov threatened to suspend
the activities of Agip KCO, the consortium developing
Kashagan, if it failed to present a plan for responding to
environmental complaints. The very next day, Iskakov
retracted his statement and announced that the Ministry had
no intention to shutdown Agip's operations,

Factors That Work Against Resource Nationalism: Ongoing
Successes and Economic Diversification Plans
-------------- -


8. (C) Despite troubles at Kashagan, Kazakhstan's energy
sector is generally humming along to the satisfaction of both
the Kazakhstanis and international investors, with several
notable successes. Karachaganak, developed by a consortium
of BG, Eni, Chevron, and Lukoil, is one of the largest
projects in Kazakhstan, with investment of over $5.5 billion.
The field holds over 1.2 billion tons of oil and 1.35
trillion cubic meters of gas. The giant Tengiz field, a
joint venture currently owned by Chevron, ExxonMobil, KMG,
and Lukoil, produces 300,000 barrels of oil a day, with plans

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to double production in the near future. The TCO consortium
has added $9 billion dollars to Kazakhstan's budget in taxes
and royalties. GOK officials acknowledge that western
technology and expertise has been instrumental at Tengiz and
Karachaganak.


9. (C) President Nazarbayev has stated on numerous occasions
that one of Kazakhstan's top goals is to join the ranks of
the fifty most competitive countries. Kazakhstan already has
the second highest per capita GDP in the former Soviet Union,
and the country's GDP has grown by at least 9.4% per year in
recent years. As part of its effort to join the fifty most
competitive states, Kazakhstan is making a strong effort to
diversify its economy with programs such as "The State
Program 30 Corporate Leaders of Kazakstan" which aims to
strengthen 30 leading companies and to involve them in
breakthrough projects. To date, the GOK has demonstrated an
understanding that attracting foreign investment in the
non-extractive sector cannot be decoupled from its actions in
the energy sphere.

Comment
--------------


10. (C) In recent years, conditions have changed for foreign
investors in Kazakhstan's natural resource sector. Kazakhstan
now feels empowered by its growing economic might to
reexamine terms of existing investment agreements and to
drive a harder bargain with future investors. This trend will
continue.


11. (C) Nevertheless, with money pouring in from the oil and
gas sector and ambitious economic diversification plans
dependent on a healthy investment climate, Kazakhstan is
unlikely to tilt too far towards resource nationalism; the
country has too much to lose. Kazakhstan's leaders
understand this, but the U.S. should reinforce the message
when necessary.

ORDWAY