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    Kazakhstan’s gas dilemma [Gas in Transition]

Summary

Political pressures are impeding gas market reform. [Gas in Transition, Volume 2, Issue 11]

by: Ben Godwin, Head of Analysis – PRISM Political Risk Management

Posted in:

Complimentary, Natural Gas & LNG News, Asia/Oceania, Expert Views, Insights, Gas In Transition Articles, Vol 2, Issue 11, Kazakhstan

Kazakhstan’s gas dilemma [Gas in Transition]

In the popular imagination, Kazakhstan is considered an oil and gas giant. However, while it may be one of the largest oil producers in the world, it is struggling to produce enough gas to supply its own domestic requirements. In fact, the government believes that there could be a deficit of gas as early as next year.

The shortage is not caused by an absence of gas. It has proven reserves of 3 trillion m3. Instead, the challenge lies in the way that the gas market is structured. Ever since the Soviet period, there have been strict caps on the gas price for consumers. The lack of price reform has meant that Kazakhstan now has the lowest gas prices in the former Soviet Union.

At such prices, there are almost no circumstances under which gas producers can make a profit. Instead, gas is sold at a loss, largely from oil producers who have no other outlet for associated gas, which is produced alongside oil. As a result, associated gas from Kazakhstan’s three major oil projects – Tengiz, Kashagan, and Karachaganak – make up 70% of the gas produced in Kazakhstan.

Another challenge is the role that QazaqGaz – the state gas company – plays in the gas market. The company ostensibly runs the gas transit network. However, it has been able to use its monopoly position to act as the country’s chief gas trader, buying from producers and distributing to domestic consumers and to the export market.

While Kazakh gas law technically allows third-party access to the QazaqGaz pipeline network, the company has no incentive to allow producers to make their own commercial arrangements. With strong historic political connections, it has also been able to guard the lucrative export market jealously.

However, despite its market dominance, QazaqGaz faces similar challenges with the domestic price of gas. It has only managed to remain solvent by cross-subsidising its export revenue to cover the losses on the domestic market.

The government announces reforms

The gas market is not the only market in Kazakhstan to suffer from the ill effects of price controls and state monopoly power. The absence of market reform has meant that the majority of the country’s commodity markets – including coal, gasoline, and agricultural products – suffer from chronic under-investment.

Since coming to power in 2019, president Kassym-Jomart Tokayev has sought to address these structural challenges by introducing a programme of supply-oriented reforms. In the gas market, this has meant delivering on a longstanding plan for staged price liberalisation. 

The government has set out a plan to liberalise natural gas prices by 2025. It has also put in place measures to allow producers to negotiate a more commercially viable offtake price with QazaqGaz. From next year, it will also introduce a more relaxed fiscal regime. Investors have, on the whole, welcomed these plans, and some have started to take a second look at the potential for the gas market in Kazakhstan.

Enter politics

While well-intentioned, these plans have not survived first contact with the Kazakh population intact. The programme of liberalisation of consumer gas prices began this year with the liquid petroleum gas (LPG) market, a fuel used largely in the southwestern Mangystau region to power auto transport.

Having put off the decision due to the coronavirus crisis, the government bit the bullet on January 1, 2022 and liberalised LPG prices. The reaction was immediate. In Mangystau, prices doubled overnight, causing protestors to pour out onto the streets.

Within days, protests had erupted across the country, including in Almaty – Kazakhstan’s largest city. What began as a demonstration against LPG price hikes quickly transformed into a nationwide anti-government movement. After years of poor socio-economic development, slow growth, and rising inflation, the LPG hike was the spark that lit a fire that nearly overthrew the entire government.

Amid the chaos, President Tokayev brought in the army and issued a ‘shoot to kill’ order, resulting in the deaths of at least 238 people, according to the Kazakh government’s own figures.

Gas policy in Kazakhstan at a crossroads

Since restoring order, Tokayev has turned his attention to political and economic reforms designed to satisfy the population’s demands for change. This has been a period of highly reactive and – at times – contradictory policymaking.

In terms of gas policy, the government remains ostensibly committed to price liberalisation. It has also set out measures to allow for the consumer price cap to be increased more regularly and extended its tiered pricing system. This will allow QazaqGaz to charge more to industrial consumers as well as Kazakhstan’s growing crypto mining sector while protecting the most vulnerable household consumers.

While gas producers will welcome these statements, they will also note the reality on the ground. In practice, the government has restored price controls on LPG and has not clarified the timetable for the phased liberalisation of natural gas prices. It is not likely to increase prices until it sees an improvement in living standards.

While ostensibly a step towards price liberalisation, the creation of extra price categories maintains the policy of shielding the country’s largest consumer base. Though politically prudent, it only puts off a decision that will have to be implemented in the long term.

The government has also done little to remove the monopoly power of QazaqGaz. While the government is planning to give producers the ability to independently negotiate offtake prices with QazaqGaz, there is little incentive for the state monopoly to offer concessions to these producers.

Moreover, the company is getting directly involved in gas production with the opening of a new exploration and production subsidiary, announced on November 3. This will see investors compete alongside a state monopoly for access to gas-producing assets. 

In another decision that is likely to weaken the investment climate, the government has announced that it will begin curtailing gas exports by 2023 – a knee-jerk reaction to fears of gas shortages and further popular unrest. The fear of shortages is such that Tokayev, in July, unilaterally called for the Tengiz project to supply an extra 2bn m3/year of gas.

This decision to curtail exports marks a missed opportunity by the Kazakh government. It could have encouraged investment by offering producers quotas for gas exports in exchange for supplying the domestic market. If carefully managed, such a method could have seen domestic needs served while allowing producers to generate profits on the export market.

Finding a middle path to gas reform

There are no easy solutions to Kazakhstan’s gas dilemma. Tokayev has demonstrated a consistent desire to see market reform in the gas sector. However, in the face of overwhelming social pressure, the government has largely reverted to its existing policy of controlling prices.

The president will go to the polls on November 20 in a presidential election that will mark the final act of a year of turmoil in Kazakhstan. A shoo-in for a second term, Tokayev is likely to appoint a cabinet in his image and could begin to move away from the reactive approach of this year as the events of January 2022 draw further in the distance.

While Kazakhstan’s socio-economic problems will remain front and centre for the foreseeable future – particularly as the current global economic turmoil rolls on – the Tokayev administration may yet navigate a middle ground that allows it to conduct real market reform in the gas sector while not incurring the wrath of a beleaguered population that is extremely sensitive to price rises.


 

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PRISM Political Risk Management was established to help investors in emerging and frontier markets to assess the political, operational and economic risks which they face, through the provision of high quality independent analysis and strategic advice.