Government and Business: Options for Compromise
Problems which the mineral producers have must be solved through the economy,
production and law
The oil and gas sector remains one of the main drivers of economic growth of Kazakhstan. In the current environment for the sustainable development of the industry it is necessary to conduct new structural reforms. We asked the General Director of KAZENERGY Association, Aset Magauov, to share what specifically needs to be done to improve the current condition of the mineral producers.
Will you tell us about the current situation in the oil and gas industry? What effect did the tenge devaluation and the fall in oil prices produce on the activities of mineral producers?
Kazakhstan's economy shows a slowdown in its development: in the first half of 2015 the economic growth was only 1.7%, compared with the relevant period of the previous year. First of all, this was caused decreased oil prices, since Kazakhstan exports mainly raw products. The dynamics of production of crude oil and gas condensate remains unchanged. For example, in the first half of 2015, 40.2 million tons of oil and gas was produced, a 2% increase compared with the same period of last year (39.7 million tons). Along with that, it was marked that the supplies of hydrocarbons and petroleum products to foreign markets reduced. In the first quarter of 2015 the export volumes for crude oil and natural gas decreased by more than twice against the same period of 2014 from $17,110 million to $7,959 million, and for coke and petroleum products fell by 1.6 times from $1,076.1 million to $653 million. In general, in order for the petroleum industry yet as the main driver of economic growth to sustainably develop, it is necessary to implement structural reforms.
As for the devaluation, in my opinion, it will produce a positive effect on financial results of the exporters. Along with that, one should not expect a proportional increase in revenues in tenge of these enterprises. With the current oil prices, supplies to the domestic market are, in average, 40% of the total sales volumes. However, part of the taxes in the industry is calculated in U.S. dollars (for example, Customs Duty on Exports, further CDE), the other part is tied to the volume of sales/revenue (MET, rent tax). Transport costs are also paid in dollars. All these factors will smooth a momentary positive effect. In the future, we should expect some growth in the cost of budget items for imported materials and components, and later on an increase in the cost of import related services. Along with that, in the medium term, the oil and gas sector will get certain positive impetus which will make it possible to meet the performance indicators of the current year.
The Government adopted a resolution reducing the CDE to $60 per ton of crude oil. What else measures, in your opinion, needs to be taken so that the industry could operate and develop in the condition of low oil prices?
KAZENERGY Association jointly with the Ministry of Energy conducted two analyzes of the financial condition of the mineral producers: 1) for 52 companies at an oil price of $50 per barrel in 2015, 2) for 61 companies at the oil prices of $40, $50, $60, and $70 per barrel for the period of 2015–2017. Following the results of these studies, the conclusion is that at a fixed rate of CDE of $60 per ton and at a price of crude oil of $50 or less per barrel, the majority of enterprises in the sector have negative or low profitability, which adversely affects the capital investments and leads to the risk of a fall in annual production.
In this regard, a number of proposals were introduced to the government for consideration. Firstly, in order to avoid duplication of payments, it is proposed to set off the amounts of CDE in the amount of the rent tax similar to the procedure in effect for the offset of amounts of deductions to social insurance. With this, the obligatory condition of using the amounts of set-off strictly for the purpose of developing exploration and launching into operation of new wells. At the moment, the proposal is being studied by the Ministry of National Economy.
The second proposal concerned the options for binding the scale of rates of CDE with the world oil prices. Our association announced the option, which is based on: 1) the calculation of rates of CDE introduced in 2005, taking into consideration the change in the minimum threshold from $20 to $30 per barrel; 2) the minimum reduction in the rates of CDE, ranging between $40 and $70 per barrel, as the most sensitive range of oil prices for mineral producers; 3) the introduction of a progressive rate of CDE at an oil price of more than $70 per barrel that reflects the logic of increasing the burden on the mineral producers adequately to increasing world prices for hydrocarbons.
It should be noted that the Ministry of Economy produced for consideration an alternative option of the scale binding the rates of CDE with the world price. The option is marked by an insufficient reduction in the rate of CDE at prices less than $50 per barrel and the maintaining of the current level of burden on the mineral producers at prices ranging between $50 and $60 per barrel. However, at a price of more than $70 per barrel, a progressive rate of CDE is provided.
In this regard, the association hopes that the government will adopt the compromise option that takes into account the interests of both the mineral producers and state agencies.
As the third proposal KAZENERGY initiated amendments to Resolution #1528 of the Government which facilitate the application of the procedure for referring some fields to low-profit ones and receiving privileges on MET.
The government of Kazakhstan already declared its firm intent to assist in simplifying the procedures for obtaining privileges on MET for low-profit mineral producers. With this, 39 companies could take advantage of these privileges, and the reduction in the tax burden is projected at a level of 146 billion tenge.
In general, we believe that these proposals will make it possible already in the medium term to ensure stable development of the oil and gas sector in our country.
KAZENERGY Association participated in development of the concept "Code of Mineral Resources." What initiatives were put forward by KAZENERGY and whether all of these were adopted?
Indeed, in July this year the Interdepartmental Commission for Law Drafting Activities under the Government approved the draft Concept of the new Code "On Mineral Resources and Mineral Production", in the development of which our association took an active part in collaboration with the Ministry of Investment and Development, the Ministry of Energy and other concerned organizations. Currently, in accordance with this concept, the first edition of the draft Code is under preparation, which after its completion will be discussed once again in detail. In this regard, it is too early to talk about any initiatives as "adopted".
In general, the Code of Mineral Resources lays down the basic contours of legal regulation in the area of mineral production for years ahead, and this document is extremely complex and voluminous, in the preparation of which many questions that require analysis and discussion are raised.
Based on an analysis of key statistical data showing the state of the oil and gas sector, as well as an analysis of opinions of the companies operating in the sector, we can draw a conclusion about the following trends and factors existing at the moment: increased volatility of oil prices on global markets, the high rate of tax burden on the oil and gas sector in Kazakhstan (especially, at early stages of field development), unstable legislation (frequent amendments to the laws), extensive bureaucracy of administrative procedures and, as a consequence, their time length, the reducing stocks (lack of advanced growth in reserves over production), increased dependence of the country on the "Big Three" (Kashagan, Tengiz, Karachaganak) and further stagnation of the rest of enterprises in the sector.
In aggregate, the above-said trends and factors imply risks of reducing attractiveness and competitiveness of the sector in terms of investments attraction.
Taking this into account, we see that the key conceptual objectives are as follows: the development of measures encouraging private investment in exploration, the ensuring of the highest possible degree of predictability and stability of regulation ("rules of the game"), the simplifying and shortening of the procedures and time of interaction of mineral producers with the regulating agencies. In our view, these objectives should be implemented within the framework of the new Code that will increase the competitiveness of Kazakhstan's laws on mineral resources in terms of attracting investment from abroad.
During the preparation of the Concept of the draft Code in 2013–2015, the association acted as the main platform for discussing regulatory issues in the field of mineral production, namely hydrocarbons. A separate working group operated on the basis of KAZENERGY, and in autumn of last year a large international conference was held. In addition, by order of the association the leading international center for law issues and policy in the field of energy, oil and minerals carried out in Dundee (United Kingdom) fundamental studies of best international experience in legislative regulation of relations at all stages of development and production of hydrocarbons, which was a great help in the development of the Concept.
Following the results of discussion with the concerned ministries, and primarily with the Ministry of Energy, most of the association’s proposals were outlined in the said document. Let me enumerate briefly the provisions of the concept of the Code, which follow from the conceptual objectives set above. The first one is the analysis and the maximum possible simplification of administrative procedures on the basis of the proposals received from the mineral producers – members of the association. The second one is a gradual transition to a system of calculation of reserves, based on international standards. The third one is an open access to geological information. The fourth one is that at the stage of geological study of mineral deposits there were offered new forms of contracts "with risk", based on international experience and having a goal to make the geological study of mineral deposits attractive and understandable for financing at the expense of private investors. The fifth is that it was proposed conceptually to use only contracts for combined exploration and production. The sixth is that along with traditional exploration, on the terms and conditions existing at the moment (a bid with certain scope of liabilities), it was proposed to introduce a form of "simplified exploration" with regard to unpromising and little-known fields (on the terms "who has come the first will get the first " with a lesser scope of obligations and with a limited period of 3 years, with the right to proceed to full-scale exploration).
The seventh is that at the stage of exploration and production it is proposed to shift to the internationally recognized forms of project documents and to greatly simplify the process of their examination and approval. The eighth is the setting forth in the Code of an exhaustive list of violations of contractual obligations and other grounds for termination of the contract. With this, at the stage of exploration and production it is proposed to provide for the right to arbitration. The ninth is that we proposed a number of tax instruments, including the blurring of tax boundaries between the contracts for exploration and production, the exemption of exploration from VAT, the set off of CDE on the rent tax, and other initiatives. It should be noted that the proposals on tax regulation are now actively discussed jointly with the mining sector within the framework of the working group at the Ministry of National Economy that was specifically created on KAZENERGY’s initiative. In case of their implementation, it will be profitable for the mineral producers to invest in exploration. No doubt, these proposals will need to be further discussed in detail, but we are confident this is the right direction, and the initiatives of such level should be taken into consideration in the framework of work on the Code.
Along with that, a number of the proposals of the association that are at the junction of economic, industrial and legal areas, are complex and need further analysis. Among them, along with the tax regulations reforming package I already mentioned, I can cite a number of issues related to the principle of "rational development of mineral resources", the production profile control, the project documents, and so on. Thus, our experts continue work in these directions.
Will you explain why some items of environmental legislation, such as the temporary storage of waste, "triple responsibility", and greenhouse gas (GHG) emissions raise questions to mineral producers?
The need for regulation of "temporary storage of waste" from production arises in connection with the current risks of the mineral producers due to the lack of clear legislative regulation of this matter. For example, today, in some regions there is a practice of extra charges on the amounts of tax payments for emissions of harmful substances into the environment (as a result of waste disposal) and collection of fines and administrative penalties in cases, where the waste is transferred on a contractual basis to specialized contractors for their placement, treatment and disposal. Such payments (extra charges, penalties and fines) can be large amounts.
"Triple responsibility" means that for one violation (a disposal of emissions into the environment above the permitted limit or an unauthorized one) the enterprise can be brought simultaneously to the three types of liability, and thus, the amount of liability so arising, lead, in our view, to an excessive burden on such a mineral producer. The matter is, in particular, in the "tax liability", which is calculated at the rate of the tax multiplied by 10 times, the next is the administrative liability where the amount of the fine is similar to the amount of the tax liability (the rate of the tax multiplied by 10 times), and the next one is the liability to compensate for damages to the environment with the application of unjustified and non-transparent formulas for valuing damage to the environment by using the indirect method.
Meanwhile, the state agencies recognize the need to amend laws accordingly on these matters, and thus, they together with the business community are carrying out work to amend regulations concerning the emissions into the environment. Some proposals on reforming the environmental laws were put in action in the draft law which is already submitted to the Parliament for consideration. In its turn, those proposals which are aimed to change the "tax liability" are now being discussed by a working group under the Ministry of National Economy.
Furthermore, in matters concerning the recovery of damage to the environment, the enterprises are offered to revise the current formulas for measuring and valuing the damage by using the indirect method. To date, an individual working group has been created in the Ministry of Energy, aimed to develop in the new edition the rules for measuring and valuing the environmental damage. The working group involves concerned state agencies, industry associations and mineral producers.
With regard to the regulation of greenhouse gas emissions, that fact is worthy of noting that in 2013 Kazakhstan put into action a domestic system for controlling emissions by those enterprises which are covered by the National Plan of GHG Allowance Allocation.
With this, the plans for 2013 and for 2014–2015 allocate GHG allowances by using the historical method and set permitted limits at the level of emissions which the enterprises produced in previous years. Thus, in the allocation of GHG allowance, the need to increase the production of heat and electricity, as well as the growth of production of coal, crude oil and natural gas are not taken into account, i.e. in the increase of production capacity the enterprises cannot increase the set limit of emissions.
Besides, the laws do not allow the enterprises in some cases to reasonably get extra GHG allowances and thus make them carry considerable financial costs for their purchase. For example, during the period of action of the National Plan 2014–2015 the enterprises – the members of the association – in the last year alone purchased СО2 allowances in the volume of 533 thousand tons to the amount of more than 500 million tenge.
I should note also that the system of regulation of GHG emissions in Kazakhstan is, in fact, of a discriminatory nature, as it envisages measures to reduce GHG emissions only for the enterprises which are covered by the said Plan (installations of the operators with the excess of 20 thousand tons of СО2 per year), which accounted for, in average, not more than 50% of the total emissions in the country as a whole.
What do you think what price of A-92 gasoline must be in the current situation in the market?
Earlier in the government, two options of pricing of gasoline were under consideration. The first scenario was the abolishment of state regulation of the retail price of AI-92 gasoline. The second one provided for the preservation of state regulation, based on the level of wholesale prices on the border of Russia and Kazakhstan. As you know, the Government applied the first option, and the AI-92 gasoline was excluded from the list of petroleum products, for which the state regulation of prices was set. We suppose that the given decision will make it possible to resolve the shortage of gasoline in the market by importing it from the Russian Federation, thereby to avoid the repetition of the situation with its shortage that occurred in the recent years. Currently, about 30% (1 million tons) of the country's demand for gasoline is met by importing it under the contracts concluded in a foreign currency. Therefore, from now on, the price of gasoline will be determined by the market, taking into account the interests of all the market players.
The construction of a fourth refinery in the country could solve the problem of fuel shortages in the market. What do you think what option for the location of the new plant is most suitable?
At the moment, proposals from the local government offices of the five regions: Aktobe, Mangistau, Karaganda, Kyzylorda and South Kazakhstan regions, concerning the location of the fourth refinery are presented for consideration of the ad hoc working group.
The major criteria for the construction of the plant are: the availability of the railway transport infrastructure, pipelines for oil transportation, power generating facilities with free capacity, sources of fresh water, and labor resources. Besides, that fact was taken into account to what extent is the region dependent on external supplies of petroleum products, and whether there are an excessive number of refining facilities there or not. The work on this matter is still in progress.
At the last meeting in the Ministry of Energy, the decision was taken that the KazMunayGas Company at its own expense will carry out a feasibility study for the construction of the fourth plant. There must be taken into account all the factors, which affect the economic expediency of the project. It is expected that after the launch of the new refinery in operation in Kazakhstan there will be a surplus of petroleum products. So now it is necessary to conduct additional market studies to understand whom we can sell the surplus products.
