№10 October 2012Table of contents Issue Archive
№ 9 (September 2012)
In the 21 years since the Soviet breakup, Kazakhstan has had to continually refocus its policy making to insure its independence. Initially it needed to distance itself from Russia, but soon that evolved into a multi-vector approach that included not only new allies but Russia as well.
By Ben Priddy
Afterall, Russia was Kazakhstan’s No. 1 trading partner throughout much of the post Soviet period; and landlocked as it is, Kazakhstan needed Russian transit routes to export its oil and gas.
To minimize the shadow of “Big Brother”, Kazakhstan made as many friends as it could, hence the multi-vector concept coined by western policy analysts. Kazakhstan invited in Western international oil companies (IOCs) to gain political leverage from the West. When the IOCs started to flex their muscles, Astana created a counter balance by welcoming in China.
The result? Kazakhstan today has two “Big Brothers” – Russia to the north and China to the South, in what appears to be a game changer for Central Asia. China as of 2010 surpassed Russia as Kazakhstan’s No. 1 trading partner and today controls a little less than a third of Kazakhstan’s oil production.
Kazakhstan’s next move? Resource nationalism
At last year’s KIOGE, Kazakh Prime Minister Karim Massimov stated that Kazakhstan plays a vital role in global energy security, encouraging “the diversification of transport routes of energy resources to end markets,” and acting as an important energy partner to regional economies. But despite the country’s geographic proximity to, and strong historical ties with Russia, the real story behind Kazakhstan’s current energy market and geopolitical challenges is how the operations of Chinese national oil companies (NOCs) are affecting those of Western international oil companies (IOCs). Growing Chinese presence doesn’t necessarily mean rising competition with IOCs. But it does have implications for changing Kazakhstan’s domestic energy policy, which will affect IOC oil projects.
Western IOCs have traditionally enjoyed a tremendous advantage over NOCs due to their greater access to capital markets, more efficient operating strategies, and higher operating cash flows. However, due to the global financial crisis and declining access to capital in the West, they are facing a formidable competitor in China over future access to new fields around the world, including in Kazakhstan. China’s growing use of its enormous foreign currency reserves to acquire overseas energy assets, and the rise of resource nationalism in many producer countries, potentially spells trouble for Western IOCs and their current operations.
Chinese NOCs account for between 25-30 percent of all oil production in Kazakhstan today. China has expanded its presence in Kazakhstan by investing in an east-west pipeline to supply oil to the country’s Xinjiang Province with oil from fields in Western Kazakhstan, securing stakes in two of Kazakhstan’s three oil refineries – Shymkent and Aktau – and acquiring a number of smaller oil fields throughout the country over the past decade.
Over the long run, however, Chinese oil production in Kazakshtan will likely be balanced by Russian and Western participation in dominant Kazakh energy projects, especially after Kashagan comes online. Russia remains an important trade partner to Kazakhstan, particularly in light of the establishment of the Customs Union in 2010, and economic ties between the two countries are likely to increase as a result, perhaps in part to counteract the increased trade flows between Kazakhstan and China. Kazakhstan’s main export pipeline – the Caspian Pipeline Consortium (CPC) – also creates a lasting physical link with Russia.
CPC is jointly owned by Russian and Kazakh national oil companies, as well as a number of IOCs, binding the interests of all of these companies – Russian and Western – in Kazakhstan over the long term. The CPC is currently undergoing an expansion that is intended to provide additional transportation capacity for increased future production of Kazakh crude, according to Chevron, who owns a 15 percent stake in the project. Western oil companies still control Kazakhstan’s big three – Tengiz, Karachaganak, and Kashagan. And after Kashagan comes online sometime over the next few years, Western IOCs will experience a significant increase in production relative to Chinese NOCs.
The main concerns over rising Chinese participation in Kazakh energy projects are of a social and political nature, coinciding with the rise of resource nationalism in Kazakhstan. Will Kazakhstan be able to balance Chinese energy operations with its own interests in gaining greater control over domestic energy developments, and influence over the allocation of economic rents from resource extraction? What implications does this hold for Western IOCs?
Domestic Pressures Resulting from the Rise of China
Three factors initially drove Chinese investment in Kazakh energy, according to Dr. Nygmet Ibadildin, lecturer at KIMEP University in Almaty: the country’s fundamental economic need for foreign oil to satisfy growing domestic consumption requirements; Russia’s relative investment passivity in Kazakh energy; and Western oil companies’ challenges in developing the technically complex Kashagan field. As part of its energy “going-out” strategy of the past decade (see sidebar one), the Chinese government has encouraged its national oil companies to invest in energy assets in countries around the globe to satisfy its increasing domestic demand for oil, and to alleviate pressures created by the declining rates of domestic oil production and over-reliance on oil imports from the Middle East.
However, Ibadildin states that Kazakh attitudes towards Chinese investment in the country’s energy sectors have gradually changed since China’s arrival around 2000. Chinese energy companies were originally considered a “counterweight to the United States and Russia,” says Ibadildin. “The Russians and Chinese were latecomers, technologically and perhaps financially weaker [than their Western counterparts]” at that time, according to Ibadildin. The Chinese entered the Kazakh energy market by acquiring a number of smaller fields in western Kazakhstan and investing in an east-west pipeline for long-term exports of Kazakh crude to western China. Chinese NOCs often offered higher bidding prices in many tenders for Kazakh energy assets than other companies, originally attracting Kazakh authorities to increase cooperation with Chinese national oil companies. However, favorable views of China soon gave way to a sense of urgency in Kazakhstan, as the Chinese rapidly increased their energy asset holdings in the country.
The Kazakh government grew more hesitant to allow Chinese national oil companies as much free opportunity to invest as before, as national interests to control the country’s resource wealth grew within the Kazakh government. The Chinese had begun “to buy all possible projects, at different stages of development – even underexplored [deposits], or those with questionable reserves,” Ibadildin states. China’s most successful bid for a major Kazakh oil asset came in 2006, with CNPC’s acquisition of shares in PetroKazakhstan, which is jointly owned by a subsidiary of Kazakhstan’s KazMunaiGas. During the bidding for PetroKazakhstan, there were rumors that Kazakh and Russian oil companies agreed to compete against each other in order to drive up the price for shares in light of Chinese interest, according to Ibadildin.
Social concerns also arose regarding Chinese operating strategies. “Public concerns [in Kazakhstan] are great about Chinese influence. All the different aspects like possible increased migration, land and boundary [acquisitions], oil and employment [issues],” explains Dr. Ibadildin. Chinese NOCs have traditionally favored employing their own laborers in Kazakh oil projects, leading to growing discontent among local laborers over the higher wages paid to Chinese workers – an issue that doesn’t seem to be going away anytime soon. As recently as August 2012, in response to a Kazakh request to increase purchases of wheat stocks, Chinese officials offered a counterproposal to increase wheat imports from Kazakhstan in exchange for a more lenient visa regime for migrant Chinese workers. “Employment in the local scale and dominance of suppliers is a matter of great concern,” according to Ibadildin. Thus, while there is little potential for Chinese national oil companies to overtake rival Western oil companies in Kazakhstan, there is growing potential that the Chinese presence will lead to increased domestic pressures that might affect future investment in the Kazakh energy sectors. Will, for example, Kazakhstan enact stricter labor and equipment laws to govern IOCs and NOCs operations in Kazakh energy projects?
Kazakh Resource Nationalism
Current local content labor laws in Kazakhstan require IOCs to employ a certain percentage of local workers in their energy projects. One stipulation of the labor law, for example, requires IOCs to staff 70 percent of its upper management in Kazakhstan with Kazakh workers; 90 percent of skilled workers (e.g. engineers) must also be Kazakh; and 100 percent of unskilled workers employed in the oil and gas fields must be Kazakh nationals. Due to the difficult nature of finding qualified laborers needed for the highly technical Kashagan field, as well as for the expansion phases of Tengiz and Karachaganak, all three of these fields have been given exemptions until 2015. And Chinese NOCs have continued to employ a greater number of Chinese nationals than local laborers.
Local content laws also govern equipment purchases for energy projects in Kazakhstan. The Subsoil Law of 2010 requires subsoil users to purchase a certain percentage of their equipment from Kazakh producers. If, for example, the subsoil user violates this law, the government may reserve the right to terminate the subsoil use contract early. Chinese NOCs have found ways around these laws by, for example, purchasing equipment from Chinese companies, bypassing customs checks by importing the equipment unassembled, and labeling it ‘Kazakh equipment’ after reassembling the parts upon arrival in Kazakhstan.
The future legal environment governing Kazakh energy sectors and subsoil use is a wild card factor in the Kazakh energy equation. Will the Kazakh government begin to enact stricter laws regulating subsoil use and local content to attempt to reign in the Chinese further? And, if so, will this have negative implications for Western IOCs operating in Kazakhstan? The lack of public information and ability to foresee how the Kazakh government will react to changing conditions make it impossible to predict how IOC operations will be affected. Western oil companies will likely retain their dominant positions relative to Chinese NOCs in Kazakh oil production over the long run, but this fact doesn’t preclude the possibility that IOCs will face a more restrictive legal environment.
Resource Nationalism ‘Kazakh-Style’
In its annual Business Risk Report: Mining and Metals 2011-2012, Ernst & Young labels resource nationalism as the biggest business risk for extractive industries over this two year period. Citing the quick rebound of these sectors from the global financial crisis, analysts at the consulting company claim that they are increasingly becoming targets for new tax legislation “to help restore treasury conditions” in producer countries. Prior to this, and as part of the growing phenomenon of resource nationalism, concerns over ‘Dutch Disease’ in resource rich countries have provided ways for governments to increase taxes on extractive industries, as well as push for greater say in managing their energy industries. “Governments worldwide have also been looking to increase local participation in projects and we think that this trend will only increase,” according to Ernst & Young.
Over the past several years, the Kazakh government has employed tactics designed to strengthen the government’s ability to influence decision-making in the energy industry and increase its economic rent from domestic resource extraction. “Resource nationalism [in Kazakhstan] is an issue. Opposition and current public figures alike mention all the time the unfavorable contracts signed by Kazakhstan [in the 1990s],” says Dr. Nygmet Ibadildin of KIMEP University in Almaty.
Many Kazakhs view the landmark deals signed with Western oil companies in the 1990s as favoring IOCs, particularly because prices for oil at that time were significantly lower than they are today. The Kazakh government has traditionally stated that the country didn’t possess the technical know-how and general awareness of how the energy industry worked in the 1990s. As a result, they claim that they were forced to sign contracts under adverse conditions.
The Kazakh government doesn’t just go in and expropriate energy assets owned by foreign oil companies, however. In order to “keep property rights stable and enforce contracts,” the government finds its way into energy projects like Kashagan and Tengiz through its national oil companies, explains Ibadildin. To facilitate this process, the Kazakh parliament has passed a number of laws regarding local labor content and subsoil use that are aimed at protecting the state’s national interest in mineral extraction industries. One in particular, the Law of Subsoil and Subsoil Use, passed in June 2010, gives the state “preemptive and priority rights” over other entities in the purchase of subsoil rights. The state, through its national oil companies, reserves the right to purchase subsoil rights in projects that it deems critical to the national interest.
“I would call this soft resource nationalism…IOCs still are competitive in this environment because taxes are still comparatively low, and the state is much more in favor of foreign capital,” according to Ibadildin. But fines for environmental violations and new taxes have nonetheless been levied against international oil companies and foreign national oil companies alike at an increasing pace, reminiscent of some of the tactics employed by the Russian government in the past that encouraged foreign owners to sell a majority stake in projects to state-owned oil and gas companies. Much of these policies enjoy strong national support.
China’s Strategies to Acquire Overseas Oil and Gas Assets
China faces an energy security dilemma resulting from its rapidly increasing domestic demand for oil, declining rates of domestic oil production, and over-reliance on oil imports from a politically volatile region. To alleviate threats to its energy supply, the Chinese government has embraced two energy strategies.
First, it has encouraged national oil companies to expand upstream investment activities globally; either by acquiring direct ownership of energy reserves through concessionary agreements, or by cooperating with international or local companies in upstream production activities. A second strategy has served to increase China’s soft power influence around the world, in addition to securing it access to oil supplies from producer countries. China’s Export and Import Bank (Exim) has provided a number of ‘loans-for-oil’ - ‘soft’ loans with low interest rates – in exchange for contracted oil supplies or a share in oil assets as repayment. These loans are often likely larger and cheaper than ones that might be offered by Western- or Russian-backed development banks.
China has made a number of large ‘loans-for-oil’ since the economic downturn, including one to Kazakhstan that granted it ownership rights to energy company assets in February 2009. China’s Exim Bank lent the state-owned Development Bank of Kazakhstan $5 billion, while China’s National Petroleum Corporation (CNPC) provided another $5 billion loan to KazMunaiGaz (KMG) to finance a number of oil projects. CNPC’s loan gave Chinese oil firms a 50 percent stake in MangistauMunaiGaz, the biggest private oil and gas company in Kazakhstan at the time. In addition to this, CNPC was given rights to half of the oil to be produced by MMG, the other 50 percent going to KazMunaiGas. According to U.S. Energy Information Administration (EIA) estimates, Chinese NOCs have extended ‘loans-for-oil’ amounting to over $90 billion with countries around the world.
Since 2008, China has enjoyed a key advantage over global competitors in oil and gas asset acquisitions: unparalleled foreign currency reserves. As global asset prices fell following the economic downturn in 2008, China took advantage of the higher purchasing power of its foreign currency reserves to increase its acquisition of assets overseas. In Kazakhstan, leading NOCs like CNPC and the China National Offshore Oil Corporation (CNOOC) have purchased from between 50-100% stakes in fifteen energy companies. Today, Chinese companies are responsible for approximately 25%-30% of upstream production in Kazakhstan, are active in 20 joint ventures – five of which are with KazMunaiGas – and hold shares in the Atyrau and Shymkent refineries.
The EIA estimates that since 2009, Chinese NOCs have purchased assets in the Middle East, Canada, and Latin America, investing approximately $28 billion for direct acquisition of these assets from other companies. The Asian Development Bank projects that Chinese international reserves at the end of 2010 totaled over $2.8 trillion.