09ASTANA450, KAZAKHSTAN: A BILLION-DOLLAR QUESTION

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Reference ID Created Released Classification Origin
09ASTANA450 2009-03-13 10:01 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Astana

VZCZCXRO9966
OO RUEHAG RUEHAST RUEHBI RUEHCI RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK
RUEHKW RUEHLA RUEHLH RUEHLN RUEHLZ RUEHNEH RUEHNP RUEHPOD RUEHPW
RUEHROV RUEHSK RUEHSR RUEHVK RUEHYG
DE RUEHTA #0450/01 0721001
ZNR UUUUU ZZH
O 131001Z MAR 09 ZDK
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 4904
INFO RUCNCIS/CIS COLLECTIVE 1366
RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHBJ/AMEMBASSY BEIJING 0743
RUEHKO/AMEMBASSY TOKYO 1446
RUEHUL/AMEMBASSY SEOUL 0430
RHEBAAA/DEPT OF ENERGY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUEAIIA/CIA WASHDC
RHEFAAA/DIA WASHDC
RHEHNSC/NSC WASHDC 0928
RUEKJCS/SECDEF WASHDC 0841
RUEKJCS/JOINT STAFF WASHDC
RHMFIUU/CDR USCENTCOM MACDILL AFB FL
RUEHAST/USOFFICE ALMATY 1312

UNCLAS SECTION 01 OF 03 ASTANA 000450 
 
SENSITIVE 
SIPDIS 
 
STATE FOR SCA/CEN, EEB/ESC 
STATE PLEASE PASS TO USTDA FOR DAN STEIN 
 
E.O. 12958: N/A 
TAGS: PGOV ECON EPET EINV KZ
SUBJECT:  KAZAKHSTAN:  A BILLION-DOLLAR QUESTION 
 
REF:  (A) ASTANA 0317 (B) 08 ASTANA 2259 (C) ASTANA 1868 
 
ASTANA 00000450  001.2 OF 003 
 
 
1.  (U) Sensitive but unclassified.  Not for public Internet. 
 
2.  (SBU) SUMMARY:  On March 13, the director of Chevron's 
operations in Eurasia told the Ambassador that Tengizchevroil (TCO), 
in which Chevron has a 50% share, has come under "renewed attack" 
from the government over sulfur storage practices in Tengiz.  Jay 
Johnson, Managing Director of Chevron's Eurasia Business Unit 
(protect throughout), said the issue has "escalated dramatically" 
since February and has the potential to become a multi-billion 
dollar claim, which Chevron would dispute via international 
arbitration if necessary.  Johnson said local authorities have 
already frozen one TCO bank account and he expects them to seize 
other assets soon.  In a related development, TCO sent a letter of 
protest last week to the British Embassy, which characterized sulfur 
as a "waste" and not a "product" on a website and in official 
correspondence promoting their sulfur management program in 
Kazakhstan.  According to recent amendments to the Tax Code, sulfur 
is now considered a "waste" and its production is subject to 
taxation and penalties.  Also this week, Royal Dutch Shell, which 
leads offshore development of the Kashagan oil field, hosted a 
meeting with U.S., UK, and Canadian Embassy Officers to plan for a 
sulfur management conference in Astana in July.  The purpose of the 
conference is to present a legislative package that meets 
international standards and to promote sulfur in value-added 
products such as sulfuric acid, fertilizer, concrete, and asphalt. 
END SUMMARY. 
 
2007 COURT RULING PUNISHES TCO 
 
3.  (SBU) According to Chevron's Johnson, in November 2007, a court 
in Atyrau oblast ordered TCO to pay $342 million for environmental 
permits for the storage of sulfur at Tengiz.  Johnson said this 
decision represented a change in government policy.  Previously, the 
government had based its fee on TCO's annual sulfur production and 
storage.  With this ruling, however, the government calculated its 
fee based on the cumulative amount of sulfur produced and stored at 
Tengiz since 1993, and calculated the amount (erroneously, according 
to Johnson) as if TCO did not pay for sulfur stored in previous 
years.  Johnson also said that TCO initially applied for a permit to 
pay for sulfur storage on a cumulative basis, but was denied and 
told permits would only be issued on an annual basis.  Johnson told 
the Ambassador that TCO protested the government's assessment 
methods at the time, but paid the fine in order to maintain 
production. 
 
TCO DISPUTES ADMINISTRATIVE PENALTY 
 
4.  (SBU) In February 2008, Johnson said TCO was surprised to learn 
that the Atyrau court had levied a $310 million administrative 
penalty on TCO, on top of the $342 million fee the company had 
already paid.  TCO refused to pay the penalty, appealed the ruling, 
and protested directly to First Deputy Prime Minister Umirzak 
Shukeyev, who "tacitly agreed" that the government would not pursue 
the matter further.  Johnson said Shukeyev has been helpful keeping 
this issue "in a holding pattern" and has intervened personally on 
at least three occasions to block the Atyrau court from holding a 
hearing that would force TCO to pay the administrative penalty. 
 
ATYRAU COURT DENIES APPEAL, FREEZES ASSETS 
 
5.  (SBU) Nevertheless, Johnson told the Ambassador that the Atyrau 
court convened last week and rejected TCO's appeal -- without 
notifying or inviting TCO, presumably to prevent the company from 
appealing for assistance to Shukeyev.  (NOTE:  Johnson said he 
wasn't surprised by the court decision, which he suspected was 
pre-determined.  He told the Ambassador that TCO's lawyers have gone 
to court in other cases and have seen the judge's ruling already 
signed, sealed, and delivered, before the hearing even begins.  END 
NOTE).  On March 12, soon after the court ruling, Johnson said local 
authorities froze one TCO bank account and seized the assets, which 
 
ASTANA 00000450  002.2 OF 003 
 
 
amounted to less than $100, since the account is no longer actively 
used.  "Once they realize their mistake," Johnson said, "they'll 
come after our active accounts."  He added that TCO does not have 
sufficient cash on hand to pay the administrative penalty, even in 
its offshore accounts.
 
 
TAX CODE AMENDMENT DEFINES SULFUR AS "WASTE" 
 
6.  (SBU) On February 21, parliament attached a rider to the Islamic 
Banking Law that amended the Tax Code, classified sulfur as 
"industrial waste," and established a formula for calculating sulfur 
storage penalties.  Johnson said that if the tax authorities apply 
the formula based on accumulated volumes at Tengiz, the charge could 
amount to more than $5 billion.  (NOTE:  According to the amended 
Tax Code, the fee for storing one ton of sulfur would be 3.77 times 
the "monthly estimated unit," which is determined annually in the 
budget and is currently 1,273 tenge, or $8.50.  Therefore, TCO would 
be forced to pay $32.00 per ton of sulfur.  END NOTE).  Johnson 
contends that the new law violates a protocol the government signed 
with TCO in 2008, agreeing that sulfur would be treated as a product 
and not "waste", as well as the bilateral investment treaty 
governing Chevron's investment in TCO.  "The irony," said Johnson, 
"is that the government has amended the Tax Code to target TCO, when 
it has already determined that TCO's tax stability clause means the 
Tax Code does not apply to TCO."  Johnson said that Chevron CEO Dave 
O'Reilly has already written to President Nazarbayev to protest the 
government's action and has requested a face-to-face meeting at the 
end of March. 
 
TCO ORDERED TO RE-FILE TAX RETURNS 
 
7.  (SBU) In addition to losing the court appeal and having sulfur 
classified as waste, TCO learned this week that the central 
government's Tax Committee has ordered the company to re-file its 
tax returns for 2003-2006, based on a re-calculation of the fee for 
TCO's cumulative sulfur storage at Tengiz.  As Johnson said, "We 
simply cannot do that.  Each year, we must declare that our tax 
return is accurate and correct.  If we re-file the returns, it would 
be an admission of wrong doing, which would open us up to other 
fines and penalties."  When asked to speculate why the government 
seemed to be increasing pressure on TCO at this time, Johnson did 
not hesitate:  "This is money-driven," he said.  "The head of the 
Presidential Administration, Aslan Musin, was the Akim (governor) of 
Atyrau oblast when all this started.  He launched the original 
battle and now he's in a much stronger position to carry it out." 
 
THIS COULD GET UGLY 
 
8.  (SBU) Although he stopped short of requesting the Ambassador to 
intervene, Johnson said that Chevron may indeed ask for U.S. 
government assistance if the parties cannot resolve this issue soon. 
 In the meantime, he warned, "Things are going to get ugly.  TCO 
plans to make massive layoffs of working and office staff this 
month, in part to send a message to the government, but also simply 
because we cannot afford to operate under these conditions." 
Johnson added that if TCO and the government cannot resolve the 
issue in private, Chevron will reflect the cost and uncertainty of 
the tax dispute in its next quarterly filing with the U.S. 
Securities and Exchange Commission.  That would generate unwelcome 
negative publicity, he speculated, and could adversely affect 
Chevron's stock value and Kazakhstan's investment climate. 
 
TCO PROTESTS UK CHARACTERIZATION OF SULFUR 
 
9.  (SBU) On March 5, TCO's General Director Todd Levy sent a letter 
to the British Ambassador to protest the British Embassy's 
characterization of Tengiz sulfur as "waste" on their website and in 
a Russian-language translation of a letter to Vice Minister of 
Energy Askar Batalov.  The British Embassy website claimed that "the 
high level of sulphur in Tengiz oil poses a negative impact on oil 
production" and said that "the (sulfur) wastes are currently stored 
in uncovered areas causing considerable environmental damage." 
 
ASTANA 00000450  003.2 OF 003 
 
 
(NOTE:  Chevron's Johnson suspected that the British Embassy may 
have been unduly influenced by the British Sulfur Consultancy Group 
they have retained to provide technical assistance on sulfur 
management.  He also suggested that this group may have ties to 
Royal Dutch Shell, a competitor of Chevron's.  END NOTE).  The 
British Embassy subsequently pulled the offending article from their 
website and sent a Diplomatic Note to the Ministry of Energy 
correcting the Russian-language letter.  The U.K. government will 
continue to fund training and technical assistance in sulfur 
management in Kazakhstan, with a focus on developing value-added 
products using sulfur and sulfuric acid. 
 
SULFUR CONFERENCE IN JULY 
 
10.  (SBU) On March 11, Energy Officer attended a meeting with 
Canadian and British embassy officials at the local headquarters of 
Royal Dutch Shell.  The purpose was to discuss planning for a 
conference in July on sulfur management.  (NOTE:  Shell was the lead 
sponsor for a similar conference held in Astana in July 2008.  END 
NOTE).  Neil Carmichael, Shell's General Manager for Central Asia, 
said they would welcome TCO's participation in the event this year, 
but said bluntly, "We don't want an argument between TCO's lawyers 
and the government, like we had last time."  Shell proposed, and the 
embassy officers from Canada and Great Britain agreed, that this 
year's conference should avoid discussion of environmental and tax 
issues and instead focus on developing a legislative package that 
meets international standards, potentially based on the Canadian 
model, and on the use of sulfur in value-added products such as 
fertilizer, sulfuric acid, concrete, and asphalt. 
 
11.  (SBU) COMMENT:  Sulfur is a big deal in Kazakhstan, and not 
only because more than 8 million tons of it are stacked up at Tengiz 
in pallets the size of football fields.  It is a big deal because it 
has the potential to make a lot of people very wealthy, whether 
through trading contracts or through tax payments and administrative 
penalties.  Sulfur directly affects the operational, employment, and 
investment decisions of Chevron, still the largest single investor 
in Kazakhstan, and as such it is an issue that the U.S. government 
should continue to monitor closely.  Due to the nature of 
Kazakhstani crude, as oil volumes go up, sulfur mounds will grow. 
Once Kashagan and other new fields come on line, the issues 
surrounding sulfur will only become more complex, contentious, and 
critical.  END COMMENT. 
 
HOAGLAND

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