Viewing cable 05ALMATY3857

05ALMATY38572005-10-21 09:13:00 2011-08-30 01:44:00 CONFIDENTIAL US Office Almaty
This record is a partial extract of the original cable. The full text of the original cable is not available.
C O N F I D E N T I A L  ALMATY 003857 
E.O. 12958: DECL: 10/19/2015 
REF: A. ALMATY 3075 
     ¶B. ALMATY 3143 
     ¶C. ALMATY 3296 
     ¶D. 04 ALMATY 4843 
Classified By: POEC Chief Deborah Mennuti, reasons 1.4(B) and (D). 
¶1.  (C) Summary: On October 15, President Nazarbayev signed 
into law a series of amendments which expand the scope of the 
GOK's "preemptive rights" to cover the case of the sale of a 
company whose subsidiary conducts subsoil operations in 
Kazakhstan.  The new amendments appear to have been 
tailor-made to apply in the PetroKazakhstan (PK) case (refs 
A-C), and rushed into law in advance of the PK shareholders' 
October 18 vote approving the company's sale to CNPC 
subsidiary PetroChina.  Many analysts here believe the 
amendments were intended to increase GOK leverage in 
negotiations with CNPC over the disposition and pricing of PK 
assets, including the Shymkent refinery.  While this law will 
be ignored by Western courts and financial regulators signing 
off on the sale of publicly-held companies, or shares 
thereof, the penalty prescribed for non-compliance -- 
termination of a buyer's subsoil use license -- is real, and 
will likely serve the amendments' intended purpose of forcing 
prospective buyers to seek GOK approval, and give first right 
to the government to purchase "strategic" assets, prior to 
concluding a deal. The GOK justified the new amendments on 
the basis of "national security." Energy Minister Shkolnik 
drew a parallel between the new law and the 1950 U.S. 
"Defense Production Act," which, as amended, provided the 
legal basis for the "national security" objections to CNPC's 
recent bid to purchase UNOCAL. 
¶2. (C) Summary continued.  Whatever the GOK's motives in 
rushing the package into force, the lasting effect of the 
amendments is a tightening of government control over the oil 
sector. Furthermore, at least one prominent energy lawyer 
here believes that the hastily-written amendments go much 
further in altering the legal landscape than the GOK likely 
intended.  Interestingly, the sale of Nelson Resources -- 
owned primarily by GOK insiders -- to Lukoil appears to have 
beat the implementation of the new law by hours.  On the 
positive side, the amendments relax the complete ban on gas 
flaring in effect since January 2005, granting companies 
until July 2006 to submit plans for disposing of associated 
gas. End Summary. 
New Amendments Rushed Into Law 
¶3. (U) President Nazarbayev signed a package of amendments 
related to subsoil use and petroleum operations into law on 
October 15, capping a rapid approval process that began on 
September 8 when the draft law was first submitted to the 
Lower House (Mazhilis).  The new amendments modify three 
existing laws: the "Law on Oil," the "Law on Subsurface 
Resources and Subsurface Use," and the "Law on National 
Security."  The amendments are logically seen as an extension 
of the December 2004 preemption law (ref D), which applied 
only to an entity selling an interest in a contract or a 
subsurface use right in Kazakhstan.  The new law reaches 
upward in an oil company's customary chain of parent and 
subsidiary companies, extending the GOK's preemptive right 
"to any legal entity which may influence, indirectly or 
directly, the decisions made by the subsoil user."  In the 
words (reported in the press) of First Deputy Minister of 
Energy and Mineral Resources Baktykozha Izmukhambetov, the 
amendments were drafted to confront "...cases of access to 
the republic's resources not by way of transaction with the 
subsurface user, but through indirect transactions with the 
parent company of the subsurface user." 
¶4. (U) The key passage (Article 71.3) on preemptive rights 
amends the "Law on Subsurface Resources and Subsurface Use" 
(unofficial translation):  "In order to preserve and 
reinforce the resource and energy basis of the country's 
economy in newly concluded, as well as in earlier concluded, 
subsoil use contracts, exclusive of contracts of subsurface 
water and common minerals, the state has a preemptive right 
before the other party to the contract, or members of a legal 
entity that has the right for subsoil use, and other persons, 
to purchase the alienable right for subsoil use (its portion) 
and/or an interest (stock holding) in a legal entity that has 
the right for subsoil use, as well as in a legal entity which 
may, directly or indirectly, make decisions for and/or 
influence the decisions made by the subsoil user, provided 
such legal entity's activities are related to subsoil use in 
the Republic of Kazakhstan, on the terms none the worse than 
those offered by other buyers..." 
¶5. (U) The penalty for noncompliance is defined in Article 
45.2, clause 1. As amended, the relevant portion of the 
article will read:  "(The) competent body has a right to 
cancel a contract in a unilateral way of 
non-fulfillment of part 3 of Article 71 of the present Law 
regarding a state's preemptive right." 
¶6. (SBU) According to press quotes, Energy and Mineral 
Resources Minister Vladimir Shkolnik told the Parliament's 
Lower House that the GOK "developed the bill after intensive 
study of U.S. legislation," and cited a U.S. "law of 1950 
that stipulates a federal commission to consider all the 
issues of transfer to title of large assets."  (Note: 
Shkolnik is likely referring to Section 7 of the Defense 
Production Act of 1950 -- which, as amended in 1988, provides 
for inter-agency USG review of prospective Foreign Direct 
Investment which may threaten national security.  This 
process became news during CNPC's attempted purchase of 
UNOCAL.  End Note.) 
Putting Pressure on CNPC? 
¶7. (C) Western courts ruling on the sale of shares in 
publicly-traded companies (such as the Alberta court 
currently considering PK's sale to CNPC) will, by legal 
necessity, ignore the GOK's presumption of preemptive rights. 
 However, the penalty for non-compliance envisioned by the 
new law -- potential suspension of exploration and/or 
operating licenses -- will presumably be sufficient to drive 
any future buyers to seek prior GOK approval, and to give the 
GOK an opportunity to purchase desired assets in the name of 
"national security." 
¶8. (C) The consensus here is that the law -- first submitted 
to the Lower House on September 8, 17 days after the August 
22 announced sale of PK to CNPC -- was timed to increase GOK 
leverage in negotiations with the Chinese over disposition of 
PK's assets, and rushed into law in order to predate PK's 
official sale to CNPC.  According to one variation of this 
argument, the intended pressure may have already borne fruit: 
 on October 19 the official government paper, 
"Kazakhstanskaya Pravda," published a joint CNPC-KMG 
(KazMunaiGaz, the state-owned oil company) statement 
announcing the October 15 signature of a Memorandum of 
Understanding (MOU) governing KMG's "participation in the 
purchase of PK shares."  The statement announces that KMG 
will receive "a right of joint management of the Shymkent 
refinery and a right to sell oil products on parity terms 
with equal shares from each side."  (Comment: Experts here 
uniformly agree that, of all PK's assets, KMG most prizes the 
refinery. See Ref C.  However, skeptics of the theory that 
the GOK and CNPC have already reached agreement point out 
that if the details of "joint management" of the refinery 
have not been agreed-upon behind the scenes - not to mention 
the price of KMG's share - the most contentious negotiations 
likely lie ahead, and thus the new amendments' effectiveness 
as leverage remains to be seen. End comment.) 
¶9. (C) Tom Dvorak, President of PK's "Kumkol" Joint Venture 
(with LUKOIL), offered an alternative interpretation of 
events.  While the announced KMG-CNPC MOU was promising, he 
wasn't ready to abandon the hypothesis that the GOK's real 
goal was, in partnership with Lukoil, to scuttle PK's sale to 
CNPC in order buy PK later at a deep discount.  As evidence 
of Lukoil's intent, Dvorak pointed to its lawsuit in Canadian 
court to stall finalization of PK's sale until after Lukoil's 
claim to a preemptive right to the Kumkol field had been 
subjected to international arbitration.  Such a delay, Dvorak 
worried, would surely induce CNPC to rescind its purchase 
offer.  If the MOU was really a sign of GOK-CNPC agreement, 
Dvorak concluded, why hadn't Lukoil dropped its case in 
Canadian courts?  (Comment: One answer, of course, is that 
Lukoil is using its own leverage in negotiations with CNPC to 
buy-out the latter's 50% (PK) share of the Kumkol field. End 
Comment.)  According to Dvorak, yet another possible 
scenario, which Energy Minister Shkolnik's recent comments to 
the press have reinforced, was that KMG and the Ministry of 
Energy were at odds over the sale -- in which case KMG's MOU 
with the Chinese represented less than it appeared. 
The Law with Unintended Consequences 
¶10. (C) Legal analysts here fear that the hastily-written law 
may have many unintended consequences.  DentonWildeSapte's 
Marla Valdez identified two: first, the operative definition 
of the entities over which the GOK exerts its new preemptive 
rights (paragraph 4) was much too broad, and "probably will 
apply in more instances than not."  Second, the amendments to 
the National Security Law appear to obligate the GOK to 
consider numerous routine administrative acts, including 
"concluding and monitoring (subsurface) contracts," as issues 
of "national security."  However, according to previously 
existing GOK legislation, fundamental provisions of subsoil 
contracts, including contract "stability," do not apply when 
questions of national security arise.  This conclusion -- 
which Valdez speculates was unintended -- not only 
contradicts other fundamental Kazakhstani laws (the January 
2005 tax code, for example, grants tax stability to PSA 
contracts entered into after January 2004), but, if 
implemented, would alter the fundamental operating principles 
of Kazakhstani subsoil contracts.  The authors of the 
amendments, Valdez concluded, "were either really stupid or 
really devious." 
Nelson: In Under the Wire 
¶11. (C) Kazakhstan's other headline oil deal -- the sale of 
Nelson Resources, a Bermuda-based and Toronto stock exchange 
listed company, to Lukoil -- would also appear, at first 
glance, to fall within the purview of the new legislation. 
Outgoing Nelson Chief Operating Officer Simon Gill told 
Econoff, however, that Nelson's well-connected majority 
owners (which include the President's son-in-law) managed to 
finalize sale of their shares to Lukoil on October 14, 
thereby narrowly escaping application of the new law. 
Relief on Gas Flaring 
¶12. (SBU) One provision of the new amendments which will be 
welcomed by oil companies is the relaxation of the GOK's 
strict ban on gas flaring, enacted in January 2005.  The oil 
companies had made adoption of a grace period, or 
implementation phase, a priority in their 2005 lobbying 
¶13. (C) Comment.  Many important aspects of this law -- 
including its intended or effective scope -- are not yet 
clear.  Nor do we have a reliable sense of how the law is 
affecting the closed-door negotiations between the GOK, CNPC, 
and Lukoil.  We are left with the impression that the GOK is 
once again tightening its control over the oil sector, 
leaving less and less to the workings of the free market. 
Finally, the fact that these amendments appear to have been 
cobbled together and rushed to beat an October 18 deadline 
only strengthens the perception -- already ingrained due to 
the see-saw tax changes of 2004 and 2005 -- that the GOK 
lacks a coherent, overarching policy toward energy 
investment. End Comment.