An Overview of Kazakhstan’s Mining and Hydrocarbons Sector and Some Observations on Entering the Market

This is by no means a product of one or two lucky ore strikes by a bunch of “wildcatters” salivating over speedy profits and fame, but results rather from decades of hard work in the trenches. In Kazakhstan, miners, big and small, are now looking to dig more, drill deeper and tunnel faster; and perhaps unlike in the past, they now recognize that successful mining operations involve more than a few pans, a pick-up truck and some good contacts at the border. Success today requires a more sophisticated approach: understanding where you are in the mining cycle, specific knowledge of in-situ challenges (technical, financial, legal, logistical, tax and regulatory) in order to get the resource properly identified, out of the ground and to market in a timely manner at minimal cost, and, finally, a savvy ability to operate within the country.

Kazakhstan’s mining sector is vibrant and has proven to be attractive for investors – that’s why Chinese, European, Indian, Korean, Japanese, Russian and North American companies and just about everyone else is trying to set up a long term presence in country with anchor assets. And geopolitics aside, the international consensus in foreign ministries from Canberra to Ottawa and from Pretoria to Oslo is that access to Kazakhstan’s mineral resources and hydrocarbons makes for good economics.

The LSE listing of Kazakmys in 2005, KazMunaiGas (“KMG”) in 2006 and ENRC in 2007 turned heads and continues to raise interest, but there are more such listings to come because there is a lot more value in the ground. The most recent listing of a Central Asian mining company with assets in Kazakhstan was in October 2010 – Central Asia Metals Plc which raised US$ 60 million on AIM.  That’s good news for miners and for Kazakhstan.

Since independence from the Soviet Union in 1991, Kazakhstan, bordering China, Kyrgyzstan, Russia, Turkmenistan, and Uzbekistan, has attracted over US$ 70 billion in FDI[1]. In October 2010, PM Massimov confirmed that Kazakhstan seeks to attract up to US$ 100 billion in investments to the oil and gas sector alone over the next decade[2].  “We are currently exporting 1.31 million barrels (of crude oil) a day and we aim to take it to 3 million barrels a day. KazMunaiGas (the national oil company of Kazakhstan) cannot do it alone. We are looking for partners for KMG’s projects,” said Massimov[3]. In the non-hydrocarbons space, the government aims to draw in a minimum of an additional US$ 13 billion by 2015 and those figures are at best conservative. Even in the midst of continuing economic turmoil in global capital markets, for the 1st 6 months of 2010, FDI in Kazakhstan in the energy and natural resource sector was US$ 3.9 billion[4] with most of that in oil and gas – that is not a trivial amount. Total net FDI for 2010 is expected to be US$ 11.2 billion[5]; that compares to US$12.6 billion and $15.8 billion in 2009 and 2008, respectively.  Kazakhstan’s GDP growth through October 2010 amounted to 7.1%[6]

In terms of mineral reserves, there is no doubt the country is a global player.  Kazakhstan is currently neck and neck with Australia and Canada in total uranium reserves. Its chromium reserves are the second largest in the world[7]while zinc and lead are in 3rd and 4th places, respectively. Moreover, Kazakhstan is in the top ten for coal, bauxite, iron ore, gold and silver reserves [8] and holds leading positions in copper, tungsten, molybdenum, cadmium, tantalum, barite, beryllium, bismuth, fluorine, titanium and arsenic as well as in phosphates and nitrates.  And that’s for starters.

In the uranium sector, Kazakhstan is ranked the #1 uranium producer in the world with almost 28% of the global total[9], and this, in part, is due to the government’s willingness to set up partnerships with top mining companies.  Kazatomprom has joint ventures with French AREVA and Canadian Cameco.  On 24 November 2010, Uranium One also announced that it consolidated its joint venture with ARMZ Uranium Holding Co, a division of Russian nuclear agency Rosatom. Uranium One will acquire a 50 percent and 49.67 percent interest in the Akbastau and Zarechnoye mines in Kazakhstan, respectively[10]. All in all, Kazakhstan plans to increase uranium mining output in 2010 to 17,588 tons up 3,500 tons from 2009[11].

In January 2009, India’s Nuclear Power Corporation (NPCIL) signed a JV with Kazatomprom for the provision of up to 2100 tons of uranium to India. Kazakhstan has also signed nuclear cooperation agreements with Korea, USA and European Atomic Energy Community. Partnership arrangements tend to be the best option for entry into Kazakhstan[12].

In June 2010, Rio Tinto signed a 50-50 JV with Tau-Ken Samruk, the national mining company, for joint exploration and development of mineral deposits (copper, gold, bauxite and iron ore), thereby signaling to the market that the next Minera Escondida (Chile), Grasberg (Indonesia), Bingham Canyon (USA) or Oyu Tolgoi (Mongolia) may just be around the corner. To explore, interpret and define ore bodies is never easy but in Kazakhstan the task is somewhat simplified because of the heaps of historical Soviet geological data and expertise that is available. While not up to Australian JORC or Canadian NI 43-101 standards, there is enough data available so that no one needs to fly blind. There are rules and procedures in place to access this data – but mere curiosity is not enough to get you access.

The government is pushing for more Rio Tinto like deals as a way to share the exploration and development risks and the upside.  Other “Blue Chip” partnerships with companies like Teck Resources Limited, Royalco Resources Limited, Altius Minerals Corporation, AngloGold Ashanti, Vale S. A, Lundin Mining Corporation, Xstrata plc,   and Anglo-American would undoubtedly assist the government in meeting its aggressive growth targets in the mining sector.

There is no doubt that local miners in Kazakhstan together with Tau-Ken Samruk are making every effort to make sure that any partnership/JV arrangements or  earn-in/off-take agreements are transparent and meet international best practices. If a JV partnership is properly structured the rewards can be spectacular as was, for example, the case with the Escondida Chile copper mine when in 2006 it was generating more than US$1-million an hour in EBIT for its owners – BHP Billiton (57,5%), Rio Tinto (30%), a consortium of Japanese investors (10%) and the International Finance Corporation (2,5%)[13]. That is a formula for success.

On the rare earth metals front, worldwide production nearly reached 125,000 metric tons in 2009 with production expected to increase to 200,000 by 2014. China enjoys 53% of the world’s known deposits and supplies 97% of the global demand[14]. But in time Kazakhstan may be in the same league as it seeks to extract value from rare earths (scandium, yttrium, and the 15 lanthanides) used in new generation computers, turbines and cars.  Japanese companies, amongst others, have made an important move into this sector in Kazakhstan recently.  In 2009, Sumitomo Corporation set up a joint venture with Kazatomprom to extract rare earths from uranium ore[15]. In June 2010, Toshiba and Kazatomprom signed a JV to develop rare earth metals[16]. And these moves are in line with Japan’s recent “search parties” into Mongolia and Indonesia.

Korean steelmaker Pohang Iron and Steel Company (POSCO) signed in October 2010 a joint venture agreement with Kazakhstan’s resources development firm Zaman Group to produce materials used to make steel[17].  POSCO is also developing with UKTMP Kazakhstan’s  titanium production capacity[18] – titanium is mainly applied in the nuclear power, shipping, aerospace industries. Kazakhmys agreed in April 2010 to sell a 49% interest in its Aktogay deposit to China’s Jinchuan Group plc to develop a large open-pit copper mine and concentrator project in eastern Kazakhstan[19]. Junior minors also embrace the partnership approach as evidenced by scores of companies, both listed and not listed.

And that’s not all. Through 3Q2010, Kazakhstan recorded a 25.4% year-on-year increase in its ferroalloy exports to 946,600 mt, up nearly 70%, and valued at $1.356 billion[20]; total production through November 2010 came in at 1.6 million tons[21].  The production of refined gold increased 27.2% from the same period last year to 12,069 kg[22], crude aluminum grew 8.1% to 1.7 million tons[23], and semi-refined copper increased 3.6% to 299,190. Miners expect longer-term Chinese growth to drive demand for ferroalloys and many other metals[24].  And Kazakhstan could be the world’s next superpower in any or all of ferroniobium, ferrophosphorus, or ferrovanadium.

Historically, coal mining has been Kazakhstan’s chief recoverable hydrocarbon because of its abundance, quality and accessibility. There are vast reserves (estimated total deposits of 34.5 billion short tons[25]) of mostly anthracite and bituminous coal plus additional significant and still to be properly understood resources deep underground.  Kazakhstan mined 98.2 million tons of coal through November 2010, up 9.7% over the same period in 2009[26]. Bogatyr and Severnyi coal mines together expect to deliver 38 million tons alone to their customers by year end – with time, these mines can potentially become the size of Black Thunder in Wyoming as the owners plan to invest US$ 600 million over the next three years to upgrade operations[27]; this initiative falls within the scope of the Kazakhstan-Russian JV between “Samruk-Energo” JSC and “UC RUSAL”, the Russian miner that IPO’ed in Hong Kong in March 2010 raising US$ 2.2 billion[28].

Coal production in Kazakhstan has increased primarily because of demand from Chinese and Russian power plants. Kazakhstan could very well move into the top 10 producers of coal in the world over the next few years.  Europe has its sights on gaining further access to Kazakhstan’s estimated 2.5 trillion cubic meters of proven natural gas reserves, which remain largely undeveloped[29].

Kazakhstan’s proven oil reserves are estimated at 30 billion barrels, including both onshore and offshore fields. Oil development is concentrated in several major fields – the Tengiz, Karachaganak and Kashagan, the largest outside the Middle East, as well as in the Kurmangazy and Uzen fields. There are other basins near the Chinese border and around the Aral Sea. ChevronTexaco, ExxonMobil, BG, Total, Agip, and Lukoil, amongst others, have been in country for many years and that is a vote of confidence;  moreover, Korean, Indian and Chinese oil companies are beginning to make an impact in the sector as well, having recently purchased significant assets.  Kazakhstan holds a total of 205 oil and gas contracts, down from 226, as of December 1, 2010. Excluding the 16 Production Sharing Agreements, there are 69 exploration contracts, 52 for production, and 68 for exploration and production[30].

As of December 1, Kazakhstan had 205 oil and gas contracts, including 68 contracts for exploration and production, 69 for exploration alone and 52 for production, Magauov said. Kazakhstan also had 16 Production Sharing Agreements (PSAs), Novosti-Kazakhstan said, citing Magauov.

At the policy level, the government has remained a strong backer of the private sector – thus supporting in both words and actions the view that the private sector is more efficient than the government in running mining operations. This view is firmly lodged in the mindset of government officials and, most importantly, is upheld by the executive branch of Government with the support of Parliament. For this reason, more than 90% of Kazakhstan’s mining companies, excluding in the Uranium sector and some Samruk-Kazyna assets, are owned by the private sector. Nevertheless, some observers are a bit concerned by the government’s recent move to increase its holdings in some private companies and by its imposition in August of new export duties for oil & gas companies.  The relationship between government and private sector, which can be a sensitive one in even the most developed economies (e.g. Australia’s proposed “Petroleum Resource Rent Tax” and “Minerals Resource Rent Tax” legislation), must be balanced carefully, especially in a country such as Kazakhstan where the mining industry is valued at nearly US$ 25 billion and makes up 19% of the GDP[31].

The tax regime in Kazakhstan, while complex, is comparatively more favorable than anywhere else in the region and subsoil use rights are among the best in the new high growth markets.  Over the past few years, however, the government, in part because of the economic crisis, has become more assertive towards investors, both foreign and domestic.  The government has also recently amended “Law No. 2-IV of the Republic of Kazakhstan on the Introduction of Changes and Amendments to the Law on Subsoil and Subsoil Use” (24 October 2007). The changes to subsoil legislation allow the government to unilaterally modify a subsoil use contract “if the subsoil user’s activity leads to significant changes in the government’s economic interests, thereby threatening the national security of the country”[32].

Moreover, as of 1 January 2009, Kazakhstan will no longer sign any new production sharing agreements with subsoil users, although PSAs concluded prior to that date are not nullified. The new Tax Code also eliminated the tax stabilization regime for subsoil use contracts – except for PSAs which have undergone a mandatory tax review, were signed before2009 and approved by the President of Kazakhstan.   Other subsoil use contracts, irrespective of when they were concluded, receive no tax stabilization treatment and are subject to taxation “in accordance with the tax law in effect at the time when a particular tax liability arises” [33]. In accordance with the new Tax Code, subsoil use taxes include special subsoil use payments (subscription and commercial discovery bonuses and reimbursement of historical expenses), the mineral extraction tax, and the excess profit tax. These taxes apply in addition to the other taxes and obligatory payments stipulated by Kazakhstan tax legislation[34].

The procedures to obtain exploration and production licenses seem to be relatively tidy and yet no one should underestimate the intricacy of maneuvering through the various ministries and local government offices or completing tender document requirements. Legal requirements and compulsory measures in connection with environmental policies, safety, national content (a matter of increasing importance), local staff training and various other corporate regulatory provisions can be onerous and at times applied arbitrarily. In this respect, it is always prudent to have a local partner who “knows the ropes” and who can properly structure investment and commercial activities so as to comply with the law to the greatest extent possible.

The national currency, the tenge, is freely convertible with few restrictions placed on transactions in and out of the country. Currency movements are governed primarily by Law on Currency Regulation[35] and the National Bank’s regulations. Exit options on investments, to name only a few, include trade sale, IPO (although that should not be the prime reason to list) or private equity arrangements.

Mining equipment is available and suppliers are swarming into Kazakhstan to make sure that everyone is appropriately equipped. It was no fluke that in September, MiningWorld Central Asia 2010 featured 215 companies from 25 countries:  Australia, Austria, Belarus, Belgium, UK, Germany, Iran, Spain, Italy, Kazakhstan, Canada, China, Netherlands, Norway, UAE, Peru, Poland, USA, Turkey, Ukraine, Finland, France, Switzerland, Sweden and South Korea.  The exhibition space in 2010 was 80% bigger (6,000m2) than in 2009 and this at a time of continuing economic commotion in the capital markets. Conferences that focus on mining in Central Asia are well attended and increasingly frequent – yet again another sign of optimism in the region and the sector.

Without a doubt, the vast quantities and variety of Kazakhstan’s natural resources, as well as its relatively stable economic and political system, will continue to attract the attention of miners, financiers and politicians for many years to come.  For anyone entering the country, especially for the first time, it is smart to team up with a local counterpart before digging and a sine qua non to seek advice before signing MOUs, entering into joint ventures, doing an acquisition, or proceeding with an off-take or earn-in arrangement.

Despite the multiple challenges associated with the further development of its energy and natural resources, Kazakhstan continues to move forward in becoming a world class destination for miners. Kazakhstan  has arrived with Uranium; it needs a slight nudge with oil, and a bit of a shove in resources  such as tin, gold, and molybdenum, to mention only a few, in order to reach its full potential and meet the country’s  objective of raising some US$ 115 billion in the natural resources sector by 2020.  Another sign of increasing confidence: Australia has recently launched a series of mining missions to Kazakhstan, which it sees as a “high-potential” destination for exploration and development.  So keep an eye on Kazakhstan – but make sure it’s an educated one.

* Javier Piedra is Head of  Corporate Finance, KPMG in Central Asia, based in Almaty, Kazakhstan.

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[1] Kazakhstan Embassy to USA and Canada )

[2]www.rigzone.com/news/Kazakhstan Seeks $100B in O&G Investments, SINGAPORE (Dow Jones Newswires), Oct. 13, 2010

[3] www.menas.co.uk/caspian_focus/news/article/1040/Kazakhstan; 14.10.10 Caspian Focus Kazakhstan’s seeking $100 billion in investment

[4] National Bank of Kazakhstan; includes re-invested earnings and also intracompany loans

[5] UniCredit, CEE Quarterly, Economics & FI/FX Research, December 2010

[6] December 13, 2010. Interfax-Kazakhstan

[7] www.icdachromium.com

[8] Kazakh-British Chamber of Commerce

[9] World Nuclear Association. Uranium and Nuclear Power in Kazakhstan (November 2010). www.world-nuclear.org

[10] http://www.reuters.com/article/idUSN2421863620101124; Date: 24 November, 2010

[11] www.wise-uranium.org/upkz.html; Date: 13 October, 2010

[12] World Nuclear Association. Uranium and Nuclear Power in Kazakhstan (November 2010)

[13] http://www.miningweekly.com/article/bhp-billiton-searching-for-next-escondida-in-drc-kazakhstan-and-mongolia-2006-06-09

[14] http://www.commodityonline.com/news/China-leads-global-rare-earth-market; November 22 2010

[15] http://www.sumitomocorp.co.jp/english/news/2009/20090812_082824.html; Aug. 12, 2009

[16] http://diapazon.kz/kazakhstan/kaz-economy/28623-kazatomprom-i-toshiba-podpisali-soglashenie.html; 3 июня 2010

[17] http://www.kursiv.kz/1195205447-posco-i-zaman-group-sozdadut-sp-po-proizvodstvu-ferrosilikoalyuminiya.html; 22 октября 2010

[18] http://www.posco.com/homepage/docs/eng/jsp/prcenter/news/s91c1010025v.jsp?idx=1358; April 30, 2010

[19] www.kazakhmys.com/uploads/kazakhmysplcaktogay26april10.pdf; April 26 2010

[20] http://www.steelorbis.com/steel-news/latest-news/kazakhstans-ferroalloy-exports-up-254-percent-in-jan_sept-567570.htm (Wednesday, 24 November 2010)

[21] State Agency for Statistics of Republic of Kazakhstan, Interfax, December 13, 2010.

[22] Ibid

[23] Ibid

[24] http://www.steelorbis.com/steel-news/latest-news 12 November 2010

[25] http://www.eia.doe.gov:80/emeu/cabs/Kazakhstan/Coal.html; November 2010

[26] Kazakhstan State Agency for Statistics (December 13, 2010 – Interfax)

[27] www.kazpravda.kz/c/1287212011/2010-10-16

[28]www.rusal.ru/en/display.aspx?id=58&lang=en

[29] Shamil Midkhatovich Yenikeyeff (PDF). Kazakhstan’s Gas: Export Markets and Export Routes. Oxford Institute for Energy Studies; November 2008)

[30] Silk Road Intelligencer: News and Analysis from Kazakhstan, December 15th 2010.

[31] 25.11.2010 12:03:51 Kazakhstan Mining Report Q4 2010 – a new market research report on companiesandmarkets.com

[32] KPMG Investment Guide 2009 (page 38) – one of a series of booklets published by KPMG Tax & Advisory LLC, a Kazakhstan limited liability company and a member of the KPMG network of independent member firms affiliated with KPMG international, a Swiss cooperative.

[33] Ibid, page 25 (Article 303 of the Tax Code).

[34] Ibid.

[35] Law No. 57-III of the Republic of Kazakhstan on Currency Regulation and Currency Control, dated 13 June 2005, as amended (hereinafter, the “Law on Currency Regulation”).