KAZAKHSTAN: AES AGREES TO EARLY BUY-OUT OF EKIBASTUZ

UNCLAS SECTION 01 OF 03 ASTANA 000555

SENSITIVE
SIPDIS

STATE FOR SCA/CEN, EUR/CARC, EEB/ESC
STATE PLEASE PASS TO USTDA FOR DAN STEIN

E.O. 12958: N/A
TAGS: PGOV ECON ENRG EINV KZ
SUBJECT: KAZAKHSTAN: AES AGREES TO EARLY BUY-OUT OF EKIBASTUZ
MANAGEMENT CONTRACT

REF: (A) 08 ASTANA 2177 (B) 08 ASTANA 2086

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1. (U) Sensitive but unclassified. Not for public Internet.


2. (SBU) SUMMARY: On March 20, Kazakhstan's largest private mining
company, Kazakhmys, terminated after just 15 months a three-year
management agreement for U.S. power company AES to run the Ekibastuz
coal-fired power plant. The contract, which was scheduled to end on
December 31, 2010, would have paid AES $381 million if the company
had met certain revenue targets. Instead, AES will receive $80
million in April 2009 and $102 million in January 2010. AES
Kazakhstan publicly called the early termination a "mutual decision
that will benefit both AES and Kazakhmys." In private conversations
with us, company officials blamed the economic crisis for the
termination, and also suggested that state-owned company
Samruk-Energo played a role in the decision. An industry analyst
argued that AES no longer has anything of value to contribute to the
development of Kazakhstan's energy sector. END SUMMARY.

AES'S EARLY DISMISSAL


3. (U) On March 20, Kazakhstan's mining giant Kazakhmys announced
the early termination of a management contract with AES for the
latter to run the Ekibastuz GRES-1 coal-fired power plant as well as
the Maikuben coal mine. In May 2008, Kazakhmys acquired Ekibastuz
and Maikuben from AES for $1.5 billion. Under the terms of that
agreement, AES was to operate Ekibastuz on behalf of Kazakhmys until
December 31, 2010. The three-year management contract was to pay
AES up to $381 million if the company met targets for revenue,
profitability, and capital improvements. Under the terms of the
buy-out, however, Kazakhmys will pay AES $80 million in April based
on 2008 results and $102 million in January 2010. Kazakhmys's CEO
thanked AES for facilitating the management transition and said,
"This agreement reduces our cash commitments, which is welcome in
the current environment. It should also allow us to create a more
integrated approach to all of our power facilities, which together
represent over 20 percent of Kazakhstan's power output." Since
1996, AES has invested over $200 million in modernization programs
bringing into operation more than 2,000 megawatts of generation
capacity at Ekibastuz.

ECONOMIC CONDITIONS BLAMED FOR EARLY TERMINATION


4. (SBU) On March 24, AES Vice President Mike Jonagan told Energy
Officer that the early buy-out of the management contract was the
inevitable result of the economic crisis and the government's
decision to fix electricity tariffs for the next seven years.
Jonagan confirmed that under the terms of the original management
contract, AES would have been paid $381 million in total if
financial performance targets were met. According to Jonagan, in
2008, the Ekibastuz power station delivered strong financial
results, which guaranteed a significant payout to AES for that
period. In 2009, however, Jonagan said the deepening crisis "made
it very unlikely" that the company would achieve the minimum
financial threshold for AES to receive payment. Therefore, he said,
both parties understood that it was just a matter of time before AES
itself terminated the agreement to ensure that it received at least
the minimum payout possible. Interestingly, Jonagan did not blame
the government's pending anti-trust ruling against AES -- a matter
which the company may still take to international arbitration -- for
the early dismissal (reftel A). Indeed, he sounded positively
upbeat about the announcement, saying, "We are parting ways under
fairly good terms and with minimal hard feelings. The economic
crisis really killed the business, which means they are postponing
the capital expansion program. We basically became redundant in the
economic environment that evolved -- something no one predicted when
we signed the contract in December 2007."


5. (SBU) During a March 26 meeting with the DCM, AES Country
Manager Doug Herron speculated that Kazakhmys was eager to exit the
agreement due to its own cash flow constraints. Kazakhmys has lost

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nearly 90 percent of its market value in the last year and,
according to Herron, the company reported no earnout at all from
Ekibastuz in 2008. Herron said that some AES corporate officials
are concerned that Kazakhmys will not meet its next scheduled
payment to AES, although he himself was not worried, because AES has
a letter of credit guaranteeing payment. Herron also said the
government's regulation of electricity tariffs will adversely affect
the profitability of the power plant and AES's other power companies
in Kazakhstan. However, he added that the tariff regulation does
not unfairly discriminate against AES by setting a lower rate for
their hydropower assets, as did an initial draft. Herron also noted
that the central government's decision to fix electricity tariffs
nationwide means that local governors will no longer be able to
request preferential treatment for power consumers in their oblasts.
"That used to be a terrible problem," said Herron. "Now, with the
regulation setting capped rates by fuel type, there's much less
local interference."

GOVERNMENT PLANS TO TAKE BACK ENERGY ASSETS


6. (SBU) Herron noted that state-owned Samruk-Energo, which is a
wholly-owned subsidiary of the Samruk-Kazyna National Welfare Fund,
plans to acquire 40 percent of Ekibastuz from Kazakhmys. He
suggested that as a result, Samruk-Energo may also have played a
role in pressing Kazakhmys to terminate AES's management contract
early. (NOTE: In February 2008, when AES announced the sale of its
interest in the Ekibastuz power plant and the Maikuben coal mine to
Kazakhmys, Prime Minister Karim Massimov ordered Samruk-Energo to
negotiate with Kazakhmys for an ownership stake in Ekibastuz. In
October 2008, Kazakhmys and Samruk-Energo signed a memorandum of
understanding agreeing to joint ownership of Ekibastuz and Maikuben.
Samruk-Energo Managing Director Alexander Li said at the time that
the company would need six more months to complete the necessary due
diligence and report its findings to the government, and
approximately one year to complete the deal. In November 2008,
Kazakhmys asked the government to expedite its acquisition of
Ekibastuz and the Maikuben, warning that it did not have sufficient
funds to repay the loan it took to finance the acquisition from AES.
END NOTE.)

AES HAD "NOTHING OF VALUE" TO CONTRIBUTE


7. (SBU) On March 24, Moscow-based energy consultant Paul Boyne
told Energy Officer that AES was being "run out of the country"
because they no longer had anything of value to contribute to the
development of Kazakhstan's power sector. Boyne, who has worked as
an advisor to Samruk-Energo, said, "All the equipment at Ekibastuz
is Russian. All the expertise is with the local staff, not the AES
management team. And AES can't arrange any capital investments for
the plant, so they are totally useless." Boyne said AES knew it
could not fulfill the goals in the management contract and should
consider itself fortunate to walk away with such a large payout. "I
wasn't surprised that AES left," he said. "The only surprise to me
is how fast it happened."

SOUTH KOREANS INVEST IN POWER SECTOR


8. (U) On a separate but related note, the Korea Electric Power
Corporation announced on March 25 that a consortium involving
Samsung C and T Corporation was selected as the prime bidder for
construction of a $2.5 billion thermal power plant in Balkhash, in
eastern Kazakhstan. The consortium plans to finalize a formal deal
with Samruk-Energo in 2010, with the aim of completing a plant with
a capacity of 1,200-1,500 megawatts by 2014. The consortium will
own 75 percent of the new venture and operate the plant once it is
built in Balkhash.


9. (SBU) COMMENT: Unlike previous government decisions affecting
AES, in this case, the company has not asked for sympathy or support
from the U.S. government. AES seems genuinely satisfied to exit its
Ekibastuz management contract at the half-way point, with

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approximately half of the revenue it had planned to collect. AES's
country manager even called the early buy-out "the cream on top" of
the billion-dollar sale of the power plant to Kazakhmys in 2007.
However, the transaction does make one wonder where AES will go from
here. The company's anti-trust dispute looks headed for
international arbitration, Samruk-Energo has replaced AES at
Ekibastuz, and Korean rival Samsung is grabbing headlines and
winning billion-dollar contracts to build new power plants. AES now
has only two hydropower concessions until 2019, and two combined
heat-and-power plants that even they admit no one wants, as their
strategic presence in the region. END COMMENT.

HOAGLAND