How to Stop the Decline in Oil Production: Six Measures

Oil production in Kazakhstan has now been falling for a second quarter in a row, and there are very few preconditions for growth. Output at the large fields has already peaked. In 2008 a moratorium on new fields was announced, on the grounds that order needed to be restored in subsoil use. The strategy of the Ministry of Oil and Gas (MOG), which most likely came about by accident, as a result of the stalling of small and mid-sized subsoil users, was aimed at developing the large fields, with a bet on Kashagan. In practice, the large projects have not delivered, and the small ones were simply not allowed to develop.

From the moment a license is obtained to the start of production takes roughly 5–7 years. This means that over the next 5–7 years we will not see any serious growth in output, Kashagan aside.

The plan was to completely transform, within 5 years, the relationship between subsoil users and the competent authority. In practice, over that period the Subsoil Use Law was amended in a way that only made the bureaucracy worse, a new Tax Code was introduced that increased the tax burden on subsoil users, and two new bodies were created: the Kazcontract Agency, whose workings are unclear and which is, in principle, unlawful as regards the procurement of goods, works and services (GWS), since GWS are procured openly through tenders and the subsoil user can neither influence the procurement nor determine its content; and the Geology Committee, which is not subordinate to the MOG and often acts at its own discretion. All of this together has added to the bureaucracy, bred further irresponsibility and increased the workload of the line ministries. Meanwhile, existing fields are not being developed, and new investors are not particularly eager to come to Kazakhstan, partly because of red tape and petty extortion at the lower levels. The result is falling production.

The question now will be how to increase production in Kazakhstan and what needs to be done.

First, the MOG, the Ministry of Industry and New Technologies (MINT) and the agencies need to be reorganized so that one ministry is carved out that would be fully responsible for subsoil users. It could be called something like the Ministry of Natural Resources, or the Ministry of Energy and Natural Resources, although the former sounds better. Everything related to oil refining should go to MINT, which would concentrate industrial facilities and the secondary processing of raw materials. This would bring all subsoil-use issues, the foundation of Kazakhstan's economy, together in a single ministry.

Second, the law on subsoil and subsoil use urgently needs to be changed, streamlining approval procedures and the work of the various interagency, expert and working groups.

Third, order needs to be restored in tax legislation, since it contains gaps in the taxation of subsoil users (I wrote about this earlier using uranium as an example).

Fourth, the preemptive right of national companies to acquire assets at the exploration stage, and in producing companies whose reserves are below a certain level, should be abolished. For example, I have not heard of a single deal in which KazMunayGas exercised its priority right. Yet review at the national company level always means time and additional bureaucracy, which holds back efforts to attract foreign investors.

Fifth, reporting needs to be unified and linked with tax and audit reporting. Subsoil users keep separate accounts for subsoil-use activities. The tax authorities should be made agents for collecting reports for the competent authority, which would not require much extra effort from the Tax Committee. As for auditors, audit firms should be accredited and made responsible for verifying compliance with subsoil-use legislation.

Sixth, the procurement of GWS needs to be simplified. The whole system of procuring GWS through tenders was introduced in order to:

1. Reduce subsoil users' costs, so as to increase the tax base.

2. Increase local content by giving Kazakhstani producers a notional 20% discount. In the end, it has only made things worse.

On the first point: if prices are inflated inside Kazakhstan, the tax base still remains in Kazakhstan, and for imported GWS it is enough to apply the transfer pricing law (which, incidentally, also needs substantial revision, since not every lawyer understands the "arm's length" principle :))) ). As a result, there would be no overall reduction in Kazakhstan's tax base.

The second point is even simpler. If procurement is conducted under subsoil users' internal rules, they can be made responsible for meeting local content requirements, and that would deliver a greater effect than the current system.

Exempting subsoil users from mandatory tenders would also cut the time needed to fulfill contractual obligations by 2–3 months.

An extended government meeting will be held on August 6. I hope it will make sensible decisions on reorganization, because if we rely solely on the State Program for Accelerated Industrial and Innovative Development (SPAIID), we could even slip into recession in 2015.