National fund and Kashagan

Approximately a year ago a new concept of forming and functioning of National Oil Fund started to operate. Actually, it is not a new, but the first concept, because before 2006 there was no concept; while the fund was established in 2000.
Initially the fund was designed to have more functions that just save money for future generations (though these functions are very important, as shown by Norwegian example). In our conditions the fund indirectly, but strongly, influenced stability of the financial system, and gave some (though far from complete) understanding of the processes in the oil sector of the economy. Probably, if everything had developed smoothly as in previous several years, then there would have been more clarity with functioning of the fund and oil sector in general. But the Kashagan battle has started. Because over politicized Kashagan was branded as “our everything”, after it got some problems, so did the National Oil Fund – recently people started to talk about using its funds to finance KazMunayGas’s work on the deposit, if its participation in the consortium increases.
This issue is not only about the fund’s future, it is required to take a closer look at the condition of Kazakhstan’s oil industry.
“Using the resources of the National Oil Fund for development of oil industry is inadmissible and intolerable. The country’s future depends too much on oil industry and on realization of risky projects, which are financed by the growing incomes of the budget through new development institutions united in SDF Kazyna. How can we use the resources of the National Oil Fund, which is the strategic reserve of national economy?” – Meruert Makhmutova, well known Kazakhstani expert, director of Centre of Public Problems Analysis, comments this situation. She was one of the first Kazakhstani experts to consider formation and functioning of oil funds and transparency mechanisms of oil sector.
By the way, the transparency issue will become very important, if the reserves of the fund are drawn out for the oil projects. In this case the issue will quickly grow from the stage of discussions by the experts to the stage of political battles. As Mrs. Makhmutova said in her interview to “Exclusive”: “Oil sector in Kazakhstan is like a closed unit. Less than 3% of economically active population are employed in the sector, while the wages are much higher than in other sectors, especially public sector. For example: in 2006 the average monthly wage in our economy was 40 thousand tenge, teachers and doctors on average earned 20 thousand tenge, while average monthly wage in oil sector was 78 – 80 thousand tenge.”
Before the new concept of the National Fund became effective, the weakness was that the companies that had to pay out into the fund were assigned by governmental decree. It allowed the government to freely redistribute the finances between the budget and National Fund. Last year this function was partially transferred to the Parliament. That is the Parliament now knows who pays into the fund. But this year, when the list of payers changed again, the right to determine the payers was transferred back to the government. This, according to Mrs. Makhmudova, allows the government quite freely choose where to channel the financial flows: to the budget or to the National Fund.
How is the fund replenished now, after 6 years of its establishment? This question is important, because if some resources of the fund are used for realization of Kashagan project, we need to know how much will be left in the fund and how long will it take to replenish it back to current level. These questions are difficult. We have to start from the input of oil sector into GDP of our country. Surprisingly, recently the input has been estimated very differently from 8% to 49%.
“For example, the Statistical Agency of RK (Republic of Kazakhstan) estimated it to be 14%, the IMF’s figure was 8%, the Ministry of Economy and Budget Planning said that due to cumulative effect, oil extraction and services in the sector make up 49,5% of GDP. Here the following requires attention: even the term oil incomes has recently changed several times in our country. For example, it was announced that since 1 July 2006, after adopting the Concept of the National Oil Fund, the terms oil and non-oil incomes and deficit were finally determined. At the same time number of payers into the fund increased from 6 to 55. Every company that produced and sold oil and gas condensate were added to the list of payers. But this year the definition of oil incomes was broadened again, now it includes the incomes from exploration, extraction and sales. So all of these definitions are unstable” – said Meruert Makhmutova.
In this respect, the incomes of the National Fund and state budget were also reconsidered… As we can see from these examples, the term “oil income” is pretty flexible. So, with such flexible incomes into the fund, is it possible to forecast it future accumulated resources, especially after some withdrawals, even for an important project like Kashagan?
“The contribution of oil sector into the consolidated budget, excluding the republican budget and National Oil Fund, is about 30% of the inflow. Currently, significant part of exports of oil and other hydrocarbons, leaves Kazakhstan through offshore areas.” – said Mrs. Makhmutova.
Here is another important issue: offshore exports. The situation is surprising, while the country needs to quickly develop the most significant oil deposit, and people discuss whether they can use the accumulated resources of the National Oil Fund, considerable amounts are going past the state pocket.
“Before 2004 approximately 1/5 of Kazakhstan’s oil export was directed to Virgin and Bermuda Islands. Since 2004 Switzerland replaced the islands. During 2004 – 2006 approximately 1/3 of Kazakhstan’s hydrocarbons export went to Switzerland at prices lower than world average. Thus, during these three years it accumulated to an annual volume of production. According to our calculations, annually the oil sector diverts 1,1 billion USD away from taxation. These amounts have at least evaded corporate income tax, bonuses, royalty, share of product (if it is PSA – product share agreement), etc. Taking into account that the tax burden is about 30%, the losses to the budget during three years are at least 1 billion USD only on export to Switzerland” – said director of Centre of Public Problems Analysis.
According to Mrs. Makhmutova, in general it is impossible to accurately calculate the oil incomes: the contracts on oil extraction and PSAs are closed information, and the taxation is stipulated in each contract separately. It makes income of the budget and the National Oil Fund unpredictable. Who knows when and how much each company has to pay in bonuses and royalties, which are dependent on its volume of production? “This information should be available to the Ministry of Finance and Ministry of Economy, but judging by their poor budget predictions, the information is either not taken into account or is not fully available.” – said the expert.
Even such seemingly obvious question as the level of taxation of oil related operations is interpreted quite widely. When Zeynulla Kakimzhanov was the Minister of Finance he said once that from each dollar in oil sector, the budget receives 15 cents; but the coefficient of tax burden is much higher in other sectors of economy. At the same time foreign investors said that oil sector taxation level in Kazakhstan is one of the highest in the world – 78%. These diametrical assessments prove that without uncovering the contract terms, conditions of PSAs and taxation conditions, it will be difficult to make conclusions on fairness of oil sector taxation, - said Mrs. Makhmutova. For example, in the PSA on Kashagan Kazakhstan’s current share is 2%, and when intensive production starts the share of our republic will not be higher than 10% for a long time, until the consortium covers its expenses. Thus, talking of this particular project, current attempts by the government to reconsider the conditions are quite reasonable.
“Though, conditions for extraction on the deposit are quite complicated, and our foreign colleagues say that Kazakhstan’s government will not resolve Kashagan’s problem by just changing the operator. For example, Chinese companies cannot do it, they don’t have the required experience of working off-shore. ”And it is obvious that KazMunayGas also doesn’t have such experience. Thus, by spending the resources of the National Oil Fund to buy out the share in Kashagan project and make KMG the operator on the deposit, we will invest the fund’s money into a risky project. Actually, the fund doesn’t have a very large amount – approximately 18 billion USD. This amount could be spent within 2 – 4 years on different “breakthrough projects”. – said Mrs. Makhmutova.