Subsoil Use Code Draft: What to Expect?

Since the Republic of Kazakhstan gained independence up to the present, legislation has been on constant development—new laws are being adopted, strategies are changing, and with them changes in the approach and established practices of applying the law have ensued. Today, the state is trying to move away from the command methods of influence on the economy and business and shifting to partnerships, applying the best national and international practices.

Let us view the sphere of subsoil use. In your opinion, is the current legislation that regulates subsoil use in Kazakhstan progressive or not? Let us try to look at this issue through a brief analysis of the major innovations on the concept of the Code “On Subsoil and Subsoil Use” presented by the National Chamber of Entrepreneurs and the KazEnergy Association. The first draft of this Code is currently an issue, with comments and suggestions to the text under consideration.

Code “On Subsoil and Subsoil Use”: What is the purpose?

Currently, the draft of the Code “On Subsoil and Subsoil Use” (hereinafter the Code) is under extensive discussion. It is a new regulatory document which is due to replace the current law of the Republic of Kazakhstan “On Subsoil and Subsoil Use,” which was adopted in 2010. The existing act is not outdated yet. So why repeal it and adopt a new act and add to that a codified one?

The decision to change the normative regulation for a sphere as common in our country as subsoil use is most likely motivated by the following reasons:

1) Fragmentation of legislation regulating the use of mineral resources and its frequent changes.

For the purpose of executing the law “On Subsoil and Subsoil Use,” a great deal of subordinate legal acts were adopted, many of which eventually turned out to be contradictory either to one another or to acts in other branches. Moreover, since the act entered into force, nearly 300 amendments have been made to it. Normative regulation of the subsoil use market has changed so frequently that its members seem to have failed to synchronize their activities with the new order. This situation does not promote stability in the industry as the relations in the sphere of subsoil use are of lasting nature, and an investor relies on the stability of the legal conditions of his activities. Perhaps the adoption of the Code would relieve legislation of permanent transformations as amending a code is procedurally more complicated than amending a law. In addition, with respect to stability as a means of attracting investors, the authors of the Code also propose the so-called stabilization of conditions of subsoil use: the rates of lease payments, exploration and production costs, and others.

2) Investment unattractiveness of legislation on subsoil use and excessive regimentation of access to subsoil.

Kazakhstan’s current legislation on subsoil vests the state with wide authority in this area. In other words, the industry is excessively regulated. This is due to the fact that in the middle of the 20th century, the legislation of the Republic of Kazakhstanintegrated the Soviet principles of economy planning in which any activity is subjected to total regulation. By contrast, in a market economy the legislation should be flexible. Therefore, the initiators of the Code based it on a fairer and more balanced mechanism of “communication” between the state and subsoil users, which can attract investments. Western investors are not used to entirely depending on state authorities. They are used to doing business with minimal interference from officials.

3) Need for a better implementation of international practice in domestic subsoil use.

On the one hand, the current normative regulation of the sphere in question does not fully account for all the subtleties of the existing legal relations in the subsoil use as well as the relations that have actually developed but has not been settled yet. On the other hand, this does not correspond to the global practice. The developers of the Code, therefore, in analyzing the current trends of regulation of relations in the sphere of subsoil use and the best practices in the sphere of subsoil use, propose to include in the current legislation truly revolutionary provisions which Kazakhstan never knew before. They are of fundamental significance to improving the investment climate in the sphere.

Let us review some of the innovations in light of the existing order in the sphere of subsoil use.

Geological studies and exploration of subsoil

Currently, geological studies of subsoil can be financed by both budgetary resources and capital from private individuals. However, in practice this operation is basically carried out by the state as engaging in geological studies is not profitable for private businesses: while investing in studies, entrepreneurs would not be able to dispose of their obtained information on subsoil afterward because the current law “On Subsoil and Subsoil Use” consolidates the obligations of parties (contractors) engaged in geological studies of subsoil to transmit their acquired information to the state. Moreover, the investing contractor cannot obtain the first right of subsoil use in the area of study.

The Code aims to improve matters of geological study conducted by entities in the private sector. Thus, according to the results of subsoil study, the contractor would have the right to sell its acquired geological information to interested parties or use it for its own investment purposes, which can be perceived as prioritized obtaining by such contractor of rights to subsoil use for personally selected subsoil plots located within the territory of the study. In addition, the Code will give contractors the right to carry out their geological studies in areas occupied by other subsoil users through public easement. This will give investors more freedom.

With regard to subsoil exploration, as opposed to the existing order of investors’ right to explore, the Code, inter alia, proposes to decrease the investors’ obligations to spend on the social and economic development of the region, local training, research and development, and construction works.

More clarity in distinction of the operations stages?

According to the law “On Subsoil and Subsoil Use,” two types of contract apply to development operations:

1) Development

2) Combined exploration and development

Contracts normally set very serious obligations for subsoil users, and in case of violation and failure to eliminate within the period specified by a competent authority, the latter shall have the right to unilaterally terminate the contract. Imagine the possible losses that would be incurred by an investor who has concluded a contract, if, for example, for some reason he fails to meet the required development volumes stipulated by the operation program (addendum to the contract) within the period specified in the contract. He would be considered to have breached contract conditions, with obvious risks and consequences.

Therefore, in the Code, first, the abovementioned rule will be excluded; second, the number of requirements that must be listed in the contract will be reduced; and third, the legal status of the subsoil user and the competent authority in a contractual relationship will be mildly equalized. To put it figuratively, after the adoption of the Code, subsoil users that have signed contracts for development or combined exploration and development will be “given a free hand.”

Apart from the above, the Code is also assigned the duty of settling disputes between subsoil users and government authorities arising from the fact that the current legislation does not provide a clear distinction between the process of extracting minerals, primary processing, and temporary storage of mineral raw materials. At the moment, these three components are covered by the concept of “development.” The production process of extracting minerals from subsoil and their primary processing and carrying to a condition suitable for disposal constitute a different stage in the oil and mining industries, which does not allow generalizations and parallels. Moreover, designation to a particular phase of the operation is very important for tax purposes since it leads to various tax consequences. We hope that this issue will be regulated by the Code.

Basis for granting the subsoil use rights

Kazakhstan’s current legislation on subsoil and subsoil use denotes a contract concluded between the subsoil user (individual or legal entity) and the state, represented by a competent authority, as the basis for the creation, modification, and termination of a right to subsoil use.

The Code proposes a distinction between a contractual and a licensing regime of subsoil use. Thus, the Code proposes the introduction of a license as the basis for the creation of a right to subsoil use or use of state man-made mineral formations, in accordance with the type, terms, and other conditions of subsoil use designated therein. Thus, the license will be applied more widely than it is at present. Contracts are supposed to remain only in the sphere of development or exploration and development of oil and gas, as well as in cases of state geological study of subsoil.

Furthermore, at present, prior to the conclusion of a contract, an investor must obtain a right to subsoil use by participating in complex tendering procedures (tender or auction) or in direct negotiations with a competent authority. The latter often faces the problem of choice of applicant for the conclusion of a contract (license)—for example, a complicated choice between one who offers a major signature bonus and another who claims an imposing work scope in the sphere of subsoil use.

To eliminate these inconsistencies, the Code proposes the stipulation of the following procedure for the granting the rights:

– granting the right to subsoil use upon application for the purpose exploring hydrocarbons in understudied areas, to a national company for the purpose of exploration and development or development of hydrocarbons, or for the purpose of development of hydrocarbons in fields with low investment potential

– granting the right to subsoil use for exploration and development or development of hydrocarbons through an auction, the winner of which is determined by whoever offers the highest amount of signature bonus

– granting the right to subsoil use for exploration and development or development of hydrocarbons on the basis of a tender, the winner of which will be determined by the commission based on the results of the comparison of work program parameters contained in the tender bids admitted for consideration based on the criteria and in the order determined by a competent authority.

Project (design) documents, reserves evaluation and procurement

Project documents. The current project documents in the sphere of subsoil use do not meet the international practice for several reasons. First, the procedure for the preparation, examination, and approval of such documents takes too long (about a year or even longer), and second, the procedure for making amendments and additions to the subsoil user is unnecessarily complicated. The latter gets particularly worse when a subsoil user who fails to perform some kind of work or fund the project on time tries to promptly adjust the technical and economic performance of the contractual work program but receives a notice from a competent authority of a breach of contractual obligations in the form of a delayed fulfillment of obligations. Consequently, there is a risk of unilateral termination of the contract with the state. Such cases prove the dependence of the subsoil user on the state “machine.” Officials may take their time to coordinate changes in the design documents and then terminate the contract because of the subsoil user violated its current obligations, although it tried to perform them conscientiously.

In the context of the aforementioned, the Code aims to resolve the issue concerning the project (design) documents so that the subsoil user has more independence and better chances of promptly responding to changes in the technical, technological, economic, and other conditions of subsoil use and freely amending and modifying its project documentation.

Reserves evaluation. The classification of reserves which currently exists in the field of subsoil use in Kazakhstan retains the principles of the Soviet classification. In this regard, the developers of the Code propose to revise the current classification of supplies in order to comply with the international supplies accounting system used in the USA, Canada, South Africa and Australia.

Procurement of goods, works, and services during subsoil use operations. To date, 99% of entities using Kazakhstan’s subsoil are forced to engage in procurement through the register of goods, works, and services used in subsoil operations, and their producers are maintained by the state. Procurement from third parties is impossible. This lack of alternatives is fraught with a decline in the quality of goods, works, and services and creates all conditions for corruption as authorities may intentionally overcharge or undercharge requirements to specification in contracts with subsoil users, thus forcing the subsoil user to purchase from certain producers. The Code proposes the abandonment of state control of subsoil users’ procurement.

Disputes Settlement

Article 128 of the current law “On Subsoil and Subsoil Use” contains an extensive reference rule which provides for cases where a dispute related to the execution, amendment, or termination of a contract cannot be resolved through negotiations; and in such cases, the parties may resolve such disputes in accordance with the laws of the Republic of Kazakhstan and ratified international treaties.

The revision of the Code with regard to this issue is more specific and gives the subsoil user the right to opt for arbitration or the courts of the Republic of Kazakhstan as a means of handling disputes related to subsoil use. Furthermore, the Code aims to regulate the basic provisions of arbitration—namely, the type, place, language of arbitration, and number of arbitrators. The advantages of a dispute by arbitration are obvious and cover the convenience of the parties in choosing the location of the dispute, short term of proceedings, unfeigned effort of arbitrators to tangibly help the conflicting parties reach a consensus with minimal losses for both sides—in contrast to the officialism of state courts—and a different attitude toward privacy issues. That is why consolidation of the possibility of a dispute resolution by arbitration in the Code would be an excellent demonstration in behalf of Kazakhstan’s aspiration to provide investors with a guarantee of their rights when investing their capital in the sphere of subsoil use.

Summary

In the foreword to this article, we questioned the progressiveness of Kazakhstan’s legislation in the sphere of subsoil use. Just so you understand, progressive legislation is not just a likable wording from codes and laws but an effective law which specifically regulates this or that sphere of social relations and which gained approval from the participants of such relations expressed through an effort not to circumvent the law but to abide by it.

Obviously, many provisions in the Code will be modified considerably, and a number of progressive ideas will not be accepted in the form in which they are proposed by the Code. Furthermore, the current revisions on some points in the draft of the Code are debatable. However, the developers of the Code have a clear vision of their ultimate goal, and the first draft makes them believe that a great work for a more profound study of the issues of domestic law enforcement and the analysis of best international practices has been carried out. The state’s subsoil industry may soon witness revolutionary changes. With the adoption of the Code, we shall see for ourselves.