Is Kazakhstan Open For Business?

| December 22, 2017 | 0 Comments

 

Now that almost six months since the launch of the Expo 2017 Astana have passed, how successful was Kazakhstan’s $3 billion effort to tell the world that it’s “open for business?” Ahead of the Expo, the government of Kazakhstan certainly did its best to raise expectations and to position itself as a regional powerhouse, keen on diversifying its oil-dependent economy. Indeed, in the more than quarter century since the country gained independence from the USSR, GDP growth has come mainly off the back of Kazakhstan’s vast natural resources. But with the price of oil and gas – which account for around 60% of exports – having plummeted, and with GDP having grown by a mere 1% last year, the government has been making urgent efforts to woo foreign investors. Hence the theme of the fair – “Future Energy” – and the government’s campaign to host the Expo in the first place as part of a nation-branding scheme.

However, the investment climate is problematic.  AES, one of the first foreign companies to invest in the country is all too familiar with the problems. An AES spokesperson explained how Kazakhstan forcibly seized two hydroelectric power plants that AES had acquired in a concession deal 20 years earlier – and paid the firm only $1 in return for the assets.

 AES was among the first and only foreign investors outside the oil sector to invest in Kazakhstan, having entered the market in 1996, when the country was still making only halting progress in the transition from a planned to a market economy. At the time, the electricity sector was still state-owned and on the verge of collapse due to chronic lack of funds.

AES’ first move was to acquire the newly privatized Ekibastuz GRES 1 coal-fired power plant in the Pavlodar region. Encouraged by Kazakhstan’s commitment to support foreign private investment, AES later entered into a concession agreement and acquired four coal-fired heat and power plants, together with a 20-year concession for two hydroelectric plants in East Kazakhstan. To ensure the plants were operational during the winter and to upgrade their efficiency, AES invested almost $400 million in the plants included in the concession – even though investment in the sector still posed considerable risks.

As the economy started picking up in 2001 thanks to high oil prices, the government started having second thoughts over its decisions to sell assets to foreign investors such as AES. As a result, it started efforts to re-appropriate the plants and to render the concession agreement null and void.

The only snag was that Kazakhstan had provided a number of guarantees and promises through the concession agreement as well as through existing legislation like the Foreign Investment Law – guarantees which were pivotal in AES’ decision to pursue the investment.

But that didn’t stop Kazakhstan from signaling it wouldn’t extend the concession, nor fulfill its promises – a fact that became increasingly clear as the expiry date of October 1, 2017 approached. In April 2017, AES was officially informed that Astana would require the return of its plants by October 1, without offering any explanation or chance for negotiations. As part of the return process, Kazakhstan was required to pay AES a transfer payment calculated in accordance with a contractual formula, which was designed to ensure that the firm would be compensated for any value it contributed to the plants over the concession period. In July, AES shared its calculation for the payment, which totaled approximately $87 million, along with detailed supporting documentation. The following month, Kazakhstan responded with a one-page estimate of $60 million – with no documentation included.

Following additional back-and-forth, Kazakhstan notified AES that the amount due was only $1 for each plant. Perhaps fittingly for such a bizarre figure, the government did not provide any details for its new calculation.

In its April notification, the government stated that an amount equal to AES’ calculation of the transfer payment would be deposited into escrow, in return for which the firm must transfer the plants, and that arbitration would be necessary to establish the correct payment. AES objected, but the government went ahead nonetheless and reiterated its demand for the “immediate” transfer of the plants. AES complied.

In addition to not paying AES, Kazakhstan set up a flawed escrow agreement that allowed the government to direct the release of funds to any person (including itself) at any time, which prompted AES to apply for a temporary injunction preventing them from doing so. Although AES has been reaching out to local authorities to find a mutually agreeable solution, Kazakhstan has so far refused to engage in settlement discussions, which may force AES to initiate arbitration.

As the spokesperson explained, the affair serves as a warning bell for other investors looking to enter the country. Indeed, other foreign energy firms operating in Kazakhstan have suffered similar fates. These include the US firms CCL Oil, Turkey’s Türkiye Petrolleri Anonim Ortaklığı, and the Dutch firm Liman Caspian Oil B.V.

As they put it, if the government truly wants to diversify its economy and attract business, “It should guarantee a stable regulatory framework and allow investors to repatriate profits and be treated fairly under the contracted agreements.” Indeed, such a strategy would go far towards ensuring the expo delivers on its promises.

 

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