Kazakhstan’s Tax Squeeze

March 10. Forbes. Oxford Analytica

Proposed policy changes could increase the burden on foreign investors.

Kazakhstan's Tax SqueezeMost contracts between Kazakhstan and foreign oil and gas companies were signed in the 1990s, when the country was cash-strapped and struggling to recover from the post-Soviet economic meltdown. At the time, foreign companies making investments were taking a substantial risk.

Early welcome. Initially, the Kazakh leadership was very welcoming to the oil companies and grateful for their investments in difficult times. However, as the economy gradually recovered and oil prices began to rise in the late 1990s, leading Kazakh politicians, as well as members of the opposition, periodically called for revisions to these early contracts. There was a growing sense that Kazakhstan had been taken advantage of because of its dire fiscal situation and inexperience in negotiating. Yet President Nursultan Nazarbayev repeatedly defended the contracts over the years, and rejected outright any suggestions that they ought to be changed. He said that the chapter of the 1990s was closed and should remain so.

Policy reversal. It was thus all the more surprising when Nazarbayev told a cabinet meeting on Jan. 22 that times were changing and that the issue of immunity from legislative changes, as stipulated in production-sharing agreements (PSAs), needed to be revisited. The outcome he desires is clear: His unexpected policy reversal was motivated by the need to increase budget revenues substantially. While he may succeed, the maneuver will further dent Kazakhstan’s image as an investment-friendly country.

Within days of the president’s remarks, his cabinet swung into action:

-On Jan. 26 Minister of Energy and Natural Resources Sauat Mynbayev warned foreign companies that they should prepare themselves for losing their exemption from domestic taxation. In a statement to parliament, he said that the only way to take away a company’s tax exemption would be to annul its existing contract.

-Then on Feb. 4 Prime Minister Karim Massimov ordered the government to draft new tax rules to abolish exemptions for foreign firms working on large oil and gas projects. Although no particular agreement was singled out, this will likely concern the country’s three largest oil contracts-for the Karachaganak, Kashagan and Tengiz fields. They are being developed under fixed-tax regimes. As each of these projects involves several partners-such as Chevron, ExxonMobil, Total and others-the changes will ultimately affect most foreign energy majors operating in Kazakhstan.

Investor objections.BG Group, which holds a 32.5% stake in Karachaganak, one of the world’s largest oil and gas-condensate fields, has so far been the most vocal of the major investors in commenting on the upcoming changes. CEO Frank Chapman has said that foreign investors have a right for their contracts to be respected and to be treated the same after having spent money in the country as when they first started.

Tax changes. Details of the planned tax changes have not yet been announced. The reason given for discarding the tax exemptions is to ensure that all natural-resource companies operating in Kazakhstan pay taxes according to the legislation in place today-and not the laws of the mid-1990s, when the contracts were signed. A new tax code went into effect in January 2009, and was designed to unify and increase the overall tax burden on the oil and gas sector. These reforms were part of the government’s economic diversification program: Taxes in the oil, gas and key metals sectors were to be boosted, while taxes for smaller businesses in other sectors of the economy were to be cut. The tax code included a new mineral extraction tax that is planned to increase incrementally on a sliding scale through 2010-11.

Outlook. Proposals to increase the tax burden on international oil companies are likely to make the investment climate in Kazakhstan even less predictable. However, considering the large size of the country’s oil reserves-and diminishing opportunities to develop new fields elsewhere-foreign investors will ultimately have little choice but to accept the new terms.