KAZAKHSTAN: AES CONSIDERS ALTERNATIVES TO ARBITRATION

UNCLAS SECTION 01 OF 03 ASTANA 000049

SENSITIVE
SIPDIS

STATE FOR SCA/CEN, EEB/ESC, S/EEE, S/CIEA
STATE PLEASE PASS TO USTDA

E.O. 12958: N/A
TAGS: PGOV PREL PINR ECON EINV ENRG SOCI KZ
SUBJECT: KAZAKHSTAN: AES CONSIDERS ALTERNATIVES TO ARBITRATION

REF: (A) 09 ASTANA 837
(B) 09 ASTANA 555

ASTANA 00000049 001.3 OF 003



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


2. (SBU) SUMMARY: On January 15, a senior executive from U.S.
power company AES told the Ambassador that the company has worked
with Kazakhstan's Ambassador to the United States to prepare a
settlement letter to the government to resolve a long-standing
dispute over alleged antimonopoly behavior. The Ministry of Finance
currently is reviewing the matter with regional officials from East
Kazakhstan Oblast, where AES owns two combined heat and power
plants, has concessions on two hydropower plants, and manages
contracts for power distribution networks. Separately, the region's
governor blasted AES in the local press, accusing the company of
breaking the law by unilaterally raising electricity tariffs without
regulatory approval. On July 31, 2009, AES filed a Notice of
Dispute with an international arbitration court and has until
February 11 to decide whether or not to file a formal request for
arbitration. The AES executive expressed optimism about the
possibility of a settlement if Prime Minister Masimov became
personally engaged. END SUMMARY.

AES ASSETS IN EAST KAZAKHSTAN


3. (SBU) In Kazakhstan, AES owns two combined heat and power plants
(the Ust-Kamengorsk CHP and the Sogrinsk CHP in Novaya Sogra),holds
concessions on two hydropower plants (in Ust-Kamenogorsk and in
Shulbinsk),and has management contracts for power distribution
networks in East Kazakhstan. Shortly after taking office, the
governor (Akim) of East Kazakhstan, Berdybek Saparbayev, extended
AES's contract for five years, through February 2014, at a fixed fee
of $100,000 per year.

THE CASE AGAINST AES


4. (SBU) In 2007, the government of Kazakhstan assessed AES a $200
million fine for alleged antimonopoly activities. AES has paid $29
million of the fine and has had another $6.5 million in assets
frozen. Because negotiations to resolve the dispute have not been
successful, AES sent the Prime Minister a letter on July 31, 2009 to
inform the government that AES will take the case to international
arbitration. According to Regional Vice President Mike Jonagan,
Samruk Energo subsequently pressured AES to sell its prized
hydropower plants (ref A).


5. (SBU) During the Ambassador's visit to East Kazakhstan Oblast,
Jonagan and Saparbayev expressed their optimism on August 20, 2009,
that the dispute could be resolved amicably. Jonagan, however,
privately alleged that other forces were at play, including the
personal interest that President Nazarbayev's son-in-law Timur
Kulibayev has shown in the AES-managed hydropower plants. He said
that AES simultaneously filed for international arbitration and a
London-court injunction to prevent a Kazakhstani joint-stock company
from obtaining confidential information about the ownership and
registration of shares in the AES-managed two hydropower plants.
Jonagan claimed that this joint-stock company, which he suspects
Timur Kulibayev owns or controls, has "made a strong push" for the
hydropower plants. "Two or three years ago," he asserted, "someone
-- most likely Kulibayev -- gave the order to start these court
cases against us. Kulibayev has a personal interest in buying
shares in these hydropower companies. He's now back in the game,"
as Deputy Chairman of Samruk-Kazyna, which owns Samruk Energo, which
is the beneficial owner of the hydropower plants. "He got these
legal issues started, and now it's taken on a life of its own."


6. (SBU) In response to AES's decision to seek international
arbitration, Jonagan said the government has engaged an
international law firm to represent their interests, the same firm
that represented them during litigation with K-Mobile. Jonagan
expressed his hope for an out-of-court settlement of the dispute and
noted AES's willingness to amend the hydropower contracts in the

ASTANA 00000049 002.3 OF 003


government's favor in order to "normalize relations and move forward
with a clean slate."


7. (SBU) The Agency for the Regulation of Natural Monopolies (AREM)
also has criticized AES for behaving like a short-term speculator,
not a long-term strategic investor. AREM claims that more than 10
years after AES's initial investment, the company still has not made
any major capital investments at the power plants it owns and
operates. On a related note, the Almaty regional government
continues to pursue back taxes from a trading company, long-defunct,
that AES established when it first entered Kazakhstan.

AES PREPARED TO GO TO INTERNATIONAL ARBITRATION


8. (SBU) On January 15, Jonagan told the Ambassador that he met
earlier that day with Vice Minister of Finance Ruslan Dalenov to
discuss the charges against AES. According to Jonagan, Dalenov was
defensive when told that local tax authorities had acted improperly,
and he primarily was concerned about the financial cost of
international arbitration. "I understand his position," Jonagan
said. "He's under orders to delay, stall, delay, stall." Jonagan
told Dalenov that AES has retained an expensive U.S. law firm to
advise the company on the case and is fully prepared to file the
necessary papers to formally request arbitration on February 11,
when the Notice of Dispute expires. According to Jonagan, Dalenov
asked if the government should hire its own law firm in response.
"Considering that we have made zero progress despite six months of
talks, I would say yes," Jonagan reportedly told Dalenov.

"NO SANITY IN THIS PROCESS"


9. (SBU) Jonagan indicated that its new power-tariff structure lies
at the heart of the dispute, and could offer a way out of the
impasse. "Currently," he complained, "there is no sanity in the
(tariff-setting) process. Wholesale electricity prices and
transmission costs have just increased by 25%. Every other retail
power company in Kazakhstan received a tariff increase -- every one,
except us." Jonagan said he told Dalenov that AES's inability to
charge market rates for power in East Kazakhstan is driving the
company inexorably to international arbitration. He suggested to
the Ambassador that the government's agreement to a sufficient
tariff increase (at least 25%) might convince AES to drop its
arbitration claim. "But that's going to be a tough pill for the
Akim (governor) to swallow," Jonagan asserted.

EAST KAZAKHSTAN AKIM OUTRAGED


10. (SBU) On January 14, East Kazakhstan's Akim Saparbayev lashed
out at regional power-distribution company Shygysenergotrade, which
is owned by AES. According to local press reports, Saparbayev was
"seriously disturbed" by the company's decision to increase
electricity tariffs on January 1 without the consent of the
regulator and to terminate power supply contracts with local
enterprises. "As the head of the region, I will not tolerate
violations of existing legislation in East Kazakhstan, and will not
allow this company to agitate the population," Saparbayev was quoted
as saying. Saparbayev reportedly also criticized AES for not
meeting its social obligations.


11. (SBU) Jonagan told the Ambassador on January 15 that AES
applied several months ago for an increase in the tariff, but the
regional regulator returned the application and refused to forward
it to AREM in Astana, because the company allegedly did not properly
fill out the paperwork. Jonagan said that Shygysenergotrade then
published a notice in regional newspapers in East Kazakhstan,
announcing its intention to increase electricity tariffs effective
January 1, "provided the company receives the necessary regulatory
approvals." Jonagan noted that news reports, which republished the
Shygysenergotrade announcement, omitted this critical disclaimer.
In fact, Jonagan underlined, the company has not acted unilaterally
to impose new rates, as Saparbayev was led to believe.


ASTANA 00000049 003.3 OF 003



12. (SBU) Jonagan said he had a tough, tense discussion with
Saparbayev on January 14 during which Saparbayev agreed to "do
everything in his power" to enact a new tariff by January 26.
Jonagan speculated that Saparbayev would push for a 10%, rather than
the 25% or greater, increase that AES needs to remain competitive in
the retail power market in Kazakhstan.

STAND OFF WITH KEGOC


13. (SBU) Local press also reported on January 15 that
Shygysenergotrade received a telegram from national power-grid
operator KEGOC demanding that it return 15 million kilowatt hours of
power to the grid. KEGOC reportedly informed local authorities that
Shygysenergotrade is violating Article 13 of the Law on Electricity
and the March 19, 2008, Order of the Ministry of Energy and Mineral
Resources, which determine the daily schedules for electricity
generation and consumption. Jonagan told the Ambassador that the
company cannot purchase the required amount of electricity and sell
it at the low rate set for the company in 2010. "We are already $13
million in debt," he said. "We can't continue to sell electricity
at a loss." Jonagan said AES has applied to AREM to negotiate a 25%
rise in the tariff. He claimed that even an increase of that amount
would enable the company to "just skate by. Anything less than that
would be a disaster."

A MEETING WITH THE PRIME MINISTER


14. Jonagan told the Ambassador that AES senior executives
contacted Kazakhstan's Ambassador to the United States, Yerlan
Idrissov, who reviewed a draft settlement letter and recommended the
company discuss the matter directly with Prime Minister Masimov.
According to Jonagan, AES tentatively arranged to meet Masimov in
Davos, Switzerland, during the World Economic Forum on January 23,
but Post subsequently learned that Masimov cancelled his travel
plans. Jonagan suggested that a meeting with Masimov -- preferably
on the margins of another event outside Kazakhstan -- would help to
resolve this dispute before it goes to international arbitration.


15. (SBU) COMMENT: The manner in which this dispute is managed
will test the government's commitment to creating a favorable
investment climate and honoring contract stability, as powerful
interests in the East Kazakhstan region and at the center attempt to
influence the outcome. We are encouraged by the continued
commitment of AES and the government to dialogue and negotiation,
and will help facilitate a meeting between the U.S. company and the
Prime Minister. END COMMENT.

HOAGLAND