Kazakhstan has adopted a new Subsoil Law 1 in mid-2010 which gives the government a stronger hand in its dealings with investors and replaces the previous Subsoil Law and the Petroleum Law. This article outlines the key changes from the previous regime and comments on some of the implications of these changes for investors in the oil & gas and other extractive industries in Kazakhstan.
Existing Licenses and Contracts
Existing subsoil use licenses and contracts remain valid. However, a number of provisions of the new law have retroactive effect—associated gas processing and utilization, project documentation for production contracts, and local content requirements. These are discussed further below.
Although the relevant provisions of the new law are worded in a similar way to those in the previous Subsoil Law and the Petroleum Law, the actual stabilization protection offered is significantly narrower. The threshold for stabilization protection to apply is where changes in law “worsen the results of commercial activity of a subsoil user.”
As was the case previously, stabilization does not apply to changes in law in relation to national security, defense, environmental safety and healthcare. However, the new law also provides explicitly, for the first time, that stabilization does not apply in respect of changes to tax and customs legislation. This is consistent with the general trend in Kazakhstan’s fiscal regime in recent years, which culminated in the new Tax Code in 2009. Under the Tax Code, only production-sharing agreements entered into prior to January 1, 2009 and subsoil use contracts specifically approved by the President retain stabilized fiscal regimes. While the Tax Code specifically addresses taxes and other mandatory payments to the state budget, it is unclear at this stage whether the customs legislation will do so in respect of customs duties and fees.
Grants of Rights and Types of Contracts
The procedure for granting subsoil use rights remains broadly similar under the new law. The acquisition of rights by direct negotiations is only available to the National Company (i.e. KazMunaiGas), to companies which have made commercial discoveries under exploration contracts, and in situations where a second competitive tender has been held involving a single bidder. All other grants must follow a competitive tender process in which the selection criteria focus on the level of the signature bonus and the proposed social and infrastructure spending commitments.
Combined exploration and production contracts are abolished by the new law, except when specifically approved by a decision of the government if the project involves a property of “strategic significance and/or a complex geological structure” (Article 61.4). Exploration contracts may be signed for a period of up to six years, with a one-off extension of up to two years available for offshore properties. The law previously permitted two extensions of two years each for both on-shore and off-shore properties. Production contracts will be available for up to 25 years generally with up to 45 years available for “major and unique” deposits (Article 67.4).
Transfers of Interests and the Pre-emptive Right
The requirement to obtain the consent of the competent body for transfers of direct interests in subsoil use contracts and equity interests in subsoil users has been expanded to explicitly cover a broader range of transactions, including transfers by succession, initial public offerings by parent entities of subsoil users, and transfers higher up in the corporate chain.
The new law also clarifies the types of transfers of direct and equity interests which are exempt from the consent requirement— sales of securities on a recognized exchange, transfers between 99% commonly owned affiliates (except where the transferee is registered in a tax haven jurisdiction), and transfers of less than 0.1% of shares.
The scope of transfers triggering the pre-emptive right of the state to acquire interests in subsoil users or parent entities (formerly contained in Article 71, now Article 12) has not changed. However, free-of-charge transfers now trigger the pre-emptive right.
These amendments were generally anticipated and do not represent a fundamental change of the government’s position. Indeed, the greater clarity provided by a specific application procedure in relation to consents and pre-emptive right waivers (Article 37) is to be welcomed. However, the time frame set out in the law for the consent and waiver procedure is now over three months (previously a month and a half), adding potentially significant delays.
Termination of Contracts
The state may unilaterally terminate a subsoil use contract when:
- a subsoil user has failed to cure breaches of its contract following two notifications from the competent body;
- a transfer of a direct interest in a contract or an equity interest was made without consent;
- a subsoil user does not agree to amend its contract “to restore the economic interests” of the state (Article 71.3); or
- there is a threat to national security.
Aside from item (i) these bases for unilateral termination are largely unchanged from the previous Subsoil Law.
The new law provides that where the parties cannot resolve a dispute by negotiation, they “shall be entitled [to do so] in accordance with the laws of the Republic of Kazakhstan and international treaties ratified by the Republic of Kazakhstan” (Article 128.2). Kazakhstan law generally permits international arbitration, as do certain treaties to which Kazakhstan is a party. However, this provision of the law is seen as an attempt to limit investors’ ability to draw the Republic into international arbitration.
Project Documents and Gas Processing and Utilization
As a prerequisite to entering into a production contract, subsoil users must prepare “project documents” containing the technical and commercial parameters of exploration, appraisal and development of a particular asset. Existing holders of subsoil use rights must ensure that project documents are prepared and approved by the competent body within 12 months from the date of enactment of the new law (i.e. by early July 2011). Similarly, work programs based on the approved project documents must be submitted for approval within 18 months of enactment.
At this stage, there is limited guidance in the law as to the content of the project documents. One point which is clear is that the project documents must include a “section” on processing/ utilization of associated gas (Article 86.6). New production and combined exploration/production contracts must provide for processing and utilization. For existing contracts, subsoil users are required to enter into a separate agreement with the competent body which will become an attachment to the subsoil use contract. Flaring is generally prohibited, except in certain emergency or testing situations.
In line with the government’s policy of legislating to increase the Kazakhstan content of goods and services used inthe oil & gas sector, the new law imposes stringent requirements in relation to procurement activities by subsoil users. Depending upon the exact provisions of a particular contract, some subsoil users may be exempt from the statutory requirements. However, the transitional provisions in Article 129 instruct all subsoil users “to be guided by the requirements” of the new law. This indicates that subsoil users will be expected to comply with the statutory regime rather than the specifics of their contracts, unless able to prove that doing so would “worsen the results of [their] commercial activity.”
Although the new Subsoil Law gives greater power to the government in the regulation of extractive industries, it does not represent a fundamental shift in Kazakhstan’s policy. Limited fiscal stabilization, the pre-emptive right of the state, strict local content requirements—these changes occurred in Kazakhstan law over the past several years. However, the new law solidifies these changes and applies them broadly, limiting stabilization protection available to existing investors.