The Business: Oil companies face hard drill in Kazakhstan

By Richard Orange

25 July 04

FOR the hardened oil diplomats and country experts in BG Group's offices in Almaty, Kazakhstan, last week's visit by the local tax police, charging the UK gas firm with illegally smuggling $2.7bn (£1.5bn, €2.2bn) worth of gas across to Russia was just business as usual. But it is also yet another sign of the toughening business climate.

BG rejects the charges, saying that it has followed the letter of the law in the way it has exported gas liquids from the field it operates in Karachaganak to be processed at Orenburg in Russia. But following the law may not be enough.

While the Yukos affair has focused foreign investors' minds on weaknesses in the rule of law in Russia, the situation in neighbouring Kazakhstan, one of the oil industry's prime hunting grounds, also looks shaky.

Times have changed since die innocent early 1990s when the Caspian state doled out contracts to big international majors on terms that many locals now argue were far too generous. Now, with little chance of foreign investors walking away from some of the world's largest undeveloped oil fields, Kazakhstan, led by authoritarian president, Nursultan Nazerbayev, is throwing its weight around.

The republic has long been seen as among the most stable of the former Soviet states. Despite Nazerbayev's suppression of opposition parties and vice-like control of the media, the regime has none of the nuttiness affecting nearby Turkmenistan, where President Saparmuratniyazov has set up a Stalinist personality-cult resembling North Korea's.

But Nazerbayev's economic strategy is becoming more interventionist, especially with regard to the oil industry. Last month the authorities impounded a drilling rig contracted from Parker drilling, accusing the US firm of avoiding $6m in custom duties.

While seemingly unrelated, observers see both the rig seizure and the BG investigation as warnings to foreign companies of what might happen if the state company does not win a stake in Kashagan, the largest oil discovery for 30 years, which BG is selling.

The impounded Parker rig was in the shallow Northern Caspian Sea where Kashagan is located. Kazakhstan had already started extracting more revenue from the Kashagan partners, demanding a massive fine for the two-year delay of first production from the project to 2008, but last month it went one step further.

Just as BG was seeking government approval for the $1.2 billion sale of its 16.7% stake to the other partners, the Kazakh government decided that it wanted the stake itself.

The partners themselves had muscled in on a previous sale of the stake to China's Sinopec, using the terms of the original contract, but none of the terms gave Kazakhstan's Kazmunaigaz a similar right, and it admitted as much.

It cited instead an article in the constitution, which declares the subsoil "the exclusive property" of the state. This sets a worrying precedent, given that it could be extended to almost any oil field.

The state also argued that having the state oil company in the consortium would make it easier for the partners to deal with bureaucratic and technical procedures, with the menacing implication that bureaucracy could more onerous if it is excluded.

There is a vast amount of money at stake. The $29bn development could hold as much as 13bn barrels of oil not far off the total reserves held by an international major such as Shell or Exxon Mobil.

As a result, the partners, Eni, Royal Dutch/Shell, Total, ExxonMobil, and Conoco-Phillips, will not taking the Kazakhs' move lying down, and negotiations are expected to continue in London this month.

Unwelcome visits from the tax police are the most visible sign of the tougher business environment, but companies working in Kazakhstan are also reporting a worsening of everyday problems.

Corruption has previously mainly been a problem only at the very top levels of the Kazakh government, with everyday activities normally quite straightforward. But this is changing; the European Commission warns prospective investors of the constant bureaucratic complications they should expect to face, with the tax and customs departments causing the most difficulties.