TABLE OF CONTENTS

  1. Introduction
  2. Intended Plan for Legal Changes
  3. A Change in Plans
  4. Financial Crisis
  5. Realizing a Lack of Expertise
  6. A Shift from Russia
  7. An Impending Succession Crisis
  8. Opportunities from these Four Crises
  9. Continued Red Flags
  10. Gateway Laws Introduced
  11. Planned Legal System Modifications

INTRODUCTION

There is quite a bit of maneuvering going on inside the Kazakh government at this time due to panic over thefinancial crisis, changes in the law, shifts in the region and uncertainty over the future of the country. Over the past few years, the Kazakh government developed a goal to get more—be it money for its pockets or expertise for its state firms—out of the massive energy projects in the country that were nearly all foreign run.

But the global financial crisis has crippled the country, with the banking sector particularly hard hit. Businesses and individuals are reluctant to keep their money in Kazakh banks, whichhave to supplement their domestic deposits with loans from abroadin order to lend domestically. Increasing oil revenues and foreign capital financed a domestic boom across the country.By the end of 2008, Kazakh banks’ total external debt stood at $39.2 billion, and total private sector debt was equal to $103 billion, equivalent to 86 percent of the projected 2009 GDP.

Astana had been watching the example of its large northern neighbor, Russia, whichpassed a slew of laws from 2005 to 2007 restricting foreign access to its energy sector. To many in the Kazakh government, especially those in the energy sector, there was much money to be made in the state’s running these massive energy projects instead of foreign firms. Also, the government considered it imperative to the country’s strategic interests to run most projects that involved the country’s massive energy wealth.

But Astana did not have the experience or weight that the Kremlin did in aggressively targeting foreign firms. The Kazakh government started with specified targeting of companies with accusations of tax evasion, cost overruns on strategic projects and breach of contract in failing to meet deadlines. But over the summer, the Kazakh government came up with a plan for a massive restructuring of the laws in Kazakhstan concerning the energy sector that would affect all new and old projects and firms working in the country.

THE INTENDED PLAN

The new laws regardingKazakhstan’s energy sector were going to systemize the government’s ability to take over any project in the country—in short, the government was looking to nationalize a good chunk of the energy sector. According to STRATFOR sources in the government, the new laws fell under the “government’s right to ensure the success of projects it deemed nationally strategic”—which covered all of energy. The new laws would:

  • renegotiate all existing contracts
  • set rigorous deadlines for those negotiations
  • set rigorous deadlines on the successful implementation and running of a project

Should a firm or consortium fail in any of these three areas, then the government had the right to take over the contract.

Another change was to introduce a “quality” clause into all energy contracts in the country that would allow the government, at any stage of the contract, to decide if the company or consortium was up to the government’s standards —whatever those standards might be at the time. The ability for a company to keep working would then be determined by its “quality,”whether it is favorable to the government and its security.

The Kazakh government was looking to once again change the country’s tax codes—a set of laws that was continually being rewritten, amended and purposefully kept vague in order to allow the government to use the laws as it wished.

Another change to the laws was to require the inclusion of state firms in any major energy project—whether they were energy firms like KazMunaiGaz or fledgling firms. This was to ensure that the Kazakh government’s companies were gaining the expertise needed from the other consortium members. The government’s initial goal was to first create joint ventures for their inexperienced companies and then later require the full use of their firms down the line.

Any transgression against these new laws by a company would result in the nullification of its contracts in the country.

A CHANGE OF PLANS

The government’s plan for dramatically changing the laws in the country was drafted and being prepared to be submitted to parliament for approval in December or January. However, the government has been hit with a series of crises and realizations—from the financial crisis, the government’s lack of technical expertise, a shifting situation in Russia and an impending succession crisis in the government—that have frozen many of its plans and sent them back to the drawing board.

The Financial Crisis

The financial crisis in Kazakhstan is crippling the country and government much more than it ever expected. Even before the financial crisis intensified in late 2008, Kazakhstan’s developing banking sector was vulnerable. Since Kazakh business and households are skeptical about keeping their cash at the banks, Kazakh banks supplemented their thin domestic deposit base with capital loaned from abroad, allowing the banks to lend domestically. Increasing oil revenues and foreign capital financed a domestic boom across the country.At the end of 2008, Kazakh banks’ total external debt stood at $39.2 billion, and total private sector debt was equal to $103 billion, equivalent to 86 percent of the projected 2009 GDP.
When capital flew to safety as the financial crisis intensified in late 2008, however, the ensuing exchange-rate volatility put serious pressure on Kazakh banks. In addition to the pressure placed on the banks by the collapsing domestic real estate sector, Kazakhstan was forced to devalue to tenge[?] by 22 percent in February to maintain industrial competitiveness with Russia, whose ruble was also depreciating due to the financial panic. The devaluation increased the real cost of servicing the external debts held by the banks and the private sector.The Kazakh government nationalized two of the country’s biggest banks— BTA and Alliance Bank. The government has been using funds from its offshore national oil fund to plug the growing budget deficit, though this practice was halted in September per the instructions of President Nursultan Nazarbayev.

According to STRATFOR sources in the government, Kazakh banks are closer to a broad collapse than is being publicized. Sources say that the banks are literally empty due to a lack of foreign cash coming into the country and resistance from the Kazakh people to keeping their own cash in banks. The Kazakh government has reportedly frozen its own accounts— for pensions, welfare and other social services—in order to keep cash in the banks instead of sending it out to pay for those services.

Many within the Kazakh government believe that the only way to fix this massive crisis is for foreign groups to start placing large amounts of cash back in Kazakh banks. The Kazakh government has been discussing this option with certain foreign energy firms in the country that it had previously been targeting under the plan for nationalizations. Some deals have already been struck between the Kazakh government and energy firms like BG Group for those firms to put cash into the system in trade for their legal woes disappearing.

The Kazakh government has also realized that, should it change the laws in the country, start targeting foreign firms and nationalize projects, it will lose its source for the bulk of the country’s cash. More than 50 percent of the government’s budget comes from the energy sector, much of that by taxing foreign firms and their investments.So the investment climate in the country would undoubtedly get worse. This was not as critical an issue when revenues from oil exports were skyrocketing off high oil prices, but the Kazakh government can not afford to lose so much money from the foreign firms now.

Lack of Expertise

As Kazakhstan contemplates nationalizing many components of its energy industry, the question has emerged inside the government and energy circles whether or not Astana will be able to run projects without the partnership and assistance of foreign firms. It is no secret that Kazakh energy firms simply do not have the technological expertise of their Western counterparts. A great deal of expertise is needed, considering that much of Kazakhstan's energy resources lie in the Caspian Sea region, a notoriously difficult setting to conduct operations due to its freezing over most months of the year and its landlocked position.There is a growing realization that such plans for nationalization could be severely harmful and potentially threaten the very existence of the energy sector itself.
While Kazakhstan's government has expressed its desire to engage in joint ventures, any nationalization process is certain to scare away international energy firms from such projects. According to STRATFOR sources in the country, the energy services sector is a particular point of concern should nationalization occur and represents the biggest black hole in the industry. While Kazakhstan's indigenous services firms have been around for quite some time, they have never been involved much in serious projects that required technical know-how.

But this also brings up an interesting possibility: If foreign services firms were to offer joint-venture opportunities to Kazakhstan themselves, they could remain in the country and indeed increase their leverage by making the value of their presence and collaboration quite clear. That is because Kazakhstan is likely well aware that energy projects that require the skill level of international firms but use Kazakh firms instead could spell big trouble for the country.

Russia Issue

Another issue that has caused the Kazakh government to pause in implementing its summer plans for nationalization are the impending changes in energy laws in Russia. Kazakhstan’s large and energy-rich neighbor, Russia, is currently implementing a series of laws that would make the country more attractive to investors, while repealing their restrictive energy laws against foreign firms in the country. One of the reasons investors have always preferred Kazakhstan over Russia is that investors in the latter never had legal protection. In theory, the new investors’ rights laws would protect businessmen and investors in Russia at a time when Kazakhstan is drafting the laws that would do the opposite.

The next change in Russia is that it will repeal the strict energy cap laws then President Vladimir Putin put in place in 2007. These laws affect strategic industries and clarify which assets would be off-limits to foreigners. The sector affected most by these laws was energy. These laws have made Russia an unattractive environment for foreign businesses to maintain or expand investments in energy projects, even though Russia is one of the world’s most energy-rich countries. These changes in Russia are bringing major firms that have been much more interested in Kazakhstan in recent years back to Russia—creating much more competition for investments that used to be simple for Astana to attain.

Astana is now concerned that if it tightens its laws while Moscow is liberalizing its laws, then the major energy firms with cash will head north instead. According to STRATFOR sources, this is already happening with U.S.-energy giant Chevron, which is leveraging its negotiations with the Kazakh government for new projects with the threat that the company is already striking better deals with the Kremlin for larger projects in Russia. The Kazakh government is worried that more energy firms could leverage their relationships with Russia against their relationshipswithKazakhstan.

Impending Succession

The fourth issue that has caused the government to pause over changing the laws in Kazakhstan is the impending succession crisis. This fall, those within Kazakh government and political circles have started to realize that time is quickly running out for Nazarbayev to choose a successor. The public is starting to talk about Nazarbayev’s age— he is turning 70 next year, while the life expectancy in Kazakhstan is 66.There is a growing and tangible sense of panic, uncertainty and competition among various political groups to secure positions or prove that they are the closest to the aging president.

But this has also created a level of competition in certain circles, especially those that deal with the energy sector, to have personal relationships and ties to energy firms or foreign governments. The logic behind this is that many in Kazakhstan believe a major crisis of succession will erupt in the next five years with no real heir apparent to the Kazakh throne; many of those in the running are deemed unqualified by political elites. Should a major crisis break out, many politicians and officials are looking to quickly build up their personal wealth to help them weather the storm and create ties outside of the country to people, firms or governments that could give them leverage inside of Kazakhstan.

This wheeling and dealing includes energy firms that are negotiating with certain political groups in the country. For example, Total has recently struck quite a few large deals in the country, and STRATFOR sources have hinted that much of this is because of its growing relationship with Nazarbayev’s son-in-law, Timur Kulibayev. BG’s recent good fortune in Kazakhstan is partially due to its deepening relationship with Kulibayev and Energy Minister Sauat Mynbayev. Sources also have indicated that Prime Minister Karim Masimov is personally tied to —and allegedly bankrolled by —China’s National Petroleum Corporation (CNPC).

STRATFOR willdelve further into the succession crisis in the next few months as it starts to define the main groups running Kazakhstan politically and its strategic sectors as everyone jockeys for power.

OPPORTUNITES FROM THE CRISIS

Such a crisis has presented quite a few opportunities for groups, firms and governments to take advantage of the situation in Kazakhstan.

  • As mentioned above, some firms like BG are striking deals with the Kazakh government to trade their legal woes for putting cash in the banks. It isn’t a coincidence that BG’s international arbitration with the Kazakh government was dropped in October and that, in the weeks following, BG announced it had struck a deal to expand its operations in the massive Karachaganak project.
  • The growing realization of the country’s lack of expertise in the country gives energy firms and services companies the opportunity to leverage their know-how with the Kazakh government. There is also an opportunity for some firms with specific expertise to go to the Kazakh government and offer to create a joint venture in trade for more or better projects in the country—though STRATFOR has yet to hear of any group doing this.
  • Having more competition in the region with Russia allowing foreign firms to come back into the country bodes well for foreign energy firms, which can leverage their ability to go next door should Kazakhstan continue to target foreign firms and actually implement harsher laws.
  • The impending succession crisis has left nearly every political circle vying for foreign connections and financial backers. It is not clear which groups will be the most successful, with competition growing fiercer by the year. But this has left a lot of doors open not only for foreign governments to back one group or another but also for foreign firms to find connections that could lead them to bigger deals once the dust settles.

CONTINUED RED FLAGS

Though the major legal energy changes in the country are currently on hold while the various crises and concerns play themselves out—creating many opportunities for foreign firms—there are some very large and dangerous red flags still fluttering on the horizon.

Gateway Legal Changes

Though the Kazakh government has not implemented all the laws that we have been following since this summer, they are currently passing a substitution called the “Law on Kazakhstan’s Content.” President Nazarbayev had set an October deadline for the government to draft and submit a draft of a new law that wouldincreaseKazakhstan's procurement of goods and services. But the parliament is just now starting to review the draft. The process is being kept somewhat secretive and it is unclear when the law will go into effect.

In theory, "The draft law provides for introducing [the] monitoring of domestic producers. In order to support Kazakhstan’s producers, we have to introduce a single terminology, distribute the scope of responsibilities among the state agencies in the monitoring [of] the Kazakh content and designate administrative responsibility,” this according to Kazakh Energy Minister Sauat Mynbayev.