Kanatbek Safinov: National Security Above All

From Oil Review:

Development and strengthening of public presence in the energy sector, in Kazakhstan, should lead to the adoption of a law on nationalization defining the clear legal frames for nationalization of some kinds of property, which, on the one hand, will enable to advocate the national interests of the state more effectively and, on the other hand, will set more apparent rules for. We ask Kanatbek Safinov, a leading lawyer in the field of subsoil use, Managing Director and member of the Board of the Kazakhstan Holding Company for Samruk State Assets Management, to share his opinion on this matter.

How the Law On Subsoil and Subsoil Use, which gives the state the preferential right to buy out a share, can progress in the process of continuing development of the oil and gas industry of Kazakhstan?

The practice of strengthened presence of the state in the energy sector of the national economy is more a worldwide trend in conditions of significant consumption of energy resources rather the Kazakhstani invention. This trend is closely linked with the necessity of ensuring the economic and national security of the state.

In a well-known discussion between Kazakhstani specialists in civil law and academician S. Zimanov on the adoption of amendments to Article 71 of Law on Subsoil and Subsoil Users concerning the preferential right of the state, the latter one gave clear understanding of the role of the state in subsoil use contracts in the present-day conditions. He gave reasonable evidence to the deficiencies and narrowness of the approach aimed to limit the role of the state in subsoil use contracts to only the provisions contained therein and to considering the role of the state only in the limits of such contracts.

At that time S. Zimanov explicitly formulated an axiom: an adequate understanding of the role of the state and its authorized bodies in subsoil use contracts lies not only in the regulative framework of these contracts, but also in the body of the laws and regulations governing these contractual relations and defining the legal status of the parties to them. For the state to act as a party to subsoil use contract it becomes necessary to be guided by the body of regulations and legislative acts and primarily by the Law on National Security.

Article 71 of the Law on Subsoil and Subsoil Use should be regarded as the first step by the state associated with the policy of resumption of control over national strategic resources, safeguarding and reinforcing the resource and energy basis of the Kazakhstani economy.

The logical continuation of the regulative idea set forth in Article 71 of the Law on Subsoil and Subsoil Use are new provisions of the Law on Subsoil and Subsoil Use that are being currently discussed in the Parliament Mazhilis, which will enable the state to restore the economic balance of the parties’ interests upset by the subsoil user’s actions, affecting the national economy and posing a threat to the national security.

In the case of subsoil user’s actions causing a significant change in the economic interests of the republic and threatening the national security, the draft law provides for the right of the state to demand amendments to contractual provisions with the purpose to restore the national economic interests.

The draft law provides that determination of subsoil use areas that are of strategic importance for the state shall be referred to the scope of the government’s competence.

The law also provides for extended list of grounds under which a subsoil use contract may be terminated in a case of failure by parties to reach consensus on amending the contractual provisions within the maximum allowed time of up to one year.

Besides, it is proposed to amend the Law in force with an article entitling the competent body on the government’s initiative to unilaterally waive the fulfillment of the contract in the event of threat to the national security as a result of a subsoil user’s activities.

A not insignificant aspect is the retroactive effect regarding earlier concluded contracts, that entirely matches the provisions of the earlier and current investment legislation (in particular, the Law on Foreign Investments of 27 December 1994 and the Law on Investments of 8 January 2003).

I think that development and strengthening of public presence in the energy sector, in Kazakhstan, should lead to the adoption of a law on nationalization defining the clear legal frames for nationalization of some kinds of property, which, on the one hand, will enable to advocate the national interests of the state more effectively and, on the other hand, will set more apparent rules for investors.

Development of the national legislation towards the above mentioned direction may have an effect on the investment climate. At the same time one should understand that the state for many years has been arranging favorable conditions for the attraction of investments in Kazakhstan with the purpose of a mutually beneficial cooperation with investors.

In these years inward investments in the Republic including those in the energy sector pursued, in the long run, earning some profit by investors. The legislation stability regarding invariance of contracts and earning profits by an investor as well as free outward investments remain strong priorities of the state policy.

Along with that some investors trying to find weaknesses in earlier concluded contracts think that possessing strategically important, for the republic, resources and objects they independently and without consideration of the economical and political interests of Kazakhstan will determine their fate, including alienation of facilities, determination of the term of commercial production commencement, routes of produced raw material supply etc.

Some investors trespass the limits of their commercial interests and pursue political interests, which may contradict the national interests of the republic.

In practice, there are instances when investors by referring to the law provisions concerning stability of contractual provisions do not recognize the effect of one legislative acts, but in practice comply with other legislative acts improving their position, without amending the contractual provisions by the parties.

Therefore, I think that an investor who develops strategic deposits of the Republic of Kazakhstan, available for a period specified in the contract, should pursue the purely economic interests, i.e. the estimated rate of return for the entire contract period, and also bear corporate responsibility for efficient development of the deposits so as not to prejudice the economy, environment and social life of the region and nationwide. These requirements are based on the international practice of corporate business responsibility for compliance with the international and national standards in ecology, transparency, investor’s attitude to the economy and social sphere of the host country.

The host country’s role is to ensure the investor’s profit earning and to maintain the economic interests balance.

This distribution of interests from the standpoint of investors and the state, i.e. the guarantee of the economic profit of the investor along with the protection of national interests forms a balance, which should be considered while developing the legislation in future.

In the legal regulation of other industries a similar development is envisioned. In this connection it is worth mentioning the recent ‘Law on amendment of some legislative acts of the Republic of Kazakhstan on matters ensuring the state’s interests in the field of economy, which, in particular, introduced a conception of strategic facilities and the criteria of referring one or another kind of property to them.

This law has supplemented the Civil Code with principal provisions stating that encumbrance of strategic facilities with a third person’s rights, or their alienation is possible only under the government’s authorization. The law also vested the preferential right to the government for the purchase of a strategic facility at the market price if the private owner of the strategic facility intends to sell it.

Some investors, which earlier obtained strategic facilities as a concession, lease or own these objects on the other grounds, are attempting to withdraw these objects from the state control and then alienate them directly or indirectly without consent of the state as an owner. With that they should clearly realize the consequences of their decisions in the context of the above mentioned laws.

Referring again to the Law on Subsoil and Subsoil Use I should stress that since hydrocarbon reserves refer to the category of depleted and nonrenewable ones, the reality of possessing them is more attractive than money.

In all countries one can notice a recent tendency towards more practicable and effective use of hydrocarbon reserves, the strengthening of state control over private business, which is specialized in energy resource production. It is typical that many countries possessing hydrocarbon raw materials long ago developed a policy on establishing of national state companies both for the purposes of development of state entrepreneurship and of additional control of the processes taking place in the oil and gas industry.

This policy along with controlling functions of state bodies allows successfully applying elements of partnership control to subsoil users when developing oil and gas fields collectively.

No doubt, the state as a sole partner or shareholder of a national company should and do give a certain support thereto in development.

Article 71 of the Law on Subsoil and Subsoil Use in the current edition enables a national oil company to remain a driving force for the domestic economy.

Independent development of deposits by a domestic company entails the necessity of applying and developing new Kazakhstani technologies, use of domestic machinery thereby creating new jobs for Kazakhstani people. As a result, we have an opportunity to encourage the further advancement of domestic innovation technologies, the industrial sector and the social sphere.

How the amended Law on Subsoil and Subsoil Use can influence the future plans of KazMunayGas?

Under Article 71 of the Law on Subsoil and Subsoil Use, the preferential right to purchase an asset to be sold in the field of subsoil use belongs to the state. At the same time the state after acquisition often transfers relevant assets to the national company.

Regulations on the state’s preferential right to acquire assets to be sold in the oil and gas industry set forth in the Kazakhstani legislation enables a national company to multiply its capabilities thorough entering into contracts earlier concluded without the state participation as a contractor, or through acquiring participating interest (shareholdings) in the authorized capital of companies, being subsoil users in the Republic of Kazakhstan. Emergence of new lossless assets to KazMunayGas as a result of such acquisitions will contribute to the increase in dividends to be distributed, based on the performance results. I call this assets ‘lossless’ because they are no longer encumbered with a risk of unsuccessful exploration, in contrast, they have a real price and proven hydrocarbon reserves.

It is of note that Article 71 of the Law on Subsoil and Subsoil Use enables KazMunayGas to create a mechanism of monitoring of prospective subsoil use sites (and blocks in sea). Then in future when transferring subsoil use rights to such sites or participating interests (shareholdings) in subsoil use companies, with awareness about one or another subsoil use sites (blocks), to make proposals to the government on the assets that are of interest for KazMunayGas.

Besides, due to the opportunity for the state to use a preferential right, the national company can achieve the increase in reserves not only in the domestic market. It has also an opportunity to create the base for expansion to foreign energy markets, which finally will lead to increased deductions to the state budget and forming a niche for the Republic of Kazakhstan in the international market.

It is known that after adoption of legislative amendments giving the state a preferential right to buy out the interests of investors, a concern arose that these amendments may complicate transactions of selling interests. What points do remain unclear?

Concerns that these amendments will complicate interest sale transactions both for contracts and for authorized capital of a subsoil user are unlikely to be reliable.

Such procedures already take some time for execution of the transaction. This connected with the necessity to evaluate an asset to be alienated and also with possible pretenders to purchase. Any seller is interested in getting a maximal price which, in its turn, is formed on the basis of unbiased data of production costs incurred and depends on recoverable reserves volume, market oil price, infrastructure closeness etc. Permit of the competent body for the transaction or reasoned decline for the transaction should be issued within 45 days from the date of filing by the subsoil user of the relevant application in accordance with provisions of Article 14 of the Law on Subsoil and Subsoil Use. The application should contain a clear indication of the person to whom the assets is to be sold. Failure to observe the permit obtaining procedure by subsoil user means, by virtue of Article 14 of the above mentioned law, that the transaction is invalid as from the time of its execution.

The state’s right to preferential acquisition already has been used many times in practice. And as the practice showed the state acquiring an asset on preferred basis is to pay to the seller the final price agreed between them, in other words, the state doesn’t dictate the price it wants to buy the asset at. This means a market approach to the matter by the state.

Along with this, some companies based on their own considerations and strategies are willing to pay more for assets to be alienated. It is natural to ask: what is to be done if an asset to be sold is really of strategic importance for the republic however it is overpriced considerably? Has the state a right to introduce a mechanism of price regulation in general or to provide it only for cases of acquiring assets by the state? Any asset acquired under sale contract will be recorded in the books at the transaction price. The issues of its subsequent reevaluation in the course of business operations in view of obvious inconsistencies of the real price of an asset with the price actually paid for it are not the subject of consideration or regulation by whatever legislative act, i.e. all such issues are subject to corporate regulation only.

There’s a need ahead to toughen measures of administrative responsibility of a subsoil user for violation of the environmental laws, inefficient use of subsoil reserves and aggressive exploitation of subsoil. These measures should be accompanied not only by penalties but also include other response measures such as suspension of operations for long periods in order to eliminate faults, and upon revealing of facts of systematic ignorance to meet the national legislation requirements on the part of a subsoil user, to let the competent authority to terminate contracts for the given violations without any indemnification by the state to the subsoil user in fault. But that is a subject of another talk concerning the subsoil use.

News Roundup - October 25, 2007

Reuters: Kazakhstan Shuts Ddown Opposition Web Sites

Kazakhstan has blocked access to a number of opposition Web sites in a move Internet users condemned on Wednesday as a crackdown on freedom of speech…

The Register: Kazakhstan Blocks Opposition Websites

Kazakhstan yesterday blocked access to several websites critical of the government, including the “main opposition outlets”, kub.kz and geo.kz, Reuters reports…

EurasiaNet: Kazakhstan Blocks Critical Websites As Opposition Cries “Cenzorship”

Kazakhstan has blocked four opposition news websites in a move that media freedom advocates called “political censorship” in a country increasingly seeking to portray itself as an emerging democracy…

Forbes: Development Bank of Kazakhstan’s Medium Term Note Issue Ratings Affirmed

Fitch Ratings said it has affirmed the medium-term note programme of Development Bank of Kazakhstan at ‘BBB’ long-term and ‘F3′ short-term, after the size of the programme was doubled to 2 bln usd…

Reuters: Kazakh KazMunaiGas Seeks $3 Billion Loan

KazMunaiGas, Kazakhstan’s national oil and gas company, will borrow $3 billion on the international markets to a fund a refinery purchase, Interfax news agency reported on Wednesday citing banking sources…

International Herald Tribune: Kazakhmys Shares Drop as Copper Cathode Production Fell

Shares in Kazakhmys PLC fell more than 7 percent Wednesday after the mining company with operations in the former Soviet republics said copper cathode production fell 6 percent in the first nine months of the year…

Reuters: Kazakhmys Q3 Copper Output Down, Shares Slide

Copper miner Kazakhmys Plc posted weaker third-quarter copper cathode output on Wednesday and gave details of production problems that would trim 2007 production, hitting its shares…

Mining Journal: Kazakhmys Production Falls after Flooding

Kazakhmys plc, Kazakhstan`s biggest copper producer, said third-quarter output fell 19% after a flood affected its South Mine…

CACI Analyst: Bread Crisis in Kazakhstan Hightens Social Tension

To all appearances, the Kazakh government was totally unprepared for the unprecedented rise in bread prices aggravated by runaway inflation. At a government meeting on October 1, Prime Minister Karim Masimov, irritated by the helplessness of regional governors in coping with galloping prices, assigned them the task of creating grain reserves to stabilize the food situation in their respective regions…

neweurasia.net: India Looks to the Caspian

Turkmenistan’s gas and oil reserves may soon attract the attention of yet another world players, Russian newspaper RBK daily reported Tuesday…

DefenseNews.com: Kazakhstan To Build Up Navy To Protect Oil

Kazakhstan plans to build up its naval force on the Caspian Sea to guard its vast offshore oilfields and diversify arms imports, the Central Asian state’s defense minister said Oct. 24…

RIA Novosti: Kazakhstan Lifts Ban on Russian Rocket Launches from Baikonur

Kazakhstan has lifted its ban on launches of Russian Proton-type rockets from its space center in Baikonur, a government spokesperson said Wednesday…

Reuters: Kazakhstan Lifts Ban on Russian Rocket Launches

Kazakhstan, home to Russia’s Baikonur cosmodrome, has lifted a ban on launches of Russian Proton rockets that was imposed after one of them crashed, the government said on Wednesday…

Guardian Unlimited: Kazakhstan Target Astana Success at Tour de France

Kazakhstan hopes to use its newly revamped Astana cycling team to win next year’s Tour de France, the head of the Kazakh Cycling Federation said on Wednesday…

Global Voices Online: Kazakhstan: Prices Unleashed

Immediately after the parliamentary elections, which were deemed undemocratic by the international monitors, the prices went crazy in Kazakhstan…

Interfax: Kazakhstan Drops Plans for Power Plant Construction with China

The government of Kazakhstan has frozen talks on a joint project with China to build a large power plant in the Ekibastuz coal region of Pavlodar region, a government source told Interfax…