Legislation on Gas and Gas Supply

Associated Gas: changes introduced by Draft Law of the RK «On Gas and Gas Supply» (Draft Law as of September 2010).

On 24 June 2010 President of the RK signed new Law of the RK «On Subsurface and Subsurface Use». One of the changes established by this Law was introduction of state ownership for associated gas as well as establishment of obligation for subsurface users on implementation of measures aimed at rational and integrated use of associated gas including its processing.

Issues of state ownership for associated gas were considered without going into details in the recently adopted Law. Therefore, in the nearest future it should be expected that Government of the RK will initiate adoption of a number of regulatory legal acts as well as amendments to existing regulatory legal acts on issues related to implementation of state ownership to associated gas and gas products.

One of first signs was Draft Law of the RK «On Gas and Gas Supply» prepared by the Ministry of Oil and Gas.

What are its main principles, which issues does it specify, who is interested in its adoption?

These and many other issues have been considered in the Article given below.

State will oblige subsurface users to process the associated gas owned by state and reimburse only operating costs to the latest.

In accordance with Article 15 of Draft Law commercial gas processed from produced associated gas owned by the State in accordance with legislation of the Republic of Kazakhstan on Subsurface and Subsurface Use shall be transferred by producer to the ownership of national operator. In this case national operator shall reimburse operating costs related to production of commercial gas from specified associated gas to producer.

In other words we can make a conclusion that most probably subsurface user will be the producer of commercial gas produced from associated gas owned by the State.

The following factors allow us to come to such conclusion:

First of all, it is unlikely that someone will process gas without profit element (only for reimbursement of operating costs). It means that voluntary engagement of interested parties in investing into processing of associated gas would be impossible.

Secondly, if nobody wants to deal with processing on a voluntary basis, then the one, on whom this obligation is imposed by legislation, shall be dealing with this. That is subsurface user producing associated gas and obliged by Law of the RK “On Subsurface and Subsurface Use” to ensure rational and integrated use of associated gas including its processing.

In such case upon transfer of commercial gas to national operator only operating costs will be reimbursed to producer. Even though there is no definition of notion “operating costs” in the Draft Law, chances are high that these costs may not include producer’s costs for construction of facilities for processing of associated gas, costs to produce the gas etc.

State monopoly for procurement of commercial gas produced from associated gas owned by the State.

In the Explanatory Note to Draft Law “On Gas and Gas Supply” it is specified that this Draft Law is aimed to introduce new state policy in gas sphere based on detailed analysis of existing problems and foreign experience in the sphere of organization and regulation of gas industry.

Which state policy will our state implement in gas industry?

Thus, in Resolution of the Government of the Republic of Kazakhstan dated 03.08.2010 №776 «On Strategic Plan of the Ministry of Oil and Gas of the Republic of Kazakhstan for 2010-2014» it is pointed out that while there are special laws on gas in many countries worldwide (USA, Great Britain, Norway, France, Russia, etc.), «…in Russian Federation monopoly right for export of gas is established on the legislative level …».

It means that policy of Kazakhstan on «state monopoly in the sphere of gas turnover» was taken as an example by the Government of the RK. In other words «example to follow”.

Thus, objective of state authorities of the RK is not development of competitive market of commercial gas, but establishment of state monopoly for all commercial gas produced from associated gas irrespective whether it is owned by state or subsurface user. In its turn a number of provisions of Draft Law «On Gas and Gas Supply» confirm this assumption.

Thus, Article 17 of Draft Law specifies priority right of state for procurement of commercial gas produced from associated gas owned by the State.

In this case gas will be purchased by national operator not on terms of competitiveness with other potential buyers (that is procurement on terms as good as terms proposed by other potential buyers). On the contrary, procedure of price determination will be established by Government of the RK.

Only in case if national operator refuses to purchase gas in writing or does not accept proposal of subsurface user on purchase of commercial gas, then subsurface user shall have a right to sell it to the third parties.

It means that there is a high risk that, first of all, subsurface user will be deprived of the opportunity to sell commercial gas produced from associated gas owned by it at market price as formation of prices will be implemented in accordance with procedure established by Government, but not on the basis of market price of gas (supply-and-demand situation). Secondly, it is unlikely that national operator will refuse from purchase of gas at such «fair» price. We should not forget also that even if national operator refuses to purchase commercial gas from subsurface user, it would be possible to sell such gas only to a limited number of buyers that have access to gas pipeline system of the RK.

In this connection we should mention other innovation proposed by Draft Law «On Gas and Gas Supply», that is priority right of the state for acquisition of:

•\talienated title to facilities of uniform supply system of commercial gas;

•\tshare of ownership rights in facilities of uniform supply system of commercial gas;

•\tstock of shares (shares of participation) of legal entities – owners of uniform supply system of commercial gas.

In this case, in accordance with Draft Law «On Gas and Gas Supply» uniform supply system of commercial gas includes all facilities related to production of commercial gas, main gas pipelines, commercial gas storages, gas distribution systems and gas compression stations, but does not include field gas pipelines and production facilities for transportation, storing and sale of liquefied gas.

It means that state aims at establishment of legal grounds not only for monopolization of commercial gas market produced from associated gas, but also at continuation gas pipeline system monopolization.

Incentives for production of liquefied natural gas.

In accordance with Draft Law «On Gas and Gas Supply» priority right of the state for acquisition of gas produced from associated gas will not be applied to:

•\tcommercial gas produced from crude gas produced in gas and (or) gas-condensate fields;

•\tliquefied natural gas;

•\tcommercial gas produced in the process of regasification of liquefied natural gas.

Also, in accordance with Draft Law “On Gas and Gas Supply” priority right of state for acquisition of gas supply system facilities shall not be applied to production facilities for transportation, storing and sale of liquefied gas.

Thus, developers of Draft Law “On Gas and Gas Supply” try to create incentives for subsurface users – owners of associated gas to invest in processing of associated gas into liquefied gas, which they can sell without restraint and establish prices for it independently.

State reserves the right for protection of internal market of liquefied gas by regulation of export of liquefied gas by establishment (change) of customs, protective, antidumping and compensatory duties, export quotas for liquefied gas as well as by establishment of minimum volume of liquefied gas production for internal market of the Republic of Kazakhstan.

Also, we would like to draw you attention to the fact that Draft Law “On Gas and Gas Supply” does not consider issues of liquefied gas production from associated raw materials owned by state (whom to sell, what will be reimbursed to its producer, etc.).

Conclusions:

In general, the issue of processing of associated gas that represents more than half of all discovered gas reserves in Kazakhstan (thus, in accordance with data of NC KazMunaiGas JSC 34,5% of total volume of discovered gas reserves in Kazakhstan is associated gas of Kashagan Field, 17,3% – associated gas of Tengiz Field) has been imminent for a long time. And solution of this issue should be in the interests of all participants of this process including state and subsurface users.

First of all, processing of associated gas should be considered in the framework of each specific project and should be economically efficient for subsurface user. That is if processing is not profitable, subsurface user shall have a right to confine itself by measures of utilization of associated gas. In this case for determination of economic efficiency it is necessary to take into consideration not only issues of processing, but also issues of delivery of processed commercial gas to consumers. In fact, it is clear that it is impossible to construct gas pipeline to each field.

Secondly, issues of processing by subsurface users should be solved in parallel with solving of issues on further development of gas pipeline system, gas distribution and gas-consuming systems by state that allow to accept commercial gas from subsurface users and deliver it to final consumer or sent to export.

Thirdly, state should not solve financing problems of gas pipeline system development at the expense of subsurface users (by gas extraction at knock-down prices).

Fourthly, state should not confine itself by administrative methods for solving issues of associated gas processing hiding behind unwillingness of subsurface users to invest in processing.

Also, it is necessary to remove causes of such unwillingness, which are usually objective and conditioned by absence of uniform gas pipeline system covering all country, absence of access to sale markets domestically and abroad, etc, and to establish conditions for further development of gas industry of the RK in parallel with enforcement measures.