09ASTANA555, KAZAKHSTAN: AES AGREES TO EARLY BUY-OUT OF EKIBASTUZ

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Reference ID Created Released Classification Origin
09ASTANA555 2009-03-31 10:54 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Astana

VZCZCXRO4969
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 #0555/01 0901054
ZNR UUUUU ZZH
O 311054Z MAR 09
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 5051
INFO RUCNCIS/CIS COLLECTIVE 1418
RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHBJ/AMEMBASSY BEIJING 0798
RUEHKO/AMEMBASSY TOKYO 1501
RUEHUL/AMEMBASSY SEOUL 0485
RHEBAAA/DEPT OF ENERGY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUEAIIA/CIA WASHDC
RHEFAAA/DIA WASHDC
RHEHNSC/NSC WASHDC 0981
RUEKJCS/SECDEF WASHDC 0894
RUEKJCS/JOINT STAFF WASHDC
RHMFIUU/CDR USCENTCOM MACDILL AFB FL
RUEHAST/USOFFICE ALMATY 1363

UNCLAS SECTION 01 OF 03 ASTANA 000555 
 
SENSITIVE 
SIPDIS 
 
STATE FOR SCA/CEN, EUR/CARC, EEB/ESC 
STATE PLEASE PASS TO USTDA FOR DAN STEIN 
 
E.O. 12958: N/A 
TAGS: PGOV ECON ENRG EINV KZ
SUBJECT:  KAZAKHSTAN:  AES AGREES TO EARLY BUY-OUT OF EKIBASTUZ 
MANAGEMENT CONTRACT 
 
REF:  (A) 08 ASTANA 2177 (B) 08 ASTANA 2086 
 
ASTANA 00000555  001.2 OF 003 
 
 
1. (U) Sensitive but unclassified.  Not for public Internet. 
 
2.  (SBU) SUMMARY:  On March 20, Kazakhstan's largest private mining 
company, Kazakhmys, terminated after just 15 months a three-year 
management agreement for U.S. power company AES to run the Ekibastuz 
coal-fired power plant.  The contract, which was scheduled to end on 
December 31, 2010, would have paid AES $381 million if the company 
had met certain revenue targets.  Instead, AES will receive $80 
million in April 2009 and $102 million in January 2010.  AES 
Kazakhstan publicly called the early termination a "mutual decision 
that will benefit both AES and Kazakhmys."  In private conversations 
with us, company officials blamed the economic crisis for the 
termination, and also suggested that state-owned company 
Samruk-Energo played a role in the decision.  An industry analyst 
argued that AES no longer has anything of value to contribute to the 
development of Kazakhstan's energy sector.  END SUMMARY. 
 
AES'S EARLY DISMISSAL 
 
3.  (U) On March 20, Kazakhstan's mining giant Kazakhmys announced 
the early termination of a management contract with AES for the 
latter to run the Ekibastuz GRES-1 coal-fired power plant as well as 
the Maikuben coal mine.  In May 2008, Kazakhmys acquired Ekibastuz 
and Maikuben from AES for $1.5 billion.  Under the terms of that 
agreement, AES was to operate Ekibastuz on behalf of Kazakhmys until 
December 31, 2010.  The three-year management contract was to pay 
AES up to $381 million if the company met targets for revenue, 
profitability, and capital improvements.  Under the terms of the 
buy-out, however, Kazakhmys will pay AES $80 million in April based 
on 2008 results and $102 million in January 2010.  Kazakhmys's CEO 
thanked AES for facilitating the management transition and said, 
"This agreement reduces our cash commitments, which is welcome in 
the current environment.  It should also allow us to create a more 
integrated approach to all of our power facilities, which together 
represent over 20 percent of Kazakhstan's power output."  Since 
1996, AES has invested over $200 million in modernization programs 
bringing into operation more than 2,000 megawatts of generation 
capacity at Ekibastuz. 
 
ECONOMIC CONDITIONS BLAMED FOR EARLY TERMINATION 
 
4.  (SBU) On March 24, AES Vice President Mike Jonagan told Energy 
Officer that the early buy-out of the management contract was the 
inevitable result of the economic crisis and the government's 
decision to fix electricity tariffs for the next seven years. 
Jonagan confirmed that under the terms of the original management 
contract, AES would have been paid $381 million in total if 
financial performance targets were met.  According to Jonagan, in 
2008, the Ekibastuz power station delivered strong financial 
results, which guaranteed a significant payout to AES for that 
period.  In 2009, however, Jonagan said the deepening crisis "made 
it very unlikely" that the company would achieve the minimum 
financial threshold for AES to receive payment.  Therefore, he said, 
both parties understood that it was just a matter of time before AES 
itself terminated the agreement to ensure that it received at least 
the minimum payout possible.  Interestingly, Jonagan did not blame 
the government's pending anti-trust ruling against AES  -- a matter 
which the company may still take to international arbitration -- for 
the early dismissal (reftel A).  Indeed, he sounded positively 
upbeat about the announcement, saying, "We are parting ways under 
fairly good terms and with minimal hard feelings.  The economic 
crisis really killed the business, which means they are postponing 
the capital expansion program.  We basically became redundant in the 
economic environment that evolved -- something no one predicted when 
we signed the contract in December 2007." 
 
5.  (SBU) During a March 26 meeting with the DCM, AES Country 
Manager Doug Herron speculated that Kazakhmys was eager to exit the 
agreement due to its own cash flow constraints.  Kazakhmys has lost 
 
ASTANA 00000555  002.2 OF 003 
 
 
nearly 90 percent of its market value in the last year and, 
according to Herron, the company reported no earnout at all from 
Ekibastuz in 2008.  Herron said that some AES corporate official
s 
are concerned that Kazakhmys will not meet its next scheduled 
payment to AES, although he himself was not worried, because AES has 
a letter of credit guaranteeing payment.  Herron also said the 
government's regulation of electricity tariffs will adversely affect 
the profitability of the power plant and AES's other power companies 
in Kazakhstan.  However, he added that the tariff regulation does 
not unfairly discriminate against AES by setting a lower rate for 
their hydropower assets, as did an initial draft.  Herron also noted 
that the central government's decision to fix electricity tariffs 
nationwide means that local governors will no longer be able to 
request preferential treatment for power consumers in their oblasts. 
 "That used to be a terrible problem," said Herron.  "Now, with the 
regulation setting capped rates by fuel type, there's much less 
local interference." 
 
GOVERNMENT PLANS TO TAKE BACK ENERGY ASSETS 
 
6. (SBU) Herron noted that state-owned Samruk-Energo, which is a 
wholly-owned subsidiary of the Samruk-Kazyna National Welfare Fund, 
plans to acquire 40 percent of Ekibastuz from Kazakhmys.  He 
suggested that as a result, Samruk-Energo may also have played a 
role in pressing Kazakhmys to terminate AES's management contract 
early.  (NOTE:  In February 2008, when AES announced the sale of its 
interest in the Ekibastuz power plant and the Maikuben coal mine to 
Kazakhmys, Prime Minister Karim Massimov ordered Samruk-Energo to 
negotiate with Kazakhmys for an ownership stake in Ekibastuz.  In 
October 2008, Kazakhmys and Samruk-Energo signed a memorandum of 
understanding agreeing to joint ownership of Ekibastuz and Maikuben. 
Samruk-Energo Managing Director Alexander Li said at the time that 
the company would need six more months to complete the necessary due 
diligence and report its findings to the government, and 
approximately one year to complete the deal.  In November 2008, 
Kazakhmys asked the government to expedite its acquisition of 
Ekibastuz and the Maikuben, warning that it did not have sufficient 
funds to repay the loan it took to finance the acquisition from AES. 
 END NOTE.) 
 
AES HAD "NOTHING OF VALUE" TO CONTRIBUTE 
 
7.  (SBU) On March 24, Moscow-based energy consultant Paul Boyne 
told Energy Officer that AES was being "run out of the country" 
because they no longer had anything of value to contribute to the 
development of Kazakhstan's power sector.  Boyne, who has worked as 
an advisor to Samruk-Energo, said, "All the equipment at Ekibastuz 
is Russian.  All the expertise is with the local staff, not the AES 
management team.  And AES can't arrange any capital investments for 
the plant, so they are totally useless."  Boyne said AES knew it 
could not fulfill the goals in the management contract and should 
consider itself fortunate to walk away with such a large payout.  "I 
wasn't surprised that AES left," he said.  "The only surprise to me 
is how fast it happened." 
 
SOUTH KOREANS INVEST IN POWER SECTOR 
 
8.  (U) On a separate but related note, the Korea Electric Power 
Corporation announced on March 25 that a consortium involving 
Samsung C and T Corporation was selected as the prime bidder for 
construction of a $2.5 billion thermal power plant in Balkhash, in 
eastern Kazakhstan.  The consortium plans to finalize a formal deal 
with Samruk-Energo in 2010, with the aim of completing a plant with 
a capacity of 1,200-1,500 megawatts by 2014.  The consortium will 
own 75 percent of the new venture and operate the plant once it is 
built in Balkhash. 
 
9.  (SBU) COMMENT:  Unlike previous government decisions affecting 
AES, in this case, the company has not asked for sympathy or support 
from the U.S. government.  AES seems genuinely satisfied to exit its 
Ekibastuz management contract at the half-way point, with 
 
ASTANA 00000555  003.2 OF 003 
 
 
approximately half of the revenue it had planned to collect.  AES's 
country manager even called the early buy-out "the cream on top" of 
the billion-dollar sale of the power plant to Kazakhmys in 2007. 
However, the transaction does make one wonder where AES will go from 
here.  The company's anti-trust dispute looks headed for 
international arbitration, Samruk-Energo has replaced AES at 
Ekibastuz, and Korean rival Samsung is grabbing headlines and 
winning billion-dollar contracts to build new power plants.  AES now 
has only two hydropower concessions until 2019, and two combined 
heat-and-power plants that even they admit no one wants, as their 
strategic presence in the region.  END COMMENT. 
 
HOAGLAND

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