This Selected Issues paper analyzes the optimal policy response on the part of the Kazakhstan authorities to the prospective oil inflows. It surveys the literature on the so-called natural resource curse and offers an analysis of Kazakhstan’s petroleum potential. The paper analyzes the impact of the oil boom on the non-oil sector, based on a general equilibrium model. It provides an analysis of fiscal rules and fiscal sustainability and assesses the possible role of fiscal policies in addressing the “natural resource curse.”

Abstract

This Selected Issues paper analyzes the optimal policy response on the part of the Kazakhstan authorities to the prospective oil inflows. It surveys the literature on the so-called natural resource curse and offers an analysis of Kazakhstan’s petroleum potential. The paper analyzes the impact of the oil boom on the non-oil sector, based on a general equilibrium model. It provides an analysis of fiscal rules and fiscal sustainability and assesses the possible role of fiscal policies in addressing the “natural resource curse.”

III. An Analysis of Kazakhstan’s Petroleum Potential1

A. Introduction

1. Kazakhstan’s petroleum sector continues to develop rapidly with highly favorable prospects for the medium to long term. Large and rising investment, almost entirely financed from abroad, continues to flow to the still relatively underdeveloped sector. In addition to the rapid development of existing onshore petroleum fields, the development of potentially much larger reserves in the technically difficult offshore North Caspian region is under way. Kazakhstan’s proven and probable crude oil reserves are estimated at around 30 billion barrels. The petroleum sector accounts for almost one quarter of GDP and about one-half of export earnings.

2. Over the next 15 years, Kazakhstan can reasonably expect crude oil and gas production to increase substantially. A more than three-fold increase in petroleum production to around 3½ million barrels per day (bpd) would place Kazakhstan among the world’s top ten crude oil exporters, on a level comparable to Iran, Mexico, Norway, and Venezuela. Fiscal revenues from the sector could rise more than commensurately (to as much as $12 billion per year) but with a lag of several years (Figure 1).2 Most of this output increase would come from offshore fields in the North Caspian region, notably from the Kashagan field—the largest field outside the Middle East and the fifth largest field in the world. However, the lack of infrastructure, difficult climatic conditions, and environmental constraints pose significant challenges to the realization of the region’s potential. Production of natural gas, until now largely underdeveloped, is emerging rapidly, and over the past 2 years output has averaged 14 billion cubic meters (bcm). The authorities’ medium-term development plan projects a quadrupling of gas production by 2010.

Figure 1:
Figure 1:

Medium-Term Petroleum Outlook 1/

Citation: IMF Staff Country Reports 2004, 362; 10.5089/9781451820935.002.A003

Source: Fund staff projections.1/ Solid lines are based on proven crude oil reserves. Production and revenues are likely to be much higher because of expected additional North Caspian fields other than Kashagan (broken line). Enhanced recovery and field development are likely to extend the curves outward from their peaks.

3. Given the strategic nature and size of Kazakhstan’s petroleum reserves,3 and the relatively early stage of development, investment in the sector and production are relatively isolated from short-term price fluctuations. Only in the event of investor perceptions of a significant long-term oil price decline (to well below $15/bbl) or a sharp deterioration in the business climate would there be cause for serious concern. Nevertheless, issues relating to the stability and quality of the investment environment and the long-term pipeline access to world markets need to be resolved on a permanent basis.

4. The petroleum sector has already produced sizeable tax and royalty flows to the budget (some $5 billion since 2000), of which a significant portion has been saved in the National Fund of the Republic of Kazakhstan (NFRK) (Figure 2 and Box 1). Current fiscal receipts from the sector, excluding one-time payments, have accounted for almost 20 percent of general government revenue since 2000.

Figure 2:
Figure 2:

Flows to the NFRK

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2004, 362; 10.5089/9781451820935.002.A003

The National Fund of the Republic of Kazakhstan (NFRK)

Faced with a surge in foreign exchange earnings from higher oil production and prices, the authorities established the National Fund of the Republic of Kazakhstan (NFRK) in 2001. The NFRK was created to reduce the impact of volatile market prices of natural resources on the economy and to smooth the distribution of oil-wealth over generations. The NFRK is an off-budget fund and domiciled in the NBK, which has the responsibility of managing its assets on behalf of the government. All NFRK assets are invested exclusively abroad. As of end-May 2004, $3.7 billion (equivalent to 10 percent of GDP) were accumulated in the fund.

Initially, the authorities identified 12 major companies in the natural resources sector, revenues from which were subject to transfer to the NFRK. The number of entities was reduced to 6 in early 2004 and the list was limited to petroleum companies. The complexity of the funding rules has been simplified progressively. Flows to the NFRK consist of a “savings” component equal to 10 percent of the budgeted baseline revenue from the listed natural resource companies ($100 million in 2003), invariant to price changes. The “stabilization” component includes all revenues from listed companies above the baseline price, which has remained fixed at $19/bbl. In addition, the authorities allocate privatization receipts, special bonus payments, and the royalties of 4 companies to the fund. In 2003, privatization revenues of $380 million were channeled to the fund.

The use of NFRK resources (for specific projects), in the event of petroleum revenue shortfalls from the budgeted levels established at an assumed $19/bbl, is to be channeled through the budget.

B. Recent Developments

5. In 2003, crude oil output rose by 8.5 percent to reach almost 51.3 million metric tons (MT), or just over 1 million barrels per day (bpd).4 Export volumes increased by 12.5 percent to 44.3 million MT, and petroleum export earnings reached $7 billion. Fiscal receipts from the sector rose sharply to T275 billion (about $2 billion) (Table 1). Some 14 billion cubic meters (bcm) of natural gas were produced in 2003, net of around 3 bcm, which were reinjected.5

Table 1.

Petroleum Production, Exports, and Fiscal Revenue, 1998-2003

(in millions of metric tons, unless otherwise indicated)

article image
Source: Fund staff projections.

Does not include bonuses, privatization receipts or other exceptional payments.

6. Investment flows into the sector reached around $4 billion in 2003, almost entirely consisting of foreign direct investment. Three large projects—Karachaganak, Tengiz, and the new offshore field of Kashagan, which is just beginning development—account for the bulk of investment (Table 2). Investment has also been directed at establishing linkages to the Caspian Pipeline Consortium (CPC) pipeline.6

Table 2.

Summary of Principal Oil and Gas Fields

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Sources: Kazakhstani authorities; and Fund staff estimates based on industry sources.

Production sharing agreement (PSA) or royalty-tax regime.

Billions of barrels.

Millions of barrels per year.

Billions of U.S. dollars.

KeyBG = British GasBTC = Baku-Tblisi-CeyhanCAPC = Central Asia Petroleum CorporationCPC = Caspian Pipeline CorporationKMG = KazmunaigasKTO = KaztransoilPSA = Production Sharing Agreement

7. The Tengiz field, operated by ChevronTexaco, is by far the largest operating field in the country and one of the largest in the world. A dispute over a switch to an accelerated depreciation schedule and the financing of the investment program was settled in mid-2003. As a result, a 3-year investment program (primarily for gas re-injection and a second generation plan) totaling $4 billion was launched recently; it will likely almost double production to around 22 million MT per year by 2006.

8. The second phase of development of the Karachaganak gas and gas condensate field in the northwest of the country was completed in 2003. Condensate output will more than double (to around 12 million MT) and exports will be reoriented to reach world markets. A link to the CPC was completed in 2003, as a result of which the condensate sales price will approximately triple. However, quality problems have pushed back condensate exports through the CPC to mid-2004.

9. An international consortium is developing the “super-giant” offshore Caspian Sea concession of Kashagan. The find is reported to be the largest discovery worldwide in the past 30 years. The first phase of development through 2008 will involve investment of around $9 billion, of which $3-4 billion has already been made. The technically challenging environment and investment disputes with the government have contributed to a delay in the start of production from 2005 to 2008. The consortium is reported to have agreed to pay the government $150 million in compensation for the delay.

10. In 2002-03, Kazakhstan signed or ratified several important strategic agreements to secure property or transportation rights. In particular, a tripartite treaty, with Azerbaijan and Russia, delimiting the Caspian Sea bed was ratified. This removes a potential roadblock to the development of the rich North Caspian area.7 Agreement has also been reached with the Russian authorities on access to the state-owned Transneft pipeline system and the creation of a joint venture on gas, KAZROSGAZ, with the state monopoly Gazprom. The equal share joint venture will reportedly have access to Western European gas markets through Gazprom’s pipeline system at Russian domestic tariffs. The initial source of supply will be from the Karachaganak field. KAZROSGAZ projects a sales volume of about 5 bcm in 2004.

C. Long-Term Potential and Risks

Long-term potential

11. Kazakhstan is endowed with very substantial potential oil and gas reserves. Industry and official agency analyses of Kazakhstan’s hydrocarbon potential vary considerably, although there appears to be broad consensus that proven and probable reserves reach 30 billion barrels (Table 3). While a major output increase is still to come from the existing onshore fields, especially from Tengiz and Karachaganak, the most promising area is the offshore North Caspian region, including, but not limited to, the Kashagan field. Together with other fields in the area, the new offshore fields (Tyub-Karagan and Kurmangazy), being developed jointly by KazMunaiGaz (KMG) and Russian firms, could hold as much petroleum as Kashagan. This could result in crude output levels reaching 3½ million barrels per day and gas output rising to 40-60 bcm per year for an extended period of time (20-30 years) from about 2020 (Table 4).1 Investment is expected to remain at around $4-5 billion per annum during this decade.

Table 3.

Proven and Potential Reserves of Oil and Gas

(Oil in billions of barrels; gas in trillions of cubic meters)

article image
Sources: Kazakhstani and industry sources; and Fund staff estimates.

Assuming existing recovery technology and development plans.

Essentially the offshore North Caspian shelf, aside from Kashagan.

Table 4.

Petroleum Production, Exports, and Fiscal Revenue, 2004-20

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Sources: Kazakhstani authorities; and Fund staff estimates and projections.

Output from existing fields and Kashagan; new fields under development, such as the offshore North Caspian fields, have not been included.

WEO price projections (January 2004) through 2009; thereafter assuming a 2 percent nominal increase.

In addition to Kashagan.

12. Production from the offshore North Caspian field of Kashagan is expected to rise sharply from 2008 through about 2018 before reaching a plateau at around 55-60 million MT around 2030. The field could be exploitable for 70-80 years. Financial flows to the government, as is typical for production sharing agreements (PSAs), are strongly backloaded in light of the enormous investment involved in developing the field ($25-30 billion).

D. Caveats and Risks

Access to world markets—diversification of risk and the transit issue

13. Kazakhstan has suffered from its landlocked position and dependence on the dual Russian state-run oil and gas pipeline monopolies (Transneft and Gazprom, respectively).2 While export capacity constraints are not presently binding overall, some large fields remain to be connected to major pipeline routes. Kazakhstan’s main fields are at least 1,500 km from access to world markets through the Black Sea. While transit volumes through the Russian pipeline system (aside from the CPC) have risen in recent years, and a medium-term agreement with higher volume quotas was secured in 2002,3 Transneft has steadfastly resisted the introduction of an international standard quality-bank mechanism and national treatment on tariffs.4 There have also been unsuccessful attempts to bring the CPC pipeline, which represents an important threat to Transneft’s monopoly, under the control of the Russian monopoly regulation agency. The CPC pipeline represented a major breakthrough for the marketing of Kazakhstan‘s crude oil, and the link with other major fields has produced major economic gains.

14. Over the long-term, Kazakhstan will need to secure considerable new export pipeline capacity (2-2½ million bbls/day). A significant part would come through the planned expansion of the CPC to around 1.4 million bbl/day (from actual shipments of 0.4 bbl/day in 2003). Additional capacity could be provided by the BTC (Baku-Tbilisi-Ceyhan) pipeline from Baku, Azerbaijan, via Tbilisi, Georgia, to the Turkish Mediterranean port of Ceyhan from 2006 (Table 5). Output from the Azeri AOIC field is projected to begin declining by around 2012, at just about the time Kashagan output is projected to reach 30-40 million MT. However, transport costs are expected to be relatively high because of the considerable distance (1,800 km) and the BTC’s indirect routing to the Mediterranean.5 Further, an undersea pipeline link from Kashagan to Baku would likely need to be built over the longer term at considerable cost. Other export alternatives include expanding the existing swap arrangements with Iran (paragraph 16).

Table 5.

Crude Exports and Potential Pipeline Capacity Profile, 2003-20

(In millions of barrels per day)

article image
Source: Fund staff estimates and projections.

Capacity available to Kazakhstan (for the BTC 1 million bpd capacity is assumed, deducting Azeri uptake).

15. Prospects for a long-discussed crude oil pipeline to China appear to be materializing. The recent construction of an internal pipeline in China, linking the west to the south of the country, has improved the economics of a pipeline from western Kazakhstan to the Chinese border. Feasibility studies have been completed and agreement to begin construction on the first phase in mid-2004 was announced on May 17, 2004.6 Chinese national firms have also shown increasing interest in acquiring shares in Kazakhstani oil fields, notably, but unsuccessfully, in Kashagan.

16. Efforts to further diversify export routes and develop markets for Kazakhstani crude and gas involve rail and Caspian Sea links with northern Iran. Two million MT of crude per year are delivered (by KMG and Petrokazakhstan) against an equivalent value of Iranian crude on the Persian gulf. The Ukrainian authorities have publicly indicated their interest in attracting Kazakhstani crude for shipment through the Odessa-Brody line from the Black Sea to the border with Poland (to access western European markets, and as an alternative to transit through Russia or through the congested Bosporus straits). For gas, there are plans to double (to 90 bcm per year) the capacity of the Central Asia gas pipeline from Turkmenistan through Kazakhstan, and onwards to Russia and Ukraine.

The business climate and investor relations

17. Kazakhstan’s investor relations have been somewhat difficult since 2002. Foreign investors’ concerns about high profile official calls for a “rebalancing of oil contracts” appear to have abated with official assurances given in 2003 that existing contracts would not be reopened. In late 2003, a new crude oil export tax regime for all new projects was introduced with tax rates varying from 1 percent at a world price of $19/bbl to 33 percent at $40/bbl. Investors have reacted unfavorably and the ultimate impact of the tax remains unclear. Unresolved divergences in perceptions of contract fairness, risk sharing, and the relative attractiveness of Kazakhstan’s oil reserves may prove to be a source of continued friction. Additional areas of grievance cited by foreign investors include a restrictive alien work permit regime, requirements regarding local content rules and investments in local communities, and environmental rules and enforcement mechanisms that require further development. There is also a lack of framework for the financing of infrastructure (access roads, increased electricity generation, ports, etc.).

18. The role of the national oil and gas company KMG is an additional source of uncertainty. The state firm is both an investor and partner in several ventures in the sector, as well as the monopoly operator of both the gas and crude oil pipeline systems (aside from the CPC). The firm also appears to continue to exercise a regulatory and supervisory role over the sector. A law passed in 2003 grants KMG a 50 percent stake in all new offshore Caspian fields. The creation of an independent regulatory structure, recommended by the World Bank and others, remains an outstanding issue.

Technical and other aspects

19. Technical aspects of crude extraction in Kazakhstan also pose significant challenges and high development costs. Significant levels of associated gas are present in many fields, often with a high sulfur content (sour gas). The need to purify and dispose of the sour gas, which is also highly corrosive, significantly raises investment and operating costs.7 The North Caspian offshore reserves are very deep and fields face ice in the long winter months and severe fluctuations in the water level in the shallows. In the case of Kashagan, this necessitated the technically difficult building of drilling islands in waters only 3 meters deep. The protection of marine wildlife, including endangered Caspian sturgeon and seal populations, represents another important challenge. This, together with the absence of support infrastructure, including for subcontractors, raises average production and transportation costs well above those in the Persian Gulf region and elsewhere.

E. Sensitivity Analysis

20. The sensitivity analysis of the projection for fiscal revenue from existing fields (excluding the North Caspian offshore fields, but including Kashagan) is based on the fiscal revenue model of the petroleum sector developed by Fund and World Bank staff. While this model has provided remarkably accurate projections in recent years, long-term projections are necessarily subject to wide margins of error. Baseline fiscal receipts for the period 2004-49 (when existing reserves would be largely exhausted) indicate an undiscounted flow of fiscal receipts from oil of $270 billion (based on price forecast shown in Table 4). The present value (PV) of this flow would total $47 billion at end-2003, discounted at 10 percent, or $99 billion, discounted at 5 percent. The latter figure corresponds to some $6,600 per capita. Figure 3 shows the PV of the fiscal revenue flow calculated at $1/bbl intervals around the WEO baseline price forecast. As expected, the relationship is non-linear. The zero value intercept occurs at a price level of about $17-18/bbl below the WEO baseline price, or $12-13/bbl for 2004. The profile of the annual flows throughout the period is shown in Figure 4. Under the WEO baseline price assumption, incorporating other offshore North Caspian fields, would add $170 billion (undiscounted) for the period 2011-49, equivalent to a PV in 2003 of $23 billion, discounted at 10 percent, or $58 billion at 5 percent.8

Figure 3:
Figure 3:

Present Value of Fiscal Receipts from Petroleum, 2004-49 1/

Citation: IMF Staff Country Reports 2004, 362; 10.5089/9781451820935.002.A003

Source: Fund staff projections.1/ Does not include production from offshore North Caspian fields, other than Kashagan.
Figure 4:
Figure 4:

Annual Fiscal Receipts from Petroleum, 2003-49 1/

Citation: IMF Staff Country Reports 2004, 362; 10.5089/9781451820935.002.A003

Source: Fund staff projections.1/ At different prices for petroleum in U.S. dollars per barrel. Does not include production from the offshore North Caspian fields, other than Kashagan. Enhanced recovery and field developments are likely to extend the curves outward from their peaks.
Figure 5:

References

  • Dodsworth, J. R., P. H. Mathieu, and C. Shiells, 2002, “Cross-Border Issues in Energy Trade in the CIS Countries,” IMF Policy Discussion Paper 02/13 (Washington: International Monetary Fund).

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1

Prepared by Paul Mathieu. See IMF (2003) (Chapter 1) for a more detailed background discussion.

2

This projection is based on the winter 2004 World Economic Outlook price forecast for petroleum through 2008 with a 2 percent nominal increase thereafter to reflect world inflation. See Table 4 for details.

3

Observers have put the Caspian basin reserves (including those belonging to Azerbaijan, Iran, Russia, and Turkmenistan) on a par with those of the North Sea. The authorities believe that hydrocarbon deposits on the Kazakhstani territory of the Caspian Sea Basin total some 15 billion metric tons or about 110 billion barrels.

4

On average, a metric ton (MT) of Kazakhstani crude oil was equivalent to around 7.6 barrels in volume terms in 2003. Kazakhstani crude varies considerably in quality—the older fields are close to the heavy Russian Urals blend (7.3 bbls/MT), while newer fields are much lighter: Tengiz (7.9 bbls/MT); Karachaganak condensate (8.1 bbls/MT); and Kashagan (about 7.8 bbls/MT). As a result, the average number of barrels per MT is expected to continue to rise over the medium term.

5

Natural gas in Kazakhstan is almost entirely associated gas (a by-product of oil extraction) and several fields reinject significant quantities of gas into the ground to maintain crude wellhead pressure for liquids extraction. In the long term, when the liquids are exhausted, this gas can be recovered. Flaring has declined steadily, although it remains significant owing to the stranding of associated gas. In addition to efforts to build pipeline links to the existing system for domestic and foreign sale, gas has been used increasingly for electricity generation.

6

The CPC pipeline is a privately operated consortium with official Kazakhstani and Russian state participation. It runs 1,500 kms from the Tengiz area to the Russian Black Sea port of Novorossiysk. In 2003, two large fields (Aktobe and Karachaganak) were linked to the CPC, significantly cutting transport costs for both fields, and substantially raising export prices for Karachaganak. Initial capacity is rated at 28 million MT per annum (0.6 million bbls/day). Planned second and third phase expansions over the next few years will raise capacity to 67 million MT per year (1.4 million bbls/day).

7

Lukoil and KMG signed an equal-share joint venture agreement to develop the Tyub-Karagan field in December 2003. Recoverable reserves of 100 million MT (about 750 million barrels) and an exploration program totaling $150-170 million were announced. KMG and Rosneft are also jointly developing the Kurmangazy field, which is reported to have reserves in the range of 0.75-1 billion MT (5.5-7.7 billion barrels).

1

The outlook for natural gas is largely drawn from Republic of Kazakhstan (2002). See also Republic of Kazakhstan (2003a and 2003b).

2

See IMF (2003) for a more comprehensive discussion. See also Dodsworth et al. (2002); and Mathieu and Shiells (2002) for a more detailed discussion of the trade-distorting effects of the state-owned energy monopolies in oil and gas in the countries of the Former Soviet Union.

3

Essentially, the full capacity of the Atyrau-Samara pipeline (15-16 million MT) has been allocated to Kazakhstan (up from 10 million MT in 2001). Moreover, a quota of 2.5 million MT was agreed for shipments through the pipeline from the Russian Caspian port of Makhachkala to Novorossiysk. The crude oil reaches Makhachkala by ship across the Caspian Sea from the Kazakhstani port of Aktau.

4

A quality bank is an equalization scheme to compensate shippers for quality differentials between the types of crude oil mixed in a pipeline. The absence of such a mechanism penalizes lighter and sweeter crudes such as those from the newer Kazakhstani fields. National treatment (implying non-discriminatory pricing) for transportation services for oil and gas as well as rail and other infrastructure is one of the objectives driving the economic integration initiatives of Kazakhstan with Russia and other major CIS countries.

5

The BTC pipeline is presently under construction and is expected to begin operations by early 2005 with a capacity of 50 million MT per annum (1 million bbl/day). Capacity could be increased to 1.4 million bbl/day using flow enhancers and to 1.7 million bbl/day with additional pumping stations. By-passing Armenia and the Black Sea, the line follows a very indirect route to the Mediterranean.

6

The line from western Kazakhstan, which would total some 3,000 km, could be built in sections, connecting and reversing the flow of current lines from Kenkiyak to the CPC, through the landlocked Kumkol fields, and onwards to western China. The first section of about 1,000 km would run from the rail oil terminal facility at the Atasu station in the central Karaganda region to the Druzhba-Alashankou station on the Kazakhstani-Chinese border. The complete line could potentially be operational by 2007. Capital costs would be quite high (around $2-3.5 billion), as would the minimum through-put for the line to be economic (20-50 million MT/year; 0.4-1.0 million bbls/day).

7

This has been a major concern at Tengiz (the world’s deepest “super-giant” oil field), where the open stock of large quantities of low-value solid sulfur has caused major disputes with local authorities.

8

The other North Caspian fields are assumed to be equivalent in size to Kashagan, with production beginning in 2011. This could be a significant underestimate.

Republic of Kazakhstan: Selected Issues
Author: International Monetary Fund