4.5 Local Benefit: The Kazakhstani Experience

Box 4.5 Local Benefit: The Kazakhstani Experience

As Kazakhstan moves toward the status of a major oil and gas producer, it has developed a policy on sourcing hydrocarbons-related work to Kazakhstani firms. Legal mechanisms have been put in place to require oil and gas companies (or “subsoil users”) to use local goods, works, and services in their operations and to increase the proportion of Kazakhstani employees in their staff and in the staff of their contractors. The policy was first introduced into hydrocarbons legislation in 2004 with the terms Kazakh manufacturer and Kazakh origin applicable to goods, works, and services. It had little practical impact. The Kazakh Content Law of 2009 took a more robust approach to implementation and has proved effective. Virtually all of these provisions migrated into a new Law on the Subsoil and Subsoil Use (2010).

Why was this change necessary? When goods, works, and services were purchased from a foreign supplier, the funds benefited non-Kazakhstani economies, often the same country of origin as the subsoil user. All such expenses were treated as contributions to the annual minimum level of investments that were required under contracts between subsoil users and the state. Failure to meet this target could lead to unilateral termination by the state. Finally, once production was started, the subsoil users had the opportunity to avoid paying higher taxes for the investments, giving them an incentive to overstate their costs at the exploration stage.

In response, Kazakhstani content on goods is defined as a percentage share of the cost of Kazakhorigin materials and the producer’s expenses for goods processed in Kazakhstan. For services, Kazakhstani content is defined as an aggregate cumulative share based on the cost of goods used for the performance of works, as well as the agreement value and/or payments to Kazakhstani employees. It also takes into account the salary fund of the entity performing works or providing services. Among the key elements in the Kazakhstani regime is an online registry of goods, services, and work in subsoil operations that allows the authorities to monitor the operation of the procurement rules, according to the 2010 law. Quarterly reports by subsoil users ensure that this mechanism allows the authorities to monitor fulfillment of obligations on content. Calculation of the local benefit percentage is done by means of a uniform method. Certification of local benefit is also used. There is also a long-term plan with targets for local benefit set in percentage terms.

Violations of procurement rules are treated as a breach of the subsoil contract and the penalties may include termination of that contract.

Natural gas

Agreements for the exploration and production of petroleum typically cover both oil and gas. They usually contain clauses dealing with the peculiarities of the gas industry: longer lead times to identify viable markets if gas is found and to reach agreement with buyers for long-term sales contracts. Longer times are also needed for securing the high levels of investment for field development, processing, and transportation. (See pages 70–71 and 107–08 in this chapter.)47 The fiscal terms applicable to gas production have to be more attractive to investors than those for oil, because the selling price is lower than its oil equivalent (and hence offers lower profitability), transportation costs are higher, and the production profile is longer and flatter. The duration of the project and the long payback period mean that investors will tend to pay extra attention to the guarantees provided by stabilization clauses.

To anticipate the complexities of contracting, a government may provide a special legal instrument for the interim negotiating period. For example, Vietnam’s amended Petroleum Law (2000) states the following:

If discovering gas with commercial value, while lacking the consumption market as well as conditions on pipelines and suitable treatment facilities, contractors may retain the areas where gas is found. The duration of retention of such an area shall not exceed five (5) years and may, in special cases, be extended for two (2) more years. Pending the consumption market and the conditions on pipelines and suitable treatment facilities, the contractors shall have to proceed with the work already committed in the petroleum contracts (Le Leuch 2011, at 8.6.2).

The concept of a specific retention lease was first developed in Australia. Its objective is to encourage the exploration of gas and the identification of commercial gas markets by granting the contractor enough time to assess the

82 OIL, GAS, AND MINING

viability of the discovery and its potential for marketability. In the Offshore Petroleum Act of 2006 a five-year retention lease is provided for. The criteria for granting it are (1) that the block contains petroleum and (2) that the recovery of such petroleum is not currently commercially viable but is likely to become so within 15 years. Guidelines have been issued to define what “likely to become commercially viable” means. The Australian legislation anticipates a further complication for gas development:

Where commercial viability is dependent on combining a development with other potential third party developments or access to third party facilities or technology, the petroleum will not be considered commercially viable if the titleholder is unable to complete an agreement to jointly develop or complete an access agreement for use of facilities or technology which provides an acceptable rate of return. . . . The Joint Authority may declare an offshore pipeline to be subject to common carriage (Le Leuch 2011, 8.6.4).

In a spirit of realism, the Australian authorities also note in their Guideline for Grant and Administration of Retention Lease that success is not guaranteed even if a period of extra time is granted:

[I]t is recognized that the market for natural gas is often characterized by large, long-term contracts, at specified rates over specified periods, and specific quality. Therefore, in some circumstances, the Joint Authority may agree that an otherwise commercially viable gas project (assuming current prices) is not commercially viable and may not proceed due to an inability to obtain a contract at prevailing market terms and conditions, which would support development. Alternatively, the Joint Authority may accept that the level of resources, while substantial may be insufficient to meet any currently available market opportunity (e.g. an LNG project) (Le Leuch 2011, 8.6.4).

In approaching the design of specific contract clauses on this subject, it should be noted that there has been a shift in recent years to include incentives for foreign investors to develop any gas reserves found. Typically, the PSA contractor would be granted more attractive fiscal and contractual terms for gas projects. Years ago, a different approach was adopted in many countries: there would be an automatic transfer of a gas discovery to the state or its national oil company.

An example of this regime in a modern contract is found in Angola (Le Leuch 2011, 8.7.3). Where nonassociated gas is discovered, the rights for its appraisal and exploitation are automatically transferred to the state company without any compensation to the contractor, unless the state company invites it to participate in the development of the gas field on terms that the parties agree on. Until the 1980s Egypt had a similar approach, with the result that gas exploration was neglected. This approach is nowadays the exception rather than the rule. Egypt modified its PSAs to give the company the right to develop and produce gas under certain economic provisions included in the PSA which are more favorable than those for oil. The result was a significant growth in gas production, domestic gas utilization, and exports in subsequent years. The Angolan example highlights what may happen if no provision is included on the consequences of a gas discovery for the right holder or investor. Without some prior right to develop the resource, it would be obliged to negotiate with the government in competition with other companies or it may find that its discovery is handed over to a state company to develop with or without foreign partners.

Box 4.6 outlines the main provisions in petroleum contracts signed with the host government that relate particularly to natural gas. Chapter 5 reviews the main characteristics of gas industry contracts, such as agreements between buyers and sellers, pricing arrangements, and an overview of how the downstream sector is organized for natural gas and LNG operations.

There is one kind of contract that is designed to address a specific set of circumstances: a gas deposit has been discovered but the investor was not interested in developing it and surrendered its rights. Several years, perhaps decades, later, the deposit appears highly commercial and investment in development is possible. In such circumstances, a government may offer to a new investor a development and production-sharing agreement (DPSA) or an appraisal/ development and production agreement. Appraisal of the existing discovery would confirm whether the gas resources within the block are sufficient to justify a final decision to invest. The agreement with the new investor would include a field development obligation but no exploration rights. Qatar, one of the world’s most successful gas-exporting countries, has adopted this approach. The various DPSAs were concluded between the national petroleum company and foreign investors to develop nonassociated gas from the giant North Field.

The consequences of a failure to develop a gas policy that leads to a monetization of the country’s gas resources are

CHAPTER 4: POLICY, LEGAL, AND CONTRACTUAL FRAMEWORK 83