Legal Aspects of International Cooperation in Petroleum Projects. PSA 1 Pros and Cons

1. Legal Aspects of International Cooperation in Petroleum Projects. PSA1 Pros and Cons Zhumageldy Yelyubayev Chevron EBU Managing Counsel KPLA President June 22-24, 2011, Almaty

2. International Legal DocumentsRelating to the Obligations of Kazakhstan in the Sphere of Subsoil Use • The European Energy Charter of December 17, 1991; • The Energy Charter Treaty of December 17, 1994; • The Mining Charter of the CIS Member States of March 27, 1997; • The Agreement on Cooperation in the Prospecting for and Exploration and Exploitation of Mineral Resources of March 27, 1997; • The Agreement between the Republic of Kazakhstan and the Russian Federation on the Delimitation of the Seabed of the Northern Part of the Caspian Sea for the Purpose of Compliance with Sovereign Rights to the Exploitation of Minerals of July 6, 1998; • The Agreement on Cross-Border Cooperation in the Sphere of Subsoil Exploration, Development and Protection of May 31, 2001; • The Agreement between the Republic of Kazakhstan, the Azerbaijan Republic and the Russian Federationon the Point of Junction of the Delineation Lines of the Contiguous Areas of the Caspian Seabed of May 14, 2003; • The Agreement for Cooperation in Peaceful Uses of Nuclear Energy between the European Atomic Energy Community and the Government of the Republic of Kazakhstan of December 5, 2006.

3. General Principles of International Legal Documents • Step-by-step approximation of laws and other normative acts regulating subsoil use relations; • Establishing new systems of environmental monitoring of the geological environment of cross-border regions; • Developing a concurred policy in the sphere of standardization and certification of mineral resources and their products.

4. Obligations of Kazakhstan under the Energy Charter Treaty • To ensure within its jurisdiction it has and enforces such laws as are necessary and appropriate to address unilateral and concerted anti-competitive conduct in “Economic Activity in the Energy Sector” (Clause 2 of Article 6); • To take the necessary measures to facilitate “the Transit of Energy Materials and Products” consistent with the principle of freedom of transit and “without distinction as to the origin , destination or ownership of such Energy Materials and Products or discrimination as to pricing on the basis of such distinctions, and without imposing any unreasonable delays, restrictions or charges” (Clause 1 of Article 7); • To acknowledge the importance of open capital markets in encouraging the flow of capital to finance trade in “Energy Materials and Products” and for the making of and assisting with regard to “Investments in Economic Activity in the Energy Sector in the Areas of Contracting Parties (Clause 1 of Article 9); • To promote conditions for access to its capital market by companies and nationals of “Contracting Parties”, for the purpose of financing trade in Energy Materials and Products and for the purpose of “Investment in Economic Activity in the Energy Sector” on a basis no less favorable than that which it accords in like circumstances to its own companies and nationals (Clause 1 of Article 9);

5. Obligations of Kazakhstan under the Energy Charter Treaty(continued) • To examine in good faith requests by Investors with regard to “key personnel” to enter and remain in the territory of the country “to engage in activities connected with the making or the development, management, maintenance, use, enjoyment or disposal of relevant Investments, including the provision of advice or key technical services” (Clause 1 of Article 11); • To permit Investors of another “Contracting Company” to employ any “key person” of the Investor’s choice, regardless of nationality and citizenship provided that such key person has been permitted to enter, and work in the territory of the country (Clause 2 of Article 11); • To undertake to facilitate access to energy resources, inter alia, by allocating in a non-discriminatory manner on the basis of published criteria authorizations, licenses, concessions and contracts to prospect, and explore for or to exploit or extract energy resources (Clause 4 of Article 18); • To be fully responsible for the observance of all provisions of the Treaty and to ensure such observance by regional and local governments and authorities within its Area (Clause 1 of Article 23); • To provide to the Secretariat (a special working body governing the affairs of the Parties to the Energy Charter Treaty) “a list of all tariff rates and other charges levied on Energy Materials and Products at the time of importation or exportation”, notifying the level of such rates and charges and any changes to such rates and charges (Clause 2 of Article 29).

6. Key Provisions of the Mining Charter Adopted on March 27, 1997 by the CIS States • Step-by-step approximation and harmonization of legislative and other regulatory acts in the sphere of prospecting for and exploration, exploitation and protection of subsoil; • Improvement of the legal basis for economic cooperation in the conditions of establishment of market relations; • Conducting on a mutually accepted basis geological exploration of subsoil and mineral restoration, provision for efficient production, transportation and exploitation of minerals and products subject to simultaneous improvement of safety and mitigation of environmental pollution issues; • Design and proposal of new mechanisms of efficient cooperation of public control and administration authorities and economic entities.

7. Obligations of the Energy Charter Member States • Restoration of cooperative relations between the business entities of the Parties; • Ensuring access to and exploration and development of subsoil in accordance with the national legislations of the Parties; • Design and implementation of joint programs in the sphere of geological study of subsoil, and restoration and qualitative improvement of mineral and raw materials base; • Harmonization of mining facilities development and location; • Measures for developing of the infrastructure of mining facilities; • Facilitation of access to transportation infrastructures for the purpose of international transit of flows of mineral resources and their products;

8. Obligations of the Energy Charter Member States (continued) • Facilitation of access on commercial conditions to new technologies used in the sphere of exploration, production, processing and exploitation of mineral resources; • Setting up conditions for rational and complex utilization of reserves of mineral deposits; • Assistance in measures aimed at design and implementation of resource saving technologies and productions; • Assistance in the attraction of investments into mining facilities of the Parties; • coordination of measures for improvement and approval of regulatory methodological documents regulating geological exploration, classification of mineral reserves and other geological information; etc.

9. Other International legal Acts • The Agreement between the Republic of Kazakhstan and the Russian Federation on the Delineation of the Seabed of the Northern Part of the Caspian Sea for the Purpose of Compliance with Sovereign Rights to the Exploitation of Minerals dated July 6, 1998, and the Protocol to the said Agreement dated July 6, 1998 ratified by the RoK Law dated November 14, 2002 No. 356; • The Agreement between the Republic of Kazakhstan and the Azerbaijan Republic on the Delineation of the Seabed of the Caspian Sea dated November 29, 2001 and also the Protocol to the said Agreement dated February 27, 2003 ratified by the RoK Law dated July 2, 2003No. 457; • The Agreement between the Republic of Kazakhstan, the Azerbaijan Republic and the Russian Federation on the Point of Junction of the Delineation Lines of the Contiguous Areas of the Caspian Seabed dated May 14, 2003 ratified by the RoK Law dated December 4, 2003No. 501.

10. Tasks to Be Implemented by the State in the Sphere of Subsoil Use and International Cooperation • Strengthening of the role of the state in the mineral resources sector: • The state acting through its establishments (national companies, national holdings etc.) needs to have a blocking share holding and interest in legal entities developing strategic mineral deposits; it is very important from the standpoint of ensuring national security; • The state needs to develop and encourage competitive, high-tech and knowledge-intensive industries to ensure sustainable economic growth; • The state needs to preserve a favorable investment climate to attract foreign investments; • The state should establish and develop the capital market for the formation of new institutional investors; • The state should strengthen the role of national companies as profitable businesses, but not as the competent government authority

11. Measures to Improve Investment Climate and Efficiency of International Cooperation • Ensuring a high level of legislation development and stability; • Ensuring the predictability of the state policy and succession of investment decisions; • Establishing efficient, fair and uniform law enforcement practice, prompt enforcement of court judgments and arbitral awards on investment and subsoil use disputes; • Improvement of the investment legislation to ensure distinct, transparent and unambiguous legal institutions and rules meeting international standards; • Legislative and actual guarantees of protection foreign capital investments, legal rights and interests of investors; • Exclusion of unpopular administrative sanctions with regard to unilateral waiver or termination of a contract.

12. Production Sharing Agreement • The basis for any PSA is the sharing of production (useful mineral) between the contractor and the state, the owner of subsoil. • The essence of a subsoil use contract is the sharing of production.

13. Sharing of Production under PSA (example) • The contractor is entitled only to 80% of all “Profit Petroleum” through the Contract Period in which “Payback” is achieved. • The contractor is entitled to Not less than 20% nor more than 80% of total “Profit Petroleum” for each Contract Period from the Contract Period after the Contract Period in which “Payback” is achieved through the Contract Period in which the Contractor’s IRR (the annual IIR expressed as percentage and calculated under the formula contained in the PSA) exceeds 20%; • The contractor is entitled only to 10% of all “Profit Petroleum” for form and after the Contract Period in which the Contractor’s IRR first exceeds 20%, provided that should thereafter Contractor’s IRR becomes less than 20%, the provisions of the clause above shall reapply.

14. Key Aspects to Note by the State in the Sharing of Production under PSA • Adequate interpretation of the term “profit petroleum”, meaning “net product”, after reimbursement to Contractor costs related to subsoil use operations (“recoverable costs” under the PSA include capital and operating costs; exploration and appraisal costs. • The competent government authorities need to monitor the “project pay-off” process where the project capital investments return to the investor, and therefore control over the contractor’s “capital costs” is required to exclude overestimation of the cost of work performed and services obtained. • Conclusion: • If proper control over the contractor’s “recoverable costs” and “project payoff” process is maintained, it is possible to achieve 80% distribution of “profit petroleum” under PSA in the profit of state.

15. Proposals for Improving the Efficiency of State Regulation in the Sphere of Subsoil Use • To significantly reduce the duplicating of functions and overlapping of the powers of government authorities with regard to common subjects in their jurisdiction; • To minimize control and supervision costs; • To remove departmental barriers and the struggle for the spheres of influence in this branch of economy; • To avoid significant distraction of business entities (subsoil users) during audits and, ultimately, to increase control efficiency, which is a key condition of the sustainable development of the economy of Kazakhstan, its economic independence and security, creation of reliable mechanisms for regulating subsoil use relations; • To form the Republic Stock of Reserve Deposits.

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