Opportunities And Challenges Facing Texas Energy Companies In The Caspian Region

Friday, September 1, 2006 - 01:00
Bracewell & Giuliani LLP
Ileana M. Blanco

From the North Sea to the Persian Gulf to Southeast Asia, oil and gas exploration, production and service companies based in Texas are key players in global energy producing regions. Fundamental geopolitical change and rising oil prices have turned the Central Asian region surrounding the Caspian Sea into a focal point for Texas-based energy companies. The former Soviet republics that now constitute the Caspian region's Commonwealth of Independent States (CIS) - including Azerbaijan, Turkmenistan and especially Kazakhstan - have significant hydrocarbon resources estimated to equal at least 3 percent of total world reserves. As a result, the region attracts many companies vying for a share in current and planned Caspian offshore production projects. Integrated producers such as ExxonMobil, Amerada Hess and Unocal, exploration companies like Houston-based Parker Drilling and many other industry leaders have established operations or investments in the Caspian region.

Emerging Economies

Tempering such enthusiasm is the fact that the CIS countries all began their transition from state-planned to market-directed economies less than 15 years ago. The evolution of their judiciary systems is inseparable from each country's business, cultural and economic environment. Privatization and resulting rapid economic growth have created change that challenges the traditional judicial and cultural frameworks in these countries. Under these circumstances, flexibility and local knowledge are essential to pursue market opportunities.

Reflecting this, several Texas-based multinational law firms have developed significant practices to advise U.S. energy companies. Dating to the early and mid-1990s, these firms either established offices in the region, or began regular service there from offices in Moscow or London.An established local presence allows for developing the personal trust and relationships with key government officials and agencies that are essential for success in the emerging Caspian economies.

Infrastructure Creation

When newly independent Kazakhstan began the process of creating a market economy, multilateral government agencies and lawyers from the United States played key roles. The World Bank for Reconstruction and Development and the United States Agency for International Development, sometimes with the assistance of lawyers from U.S. firms that had established Caspian practices, helped craft the country's economic infrastructure of corporate governance, banking and securities regulation. This included drafting Kazakhstan's Law on Securities and Stock Exchanges, Law on Investment Companies, Law on Foreign Investment and Law on Economic Entities, as well as establishing the country's National Securities Commission and Central Bank.

The creation of the legal system followed a similar path. Kazakhstan's civil code consists of General Provisions enacted in 1995 and Special Provisions enacted in 1999. The General Provisions set forth basic principles underlying such concepts as legal entities, property and terms, general principles of transactions and obligations between parties. The Special Provisions consider contracts in detail and contain dispute resolution provisions. When creating its new civil code, Kazakhstan adjusted traditional legal models to the specific requirements of its economic evolution. Beginning with incentives to privatize property, the civil code details property rights and regulates the legal relationships between business parties, involving such commercial necessities as contracts, loans, security interest and equity capital.

Government Relations

Effective government relations with Kazakhstan's economic and finance agencies is the foundation of a successful business venture in that country. Knowledge of the laws and the key regulatory officials helps with the day-to-day requirements of doing business, involving labor, taxation, corporate governance, trade and competitive issues.

For example, lawyers representing American and other Western clients seek to maintain strong working relationships with the Kazakhstani governmental agencies most responsible for regulating the market economy, including the Financial Market Supervision Agency, the Ministry of Finance, the nation's Central Bank, and both the Customs Committee and Antitrust Authority of the Ministry of Trade. Another way of playing a key role to help shape the government's business and corporate policies is through participation in unofficial advisory Working Groups for legal affairs, oil and gas issues, labor issues and business operations.

The importance of personal relationships also applies to dispute resolution. In Kazakhstan's civil law system, although the civil code sets forth general principles, specific rules for business conduct are created in laws and regulations that are subordinated to the civil code. Good working relationships with those who make and administer commercial laws are invaluable in protecting business interests at trial.

Energy Activity

Large and mid-size multinational corporations are engaged in a mix of energy and infrastructure transactions throughout Kazakhstan. Energy companies based in the country include KazTransOil, KazTransGas, KazMunayGas and Kazakhoil-Aktobe LLP. These businesses work with multinational energy and financial corporations on financing transactions, asset purchases and sales, production and exploration contracts, establishment of joint ventures and negotiations of production sharing contracts.

The Ministry of Natural Resources is heavily involved in regulating the entire oil and gas industry. The government of Kazakhstan is also playing an active role in the rehabilitation of the Uzen Oil Field and the construction of a pipeline across Eastern Kazakhstan to China. Kazakhstani energy companies are active in the private financial markets and actively pursue Eurobond financing for their transactional and operating needs. The European Bank for Reconstruction and Development (EBRD) is also active in project financing transactions involving the Kazakhstan power industry.

The good news from Kazakhstan in 2006 is that all the major exploration companies have progressed well and are working flat out.The bad news is that the energy infrastructure has not kept pace and production facilities are being strained.There is also a major political issue in that the oil pipeline between Kazakhstan and Russia is at capacity and needs to be doubled, and this requires negotiation between the two countries.Another key issue is that, given the high price of oil, the value of oil companies in the region has never been higher, which directly affects merger and acquisition activities.

Financial Opportunity

One of the most exciting emerging opportunities in the region is the creation of the Almaty Regional Financial Center. Modeled in part after the Dubai International Financial Center, which has helped transform that Persian Gulf country, the Almaty Center is being set up as a financial 'free trade' zone with rules and regulations that will be highly efficient for major financial institutions located there. The Almaty Regional Financial Center will have a specialized court to resolve disputes over financial transactions that take place in the new financial zone. The draft law to create this court is being discussed by both the Kazakhstani Parliament and the Constitutional Council, which is the supreme authority that interprets the Constitution.

As the development of a market economy continues to advance in Kazakhstan, numerous opportunities for privatizations continue to emerge through the national securities market. Underwriters in such transactions have included CIBC Oppenheimer, Global Securities, AIG Silk Road Fund, Regent Central Asia Fund and Kazakhstan Asset Management. U.S. lawyers have worked extensively on privatizations of banks, the state telecommunications company, a large oil and gas production company and mining concerns. We also helped develop the program that has been selling the state interest in various commercial banks in Kazakhstan.

Dispute Resolution

Energy companies must exercise considerable flexibility in their Caspian region business arrangements. Standard contractual language is rarely adequate, and participants should specify that international law and accepted industry practices will govern all situations unless all partners agree to use host country law. All industry model terms regarding finance, operations, confidentiality and other areas should be customized to specific project needs. Arbitration is often the best way to resolve contractual disputes. However, to make arbitration effective, contracts should define location, forum and terms. Impartial dispute resolution under recognized international standards is the best protection for capital-intensive energy investments.

A basic understanding of civil procedural law required in Kazakhstan's judicial system is crucial to successfully resolve disputes involving taxation, contracts, anticompetitive conduct and similar issues. That requires experience at every level of that hierarchal court system including: the Supreme Court, district and regional trial courts, oblast trial and appellate forums, and specialized economic and administrative courts. Kazakhstan's adoption of its laws on Commercial International Arbitration and on Intermediate Courts in December 2004 created a new system of arbitration tribunals and intermediate courts that are not included in the state court structure. This new law on arbitration has brought greater certainty to the procedure under the New York Convention for enforcement of arbitral awards.

Key To Success

The transformation of the Commonwealth of Independent States from managed economies to free markets has been one of the key global economic developments of the past 15 years. Their progress has been substantial, but their developing economies and judicial systems still offer challenges to multinationals locating or investing there. The key to success in these countries is to have an understanding of the cultural, business and legal realities, thereby building a foundation of trust and personal relationships that facilitates pursuit of the continually expanding opportunities in the Caspian region.

A litigation partner at Bracewell & Giuliani, Ileana M. Blanco focuses on international dispute resolution involving complex commercial, energy, financial, intellectual property and lender liability controversies. Bracewell & Giuliani provides Fortune 500 companies, major financial institutions and governmental entities with practical advice spanning law, business, and public policy. With offices in Texas, Kazakhstan, New York, Washington, D.C., and London, Bracewell & Giuliani is well positioned to serve clients worldwide. For more information about Bracewell & Giuliani, visit www. bracewellgiuliani.com.

Please email the author at ileana.blanco@bracewellgiuliani.com with questions about this article.