CIC Guest View - FT World Report on Kazakhstan

FT World Report – Kazakhstan

The following are a series of articles and reports published by the Financial Times on 15th December 2004:



From satellite state into the space age
By Arkady Ostrovsky
Published: December 15 2004 08:14 | Last updated: December 15 2004 08:14

In the next year or so Kazakhstan will launch its first satellite and is likely to join the World Trade Organisation.


Both events are a measure of how far this country of 15m people, bordering China in the east and Russia in the north, has travelled since gaining its independence in 1991.
When the Soviet Union fell apart Kazakhstan was a poor, agrarian republic still bearing the scars of Stalin’s mass collectivisation. Stalin used Kazakhstan as a destination for millions of exiled and deported “enemies of the Soviet people”; his successors treated it as a testing ground for nuclear weapons and a launch pad for the space programme.
The legacy of Soviet rule is still glaringly evident in Kazakhstan’s architecture, economy and politics.
However, during the past 10 years it has been trying to build a nation state - and has achieved a lot. This progress has been partly due to its large oil reserves but also to Nursultan Nazarbayev, a pragmatic and authoritarian president who led his country from communism to capitalism.
Mr Nazarbayev, 64 and a former Communist party boss, may not be an exemplary democrat but he has managed to keep intact his country, which is the size of India and has 130 ethnic groups.
It has always been open to the influence of different nations and never displayed any nationalism. While Islam is the main religion in Kazakhstan, it remains a secular state and accommodating to other religions. Russian is widely spoken throughout the country.
Kazakhstan’s cultural and religious tolerance and Mr Nazarbayev’s pragmatism have helped the country to preserve a fine balance in the relationship between Russia, China and the US. After the fall of the Soviet Union Mr Nazarbayev resisted the temptation to become a nuclear power and returned all nuclear weapons to Russia.
Kazakhstan has also signed a 50-year lease allowing Russia to use Baikanur, the main space launching area. The lease helps the republic to maintain a warm relationship with Moscow and brings it $115m a year.
However, while stressing a special relationship with Russia, Mr Nazarbayev has been actively forging links with the west. The strategic relationship with the US was strengthened after September 11 when Kazakhstan backed the US war on terror.
The country has courted foreign oil companies, including ChevronTexaco, to develop its oil reserves on the basis of production-sharing agreements.
Kazakhstan has gained weight in political and economic terms as pressure has built on international oil companies to replenish oil reserves.
For the west, Kazakhstan is not only an important source of energy away from the Middle East but also a guarantor of stability in central Asia. The country accounts for two-thirds of the income of the region.
“For us, Kazakhstan has a long-term strategic importance,” says James Sharp, UK ambassador.
“Sustainable development of Kazakhstan will be beneficial for the whole region. On the other hand, if things in Kazakhstan go wrong, we can say goodbye to many of our objectives in central Asia.”
So far, Kazakhstan has been having a great ride. Its economy has been growing at more than 10 per cent on average for the past five years and $28bn in foreign direct investment has flown in during the past decade.
Oil production is set to triple in the next 10 years - and so is the size of the economy. The question is whether this growth is sustainable.
“Kazakhstan’s oil-based economy is doing well right now. But the country will eventually run out of oil. The question is what happens next,” says Dennis de Tray, director for Central Asia at the World Bank. What happens then depends on how it chooses to spend its new-found riches.
Economists say countries largely dependent on natural resources suffer from “Dutch disease” when a local currency appreciation makes the tradeable sector of the economy uncompetitive and often risk mismanaging their wealth.
In its recent report on Kazakhstan, the International Monetary Fund, warns of dangerous pitfalls facing oil-dependent economies.
“The flow of income to the government from oil and other natural resources has often allowed the government, rather than a private sector, to take a central role in the economy.
“Weak institutions, corruption, lack of transparency and political pressure have often led to serious misuse of and mis-allocation of resources, misguided investment strategies and spending on prestige objects.”
In recent years Kazakhstan has displayed an alarming taste for “prestige” projects.
It has spent lavishly on building a new capital, Astana, whose skyline is dominated by a white tower with a golden globe at the top.
Inside the globe is a golden handprint of Mr Nazarbayev’s palm: when a visitor presses his palm against that of Mr Nazarbayev, the national anthem plays.
Kazakhstan is also planning to spend $350m during the next three years on a space programme.
In spite of this extravagance, economists say Kazakhstan has not yet made any “irreversible mistakes”. It managed to implement essential structural reforms, including the liberalisation of the electricity monopoly and a pension system.
It has created a vibrant private sector and built one of the most advanced banking and financial systems in the former Soviet Union.
Its economy is managed by young, western-educated economists who are well aware of a need to diversify the economy away from the oil sector. Kairat Kelimbetov, the 35-year-old minister of economy, says: “Our aim is to make 15m Kazakh people competitive.”
He says the government is spending between $2bn and $2.5bn on its health and education system and has recently launched an innovation programme.
The government is also trying to reform its civil service and decentralise power in order to give more responsibilities to the regions.
But as Andrei Timchenko, a managing director of Kazkommertsbank, the country’s largest, puts it: “None of these innovation programmes and reforms will do us any good unless we can fight corruption and bureaucracy.”
Corruption and cronyism are endemic in Kazakhstan. Mr Kelimbetov says the shadow economy in Kazakhstan is about 30 per cent of the total.
Mr Nazarbayev’s critics argue that the shadow economy is the extension of shadow politics. “How can you have a transparent economy if you do not have transparent politics?” says Alikhan Baimenov, a leader of Ak Zhol opposition party.
Critics say Mr Nazarbayev and his entourage are tied in a web of family connections, clan interests and oligarchic links.
One of his daughters controls a significant part of the country’s electronic media, the other is a construction magnate and his son-in-law is a senior official in KazMunaiGaz, the state oil and gas enterprise.
Yevgeny Zhovtis, the head of Kazakhstan’s International Bureau for Human Rights and Rule of Law, says: “Like many other post-Soviet republics, Kazakhstan is ruled by a former Soviet elite.
“It has been successful in macro-economic reforms. But it has created a political system designed to protect its personal interests.
“It is naïve to think this elite can create a proper legal system.”
Mr Nazarbayev has long argued that economic reforms must move ahead of political reforms in order to preserve stability in the country.
But the opposition, which is drawing support from the growing middle class he had helped to create, says the time has come to liberalise the political system and let in proper competition of ideas.
Nobody, including the opposition, doubts that Mr Nazarbayev will win the 2006 presidential elections.
If he can liberalise the country’s political system, crack down on corruption and let the private sector take the initiative in the allocation of resources, Kazakhstan should have a bright future.
If not, it will join the club of poor oil-rich countries.


Politics: Pressure for reform is growing
By Arkady Ostrovsky
Published: December 15 2004 08:20 | Last updated: December 15 2004 08:20

On September 19, Kairat, a retired military doctor, went to vote in Kazakhstan’s parliamentary elections. Using the newly-installed electronic voting system he pressed the button for Ak Zhol, the main opposition party.


The following day he came to check that his vote had been registered. He entered his personal identification number but the computer told him that he had made an error and his vote was not valid.
This was one of many “techniques” which ensured that the Pro-Presidential party won more than 60 per cent of the votes and which made the Organisation of Security and Co-operation in Europe (OSCE) conclude that the “election process fell short of international standards for democratic elections”.
According to the OSCE, opposition leaders Galymzhan Zhakianov and Bulat Abilov were not allowed to run for office because of criminal convictions widely viewed to be politically motivated; the media coverage was towards pro-presidential parties and students and state workers were put under pressure from their teachers and supervisors.
Zharmakhan Tuyakbai, the speaker of the Mazjilis, or parliament, resigned in protest against rigging and said the elections were turned “into a farce unworthy of our country”.
Observers say the elections were particularly disappointing because of the raised hopes in the run-up to the polling day. In contrast to previous years the government had registered opposition parties, including Democratic Choice of Kazakhstan, which had been refused registration in previous elections and even allowed debates on television.
There were no political arrests or media outlets being shut down. “We really thought that the government has recognised the value of having a sensible opposition in parliament. But these hopes were dashed,” says a senior diplomat in Kazakhstan.
Economically and politically, Kazakhstan is well ahead of its Soviet neighbours such as Kyrgyzstan and Uzbekistan.
However, the country still has a long way to go before it can achieve the standards of the OSCE, over which it has ambitions to preside in 2009.
In spite of the formal presence of democratic apparatus and opposition parties the power in Kazakhstan was – and firmly remains – in the hands of Nursultan Nazarbayev, who has ruled the multi-ethnic central Asia state since 1989, first as the Communist party boss then as the first and, so far, the only president of independent Kazakhstan.
One of the smartest Soviet leaders, Mr Nazarbayev, 64, helped Kazakhstan to develop into one of the most thriving market economies in the former Soviet territory. But he has always stressed that economic liberalisation must come first, ahead of political liberalisation. “A forced modernisation of social and political systems could have destabilised the society and the state,” he said recently.
His proponents argue that Mr Nazarbayev ensured a smooth and bloodless transition from communism to capitalism by ruling with a strong hand.
He also managed, they add, to avoid the political turmoil or economic chaos that engulfed other former Soviet republics. Kazakhstan, which accommodates 130 ethnic groups, is practically the only country in this volatile region that did not have ethnic, religious or political violence.
Ermukhamet Ertysbaev, political adviser to Mr Nazarbayev, also argues that centralisation of power has allowed Kazakhstan to implement deep economic reforms which had brought the country high levels of foreign direct investment.
“We would have never achieved economic reforms if it was not for [Mr] Nazarbayev,” he says. “Why should Kazakhstan, situated between Russia and China, be a liberal western democracy? Kazakhstan cannot be an island of European and north American values in Central Asia. Democracy must have a solid economic foundation otherwise, it leads to chaos.”
The irony is that, having built a free market economy in Kazakhstan, complete with a sophisticated financial sector, Mr Nazarbayev is now coming under political pressure from his own achievements.
Mr Nazarbayev’s opponents acknowledge the role he had played in economic reforms but they insist that the corruption and cronyism which have blossomed under his rule are hindering further development of the country.
They say political liberalisation has become an economic necessity.
“There is a clear split within the elite. Mr Nazarbayev had prepared the situation when a certain dynamic part of the country’s elite got out of his control,” says Yevgeny Zhovtis, head of Kazakhstan’s International Bureau for Human Rights and Rule of Law.
“The current political system is constraining economic growth and is unable to fight corruption. The shadow economy is the extension of shadow politics,” says Alikhan Baimenov, one of the leaders of Ak Zhol opposition party.
“We are faced with the challenges of globalisation, and if we want Kazakhstan to be competitive economically, we must have political competition inside the country. At the moment, the political system is non-transparent and uncompetitive,” he adds.
The leaders of Ak Zhol party are no radicals: most of them have split from the ruling elite, including Mr Baimenov, a former head of the presidential administration, and Oraz Zhandosov, a former governor of the central bank.
The party’s backers range from impoverished doctors and teachers to young bankers and entrepreneurs of small and medium-sized companies, who want to have stability based on the rule of law.
“We are dangerous for Nazarbayev because our electorates overlap. For a long time, we did not oppose Nazarbayev personally and this allowed us to gather our strength and become established as a proper party,” says Mr Baimenov.
Ak Zhol is also dangerous for Mr Nazarbayev because, in contrast to Russia, where the reputation of liberal parties had been tainted by privatisation and post-Soviet chaos, in Kazakhstan young liberals have never been in power and have a clean record.
There is little doubt that Mr Nazarbayev will remain in power after the 2006 presidential elections. But he will have to deal with growing political pressure from the opposition.
And if Kazakhstan’s reformers are half as successful in building a modern political system as it was at economic reforms, it may yet become an island of democracy in central Asia.



Economy: Oil rich and having a ball
By Arkady Ostrovsky
Published: December 15 2004 08:34 | Last updated: December 15 2004 08:34

Patricia Velazquez, a Hollywood supermodel, is an unlikely judge of Kazakhstan’s economy. As she walked on stage to greet the glamorous crowd at a fashion show in Almaty last month, Ms Velazquez inadvertently put her finger on the challenges.


“Your country reminds me of my home country, Venezuela,” she said, smiling to flashing cameras.
Pedro Rodriguez, the World Bank’s senior economist in Kazakhstan, agrees. “It is like Venezuela at the time when it was on the rise and before it had made any significant mistakes,” he says.
Like Venezuela in the 1970s, the oil-rich republic is having a ball. Glamorous fashion shows, busy restaurants, chauffeured Mercedes cars - everything speaks of economic boom.


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During the past four years the economy has been growing at an average of more than 10 per cent, one of the fastest rates in the world. Income per capita this year is 65 per cent higher than in 2000.
Foreign direct investment has been flowing in for the past 10 years and will reach $28bn this year, 80 per cent of it in the oil sector. So, the immediate future looks rosy.
According to Kairat Kelimbetov, the minister of economy, the size of the economy - currently $37.6bn - is expected to double by 2008 and triple by 2015 as a result of increased oil production.
At the moment, Kazakhstan is producing 1m barrels of oil a day and planning to triple this output in the next 10 years. Like Venezuela, Kazakhstan is prone to the “Dutch disease”, an economic condition where sharp appreciation of the local currency fuelled by revenues from natural resources, makes the country’s economy uncompetitive.
Even bigger is the danger of the government misusing revenues from natural resources by spending them on prestigious projects rather than on health, education and infrastructure.
This is precisely what happened in Venezuela when it started to pursue the policy of industrialisation by putting money into state companies.
So far, Kazakhstan has not made any significant mistakes.
In the past decade, the country has striven to restructure its economy and create a free market. It has overtaken Russia in many of its reforms.
It has built a sophisticated banking system, introduced a private pension plan, and liberalised and privatised its electricity sector.
Furthermore, it has also established a national fund which has accumulated $4bn in oil revenue savings.
Most important of all, it now has a private sector that is driving economic activity: according to the World Bank, three-quarters of all investments in the country are made by the private sector.
However, Kazakhstan remains predominantly a natural resource economy prone to “Dutch disease” - an economic condition where sharp appreciation of the local currency, fuelled by revenues from natural resources, makes the country’s economy uncompetitive.
Kazakhstan is already showing some signs of overheating. Its currency - the tenge - is appreciating at 8.4 per cent a year against the dollar.
This, Mr Kelimbetov says, “could decimate the non-oil sector of the economy.” Mr Kelimbetov says oil-related investments, rapid public sector growth and the private sector credit boom are fuelling domestic demand which is growing faster than the country’s ability to produce.
The central bank is trying to smooth out the appreciation of the tenge by buying dollars in the market. It is also sterilising extra revenues by issuing short-term notes.
The risk of overheating could endanger the country’s efforts to diversify its economy.

Mr Rodriguez explains that while demand for tradeable goods can be satisfied by imports - and Kazakhstan has plenty of foreign exchange reserves to pay for those - demand for non-tradeable goods, which can only be produced locally, including construction, infrastructure, electricity, health and education, will put pressure on wages and inflation.
Mr Kelimbetov, a western-educated 35-year-old economist, says it is essential for Kazakhstan to build a competitive and diversified economy.
“The oil sector brings foreign investments but does not create jobs. We must overcome our legacy of being a natural resource-based economy.” Kazakhstan, he adds, is restructuring its public sector and identifying competitive advantages for the private sector.
Mr Kelimbetov says that the government is planning to spend between $2bn and $2.5bn on health education and social benefits during the next three years.
“We want to switch to a European model of school education from 2008, making particular emphasis on foreign languages and market skills. All schools will be connected to the internet,” says Mr Kelimbetov.
Kazakhstan has recently launched an innovation programme which envisages the creation of science and technology parks.
It has hired Michael Porter, a Harvard business school guru, to identify the clusters of competitiveness for the economy.
The results are still to be published but Mr Kelimbetov says they could include textiles, chemicals, oil machinery and financial services.
“This does not mean we will put money into these sectors. It means that we will create conditions for the private business to develop those areas, but the risk should stay with a private enterprise.”
He says the success of Kazakhstan’s economy depends at least as much on its macroeconomic policy as it does on its ability to fight corruption, which has become endemic in recent years.
Mr Kelimbetov says the grey economy is estimated to be about 30 per cent of the total, but the government is trying to incorporate informal sectors into the mainstream economy. “Fighting corruption is our biggest task.”
Western economists say it is important that Kazakhstan does not get carried away with public sector expansion and innovation programmes.
They argue that what the country really needs is infrastructure and a competitive, educated and healthy labour force that would be able to identify its own competitive advantages better than any academic theory. Mr Rodriguez also warns that Kazakhstan should not spend too much too quickly on its public sector expansion.
“You should not over-feed someone who has been starved, you may kill them,” he says.


Banking: Raising the standards drives consolidation
By Arkady Ostrovsky
Published: December 15 2004 08:38 | Last updated: December 15 2004 08:38

When a team of young managers started Kazkommertsbank in 1990 it was one of the smallest banks with $1m worth of assets dwarfed by the state-controlled savings bank. During the past decade it has grown into the biggest bank in Kazakhstan with $4bn of assets and capitalisation of $400m.


Its shares are listed in London and Frankfurt, it has investment grade rating and it issues international bonds. Furthermore, it has recently acquired a small bank in Moscow to facilitate Kazakh business in Russia.
Meanwhile, Halyk Bank, a recently privatised savings bank, is trying to catch up. The spectacular growth of Kazkommertsbank is not just a tribute to its managers; it is also the result of the country’s reforms of its banking and financial system implemented by successive central bank governors.
In the past decade, Kazakhstan has created one of the most dynamic and sophisticated banking systems in the whole of the former Soviet Union. It is the envy of Russian banks, which are still recovering from the 1998 financial crisis. Unlike Russia, where banking is still dominated by the state-controlled Sberbank, Kazakhstan has privatised all its banks and the private sector is enjoying healthy competition.
In contrast to Russia, where banks had served as the treasury departments of large industrial holdings, providing financing for their own shareholders, Kazakhstan’s banks are really in the business of taking deposits and lending money to individuals and companies.
As part of the reform process banks have been required to adopt international banking standards, including the risk-weighted 8 per cent capital-adequacy ratio set by the Bank for International Settlements, disclose their shareholder structure and publish audited accounts.
The consolidation process has reduced the number of banks from 200 in the early 1990s to 35 today. The commercial banking sector is dominated by Kazkommertsbank, Halyk Bank and Turam-Alem Bank. Between them, they account for two-thirds of the entire market.
To boost the confidence in the banking sector the National Bank introduced deposit insurance four years ago. As a result of these measures banking deposits in the past four years increased sixfold to $7.5bn. The ratio of deposits to gross domestic product almost doubled in the same period: from 11.3 to 21 per cent.
However, Kazakhstan’s banking system could be in danger from rapid credit expansion. Commercial loans are growing by 45 per cent a year, fuelled by capital inflows and economic growth.
Andrei Timchenko, managing director at Kazkommertsbank, says that while corporate loans still account for 70 per cent of the credit portfolio, retail credits are the fastest growing part of the banking sector. “Until 2000, we had almost no retail business. Today, it is 10 per cent of our portfolio.” Mortgages account for more than half of all retail credit portfolios.
Analysts say such rapid credit growth poses serious risks to the banking sector. The banks admit the quality of their lending portfolios has been declining in recent months. “It is hard to maintain the quality of credit portfolio during a credit boom. We are concerned about the quality of assets this credit boom is funding,” says Dennis de Tray, director for Central Asia at the World Bank.
In order to finance credit growth, banks are borrowing in dollars in the international capital markets while lending in local currency. In the past year, Kazkommertsbank, for example, has borrowed $1bn internationally in 10-year bonds. For as long as the local currency appreciates banks can make money. But once the tide changes, it may become harder for them to repay their own borrowing in hard currency.
The World Bank says second generation reforms are essential to maintain the health of the financial system. This includes the creation of domestic capital markets. Banking is, effectively, the only channel of capital distribution in Kazakhstan. While oil and gas companies with foreign participation can tap international capital markets, non-oil enterprises rely almost exclusively on bank loans.
The equity market is small and illiquid and few companies issue domestic debt. “The real sector of the economy does not use the potential of capital markets. Part of the problem is that owners do not like to disclose information required for public offering of shares or bonds and lack culture of working in the capital markets,” says Anvar Saidenov, head of the National Bank of Kazakhstan (the Central Bank).
Another difficulty is the lack of sovereign benchmark bonds that would stimulate the growth of fixed income markets. Since the government is running a fiscal surplus, it does not need to borrow. But Mr Saidenov says the government should nonetheless issue bonds and build a proper yield curve to establish a benchmark for the cost of capital.
This is also essential for the development of the pension fund industry, which has been growing rapidly during the past five years, since the launch of the privately-managed pension system in 1998. The total savings in the pension system in the past five years increased sevenfold and is estimated at $3.5bn; it could reach $9bn by 2012.
The problem is that Kazakhstan’s economy cannot absorb this level of saving and there is already a serious shortage of domestic instruments in which pension funds can invest.
The World Bank says the government should create an “escape valve” for pension funds to “park” their resources while more long-term financial instruments and vehicles are being created. “In a remarkably short period of time, Kazakhstan has developed a commendable banking and pension system. It must not rest on its laurels,” says Mr de Tray.


Caspian oil: Tightening rules of the game
By Isabel Gorst
Published: December 15 2004 07:48 | Last updated: December 15 2004 07:48

Kazakhstan is one of the few places in the world open for business to international oil producers seeking to replenish their reserves. For governments increasingly concerned about the security of energy supplies, the republic offers a plentiful source of oil outside the Middle East.


Thanks to high oil prices and keen foreign investment, Kazakhstan’s oil industry is thriving and soaring output is powering an economic boom.
For now, all Kazakhstan’s oil is produced onshore. However, since 2000, when a group of six foreign companies led by Italy’s Agip, discovered the Kashagan field in the north-east Caspian Sea, the big players’ interest has focused offshore.
Kashagan is regarded by oil companies as a fluke. In a world running out of truly huge fields, it was the biggest find in 30 years. Kazakhstan’s offshore is far more promising than other areas of the Caspian Sea. Reserves will support production of at least 3m barrels per day.
Agip and its partners have struck lucky at all five structures drilled on their acreage so far, making Caspian exploration look easy. But tapping Kashagan oil is daunting.
High pressure reservoirs are dangerous to tackle especially in ecologically fragile, shallow waters round the field.
The former Soviet Union - of which Kazakhstan was a part until 1991 - was not renowned for its care of the environment, but had banned drilling in much of the area altogether.
Kashagan wells yield poisonous sulphurous gas as well as oil.
There is no profitable gas market in or around Kazakhstan and the government has outlawed flaring. So huge state-of-the-art compressors are being imported to re-inject gas into the field for recovery later.
“Kashagan will have two lives spanning 70 years, one for oil and another for gas,” says Martin Ferstl, Shell’s chairman in Kazakhstan.
Kazakhstan’s master plan for development of the Caspian envisages investment of more than $30bn by 2015, much of which will come from foreign companies. Kashagan, the trailblazer, will alone absorb $20bn, $8bn of which will be spent before first oil is produced in 2008.
“Annual expenditure required to implement Kashagan is higher than anything I have ever seen before,” says Mr Ferstl.
In the early stages most Caspian spending will go on infrastructure projects in the remote region, including processing plants, ports and a fleet of tankers that KazMunaiGaz (KMG) has ordered from a Russian yard to shuttle exports across the Caspian.
Kazakh oil regulations oblige developers to maximise purchase of locally manufactured equipment. Italy’s Saipem has teamed up with a Kazakh partner to establish an offshore fabrication yard near the coast.

Kazakhstan believes it was too soft when negotiating early foreign oil contracts in the years immediately after independence, when the government was struggling to steady an economy reeling from divorce from the (former) USSR.
Oil prices were much lower in the 1990s but Kazakhstan offered rare access to big, already discovered oilfields that investors could not resist.
If a tough production-sharing law drafted for the Caspian is passed, investors will have to submit to operation by KMG and pay all the state company’s costs during exploration.
Foreign companies favour production-sharing agreements (PSAs) because they provide a stable tax regime for the life of a project.
But Kazakhstan, taking a leaf out of Russia’s book, is having second thoughts about handing out PSAs everywhere in the Caspian.
“Nothing is ever final in Kazakhstan,” says Julia Nanay, senior director of Petroleum Finance in Washington DC.
Oil produced under shifting tax and royalty deals will be subject to an export duty introduced this year which rises to 33 per cent when oil prices are above $40 a barrel.
“Kazakhstan is now firmly on the oil map of the world and it is quite natural that it will tighten the rules of the game. The main concern is that the tightening does not drive away investors,” says Boris Zilbermints, head of Lukoil Overseas’ Kazakhstan division.
Lukoil was fortunate to secure four Caspian contracts before Kazakhstan began rethinking the rules.
“Unless terms are improved Caspian fields will yield rates of return well below the 15-20 per cent generally targeted by oil majors,” says Mr Ferstl.
The Caspian master plan says more than 100 blocks will be let out via competitive tenders.
But companies are busy bargaining individual offshore contracts with Kazakhstan behind the scenes.
“A drop in price to just $25 a barrel could pose a high risk for investors. The danger is that companies will do all kinds of deals in the Caspian that may turn out to be marginal down the road,” says Ms Nanay.
For now onshore fields are providing all Kazakhstan’s booming oil output. The giant Tengiz field on the east shore of the Caspian has been operated by the ChevronTexaco-led Tengizchevroil (TCO) venture since 1993 and is the republic’s biggest producer.
TCO is investing $4bn in a project to boost output to 500,000 barrels per day in late 2006.
At Karachaganak field, Karachaganak Petroleum Operating (KPO), working with BG Group, Agip, ChevronTexaco and Lukoil, in 2003 completed a $4.4bn investment to double liquids production. To circumvent export constraints, KPO also laid a 675km pipeline west to the Caspian Pipeline Consortium’s export system near Atyrau.
Now 140,000 barrels a day of Karachaganak oil moves on to world markets via that route.
Karachaganak is also one of the world’s biggest gas fields. But until a viable market can be found, most gas is being re-injected into the reservoir.
Russia’s Gazprom imports some Karachaganak gas at miserly prices, and is not keen to share pipeline access to better paying export markets.


Oil expansion: Happiness is in the pipeline
By Isabel Gorst
Published: December 15 2004 08:54 | Last updated: December 15 2004 08:54

“Happiness would be multiple oil pipelines,” says Steven Mann, one of the longest serving US diplomats in the Caspian region. The goal, shared by foreign governments and oil companies, to diversify export routes out of the Caspian region’s biggest producer, Kazakhstan, has proved elusive.


Thirteen years after breaking free from the Soviet Union, Kazakhstan has grown a 1m barrels per day oil industry that supplies more oil to world markets every year.
But the landlocked republic is still dependent on pipelines across Russia to carry its exports. After all, oil is not worth much if it cannot be transported effectively to a profitable market. So control over pipelines trumps all cards in the geopolitical games played out round Caspian oil.
Ever since the first foreign investors arrived at its oilfields in 1994, Kazakhstan’s policy has been one of creating a pipeline network running north into Russia, west to the Turkish Mediterranean, east to China and south to Iran.
There was a breakthrough in September when state-owned KazMunaiGaz (KMG) - and the Chinese National Petroleum Corporation (CNPC) began building a 1,000km line east from Atasu in central Kazakhstan to Urumchi in western China.
China is the world’s fastest growing oil consumer and, as such, a market well worth capturing. Chinese companies have already invested more than $1.3bn in onshore Kazakh oilfields and are eager to win reserves in the more promising Caspian Sea.
Kazakhstan and China hope that the pipeline being built near relatively small fields around Atasu will eventually form the final leg of a far longer 3,000km system spanning Kazakhstan and carrying Caspian Sea oil east to China.
Meanwhile, Kazakhstan has landed CNPC with responsibility for making the Atasu line a success when it starts up early in 2006.
The Chinese will finance most of the $700m project and will be responsible for finding suppliers and setting the oil price, according to Uzakbay Karabalin, president of KazMunaiGaz.
“If the price is not competitive, no one will ship. It’s a purely market matter and they should take that into account,” he says.
Although producers round Atasu have enough oil to fill at least half of the 200,000 barrels per day pipeline no throughput contracts have been signed yet. Russian oil producers are invited to join in by moving Siberian oil south in an almost empty Soviet-built pipeline serving refineries in east Kazakhstan.
Their assent would begin the transformation of Kazakhstan into a transit route for other countries’ oil exports and is likely to be blocked by Transneft, Russia’s state pipeline monopoly.
When Kazakhstan became independent Russia would allow only a trickle of the republic’s oil into its export systems. As time went by Transneft has come to see transit as good business - as long as it is handling the oil.
Russia and Kazakhstan have now agreed a long-term oil transit accord: a pipeline carrying Kazakh oil north from Atyrau to link into Russia’s export system to the Black Sea has been expanded to handle up to 300,000 barrels a day.
KazMunaiGaz is negotiating with Transneft to add more capacity.
After some hesitation, Russia also agreed to allow a group of foreign companies led by ChevronTexaco to build a $2.6bn pipeline from the Tengiz field in west Kazakhstan across its territory to the Black Sea.
No privately owned pipelines had existed in Russia before. “You can see how much progress has been made in 10 years,” says Mr Karabalin.
The Caspian Pipeline Consortium’s (CPC) system began operating in 2001 and is now carrying as much Kazakh oil as it can. CPC shippers are all shareholders and eager to build up the system to transport extra Kazakh oil production. So is Kazakhstan.
But Russia, owner of 24 per cent of CPC shares, has not yet given its approval. It is keen to see state officials take over key jobs in CPC and shippers to pay higher tariffs.
CPC feeds quality Caspian oil into crowded Mediterranean markets to compete with less attractive Russian export oil. Tankers loaded with CPC crude jostle with Russian vessels for space in the congested Bosphorus waterway between the Black Sea and the Mediterranean.
Kazakh oil production is rising by more than 14 per cent a year and is expected to surge after 2006 when the republic’s biggest field, Tengiz, doubles its output.
The following year, Kashagan, an even more vast giant in the Caspian Sea, will come on stream and is expected to yield 450,000 barrels per day by 2010. However, even when host country and investor interests are aligned, it takes at least four years to establish a pipeline from scratch.
“If existing pipeline capacity is not expanded and new lines built soon Kazakhstan could end up with a lot of oil with nowhere to go,” says Edward Chow, a Washington-based oil analyst.
The Atasu line to China will be small and far away. Washington’s opposition to Iran prevents US company investment in a southern route. Together with Japanese and French companies, Kazakhstan is studying an export line via Iran. “But Iran is a dream for now,” says Mr Karabalin.
The US has urged Kazakhstan to export oil via a new pipeline being built by a BP-led group from Baku in Azerbaijan across Georgia and Turkey to Ceyhan on the Mediterranean.
It would mostly be filled with Azerbaijan’s oil. But there would be some room for outsiders in the early years and capacity could be almost doubled with more investment.
Kazakhstan, meanwhile, is negotiating a government-to-government deal with Azerbaijan to allow exports via the Baku-Ceyhan line. But progress is rather slow.
KazMunaiGaz is building a fleet of tankers to shuttle oil across the Caspian. Building an offshore pipeline is not on the cards.
Environmental provisions of a draft Caspian Convention to be agreed by all five coastal states forbids subsea trunk lines.


Astana: Coldest capital is a ‘metabolic eco-city’
By Isabel Gorst
Published: December 15 2004 08:01 | Last updated: December 15 2004 08:01

Historically, Kazakhstan’s capital, Astana, founded by decree of President Nursultan Nazarbayev in 1997, was never a place people chose to visit. Located between the bleak steppes and forbidding bogs of southern Siberia, it was built in the 1830s as a fort and manned by Cossacks defending a crossing place for traders in the shallows of the River Ishim.


Stalin drafted in German prisoners-of-war and Chechen deportees to toil in local factories and farms. After them came droves of Soviets under the banner of Khrushchev’s Virgin Lands policy to turn the steppes into a vast field of grain.
President Nazarbayev’s decree did not force anyone to forsake Almaty, Kazakhstan’s former picturesque capital 1,000km to the south-west, for Astana - on record as being the coldest capital in the world. Ambitious government and business employees understood that their careers would, from then on, be in Astana or nowhere. International corporations are still trickling reluctantly northwards.
“The generation of executives who said ‘I am not moving, but my successor will’, has not long to serve,” says David Skeels, one of the first western oilmen to relocate to Astana.
Among foreign governments, Russia came first, building a spacious embassy at the bridge dividing the old from the new town. China set up a smaller mission and the $60m US embassy will be ready in 2007.
However, Kazakhstan’s flourishing private banks have stuck to Almaty. “It is unlikely that Astana will have a Wall Street,” says Akim Umirzak Shukeev, the mayor.
Political and security imperatives prompted the government to move north. Unlike Almaty, located close to the so-called “bamboo curtain” dividing China from Kazakhstan, Astana is far from foreign frontiers. Earthquakes often rock the mountains round Almaty but do not happen in Astana.
The flatlands round Astana are home to many of the ethnic Russians which make up one-third of Kazakhstan’s population. Russians fled in the early years of independence. Those left should be rooted within the fold.
“In the US, people say they are American before stating their ethnic origins. We want people to think of themselves first as Kazakhs,” says Marat Tolibayev, Astana’s deputy mayor.
After seven years as the capital city and investment of many billions of dollars, Astana’s population has doubled in size to 500,000; by 2025, it is expected to be twice as big again.
Japanese architect Kisse Kurokawa won a tender to create a master plan for Astana. His vision of a “metabolic, symbolic eco-city for the 21st century” is springing to life in an array of marble and granite extravaganzas in the new town.
An ancient Kazakh fable about a journey to a better world was the inspiration for the centrepiece, Baityrek, representing the tree of life, is a spiky white tower whose branches clasp a golden globe. At the top, the national anthem strikes up when visitors stroke an image of the president’s palm.
Viewed from Baityrek, the panorama of Astana explains much about the kind of country independent Kazakhstan is inventing after decades under the Soviet yoke.
President Nazarbayev’s lavish residence with its ornate gardens stretching down to the river is next door to the senate and the courts of justice. A mosque, synagogue, Orthodox and Catholic churches are in place, testimony to the government’s resolve to build a secular state. Entertainment centres are exotic. The first sharks flown into Ocean Park expired so far from the sea but keepers have now found a sustaining salt and water formula.
Locals have wry nicknames for fanciful architecture. The “cigarette lighter” houses the transport ministry, the pivot of plans to establish Astana as a road and air hub at the heart of central Asia. The “grain silo” is headquarters to oil company KazMunaiGaz, mainstay of the economy. “Four Chinese brothers” with triangular tops and the metal clad “Kursk”, called after the ill-fated Russian submarine, are homes for Astana’s elite.
“Astana inspires two conflicting emotions: hilarity and jaw-dropping awe,” says a foreign banker based in Almaty.
For Zhorra Garayev, a Chechen deported to Kazakhstan as a child, Astana is nothing short of a miracle. “Before, Kazakhs were nomads, not town dwellers,” he says. “When the Soviet Union collapsed, they won a country. Now, they have all this. They are just, incredibly, incredibly lucky.”
Wanderers at heart, the Kazakhs understand and accept the dispossessed that live in their midst. “My dream is to return to Chechnya but Astana is a good second home,” adds Mr Zhorra, who is a taxi driver.
Where he lives in the old town, bulldozers are levelling tumbledown cottages. The air rings with the sound of hammers from the construction sites which are all around.
Private investment is pouring into the top end of the residential sector. “We do not want to create social ghettos,” says Mr Tolibayev. Affordable, government-funded homes will be built throughout the city.
Mayor Shukeev’s agenda is full of problems. Land speculators must be kept in check. Roads, drains and heating plants cannot cope with the town’s rapid growth. “For now, Astana is still a dream. But I think it will happen,” he says.


FoodMaster: Blazing the yoghurt trail
By Isabel Gorst
Published: December 15 2004 08:07 | Last updated: December 15 2004 08:07

A small group of Kazakh investors that leased a dilapidated dairy plant in the foothills of the Tien Shen mountains in 1995 has since grown to be the biggest dairy producer in Central Asia. FoodMaster is one of Kazakhstan’s few business successes outside the natural resources sector.


With seven plants now operating, including two in Ukraine and Moldova, the company produces annual sales of milk, yoghurt, cheese and kefir (a runny yoghurt) worth $60m and is attracting strategic foreign investors.
In October, France’s Lactalis, one of Europe’s top players in the dairy market, took over just under 50 per cent of Foodmaster from Agribusiness Partners International, the US investment fund.
In April 2003 Coca-Cola bought the marketing rights to FoodMaster’s Piko brand fruit juices and now controls the whole juice-making process at the Isyk plant. Lactalis already processes and markets cheese in Russia under its President brand; in Kazakhstan, it will retain the FoodMaster label.
Although competition from foreign dairy suppliers, particularly Russian, is intensifying, Kazakhs are loyal to local products. “We have become patriots here,” says Saken Seifullin, FoodMaster’s CEO.
Mr Seifullin was among a small group of Kazakhs that teamed up with an American entrepreneur to found FoodMaster. Dairy supplies evaporated after the collapse of the Soviet Union in 1991. So, the acquisition, at an extremely low price, of a down-at-heel milk plant at Isyk, 50km from Almaty, was a fairly safe business bet.
FoodMaster began operations by producing milk, sour cream and yoghurt - products which were not available before in Kazakhstan. “We never imagined that the yoghurt would take off so fast. We blazed a trail for our competitors,” says Mr Seifullin.
Further plant acquisitions in Astana Chimkent, Zhamboul and Kardai followed with the help of a loan from the Central Asia-American Investment Fund.
From the start FoodMaster was highly responsive to consumer demand and displayed skill in attracting and putting to good use donor funds that were unusual in Kazakhstan, says Gabriel Al-Salem, regional director for Central Asia of the European Bank for Reconstruction and Development’s (EBRD) business advisory programme.
“They built a highly competent management team, resisting the temptation to hire buddies and relatives,” says Mr Al-Salem.
FoodMaster’s worst enemy was - and still is - a chronic shortage of milk.
Kazakhstan’s dairy herds fell victim to the chaos that followed privatisation of collective farms in the early years of independence. “The cows were eaten,” says Mr Seifullin. Out of necessity, FoodMaster runs a 500-strong herd near Almaty but would prefer not to expand into farming.
Lactalis will advise on ways to improve milk yields and quality but is reluctant to be drawn into Kazakh farmyards. “We are dairymen, not cattle farmers,” says Luc Morelon, head of communications.
“The Kazakh livestock business is a very sad story,” says Pedro Rodriguez, senior economist at the World Bank in Almaty. Inventories have plunged since 1990 and building up herds takes years. Between 91 per cent of the milk and 87 per cent of the meat produced in Kazakhstan comes from smallholdings, according to a World Bank report.
Smallholdings have provided an important safety net for the poor during the economic transition. But it is time for the government to stimulate the transfer from subsistence to commercial farming.
But few people want to leave Kazakhstan’s prospering towns awash with oil money for a life in farming. “Oil money is not all good. It’s a unique problem. Life is just too good here,” says Mr Seifullin.
However, there was little sign of Kazakhstan’s new prosperity at the small town of Isyk, where what was once the smallest milk plant in the USSR, is now the biggest in Kazakhstan; it employs 300.
Spring floods had swept away the bridge over the rocky stream and FoodMaster’s plant looked slightly shabby from the outside. Antiquated large and small milk trucks trundled up sporadically looking for a sale.
“Dairy producers have no choice but to rely on a hotch-potch of suppliers...mom and pop operations with a couple of cows, or farms with small herds,” says Mr Al-Salem, whose team at the EBRD has helped FoodMaster to introduce ISO standards.
Any variation in raw milk quality immediately shows up in the end product. Sacks of imported dried milk stacked in the plant’s anteroom are a poor substitute for the wet variety.
Inside, the place is gleaming with imported processing and packaging equipment, evidence of FoodMaster’s policy of investing the bulk of profits back in the business.
The company has spent $1.8m buying Tetra Pak machines to produce state-of-the-art hermetically-sealed packages that prolong the shelf life of milk products.
Homogenisation equipment making UHT milk serves the same end, and should help FoodMaster to expand into more distant markets in western Kazakhstan and overseas.
Marketing perishable milk products is a challenge in a country that stretches over three time zones.
Thanks to support from the Agha Khan Fund, Isyk is producing 700 tonnes a year of flavoured milk in decorated cartons for delivery to children far across the mountains in Afghanistan and Tajikistan.


KazMunaiGaz: Oil producer sets its sights high
By Isabel Gorst
Published: December 15 2004 08:12 | Last updated: December 15 2004 08:12

Strong state companies are in the ascendant in most big oil producing countries. Kazakhstan, which plans to triple output in the coming decade, will be no exception.


KazMunaiGaz (KMG), founded by presidential decree in February 2002 out of a mixed bag of state oil and pipeline enterprises, is beginning to flex its muscles, helped by privileges woven into the country’s emerging oil legislation.
For foreign companies that have, until now, dominated Kazakhstan’s big oil projects, investing $15bn since 1993, the emergence of a competitor backed by a government still figuring out how best to maximise oil industry profits is discomfiting.
Kazakh policymakers sometimes sound as if they are inventing KMG as they go along. But the company’s headquarters high in the most imposing of Astana’s new office towers, lend an air of plush solidity.
A map of Kazakhstan spread out before him, Uzakbay Karabalin, KMG’s president, describes how the republic will grow into a 3m barrel-a-day producer by 2015 - ahead of Norway and only just lagging Iran and Mexico. Most output will be exported by pipeline to all points of the compass.
Kazakhstan’s Caspian waters, where every well drilled so far has struck oil, will be parcelled out in blocks to explorers. KMG already accounts for more than 15 per cent of Kazakhstan’s 1.17m barrels per day oil output and is growing fast.
“We want to be not just Kazakhstan’s biggest oil producer but also a world class, environmentally responsible company serving as a good partner to many investors,” says Mr Karabalin.
KMG is unlikely to part with its 20 per cent stake in Tengiz field operated by ChevronTexaco. Reserves there are “unbelievable”, adds Mr Karabalin. But shares in smaller ventures are being sold to raise cash for Caspian projects.
A government order assigning KMG 50 per cent of all new offshore deals should translate into more than 1m barrels a day of production within a decade.
A controversial legal amendment, allowing the government first refusal on any equity on offer in existing projects, should project KMG into the most promising Caspian project - Kashagan, where BG group, the international oil and gas company listed in the UK, is selling a 16.67 per cent stake in the Agip KCO group for more than $1.3bn.
Good money will be paid for resources that, under Kazakhstan’s constitution, belong to the state anyway. “Why should foreign companies be so allergic to that? It’s just business,” says Mr Karabalin.
Private and state companies make uneasy bedfellows. There are questions about how KMG will source funds for its share of Kashagan’s $20bn development costs.
To KMG’s delight, Tengizchevroil (TCO) raised more than $1bn in the bond market last month to help finance a $4bn expansion. US partners would have preferred to rely on their own cash reserves.
Another concern is whether KMG will ease other investors into Kashagan. The Agip-Kazakhstan North Caspian Operating Company (KCO) last year rejected BG’s plan to sell out to Chinese companies.
That move was said to have angered President Nazarbayev, who wanted China in as a balance to western interests in the group. “Unlikely,” according to Mr Karabalin. “The government is pretty cold blooded when it comes to business,” he says.
Behind closed doors, Kashagan investors admit that KMG might help to smooth draining relations with the cumbersome bureaucracy. Shutting out KMG now might invite draconian renationalisation later, as has happened in parts of the Middle East and North Africa.
“A national jewel like Kashagan exploited exclusively by foreigners is just the kind of political hot potato that gets thrown out in a leadership struggle,” says Martha Olcott of the Carnegie Endowment for International Peace.
KMG will glean management, business and technical experience from Agip KCO. “Kashagan will be like a good MBA for us,” says Mr Karabalin. Later, KMG will tackle Caspian fields independently, he adds.
Strong links exist with the Russian oil industry, itself falling under firmer state control. KMG represents Kazakhstan at three offshore structures designated for joint development with Russia under terms of a bilateral offshore boundary treaty.
President Nazarbayev’s recent proposal to part-privatise some state monopolies to enliven Kazakhstan’s sleepy stock exchange left Mr Karabalin unruffled. “It’s best to sell a company after it has been fattened up,” he says.
If KMG would model itself on any state oil company it would be Norway’s Statoil, which began life as an extended arm of government when the North Sea was opening up, and is now a big international player, 25 per cent in private hands.
“One big difference is that Statoil grew up within a developed legal system,” says Mr Karabalin.