Kazakhstan Assessment Report FINAL

USAID REGIONAL COMPETITIVENESS INITIATIVE (RCI) ASSESSMENT REPORT ON OIL AND GAS INDUSTRY LOCAL SUPPORT SERVICES IN KAZAKHSTAN

JANUARY 31, 2007 This publication was produced for review by the United States Agency for International Development. It was prepared by SEGURA/IP3 Partners LLC

USAID REGIONAL COMPETITIVENESS INITIATIVE (RCI) ASSESSMENT REPORT ON OIL AND GAS INDUSTRY LOCAL SUPPORT SERVICES IN KAZAKHSTAN

JANUARY 31, 2007

Contract No. AFP-I-00-03-00035-00 Task Order # 002

DISCLAMER The author’s views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government

TABLE OF CONTENTS LIST OF ACRONYMS ................................................................................................................. iii 1. INTRODUCTION ................................................................................................................... 1 2. BACKGROUND .................................................................................................................... 1 3. LOCAL CONTENT AND RECENT DEVELOPMENTS ........................................................ 3 4. ACTIVITIES OF LARGE IO&GCs TO DEVELOP LOCAL COMPETITIVENESS ................ 5 5. KAZAKHSTAN DEVELOPMENT STRATEGIES .................................................................. 7 6. RECURRING ISSUES .......................................................................................................... 9 7. PROPOSALS/OPPORTUNITIES FOR USAID ASSISTANCE .......................................... 13

7.1 Conduct a sector specific roundtable or series of roundtables .......................... 13 7.2 English Language Training ..................................................................................... 16

ANNEX A CONTACT LIST ............................................................................................... A-1 ANNEX B MAP OF SELECTED CASPIAN PROJECTS .................................................. B-1 ANNEX C MEMORANDUM ON THE DEVELOPMENT OF LOCAL CONTENT ............. C-1 ANNEX D MEMORANDUM ON PROCUREMENT TRANSPARENCY INITIATIVE ......... D-1

RCI Assessment Report on Oil and Gas Industry Local Support Services in Kazakhstan—January 31, 2007

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LIST OF ACRONYMS

Agip KCO Agip Kazakhstan North Caspian Operating Company NV API ASME

American Petroleum Institute American Society of Mechanical Engineers

bbl/d Barrels of oil per day boe Barrels of oil equivalent CMAR Center for Marketing and Analytical Research GOK Gosstandart

Government of Kazakhstan Committee for Standardization, Metrology and Certification of the Ministry of Industry and Trade

IFC International Finance Corporation IFK Investment Fund of Kazakhstan Innovative Industrial Strategy Innovative Industrial Development Strategy of the

Republic of Kazakhstan for 2003-2015 IO&GCs ISO

International oil and gas companies International Standards Organization

ITECA International Trade Exhibitions & Conferences KAPE Kazakhstan Agency for Applied Ecology Kazakhstan 2030 Kazakhstan Development Strategy to 2030 KazEnergy Kazakhstan Association of Oil, Gas and Energy Sector

Organizations Kazinvest Kazakhstan Investment Promotion Center KIO Karachaganak Integrated Operation KPA Kazakhstan Petroleum Association KPO Karachaganak Petroleum Operating Company BV MEMR Kazakhstan Ministry of Energy and Mineral Resources MIT Kazakhstan Ministry of Industry and Trade PSA Production sharing agreement RCI Regional Competitiveness Initiative SMEs Small- and medium-sized enterprises SPE Society of Petroleum Engineers Strategic Plan to 2010 Strategic Plan for the Development of the Republic of

Kazakhstan to 2010 Tcf Trillion cubic feet of natural gas TCO TengizChevroil USAID United States Agency for International Development USD United States Dollars VAT Value Added Tax


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1. INTRODUCTION This report is prepared as of January 31, 2007, under the United States Agency for International Development (USAID) Europe & Eurasia Bureau Regional Competitiveness Initiative (RCI). The RCI aims to increase the competitiveness of small- and medium-sized enterprises (SMEs) in the Europe and Eurasia Region. The purpose of the report is to summarize the necessarily abbreviated assessment of the oil and gas industry local support services in Kazakhstan, with an emphasis on identifying opportunities for local firms to provide or improve provision of support services to the petroleum industry in Kazakhstan. The report also presents prioritized proposals to improve competitiveness of the domestic oil and gas services sector. To maximize the limited time in-country, the assessment was conducted primarily through interviews with representatives of USAID, large international oil and gas companies (IO&GCs), international oil and gas service companies, local operators, local oil and gas service companies, government officials and other stakeholders. A list of parties with whom meetings were held is set forth in Annex A. 2. BACKGROUND Kazakhstan’s combined onshore and offshore proved crude oil reserves were estimated at 39.6 billion barrels as of December 2005, and proven natural gas reserves are estimated to be in the range of 65 to 100 trillion cubic feet (much of it associated gas). The country produced approximately 1.29 million barrels of oil per day (bbl/d) in 2005, with net exports of one million bbl/d. The Government of Kazakhstan (GOK) plans to increase production to 3.5 million bbl/d by 2015. The production is expected to come from the onshore Tengiz, and Karachaganak fields, and the offshore Kashagan field (the largest oil field outside the Middle East) in the northern Caspian Sea. The Kashagan field is still undergoing appraisal with production to begin in 2009-2010. The Tengiz field (the world’s deepest operating super-giant oil field) was discovered in 1979 and its recoverable crude oil reserves have been estimated at 6 to 9 billion barrels. The field is being developed under a production sharing agreement (PSA) by TengizChevroil (TCO), a joint venture formed in 1993, and currently composed of Chevron (U.S.) – 50 percent, ExxonMobil (U.S.) – 25 percent, LukARCO (Russia/U.S.) – 5 percent, and KazMunaiGaz (Kazakhstan state oil company) – 20 percent. Karachaganak oil and gas field, also discovered in 1979, with estimated recoverable reserves of 8 to 9 billion barrels of oil and gas condensate, and 47 trillion cubic feet (Tcf) of natural gas, is being developed under a PSA by Karachaganak Integrated Operation (KIO). KIO is a consortium consisting of BG Group Plc (U.K.) – 32.5 percent, Agip unit of ENI (Italy) – 32.5 percent, Chevron (U.S.) – 20 percent, and Lukoil (Russia) – 15 percent, with the Karachaganak Petroleum Operating Company BV (KPO) acting as operator. Major production expansion projects are planned or underway at both fields. The Kashagan oil and gas field was discovered in 2000, declared to be commercial in 2002, and is considered the most important discovery in the last 30 years. Although, as


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previously noted, appraisal is ongoing and production is not expected to come online until the 2009-2010 period, the field’s recoverable reserves are estimated at 7 to 9 billion barrels of oil equivalent (boe), with an additional 9 to 13 boe potentially recoverable by secondary recovery. Agip Kazakhstan North Caspian Operating Company (Agip KCO) is the single operator under the North Caspian Sea PSA on behalf of a consortium of seven oil companies comprised of Agip Caspian Sea B.V. of ENI (Italy) – 18.52 percent, ExxonMobil (U.S.) – 18.52 percent, Royal Dutch/Shell (U.K./Netherlands) – 18.52 percent, TotalfinaElf (France/Belgium) – 18.52 percent, ConocoPhillips (U.S.) – 9.26 percent, Inpex (Japan) – 8.33 percent, and KazMunaiGaz (Kazakhstan) – 8.33 percent. (See Annex B for a map depicting the foregoing fields, among others in the Caspian Sea Region.) The GOK’s plan to increase production to 3.5 million bbl/d by 2015 includes significant production from the Kurmangazy field, being developed under a PSA between the Russian and Kazakh state oil companies, Rosneft and KazMunaiGaz. However, the first well drilled in the field last year was a dry hole. Additional offshore blocks are being tendered. In 2003 the GOK approved a new Caspian Sea development program under the Ministry of Energy and Mineral Resources (MEMR) and the state-owned oil company, KazMunaiGaz. Pursuant to the program, more than 100 offshore blocks are to be tendered. Kazakhstan’s oil and gas sector has attracted massive foreign investment, with approximately 80-90 percent of foreign direct investment flowing to the sector. Some sources estimate that the country’s oil infrastructure could eventually attract up to 140 billion U.S. dollars (USD) in foreign investment. The U.S. Commercial Service estimated the market for oil and gas field equipment, materials, and supplies at USD 3.757 billion in 2005, with 95 percent of demand met by imports, and that the market would grow at a rate of 15-30 percent annually. Data concerning the oil and gas service sector is not easily obtainable. According to the Kazakhstan Contract Agency the data is unavailable, and it is trying to collect such information. It is more likely oil and gas service sector data is available, but spread among different sources, some of which treat the data as confidential. A recent study by the Center for Marketing and Analytical Research (CMAR) of the oilfield equipment and machinery industry estimated that the market for oilfield equipment and machinery was USD 2.07 billion in 2003, of which local production comprised only 3.1 percent or USD 65 million, although the local percentage was slowly growing. Most local SME oil and gas equipment and service providers have been unable to capitalize on the opportunities to become suppliers and vendors to the international oil and gas industry by virtue of inadequate equipment and product lines, deficient technical and managerial training, and lack of information and understanding concerning client needs and international standards.


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3. LOCAL CONTENT AND RECENT DEVELOPMENTS The GOK for some time has sought to build competitiveness by requiring preferences be given to local suppliers and Kazakhstan nationals. Most Production Sharing Agreements and the 1999 amendments to the Subsurface Use and Petroleum Laws require oil and gas companies to give preference to goods, works and services from Kazakhstan entities, all else being equal, and to give preference in recruitment of personnel to Kazakhstan nationals. In the intervening years this “local content” requirement has been progressively strengthened. Regulations adopted to implement the 1999 amendments impose onerous procurement burdens on oil and gas companies. Tenders are to be held for any purchase of goods, works, or services necessary in the conduct of oil operations, with mandatory participation of the relevant state body in the tender committee and approval of the decision of the tender committee to ensure compliance with preference requirements. The regulations are unclear on many points, including whether there is a minimum threshold for tenders. In the face of industry criticism and allegations the regulations are unworkable, the GOK promised to amend the rules. The rules remain unchanged, but apparently are rarely enforced. Further, in determining the winner of a tender, the price bid by Kazakhstani participants is to be nominally reduced by 20 percent in making the determination, if their goods, works, or services meet the required standards and the terms of the tender. Other legislative and regulatory modifications require that the tender proposal by a prospective subsurface user include the anticipated local content of their work, goods, and services; commitments to hire Kazakhstan nationals; and proposals for arranging funding for their training. More recently in March 2006, the GOK developed two memoranda. One is a Memorandum on the Development of Local Content on the Services Market of Subsurface Use (attached as Annex C), and one is a Memorandum on Implementation of Subsurface Users Procurement Transparency Initiative in the Republic of Kazakhstan (attached as Annex D). Halliburton, the international service company, signed the memoranda immediately, and now many oil and gas companies and service companies have executed the memoranda. Both memoranda are non-binding statements of intent, and expressly provide that they in no way modify or infringe on existing subsurface use contracts. The transparency initiative memorandum is between the Ministry of Industry and Trade (MIT), represented by the Kazakhstan Contracts Agency, and companies holding subsurface use rights. Under the transparency initiative memorandum, a Unified State Register of Kazakhstan Producers and Subsurface Users will be developed and access to the Register will be free for the participant companies. The participant companies agree to submit to the MIT an annual procurement plan for goods, works and services for the upcoming year, and to notify the MIT about planned procurements and publish the notice on the Register website. A Supervisory Committee is to be established composed of up to three members approved by the MIT, and up to five representatives from the companies acceding to the memorandum. The Supervisory Committee is to develop recommendations for the implementation of the transparency initiative.


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The local content memorandum is among the MIT, represented by the Kazakhstan Contracts Agency, companies holding subsurface use rights, and domestic companies providing goods, works, or services of Kazakhstan origin (domestic producers). A Working Group is to be established composed of up to three members delegated by the MIT, up to three members from the domestic producers, and up to five members from the holders of subsurface use rights. The Working group is to develop and approve a program for development of local content in the services market, including recommendations regarding products to be produced in Kazakhstan, standards for production or performance of goods, works, and services, delivery time, compliance with safety requirements, and proposals for amending current legislation. The goal of the program is to assist local producers to become more competitive in quality and price within and without Kazakhstan. On January 15, 2007, amendments to the Subsurface Use Law were adopted. As of the date of this report, the amendments had not been published. However, based on a summary of a recent draft, a principal effect of the amendments is to calculate Kazakhstan content on the basis of Kazakh ownership of the contractors. If this is indeed the case, it could negatively impact the improvement of competitiveness of local companies, since joint ventures with foreign firms increase the resources of and facilitate the transfer of technology to local companies. However, by forming such joint ventures local content would appear to be lowered. The amendments will need to be obtained and closely reviewed, once published, to ascertain their true effect. On January 10, 2007, a new Environmental Code was adopted, consolidating the prior environmental laws and a number of the normative acts. Again, the new Environmental Code had not been published as of the date of this report. However, it is understood that the new code makes significant changes to the waste management regulations. If true, the new code will dictate oil and gas companies and firms providing environmental services adapt to the new requirements. It should be noted that the Kazakhstan Contract Agency JSC was created as an official representative of the MIT and the MEMR in 2002 to address problems of competitiveness of local industries, specifically in the oil and gas sector of Kazakhstan, It was to offer professional services to local companies and foreign investors, introduce advanced contract systems, new technologies and consolidation of international standards, including a database to help link foreign investors and local service companies. Unfortunately, very little progress was made during the first four years. A new president of the agency was appointed in January 2006, and the Agency now appears to have a higher profile, with the recent memoranda and amendments related to local content referenced above. The submission of annual procurement plans from oil and gas companies is an effort to permit local suppliers to match their product lines with the needs of the companies they wish to supply. The Agency hopes to obtain information from both the suppliers and the oil and gas companies in order to assess what product lines and services can be developed and performed locally, and which do not make sense to develop locally; to build a database with value added; and to perform


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sector research for a fee. However, with respect to the use of the database, success is suspect, since it is unlikely to equal the proprietary vendor databases already developed at some expense by the IO&GCs. Transparency in procurement is another priority for the Agency. However, some IO&GCs are concerned that they and the Agency have differing concepts of transparency, and that the Agency may require and publish information that the companies consider business sensitive. The Agency has 30 employees now and expects to add another 20 employees, but it is under-funded, which it considers a particular problem in a year that is critical to assessing local company capabilities. There appears to be mistrust between the IO&GCs and the GOK. The International Finance Corporation (IFC) considers lack of trust to be the reason for the recent failure of a project intended to support the development of SME suppliers to the oil and gas projects in Kazakhstan. The project, begun in 2005, was endorsed by the GOK and local suppliers, and funded by the Government of Japan, the IFC, and three large IO&GCs (with each IO&GC contributing USD 120,000). However, one funding IO&GC withdrew and the others followed. As a result IFC abandoned the project last month. Although it is only speculation, the reconsideration of the companies concerning their funding for and participation in the project may have been prompted by uncertainties arising from pressure on the companies to sign the memoranda on procurement transparency and local content, and the knowledge that the GOK was planning to strengthen local content requirements. A final recent development, not directly related to local content, was the resignation on January 8, 2007, of Daniyal Akhmetov as Prime Minister of Kazakhstan, and the associated change in government. On January 10, Parliament approved Karim Masimov, the nominee of Kazakhstan’s President Nursultan Nazarbayev, to be the new Prime Minister. As a Chinese-born Uighur, Mr. Masimov became the first Prime Minister to be neither Russian nor Kazakh. By January 11 the government reshuffling was complete and its new composition established. Whether the change in government will have any effect on the oil and gas industry or the oil and gas service sector remains to be seen. 4. ACTIVITIES OF LARGE IO&GCs TO DEVELOP LOCAL

COMPETITIVENESS The large IO&GCs pay close attention to local content because of requirements in their PSAs or subsurface contracts, and the political sensitivity of the issue. The IO&GCs gather information from local companies they identify as having the potential to qualify as a supplier of goods or services. If a company is determined to have the potential to qualify, the company’s shortcomings are noted and it becomes eligible for training. The oil and gas companies offer varying types of assistance. Typically these would include some combination of general training in corporate quality and standards requirements, trade skills, training on qualification to meet international standards, facilitation of joint ventures or partnering, financial assistance (which ranges from training in finance, to recommendation of projects to the Development Bank of Kazakhstan, to extension of


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loans to SMEs), and other assistance. Some training activities sponsored by the IO&GCs are open, such as seminars on procedures for prequalification. Various IO&GCs provide support for universities and institutes. One IO&GC is seeking to engage up to 130 local suppliers in business development through a series of meetings to introduce them to e-procurement, using Arriba as the e-procurement platform. Since a number of IO&GCs use Arriba, if the local companies become familiar with Arriba e-procurement it gives them a portal to a larger market. Each of the large IO&GCs has its own set of qualifications, its own vendor database, and its own approach to determining which companies can be pre-qualified as a supplier. However, the principal considerations in evaluating local companies tend to be technical capability, experience and performance history, and local content. They typically use a closed tender system in which only pre-qualified companies whose capabilities match the IO&GCs’ needs associated with the tender are included. Further, the IO&GCs know what major projects are planned, and may set about developing the capabilities of certain suppliers perhaps years in advance. The effort by the IO&GCs is extensive, but many companies may be left out of the process. For example, the CMAR study concerning oilfield equipment and machinery noted that between 70 and 100 local firms may have the potential to produce to international standards, but only 16 have been selected by KazMunaiGaz a part of an oilfield equipment and machinery supply program. For some large projects or support activities, the IO&GCs will bundle their tender and only need to tender every three to five years. In such cases, the tender will most frequently be won by an affiliate or joint venture of an international oil and gas service company. Since the local content obligations rest on the producer, its contract with the direct contractor will contain requirements concerning local content, and compliance with such requirements are audited by the producer. International oil and gas service companies vary in how proactive they are in working with the local companies. Many do not maintain their own databases of local companies. The tenders of the large international service companies may be open or closed, but if closed they tend to rely on the pre-qualified vendors to the contracting producer in determining the companies to include in the tender. KazMunaiGaz, the state-owned, vertically integrated oil and gas company, by virtue of its strategic importance and the breadth of its operations, is a significant vehicle for development of the local oil and gas service sector, and improvement of the sector’s competitiveness. KazMunaiGaz was formed in 2002 by merger through Presidential decree of Kazakhoil and TransNefteGas. It is involved in almost all major oil and gas projects in Kazakhstan, by way of its ownership stake in 47 enterprises. Its operations include exploration and production, pipeline and sea transportation, refining, and oil and gas services, and it is active in the development of the petrochemical industry. For example, exploration and production operations are conducted through KazMunaiGaz Exploration and Production (and the production units EmbaMunaiGaz and UzenMunaiGaz). Its KazTransOil has a monopoly on oil pipeline transportation. KazTransGaz, which controls the principal network of gas pipelines in the country and is


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engaged in underground gas storage, is a part of KazMunaiGaz. KazMunaiGaz also owns KazStroyService (a provider of oil and gas engineering, construction and maintenance services), as well as the Atyrau Refinery. 5. KAZAKHSTAN DEVELOPMENT STRATEGIES In October 1997, the President of Kazakhstan announced the Kazakhstan Development Strategy to 2030 (Kazakhstan 2030), setting out the general long-term objectives of the nation and the strategy to achieve them. The objectives included national security; political stability and national unity; economic growth based on a market economy and encouragement of foreign investment; improvement of the health care, education and welfare systems; effective and rapid development and utilization of the country’s energy resources; infrastructure development, particularly in the areas of transportation and telecommunications; and reorganization and improvement of state bodies in order that they may become more effective and professional in the administration and execution of state activities. Numerous strategies have been developed subsequently related to the various objectives, but there have been three principal overarching implementation strategies: The January 1998 Mid-term Development Plan—1998-2000, the December 2001 Strategic Plan for the Development of the Republic of Kazakhstan to 2010 (Strategic Plan to 2010), and the May 2003 Innovative Industrial Development Strategy of the Republic of Kazakhstan for 2003-2015 (Innovative Industrial Strategy). Relying on the above strategies, President Nazarbayev now has set as a new goal for Kazakhstan—to become one of the 50 most competitive countries in the world. The Strategic Plan to 2010 identifies policy areas to be addressed in order to implement Kazakhstan 2030. For each area, the strategic plan summarizes the strengths, weaknesses, opportunities and threats (performs a SWOT analysis), establishes strategic objectives, and sets out the actions to be taken during the 2003 to 2010 period to accomplish the objectives. The development model described includes reliance on the state as the engine for economic growth and as a counterbalance to the influence of transnational corporations. It envisions state participation in the “backbone infrastructure companies” around which SMEs will develop to supply goods, works, and services under contracts. In early 2003, the Innovative Industrial Strategy was approved by decree of the President. The Innovative Industrial Strategy is an ambitious three stage effort to move Kazakhstan from an extraction based economy toward a service and technology based economy in the long term. The strategy accurately identifies the weaknesses in the Kazakhstan economy to be overcome in order to achieve its principal goal of sustainable development through non-extraction oriented economic diversification. Its focus is on production of competitive and export oriented goods, works, and services in the manufacturing and service sectors. The Strategy defines competitiveness as the “ability of the national economy to produce exportable products,” thus recognizing manufactured goods must be competitive in both price and quality—requiring they meet international standards. It further recognizes the need to build upon the investment and production potential of the energy industry in the process of transition. Growth in the


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energy sector, particularly in the Kazakhstan sector of the Caspian Sea, is expected to drive, not only increased hydrocarbon extraction, but also infrastructure development, including construction of oil and gas pipelines, seaports and port facilities, and railway terminals; new capacities in the power and telecommunications industries; the establishment of a petrochemical industry; and the improvement of other infrastructure. The oil and gas industry, therefore, generates the demand to support development of services, products and capabilities that are transferable to other sectors of the economy, and creates the preconditions for international competitiveness. The strategy seeks to encourage development of science intensive and high tech exportable products, development of goods and services with high value added, increase in productivity of fixed assets in manufacturing sectors, greater integration of Kazakhstan into the regional and global economy, and modernization and innovation initiatives. To that end the Innovative Industrial Strategy calls for new development institutions to be established and existing institutions strengthened. In April 2006, JSC “Kazyna” Fund for Sustainable Development was formed by the GOK to improve the system of state management of development institutions in the area of industrial progress and innovation, to enhance conditions for competition and economic growth, and to acquire foreign assets in priority areas for Kazakhstan. The seven Kazakhstan development institutions were placed under the Kazyna Fund, specifically Development Bank of Kazakhstan, Investment Fund of Kazakhstan (IFK), National Innovation Fund, State Insurance Corporation for the Insurance of Export Credit and Investment, Kazakhstan Investment Promotion Center (Kazinvest), Fund for Small Business Development, and CMAR. In brief, their primary functions are as follows: Development Bank of Kazakhstan: To support private and state projects, particularly infrastructure projects, through long- and medium-term, low interest rate loans. IFK: To lend financial support to non-extraction private sector initiatives through non-controlling share holding of enterprises in Kazakhstan and abroad. National Innovation Fund: To participate in the formation of innovation infrastructure (e.g., technoparks, information and analytical centers); to establish venture funds with domestic and foreign large venture investors; to participate in the authorized capital of enterprises devoted to producing high tech and science intensive output, and the development of new technologies; and to provide grant funding for scientific research and experimental engineering related to creation of new technologies, goods, or services with potential for commercialization. State Insurance Corporation for the Insurance of Export Credit and Investment: To provide direct assistance for the export of domestic goods and services through insurance and re-insurance against political and regulatory risks. Kazinvest: To promote investment in Kazakhstan by systematically searching for potential investors, informing them of investment opportunities in Kazakhstan, and providing investment assistance.


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Fund for Small Business Development: To provide credits to small business entities—President Nazarbayev, in acknowledging the Development Bank and the IFC are not available to all businesses, has stated that the Fund for Small Business Development is to become what he characterized as a kind of “financial supermarket.” CMAR: To provide marketing information and analytical support to enable diversification of the economy, and to enhance competitiveness and the export of Kazakhstan products (in effect a consultancy service to government and industry). Although most of the development institutions under Kazyna emphasize high tech industries and/or large infrastructure projects, some may represent a source of financing for local oil and gas service SMEs. Certainly the Fund for Small Business Development is such a source. The Development Bank and the IFK may also be a source of financing with respect to local oil and gas service companies involved in large infrastructure projects for the IO&GCs, but that possibility must be investigated further. Kazakhstan has undertaken a “cluster initiative” to improve competitiveness and promote economic development. CMAR has the responsibility to establish certain cluster groups. In the process CMAR identified 23 priority industries with potential for external market growth of Gross Domestic Product. Currently, CMAR has defined seven sectors for cluster formation: tourism, food processing, textiles, transportation and logistics, construction materials, and oil and gas machine building. The last mentioned cluster is directly relevant to the oil and gas service sector, while the construction materials and the transportation and logistics clusters involve cross-cutting sectors that could involve oil and gas services. The 2005 action plan of the CMAR contemplates the development by relevant oblast administrations of their own action plans, and CMAR consulting with the oblasts in development of appropriate strategies. The CMAR had hoped to inspire the oilfield equipment and machinery cluster members to be more proactive in approaching their problems and improving their competitiveness, and they have had meetings, and formed subgroups. However, in the last six months momentum has slowed and there has been little progress. Additionally, in the last 10 years Kazakhstan has established 10 national and regional technoparks and, as noted above, more are planned under the Innovative Industrial Strategy. The technoparks typically are specialized (e.g., information technology, nuclear, biotechnology, etc.) and include an area devoted to business incubators. A National Industrial Petrochemical Technopark is being constructed in Atyrau for production of petrochemicals and high tech industries within the oil and gas sector. 6. RECURRING ISSUES Certain issues related to competitiveness were repeatedly raised by those interviewed in the course of the assessment. These recurring issues are discussed below:


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Need for financing and for improved understanding of finance: Foreign investors, as well as local companies, find the margins taken by Kazakhstani banks and the security required from borrowers to be burdensome. Of course, financing needs and terms vary with the nature of the goods, works, or services to be provided by the borrower, the size and financial structure of the local company, the size and duration of the contract involved in the loan transaction, and other commercial risks identified. However, financing is a problem even for some established local companies providing goods or services to the IO&GCs, particularly when the contracts are relatively small and of limited duration. Although some IO&GCs in rare instances will provide limited advance payments or loans to SMEs, it is the exception to the rule. Therefore, if a local company wins work, in many cases it must take a loan from a bank, for which it usually will be required to pledge its contract as collateral, and often all or part of its other assets. Alternatively, it must seek a joint venture partner to help finance the job under terms that substantially reduce the local company’s share of the profit. Among some local oil and gas service companies there is an inadequate understanding of finance (e.g., cash flow needs, hidden costs, etc.). While the IO&GCs will know their needs in advance, frequently the suppliers will not know until the tender is announced, and there may be a relatively tight schedule for response. An insufficient understanding of finance can lead to a failure to consider certain costs and a loss-making contract for the supplier. Unequal Value Added Tax (VAT) Treatment: Currently the PSAs or subsurface use contracts negotiated with certain operators are biased in favor of imports by exempting the operators from VAT on imports. If the same goods or services are acquired from a local supplier, the operator must pay VAT. This places local suppliers in a disadvantageous position regardless of their ownership structure (e.g., whether or not they are a joint venture). Lack of awareness of the expectations of international companies by contractors and personnel: Local oil and gas service companies are sometimes unused to the high performance standards demanded for the world class projects of international companies, including the stringent timeliness and quality requirements, and some lack an appreciation of the consequences to the project of a failure to meet those standards—not only in economic terms, but in terms of health, safety and environmental injury. A related problem for some local contractors is a failure to appreciate the sanctity of contract—that the international company is relying on the contracted work to be performed on time, to specifications, and for the compensation agreed, notwithstanding that a subsequent opportunity perceived as more lucrative may conflict with the fulfillment of those obligations. Absence of understanding of the role market research and the capabilities to market to client needs: A common complaint among oil and gas companies is that there is a lingering Soviet mind-set among some local service companies. Such companies have failed to transition from the period in which they were told what service to supply or product to produce and the customers were expected to purchase the product or


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service. They are not client oriented. They need to learn to target the companies they want to supply, to research the target clients’ operations and to work with the target clients to identify their equipment and services requirements. With this shift in attitude and approach the service companies can adjust their product lines and effectively represent what they can do to satisfy the potential clients’ needs. Lack of information concerning the current and future needs of international companies: The flip side of the above issue is that, as previously noted, oil and gas companies typically know what they will need for a project well in advance of its implementation, but oil and gas service companies may learn of the requirements only upon issuance of a tender. There is no real system of needs analysis or for dissemination of the results of the analysis among the service sector. There should be a broader dialogue regarding the current and future needs and requirements of oil and gas companies. The Kazakhstan Contracts Agency is attempting to address this issue through the collection and publication of the annual procurement plans of oil and gas companies. Failure of local equipment, services, and manufactured goods to meet international standards: The development of the largest fields in Kazakhstan is a challenging undertaking. Production is deep, under high pressure, with a high sulfur content. Field development requires advanced drilling and processing equipment and skilled personnel. Much of the required equipment and services are not currently available locally, requiring a high level of imported equipment, and the use of Western oil and gas service firms possessing the advanced technology and capabilities. In Soviet times, Kazakhstan had a strong manufacturing sector, but primarily devoted to the manufacturing of defense machinery, and the sector was slow to convert to other applications. Kazakhstan manufacturing, therefore, fell behind technologically, and it is now a struggle to meet international standards. Most assembly lines are Russian made, but according to CMAR there is a slow shift to Italian and German machinery. The Committee for Standardization, Metrology and Certification of the MIT (Gosstandart) is the state body that establishes the standards and technical requirements to be met by most imported oil and gas equipment. Most international standards are not recognized by Gosstandart, and Gosstandart certification is not recognized outside of the Former Soviet Union. The standards employed tend to reflect 1980’s domestic technology. President Nazarbayev has emphasized the need to transition to international standards. Although the process of certification of imported goods as meeting national standards has been improved, it is still burdensome. A study concerning the approach to standards in Europe as compared to the approach taken by Kazakhstan with respect to national standards, sponsored by EU TACIS, was undertaken for a sub-group of the CMAR oilfield equipment manufacturing cluster. The study recommendations concerning harmonization of the standards had not been submitted as of the date of this report. Local manufacturers maintain they can meet the needs of IO&GCs, but complain the certifications to international standards that IO&GCs want to see, for example from the American Petroleum Institute (API) and the American Society of Mechanical Engineers


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(ASME), are too expensive. They say it costs USD 10,000 to USD 15,000 for international inspectors to audit for certification, and that there is no accreditation agency at present that can conduct API and ASME audits locally. (Note: There are professionals in Azerbaijan qualified to conduct API audits). Despite these protestations, typically the greatest costs associated with certification to international standards are those to bring plants to international standards, which can be quite costly depending on the readiness of the company. The road to compliance with international standards usually begins with International Standards Organization (ISO) 9001 quality management training, and/or ISO 14001 environmental management training, and a growing number of local firms are obtaining ISO 9001 or 14001 certifications. There are a number of companies in Kazakhstan that provide various ISO and technical certification training, including the Quality Management Center started by USAID/Pragma, and SAIT Polytechnic (South Alberta Institute of Technology) started by the Canadian International Development Agency. Both are now self-sustaining. There are between 12 and 20 other companies offering training of varying quality for certain certifications. Deficient debriefing after tenders: One complaint of local oil and gas service companies concerning the tendering process is that it takes a great deal of effort to respond to a tender, but then the unsuccessful bidders are not notified of who won the tender or why. They allege many IO&GCs and international service companies do not conduct a debriefing, leaving local companies without feedback on the deficiencies of their bid to which they need to attend. From the perspective of the companies conducting the tender, procurement managers do not always have time to debrief bidders because of the volume of tenders, but some do acknowledge it is an area that needs improvement. Lack of education in the latest technologies and corruption in the educational system: Some faculty members of universities and institutions providing technical training have not kept abreast of the latest technologies employed in the energy sector. As a consequence, graduates frequently lack familiarity with new technologies. Some IO&GCs and international service companies provide limited instruction within the institutions, and encourage students to learn of new technologies on their own initiative through the Internet, professional journals and other sources. However, the companies primarily address this educational deficiency by providing internships for students, and lengthy and extensive training programs after hire. Additionally, it is rumored that there is widespread corruption in Kazakhstan educational institutions, with students purchasing grades, or faculty being pressured by students and academic officials to award undeserved grades. This state of affairs renders transcripts from Kazakhstan institutions suspect, which results in personnel turnover in hiring companies or internship programs as validating mechanisms. The situation points to the need for more independent departments, and better qualified and better paid instructors.


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Need for English language training: Large oil and gas operators as well as international service companies identified a need for English language training. This identified need derives from the necessity for oil and gas companies to train those it hires in new technologies, as discussed above, which, in turn, requires an understanding of the English language. Kazakhstan British Technical University asserts that it is moving toward teaching all disciplines in English. The international service company Baker Hughes is considering the possibility of supporting English language training, perhaps through Society of Petroleum Engineers (SPE) student chapters or student chapters of other professional organizations. 7. PROPOSALS/OPPORTUNITIES FOR USAID ASSISTANCE USAID has long been active in assisting the development of SMEs in Kazakhstan. It can leverage the experience and credibility gained by supplementing its present SME assistance activities through a focused and coordinated program to improve the competitiveness and capabilities of local companies in selected oil and gas service sub-sectors 7.1 Conduct a sector specific roundtable or series of roundtables As an initial step USAID could conduct a roundtable or series of roundtables directed to companies with the potential to meet international standards within specific sub-sectors of the oil and gas service sector. If a series of roundtables is conducted they could be held in various parts of Kazakhstan, and be devoted to different sub-sectors. It is recommended that the program focus on the following sub-sectors:

• Oil field equipment and machinery manufacturing; • Engineering, procurement, and construction (civil and mechanical engineering); • Environmental services; and • Providers of skilled technical services

The roundtable would consist of selected companies within one or two specific sub-sector(s), as well as other stakeholders, which could include representatives of government, international oil and gas companies, international oil and gas service companies, universities and research institutes, international standards or accrediting organizations, etc. At the roundtable, the competitiveness issues identified during the assessment would be presented followed by a directed facilitated dialogue to solicit comments, identify additional competitiveness issues (both of a general nature and those specific to a sub-sector), and generate proposals to address the identified issues. The anticipated outcome of the roundtable would be consensus on next steps to improve competitiveness of the sub-sector, and a commitment from the participants to undertake the agreed steps with the assistance of USAID. A work plan would then be prepared for achievement of time limited milestones, which could serve as decision points for continued assistance.


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USAID Assistance In the case of each sub-sector, USAID would:

• Identify SMEs ready or near-ready to pre-qualify as suppliers to the international oil and gas companies

• Form a select group of such companies • Coordinate with the international oil and gas companies to identify future needs

and to confirm pre-qualification of the companies if certain requirements are met • Provide technical assistance, training and, possibly, limited commodity support • Assist the companies to effectively interface with the GOK, oil and gas

producers, contractors, and research/educational institutes • Facilitate partnerships with U.S. Government agencies and/or industry

organizations and associations • Assist in the identification of possible financing sources • Facilitate joint venture formation, if and when appropriate, in coordination with the

joint venture facilitation efforts of the international oil and gas companies • Consider the appropriateness of a study tour • If feasible, initiate pilot projects to serve as competitiveness demonstration

models Manufacturing of oilfield equipment, machinery and spare parts Manufacturing is an area in which Kazakhstan was relatively strong in the past, and many of the plants that were idled after the fall of the Soviet Union have been improved and are operating once again. Additionally, increased productivity of manufacturing assets is a part of the GOK’s development strategy. USAID should work with the Center CMAR to identify companies within the oil field equipment manufacturing “cluster” that are closest to possessing the capacity to meet international requirements for the manufacture of oilfield equipment, in order to reduce the investment needed to successfully pass a certification audit. USAID should also coordinate with the Kazakhstan Association of Manufacturers and Service Providers in the Sub Soil Sector, the Kazakhstan Petroleum Association (KPA), and the Kazakhstan Association of Oil, Gas and Energy Sector Organizations (KazEnergy) in ascertaining appropriate companies for participation. As with any project to improve the competitiveness of local oil and gas service companies, USAID would need to coordinate with the international operators concerning prequalification requirements, and provide technical assistance, training and potentially limited commodity support to assist the local firms in meeting international standards. The American Petroleum Institute (API) has indicated it would consider sending representatives to explain the standards requirements and procedures for certification necessary to earn the API monogram if at least ten companies were involved. Other international certification bodies could be called upon to assist, as well as U.S. and international associations of manufacturers, the International Executive Service Corps, and others. It must be acknowledged that, while USAID will emphasize


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SMEs among the oil field equipment manufacturers, likely participants within this sub-sector will be of a size that places them in the high range of medium-sized enterprises. With manufacturing concerns, identification of the future needs of the international oil and gas companies will be particularly critical, in order that the local firms can adjust their product lines to those needs. Training in marketing for the firms will be important in order that they can tailor their presentation to the international petroleum companies to demonstrate the local capability to meet the needs. Identification of financing sources also will likely be a significant component of USAID assistance to this industry sub-sector. Selection of one or two companies for intensive assistance and potential commodity support with the goal of obtaining the monogram of API or other appropriate accrediting organization could be a useful pilot project. A number of firms can already meet Gosstandart requirements and export to countries in the region. However, certification to international standards will open a broader export market for the local company products. Inputs tend to be more costly among Kazakh manufacturing firms, so assistance in improved procurement practices will need to be included as part of any program to make the local manufacturing companies competitive in price, as well as quality. Engineering, Procurement and Construction The largest anticipated expenditure by IO&GCs involving local content is for engineering, procurement and construction, embracing the full range of civil and mechanical engineering activities. Kazakhstan is relatively strong in construction, and local construction firms can win tenders even for complex projects. However, when the tender involves provision of combined engineering, procurement, and construction services, local companies encounter difficulties. USAID could provide technical assistance to local companies offering engineering, procurement and construction services in the development or application of innovative materials and techniques, in recruitment of needed skills, and to improve their quality and competitiveness. Alternatively, it could assist in matching local companies with complementary strengths and skill sets for the purpose of an alliance for bidding purposes, or matching local construction companies with experienced foreign firms for formation of joint ventures. Oil and Gas Environmental Services There are a limited number of local companies providing environmental services to the oil and gas industry, and they tend to be relatively small in size. The largest local environmental services company is the Kazakhstan Agency for Applied Ecology (KAPE), with approximately 170 specialists and offices in Atyrau, Aktau, Almaty, Astana, and London. The companies would need to be identified and their capabilities (particularly their shortcomings) assessed to determine those with the potential to perform to international standards. Once their correctable deficiencies were


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ascertained, USAID could provide technical assistance, training, and possibly limited commodity support, leading to any required management or technical certifications (including Health and Safety). In addition to help with identification of financing sources, marketing, and joint venture formation, assistance could be provided, as needed, with regard to the latest environmental technologies, and to educate the companies in the new requirements of the recently adopted Environmental Code, particularly the reporting, and waste management and handling requirements. It may also be possible to tap the experience of U.S. government energy and environmental agencies, as well as environmental service organizations and associations, in support of the endeavor. Of course, the assistance activities would need to be coordinated with the GOK and the international oil and gas companies. The GOK still has numerous contaminated sites for cleanup. Using selected companies within group, a financially and technically feasible pilot project(s) could be designed to demonstrate advanced project management and technical skills through cleanup of a carefully limited and delineated area selected in cooperation with the GOK. The expertise developed by the local environmental service companies should also be exportable to other countries in the region with environmental impact assessment, petroleum contamination and waste management needs. Companies Providing Skilled Labor This was a sub-sector mentioned as worthy of attention by most international operators and international service companies interviewed. USAID could identify local service firms providing skilled labor, such as machine operators, welders, pipe fitters, and related oil and gas technical services, for purposes of construction management training, technical instruction, certification, and potentially limited commodity support. When the oil and natural gas exploration and development phases are completed, the production stage will require far less manpower and materials. The benefit of assistance to this sector is that skilled labor will still be needed for operation, repair, and maintenance. 7.2 English Language Training Because of deficiencies in university level education with regard to the latest technologies employed by the energy industry, and uncertainties regarding the accuracy of collegiate transcripts, the international oil and gas companies and international service companies all have internship programs, as well as extensive multi-year training programs for graduates that they hire. Since most of the materials related to the latest technologies in which the new graduates will be trained are in English, the companies frequently look to a student’s fluency in English as one of, if not the prime criteria for selection.


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Accordingly, there is a strong need for English and Advanced English training. Baker Hughes is currently considering sponsoring English language training. USAID could partner with Baker Hughes to offer advanced English training through the student chapters of the SPE and other student professional association chapters that USAID previously helped establish. In offering such training, USAID should be able to take advantage of the student resource center at Kazakhstan National Technical University and the facilities of the institutes it also assisted in founding.


ANNEXES


A-1

ANNEX A CONTACT LIST

Name Title Location Organization Dr. George A. Zelt General Director Almaty Caspiecology Environmental

Services, LLP David Barker Country Manager-

Kazakhstan Almaty Roxi Petroleum Kazakhstan, LLP

Askar Toshtikov President Almaty BMB Munai Roza Nursaidova Representative Almaty Kazakhstan National Technical

University Society of Petroleum Engineers Chapter

Ramilya Mustafina Director Almaty Quality Management Center Patrick J. Perner Chief of

Party/Country Director

Almaty Pragma Small Business Development Project

Svetlana A. Rubtsova Managing Director Almaty “Alkor” Ltd. Machine Building Plant Khalida A. Kyrykbayeva

Marketing Director Almaty “Alkor” International FZE

Gorton M. De Mond, Jr. Regional Representative-Central Asia

Almaty International Finance Corporation

Marla Valdez Managing Partner Almaty Denton Wilde Sapte Bakytzhan Sarkeyev Deputy Chairman Almaty JSC “Center for Marketing and

Analytical Research” Daniyar Mustafinov CMAR Consultant Almaty JSC “Center for Marketing and

Analytical Research” Aliya Kayupova Kazakhstan Branch-

Managing Director Almaty SAIT Polytechnic

Karlygash Kaziyeva Deputy Director Almaty SAIT Polytechnic Asilbek A. Mirzakhojaev

Doctor of Sciences in Technics, Professor; Dean Faculty of Energy and Oil & Gas Industry

Almaty Kazakh British Technical University

Vera Mustafina Chief Manager; Director of the Center for Environmental Education and Career Development

Almaty Kazakhstan Business Council for Sustainable Development

Zarina Suleimenova Marketing Specialist-Caspian Region

Almaty Schlumberger

Dr. Michael Boyd Senior Economist, Office of Economic Growth

Almaty USAID

Neal Nathanson Senior Competitiveness Advisor

Almaty USAID

Timurlan Altayev Senior Account Astana Halliburton


A-2

Leader Nourlybek S. Imanbaev Executive Director

(former President of Kazakhstan Contract Agency

Astana KazMunaiGaz

Alimzhan Almambetov Advisor Astana KazEnergy (Kazakhstan Association of Oil, Gas and Energy Sector Organizations)

Aubakirov Timur Chairman Astana JSC “Kazakhstan Contract Agency” Marat Dauletyarov Local Content

Development Manager, Supply Chain Management

Atyrau TengizChevroil

John Cheramie Category manager, Major Capital Projects-Construction


Kevin Ruffcorn Contracts and Strategic Procurement Manager


Atyrau KAPE (Kazakhstan Agency for Applied Ecology)

Nina Shandybayevna Temirbayeva

Director Atyrau Atyrau Oblast Union of Business and Employers (Atyrau Entrepreneurs Association)

Natalia Makisheva Project Manager Atyrau ITECA (International Trade Exhibitions & Conferences)

Bud DeCoste Marketing Manager-Caspian Region

Atyrau Schlumberger

Adrian Gott Caspian Area-Director of Business Development

Atyrau Baker Hughes

Daniyar Yessaliyev Caspian Area-Customer Services Representative

Atyrau Baker Hughes

Kazbek Aubakirov Local Content Development Supervisor, Local Content Development Department

Atyrau Agip KCO (Agip Kazakhstan North Caspian Operating Company NV)

Marat Vice President Atyrau Tengizneftestroi, Lead Company of the TNS Group

Suleimenov Zhalgyz President Atyrau Kazkorotash Toksambai Sakhimov President Atyrau Atyrau Prom Geophysics


B-1

ANNEX B MAP OF SELECTED CASPIAN PROJECTS (Including Tengiz, Karachaganak And Kashagan Fields)


C-1

ANNEX C MEMORANDUM ON THE DEVELOPMENT OF LOCAL CONTENT


C-2


C-3


C-4


C-5


D-1

ANNEX D MEMORANDUM ON PROCUREMENT TRANSPARENCY INITIATIVE


D-2


D-3


D-4


D-5

Documents

Kazakhstan Assessment Report FINAL