1999AMENDMENTS TO LAW ON PETROLEUM

 

Source:  Judith Robinson, BISNIS InternationalTrade Specialist

January 2000

 

Kazakhstan has estimated recoverable oilreserves of two billion tons and two trillion cubic meters of gas, but theland-locked country is without major export pipelines to the West that couldbring in much-needed hard currency to solve its economic woes.  Amendments to current oil and gaslegislation were signed by Kazakhstani President Nursultan Nazarbayev on August11, 1999.  They give the 100% Stateowned company KazakhOil, now designated as a “National Company,”  enhanced powers andresponsibilities.  These includethe right to monitor foreign oil companies' activities even though it may betheir competitor.   At thesame time, KazakhOil can short-circuit tenders to invest in new oil or gasfields under the law

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Two sets of amendments, one to the Edict onSubsoil Use (see BISNIS report 12/99), and the other to the Edict on Petroleum(commonly referred to as the Petroleum Law and Subsoil Law), were passed inAugust 1999. Both sets of new amendments eliminate subsoil use licenses andallow subsoil use rights to be pledged.   The newly amended laws are awaiting the adoption of normative acts toguide implementation, expected in early spring of 2000.

 

Provisions mandating use of Kazakhstani equipment, supplies and servicesin subsoil operations have concerned some foreign oil and gas companies.    However, the U.S.Kazakhstan Bilateral Investment Treaty (BIT) has specific language thatprevents U.S. companies from being subject to local content restrictions.  Although the Kazakhstani government hasconfirmed that, under the BIT, U.S. companies operating in Kazakhstan areexempt from local content regulations, it appears at present that the new restrictionsstill could impact U.S. exporters looking to compete with local equipment/goodsin cases where U.S. exporters compete with local companies for sales to theNational Oil Company, KazakhOil, or to other domestic/foreign companies. 

 

The following text refers to the amendments to the Law on Petroleum.

 

The Petroleum Law amendments address offshore operations. They setout mandatory procedures to be followed for:

n    a commercial discovery that has justbeen made, 

n    developing work programs to beincluded in a contract, 

n    compensation of exploration costs, and

n    resolution of competing claims byvarious parties for the same deposit. 

 

The  “competent body”referred to by the amendments, is a designated State agency to which has beendelegated certain of the contracting , inspection, permitting and otherexecutive functions now required by the law.  In some cases, a “competent body” has not yet beendesignated; in others, it has been designated.  In all cases, the designation could change.  Any U.S. companies contemplatingbusiness in Kazakhstan are strongly advised to seek counsel with legal andaccounting firms active in Almaty, among whom are many U.S. firms.

 

**ROLE OF KAZAKHOIL**

 

KazakOil, a 100% State-owned closed Joint Stock Company, is headedby Mr. Nurlan Balgimbaev, who was Kazakhstan’s Prime Minister until the fall of1999, when he voluntarily resigned and returned to his former job as KazakhOilPresident.  As a result of the newamendments, KazakhOil has been accorded a greatly strengthened and preferentialrole in Kazakhstan’s oil/gas sector, and in fact, appears to have inherited theprimary management of all of the country’s oil and gas operations on behalf ofthe State.  KazakhOil’s newresponsibilities, among others dating from its creation in 1997,  include:

 

n    Development with other State agencies,of a strategy for increasing oil production, 

n    Representing the State interest inoil/gas operations through mandatory ownership of shares in new projects asprovided for in subsoil use contracts, 

n    Participating in the organization oftenders for oil/gas operations in Kazakhstan, including the offshore sectors ofthe Caspian and Aral seas, 

n    Developing and implementing newpetroleum-related projects.      

 

Kazakhstaniand foreign oil companies are required by law to bid on closed or open tendersfor Kazakhstani oil or gas projects. The winner must then negotiate a contract for the acquisition and usageterms of subsoil rights for the project with the Kazakhstani State Agency forInvestments, currently designated as the competent body for awarding suchcontracts.  KazakhOil, however,through the new amendments, takes precedence over other domestic and foreignsubsoil users through its new right to negotiate for subsoil use rightsdirectly with the Agency for Investments without the need to compete intenders.   KazakhOil isspecifically exempted by the amendments from participating in tenders. 

 

Theextent of KazakhOil’s strengthened roles as monitor, participant and possiblysupervisor of oil and gas activities, is unclear, although the company recentlystated that it will increase its monitoring of, and participation in, all oiland gas contracts in the country. Left in question is its role in current projects where it has noownership interest.

 

**CONTRACTS**

 

Under the amendments the double requirement for obtaining a subsoiluse license and then negotiating a contract has been eliminated, leaving thesingle requirement for negotiation and execution of the hydrocarbon contract.  The elimination of the license requirementis not retroactive.

 

Theonly types of contracts now recognized are:

n    Exploration contracts

n    production  contracts

n    combined exploration andproduction  contracts

n    production sharing agreements, and 

n    contracts for construction oroperation of underground structures.   

 

Previouslyrecognized contract types, e.g., service contracts, joint operation agreements,and others, are apparently to be honored if already in force, but new ones willnot be recognized.

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**Governing Law**: The new amendments limit the choice ofgoverning law in contract negotiations to Kazakhstani law.  In contrast to previous contracts,which could in most cases specify either Kazakhstani law or the law of othercountries, now the law of the Republic of Kazakhstan is the only law that cangovern onshore or offshore petroleum operations conducted inside the country.The only exceptions are offshore oil operations at deposits where, by expressstipulation in an international agreement between Kazakhstan and an adjacentState, the law of the adjacent State can be applied.

 

**Work Program**: Allcontracts must contain a “work program” defining the conditions for explorationand/or production over the contract period.  Under the amendments, these work programs take two forms:

 

n    **Minimum Work Program** defines contractorobligations for exploration activities conducted in the contract time periodand territory.  The competent bodycan release the contractor from all or part of the work program if it is proventhat fulfillment would be unreasonable due to circumstances beyond thecontractor's control (except for conditions accepted by the contractor).

n    **Annual Work Program**defines thecontractor’s annual obligations during both exploration and production, andmust be approved each year by the State Agency for the Protection and Use ofthe Subsoil, in the manner designated by the contract. This work programincludes for the year approved: exploration and production programs, detaileddescriptions of planned operations and minimum and maximum levels of production.  The competent body can demand changesin the proposed annual work program based on its own initiative or anotherState agency’s opinion that the proposed program does not follow standarddevelopment practices, violatesprinciples of subsoil use, or creates an increased risk of harm to theenvironment or to human health and lives.

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**Return of the contract territory**: Under the old law this could be stipulated in the license.  Under the amendments, however,provision for return of the contract territory must be included in thecontract.  A change of territoryrights is implemented through re-issuance of the geological allotment.   

 

**NEW ENVIRONMENTAL PROVISIONS**

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**Offshore:**  Under the newamendments, contractors conducting offshore oil operations must use bestavailable methods to protect the marine environment, and are strictly liablefor damage to the environment, or for damage to individuals or legal entitiesresulting from contamination of the seas by offshore oil operations. Part ofthe package of requirements for receiving an offshore drilling or constructionpermit to start operations, is an official opinion by an authorized inspectoron the protection of the subsoil. Moreover, under the amendments, a contractor starting offshore exploration and/or production must have asufficient quantity of equipment, materials and substances available at theconstruction site or within 30 minutes of the site to respond to oil spills orwater emissions. Risk insurance is mandatory for, among other things, cleanup andremediation costs of water pollution, or environmental damage from offshoreaccidents.

 

**Gas Flaring:** Whether offshore or onshore, the flaring ofnatural or accompanying gas is prohibited without the written permission of theState body on the protection and use of subsoil, except where flaring isnecessary to start exploration or production, for equipment assembly, or forthe safe conduct of exploration or production activities.

 

**Equipment and Property Removal:**A contractor, at its own expense, must disassembleor remove equipment and property from the contract territory when requested todo so by the competent body or the State body for the protection and use of thesubsoil, and regardless of whether ownership of the equipment and property hasbeen transferred to the Kazakhstani government.  This provision applies during the term of the contract plusup to one year after contract expiration, except when the equipment istransferred to other subsoil users or the contract provides otherwise. 

 

**OFFSHORE PIPELINE REGULATIONS**

 

Untilthe amendments, Kazakhstan had no laws regulating offshore pipelines.  The rights to construct offshoreoil-and-gas pipelines are now to be granted through issuance of a permit by adesignated competent body (an as-yet unspecified government executive agency towhich has been delegated the right to conclude and execute thesecontracts).  The competent bodyalso grants the rights to operate the pipelines.  Rights for construction and operation of offshoreoil-and-gas pipelines are not transferable.

 

**OFFSHORE EXPLORATION AND PRODUCTION**

 

**Construction and DrillingPermits and Inspections:** Offshore contractors mustapply to the competent body (undesignated in the amendments) four months inadvance to receive the written permits to begin offshore construction work orto begin drilling exploration or production wells. (Note that the amendments also require contractors toprovide paid transportation to the offshore construction sites for stateinspectors authorized to conduct the inspections required for these permits.)

 

Before a permit to start drilling a well can be issued, a contractoror subcontractor must have the following: 

n    a license to conduct the drillingwork, 

n    an inspector’s opinion on the offshoreconstruction, 

n    mandatory insurance against risksarising from drilling wells, 

n    a competent agency’s opinion on theprotection and use of subsoil, 

n    permission for the construction or theplacement of offshore construction.     

 

The amendments require that offshoreexploration and production contractors insure against property losses andliability risks, including expenses for:

n    taking a wellunder control

n    repeated drillingoperations

n    cleaning andlocalization in cases of water pollution

n    experts to removeenvironmental damage caused by offshore accidents.

 

**PROCEDURAL PROVISIONS**

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**Commercial Discovery:** The amendment specifies that the contractorhas 30 days to notify the competent body of the discovery, with summaryassessment and reporting requirements on the deposit’s commercialsignificance.   Previously the deadline wascontractually set, and no default period was given where the contract wassilent.  

 

In cases of commercial discovery of naturalgas, the new amendments required that the contractor immediately prepare thedeposit for production, but not start actual production until a sales agreementhas been concluded for the supply of natural gas from the new deposit.  Unless the contract states otherwise,its term is interrupted pending this agreement.  If no such agreement is reached within one year, thecompetent body can require that the contractor conclude natural gas sales andsupply agreement on reasonable terms, with third parties, including domestic orforeign consumers.  Previously no deadline or notice was specified, but the licensing bodycould grant the development right to another contractor where the originalcontractor did not develop the deposit having made a commercial discovery.

 

**Recovery of Exploration andProduction Costs:**Thecontractor can recover the costs of exploration and production of the depositas stipulated in the contract, but only after the start of production, and onlyin amounts of up to half the cost of the produced hydrocarbons.  This is done by giving the contractor aportion of the oil or gas that has been reserved as compensation for expensesincurred. The cost of hydrocarbons allocated for compensation of expensescannot exceed the rate of amortization deductions established by the taxlegislation.   Prior to theamendments, partial or full recovery of exploration costs was only possible ifa commercial discovery was made.  

 

**Claims to a Deposit PartlyOutside the Contract Territory:**Ifa deposit turns out to extend beyond the borders of the contract territory, thecontractor must immediately notify the competent body, requesting that thecontract territory be extended to the deposit’s peripheries to enable furtherexploration and production.  Wherepart of the newly discovered deposit falls within the contract territory ofanother contractor, that contractor must do one of the following: 

n    transfer allexploration and production rights in accordance with established subsoil rightstransfer procedures, so that there is only one contractor can conduct  exploration and/or production on thatdeposit; or 

n    agree on jointexploration and production of the entire deposit, with preliminary coordinationwith the competent body, which can in fact, force the contractor to conclude anagreement for joint exploration and production on the deposit.