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A Merger Could Ruin the Kazakh Energy Sector

Aug 3, 2016 | 17:44 GMT

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A Merger Could Ruin the Kazakh Energy Sector

The minority shareholders of Kazakhstan's lucrative energy firm, KazMunaiGas Exploration and Production (KMG EP), will vote Aug. 3 on whether to sell their shares to the firm's parent company, effectively consolidating the two. The parent company, KazMunaiGas (KMG), is fully owned by the state and is involved in some capacity in most of the country's major energy projects. KMG currently owns 57 percent of KMG EP, but the subsidiary has been fairly autonomous since its foundation — a fact that has at times put the two at odds.

KMG has a reputation for being highly political, bullying its way into the three major international projects in the country: Kashagan, Tengiz and Karachaganak. It changed the country's laws on energy, levied outlandish fines and amended contracts with international energy firms to ensure that it had a sizable stake in each of the three projects. Such behavior has kept many foreign firms from expanding cooperation with or investment in Kazakhstan. KMG EP, by contrast, is known for operating in line with standard international corporate governance practices, making it the preferred partner of foreign firms and investors.

With low oil prices weakening Kazakhstan's financial position, KMG is looking to gain full control of KMG EP. It first proposed buying out the subsidiary's minority shareholders in July 2014, but under political pressure from KMG EP's board it retracted its offer in December 2015. Since then, however, KMG's position has only worsened. Though it experienced a slight uptick in profits in 2015, it was wholly due to the government's currency manipulations — in return for which it paid higher taxes. In actuality, KMG's revenue is half of what it was in 2011, and it owes $17 billion over the next four years. The company already put off nearly all of its planned maintenance and upgrades in 2015 and 2016, and it has deferred large strategic investment projects beyond 2017. With its options exhausted, KMG is once again turning to KMG EP, which has made a decent recovery from the steep drop in oil prices, has minimal debt and currently holds $3.1 billion in cash.

If the deal goes through, it will affect the entire Kazakh energy sector. KMG EP has planned to use its cash stockpiles to drill hundreds of new wells over the next two years as its current fields age and decline. Now the company is delaying those projects, waiting to see if its finances are plundered and if the payments owed to it by KMG will be paid. But even if it gets these things, the company will be stretched by government requirements to cover shortfalls in workers' salaries caused by currency instability and inflation. The firm's Western board members have also threatened to resign if the state allows KMG a full buyout. If they do, investor and business sentiment toward the firm and the country will deteriorate.