Alienation

Yelena Butyrina

Kazakhstani investors are unable to acquire foreign refineries

Kazakhstan, while striving to join the ranks of the major oil-producing nations, wants to firmly establish itself on foreign markets by trying to acquire attractive asset. Additionally, oil and gas processing projects are already in the portfolios of private and state-operated companies, and may turn out to be a natural hedge in the event that global oil prices drop. Although knowing how much we need foreign markets is not so important, being aware of how much they need us is. Over the past two years, Kazakhstani companies have lost out on four projects in four different countries.

Stretching the Limits
Kazakhstan is seeking to profit not only from sales of crude oil and gas, the prices of which have ballooned over the past few years to record highs, but wants to process these as well. The ideal variant for Kazakhstani companies is to establish a vertically integrated system overseas, including “production, processing and retailing”. Additional extractive assets, which are already operating, will allow an increase of the resource base, high-level processing will provide quality products, and an independent distribution system will reduce reliance on monopolists in this segment.
However, the majority of attempts by Kazakhstani investors to break into the markets of other CIS nations and Eastern Europe have been unsuccessful.
The first failure on this list was that of KazMunayGaz (KMG), Kazakhstan’s state-operated oil and gas company, in the 2004 tender for a 63% block of state shares in Unipetrol, the largest Czech refinery. This had been the second effort by the Czech government to sell off its share in the refinery, the first of which failed when Agrofert, a Czech agrochemical group, backed out of its initial offer, presumably due to the unstable financial situation of the oil refineries owned by Unipetrol (a pre-emption right to buy a 51% stake in the Czech company’s refining subsidiary had been previously given to a consortium, including Shell, ConocoPhillips and Eni). Two years prior to the 2004 tender, Russian contenders had been kept out of the bidding for various reasons. Unipetrol combines the oil refineries of Ceska Rafinerska and Paramo, the combined maximum capacity of which is 9 mln tons per year, petrochemical plants, and facilities for the production of bitumen, lubricants and other oil products, as well as owning over 300 petrol stations.
Being excluded from the shortlist, along with Russia’s Tatneft and the Czech and Slovak group of Penta, by decision of the Czech cabinet of ministers was completely unexpected for KMG, as they thoroughly researched the activities of Unipetrol, and had no doubt of their winning the second tender. Moreover, KMG has confirmed that the price they offered for the 63% block was not low in the range forecast by experts, which varied from US$350 mln to US$500 mln, including repayment of Unipetrol’s debt to the state of US$160.8 mln.
Next, KMG set its sight on the acquisition of some other prosperous refining operation, stating that it would do its best to continue to fight for Czech assets. Thus, it began negotiations with others among its previous rivals, including Royal Dutch Shell, Polski Koncern Naftowy Orlen (PKN Orlen), and Hungary’s MOL, on the creation of an alliance with one of them for joint acquisition of shares in such a venture. At that time, this was practically the only option available for the Kazakhstani investor to gain a large Western oil refinery, and thereby secure guaranteed oil deliveries for processing in Europe. In this effort, KMG counted on the goodwill of Shell, which operates assets in Kazakhstan. Nonetheless, no grounds for cooperation could be found, as neither Shell nor MOL chose to exercise its right to purchase the petrochemical businesses of Unipetrol, explaining that they were only interested in oil assets. As a result, the available 63% was acquired by PKN Orlen, which bid US$479 mln for the full block, including repayment of the company’s debt to the state. This price became the only criterion for selection of the winner by the privatization commission.
Considering the interest of the countries of the EU in Caspian oil, as well as expert forecasts that they could face a deficit in hydrocarbons, KMG, not wishing to give up, made another attempt at finding a way into Europe. At the end of 2005, the state-owned company began a struggle for a 53.7% block of shares in Mazeikiu Nafta, a Lithuanian oil company held by Russia’s disgraced Yukos. However, despite official assurances by Vilnius that the government wanted to see KMG as its sole partner in the project, the Kazakhstani investor again found itself the loser after a six-month battle. The Lithuanian company went again to PKN Orlen, which, according to some reports, paid US$1.492 bln. Lithuania ostensibly considered our company unable make necessary guarantees for continuous supply of crude oil, due to the decision of Transneft, the Russian state oil transport monopoly, to terminate the ten-year agreement with Kazakhstan for transfer of up to 12 mln tons of Kazakhstani oil per year to Lithuania’s Butinge terminal. In reality, there was a collision of Kazakhstani and Russian interests in the fight for the share of Mazeikiu Nafta. The Lithuanian company includes: the Mazeikiu oil refiner, which has a capacity of 12 mln tons; the Butinge sea export terminal, with a maximum capacity of 8 mln tons; and, the Burushaski oil-trunk pipeline.
The intrigue did not end here. The Lithuanian authorities that held the remainder of the shares in Mazeikiu Nafta were apparently lying in stating that the absence of guaranteed deliveries was the main reason for KMG’s loss in the tender. Moreover, the Kazakhstani company became involved in developing several alternatives to provide delivery of oil to Lithuania, sidestepping the Russian transport system. Besides, PKN Orlen, not having their own base of raw materials, is unable to secure continuous deliveries to the country. More likely, the Lithuanian government preferred to have a Western partner, who would be independent of Russian political influence, and not a Kazakhstani one, which would be subject to disagreements on transit issues with Russia, eventually making up to [cooperatively] bring oil to Lithuania. Possibly the supposition of the Lithuanian authorities was based on the fact that Kazakhstan, despite losing, might be interested in cooperation with PKN Orlen in making oil deliveries to Lithuania, as well as utilizing the company’s network of petrol stations in Europe.
One way or another, Kazakhstan has twice lost opportunities to enter two of the largest refining projects in Eastern Europe, which were necessary for the country’s planned oil sales to Europe via Ukraine’s Odessa-Brody pipeline.
As of the beginning of this year, Kazakhstan had lost the right to participate in financing the construction of a new refinery in Georgia. A group of Kazakhstani investors, which included Bank TuranAlem (BTA), one of the largest commercial banks in Kazakhstan, recently lost to a foreign competitor in the abovementioned tender. Kazakhstani participation in this project would have allowed processing Caspian oil in Georgia, along with the sales of petroleum products on the local market. Instead, our crude is exported via Georgian ports to the West. The new US$350-mln Georgian refinery, with a capacity of 5 mln tons per year, is to be constructed without Kazakhstani participation.
As well, the largest enterprise of the Udmurt region of Russia, JSC Udmurtneft, will be developed without any assistance from JSC Exploration and Extraction KMG (EE KMG), a subsidiary of the national oil and gas company. In May 2006, EE KMG failed during the third stage of the auction for Udmurtneft’s shares. According to representatives of EE KMG, the company lost on the basis of pricing to Russo-British TNK BP, which later sold a controlling share to China’s Sinopec. In its own turn, the Chinese company sold its new acquisition to Russia’s Rosneft, which had held an option on the asset.

“Gas Magnetism”
Recently, Kazakhstan has only had successes in the gas market. Two neighboring CIS countries became interested in offers put forth by KazTransGas (KTG), the state-operated gas transportation company, which also is included in the list of KMG subsidiaries. Thus, KTG entered the market of Kyrgyzstan, and two years later, that of Georgia.
JSC KyrKazGaz (KKG), a equal JV between two national companies, which was registered in March 2004 in Bishkek, has been given entrusted management of Kyrgystan’s [portion of the] Bukhara-Tashkent-Bishkek-Almaty (BTBA) gas pipeline, an asset valued at 64.798 mln som (the Kyrgyz monetary unit). The BTBA connects Uzbekistan’s gas fields to Almaty via South-Kazakhstan oblast, and crosses the northern districts of Kyrgyzstan in three places. KKG aims to modernize the Kyrgyz portion of the BTBA, and to provide continuous delivery to the northern oblasts of Kyrgyzstan and southern ones of Kazakhstan.
KTG has, in relation to this spring’s acquisition of JSC Tbilgasi, given assurances that it will be able to change the situation for the best with regards to gas delivery to Tbilisi. The state-owned company, which purchased the gas distribution enterprise from the Georgian government, intends to invest a further US$82 mln more during the period from 2006-2011, including US$6 mln just in the current year. The newly registered KazTransGas Tbilisi (KTG Tbilisi) has received a desirable position, including a gas-distribution network of 2,000 kilometers, as well as the potential to render services to around 210,000 clients, above 3,000 municipal locations and 400 industrial enterprises. KazRosGas, a JV between KTG and Gazprom, will deliver Russian gas at a price of US$110 per thousand cubic meters to Tbilisi via the Mozdok-Tbilisi-Armania route.
KTG seriously wishes to better its enterprises in Kyrgyzstan and Georgia, making them profitable by using experience gained in southern Kazakhstan. Bishkek and Tbilisi absolutely trust KTG.

From the Yellow to the Baltic…
Ambitious Kazakhstan has already stated that it will never give up in its attempts to acquire additional oil and gas assets abroad. The geography of the plans is quite broad – from East to West. In particular, state-owned companies are continuing in their negotiations with the Kyrgyz government on the acquisition of those networks held by Kyrgyzgaz, considering Ukraine and its gas-fired electrical production, as well as pursuing plans to construct oil refineries in Turkey, Latvia and China. Besides, KMG’s offer to Riga on construction of modern oil refineries on the territory of the Ventspilsk port on the Baltic Sea may be considered as an attempt by Astana to show what Lithuania lost in refusing to permit Kazakhstan a role in Mazeikiu Nafta, and what Latvia may acquire. Although, all the abovementioned attempts by Kazakhstan have yet to be realized, and therefore the quickest return to the country for past and current failures may today hinge on the acquisition of shares in JSC Kherson NaftoPererobka and half of Orenberg’s gas processing plant. As a reminder, the former enterprise holds up to a 11-12% market share for oil products in Ukraine, and ranks third in total processing volume among the oil refineries of that country. The latter happens to be the largest gas processing plant in Russia.
Currently, KMG’s reduced share in the Kherson refinery, which is operated by Russia’s Alliance Group, comes to only 20.2%. According to some, the Kazakhstani company is actively working on increasing its stake to not less than 50%.
The situation concerning Kazakhstan’s participation in the current project is somewhat vague, considering that it has recently declared the sale of its share, as well as cessation of oil deliveries to the plant. The predecessor to KMG, Kazakhoil, had entered the Kherson arrangement in November 2000, when it acquired a 60% stake in the refinery for 35 mln grivna (the Ukrainian monetary unit), through its subsidiaries. Alliance was designated as the operator on the project. In 2002, when the newly created KMG took over all of Kazakhoil’s operations, the management of the new state company decided to end its participation in the refinery, ostensibly having discovered “greatly reduced prices for oil delivery,” the volume of which totaled about 1.5-2 mln tons per year. KMG considered that the project would, in order to be economically effective, require investment of almost US$250 mln for reconstruction of the facility. However, corresponding investments turned out to be unprofitable for the Kazakhstani party considering its [current] minority stake in the project. Ukraine, for its part, explains the decision of KMG to back out of the operation a connected to the refinery’s financial liabilities, along with low profits. While according to calculations by Alliance and Kazakhoil, returns from the refinery should have been US$5 mln per year, in 2001 this was merely US$1.4 mln. Kazakhstani deliveries to the Kherson refinery stopped in 2002, and for almost two years KMG was trying to cash out its shares, which Alliance and Rosneft were lackadaisical about purchasing. Negotiations never resulted in any agreement, and the Kazakhstani company [later] altered its position in Kherson following failures in the tenders for the Czech and Lithuanian refineries. Aside from investing funds to increase its shareholding in Kherson NaftoPererobka, KMG promises to invest significant capital into reconstruction of the facility and to make continuous oil deliveries for processing.
If an agreement on Kherson remains a still distant possibility, that of the Orenberg gas processing plant, operated by Russian gas monopolist Gazprom, is already in hand, as this agreement has already been reached. During this last summer, the board of Gazprom approved the creation of an equal JV with KMG on Orenberg. Starting from the valuation by Deloite&Touche of the gas processing facility at approximately US$700 mln, KMG should acquire a 50% stake in the plant from Gazprom, paying US$350 mln for it. The Russian side estimates further development costs of the Orenberg asset at US$500 mln. Although, only after KMG’s entry into the project, and the resultant creation of the JV, can the investment plan be reviewed, or a new one proposed. Kazakhstan is to deliver not less than 10 bln cubic meters of gas per year from the Karachaganak oil and gas field over the next 15-year period. Currently, annual deliveries amount to approximately 7 bln cubic meters of gas and 3.5-4 mln tons of unstable condensate.
Kazakhstan’s victory in this case comes from the fact that the Russian monopolist has allowed the country to enter its own market. The results of other ambitious plans of the country will become known in the next year or two.