Overview
Kazakhstan adopted a number of long-anticipated amendments to its subsoil and oil legislation in early December (the “2004 Subsoil Amendments”).(1) Most of the amendments clarify and fill gaps in the existing legislation. But certain amendments are highly controversial and appear designed to increase the oil-rich country’s control over the ownership and development of its oil, gas and other subsurface resources.
Some of the principal changes introduced by the 2004 Subsoil Amendments are summarized as follows:
(i) Terminology. Much of the terminology used in the Subsoil Use Law and the Oil Law has been clarified. This is a positive development.
(ii) State Pre-emptive Right. Perhaps the most controversial amendment is the addition of a new pre-emptive right provision (contained in the third paragraph of Article 71 to the Subsoil Use Law). This new provision grants the Republic of Kazakhstan a pre-emptive right to acquire any subsoil use right and/or equity interest in a subsoil user that the holder wishes to transfer. Specifically, the Republic is given the right to acquire all or part of the rights being transferred, on terms “not worse than those offered by other purchasers.” This pre-emptive right applies retroactively to all existing subsoil use contracts as well as to future contracts.
(iii) Pledges of Subsoil Use Right. The 2004 Subsoil Amendments change the procedures governing the pledge of subsoil use rights. In particular, amended Article 14 of the Subsoil Use Law now provides that pledges of subsoil use rights will be subject to prior approval of the Competent Body.(2) Prior to this change, pledges of subsoil use rights required only registration with the Competent Body and pledges were specifically exempt from the approval requirement. However, the practical effect of this amendment may not be as great as it would otherwise appear since the Competent Body had broad powers to refuse registrations of pledges on technical grounds. But some confusion has resulted from this amendment, since the registration requirements of the Subsoil Use Law have not been entirely eliminated,(3) thus making it uncertain whether pledges of subsoil use rights still must be registered (in addition to being approved), or whether approval alone is now sufficient.
(iv) Transfers of Subsoil Use Rights. Several clarifications have been made to the provisions in the Subsoil Use Law concerning the transfer of subsoil use rights. First, the period during which the Competent Body must approve a particular transaction (i.e., a transfer or a pledge of subsoil use rights) has been specified: 15 days from the date of the application. Previously, there was no deadline. Second, the Subsoil Use Law has been amended to make clear that subsoil use rights now can be transferred as part of the bankruptcy estate of a bankrupt licensee / contract holder (subject, however, to prior approval of the Competent Body). Previously it was unclear whether such rights terminated upon bankruptcy.
(v) Local Content. Parties tendering for subsoil use rights are now subject to additional requirements. Article 41 of the Subsoil Use Law has been amended to require tender proposals to specify the user’s commitments to the infrastructure and other economical and social developments of the relevant regions of the country. Further, Kazakhstan’s stringent local content requirements have been strengthened. Article 41 now requires subsoil users in their tender proposal to identify their commitment to hire local personnel, as well as to specify the percentage of local content of their works, goods and services (subject to compliance with local and/or international standards). In the event of “repeated” violations of the local content requirements, the Competent Body will have the power to suspend the subsoil use operations for up to 6 months and then to terminate such rights if the violations are not cured in the manner prescribed by the Competent Body.
(vi) Terms and Conditions of Production. The provisions concerning the types of contracts for performing exploration and production operations (Article 42 of the Subsoil Use Law) have been amended. One of the goals of the amendments was, reportedly, to allow for only exploration stage terms to be included in a combined contract (a contract for exploration and production), with the production stage terms to be concluded in a separate amendment or contract following a commercial discovery. However, the amended language (Article 42.3) contains contradictory provisions, leaving open the possibility that production terms still may be negotiated at the time the combined contract is executed.
(vii)Expansion of powers of KazMunaiGas. The already considerable powers of National Company KazMunaiGas have been expanded, by giving it the right to participate in virtually all major oil and gas projects in the country, either as a contractor (acting on its own or jointly with other companies) or on the side of the Government. Where KazMunaiGas operates as a contractor, it will be exempt from paying a signing bonus and from funding exploration activities (with such funding burden being shifted to KazMunaiGas’ co-partners).
(viii) Gas Utilization / Flaring. The Oil Law (Article 30-5) has been amended to strengthen the gas utilization requirements. Commercial development of oil and gas fields is now prohibited without full utilization of gas. Pursuant to the 2004 Subsoil Amendments, gas flaring will be allowed only in emergency situations (when flaring is necessary to safeguard human health and environment), or, upon obtaining a special permit, in exceptional cases of well testing or production testing. If, in such exceptional cases, flaring occurred without a permit, the subsoil user must send a written notification to the Ministry of Energy and the Ministry of Environmental Protection within 10 days.
Many issues arising under the 2004 Subsoil Amendments remain outstanding or subject to further clarification, including the following:
The new pre-emptive right provision of Article 71 of the Subsoil Law is far too brief and leaves many critical questions unanswered. Among other shortcomings, this new provision fails to specify (i) the state body authorized to exercise the Republic’s pre-emptive right, (ii) the procedures to be followed in notifying the Republic of a proposed transfer and in obtaining a decision from the Republic as to whether it will exercise such right, (iii) the parameters (including timing) to be followed by the Republic in reaching its decision (and how this will be correlated, if at all, with the approval procedure already applying to transfers of subsoil use rights), (iv) what is meant by the term “not worse than those offered by other purchasers,” and (v) the consequences of the Republic’s partial exercise of its preemptive right. In the absence of answers to such questions, it is unclear how parties currently planning a transfer of subsoil rights or shares in a subsoil user will be able to do so. Further, questions about the legality of the retroactivity of this pre-emptive right will need to be addressed by the courts or, where applicable, international arbitration. This amendment has received the most criticism of all the 2004 Subsoil Amendments. International oil companies already operating in Kazakhstan have been particularly critical, claiming that the new pre-emptive right will make Kazakhstan less competitive for international investment in its natural resource sector. Such critics assert that it will result in gradual state takeovers of the most successful private entities involved in subsoil operations and, further, that the retroactive application of the pre-emptive right violates the stability of existing contracts. It is unclear whether the concept of registration of subsoil use rights has been eliminated entirely (and replaced with the approval process) or whether, instead, the Competent Body will continue with registration of pledges (and issuance of the relevant registration certificates) as well as with the pre-approval requirement. It is unclear as to whether companies negotiating combined exploration and production contracts will be able now to negotiate upfront the terms of the production stage.
(1) Law No. 2-III On Certain Amendments and Changes into the Legislative Acts of the Republic of Kazakhstan Concerning Subsoil Use and Oil Operations in the Republic of Kazakhstan dated 1 December 2004. The 2004 Subsoil Amendments took effect on 8 December 2004 and amended certain provisions of the Decree of the President of the Republic of Kazakhstan having the force of law On Subsoil and Subsoil Use dated 27 January 1996 (the “Subsoil Use Law”) and certain provisions of the Decree of the President of the Republic of Kazakhstan having the force of law On Oil dated 28 June 1995 (the “Oil Law”).
(2) Currently, the powers of the Competent Body are vested with the Ministry of Energy and Mineral Resources of the Republic of Kazakhstan (the “Ministry of Energy”).
(3) Amended Article 8 of the Subsoil Use Law, for example, refers to the Competent Body’s authority to register pledges of subsoil use rights.
Questions regarding the above matters can be addressed to Curtis B. Masters, Partner, or Azamat Kuatbekov, Associate, at +7 (3272) 50-99-45, at: curtis.b.masters@bakernet.com or azamat.kuatbekov@bakernet.com. Reprinted by permission of the authors from Legal Alert, December 14, 2004
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