12.01.2015

Legal framework of investing in power industry of Kazakhstan

The article is aimed to summarise the laws of Kazakhstan in view of the potential local and foreign investor

Current Legal and Regulatory Regime

There are currently eight large power plants 'of national importance' inKazakhstan: four thermal power plants and four hydro power plants. There are also a number of smaller regional power stations.

Power is transmitted through the transmission networks by the so-called 'transmission companies'. The transmission companies can be of two levels: the first is a system operator, which operates the national transmission network, and the second is a regional power company, which transmits power through the regional electric grids.

The Kazakhstan Electrical Grids Operating Company (KEGOC), the system operator, is the national transmission company, which owns and operates the national electric grid. It manages the electricity market and international electricity exchange system.

In Kazakhstan there are also 18 regional power companies in each region (administrative regions), large cities, and the capital city - Astana.

The system operator and regional electricity companies transmit electric power sold by power plants (the so-called 'power generating companies'), in accordance with the power purchase agreements concluded with consumers and/or power supplying companies. The relationships between the power generating companies on the one hand, and between the system operator and regional electric grid companies, on the other hand, are governed by separate agreements concluded between them.

Beside the above market players, there are about 124,000 'power supplying companies' in Kazakhstan engaged in the distribution of power among the country's end consumers.

The Kazakhstan Law 'On the Electric Power Industry', dated 9 July 2004, was amended in 2009 to attract power investments through a new tariff-setting system for electric power generation under which investors assume certain investment committments in return for a reasonable tariff (the "tariff for investments" mechanism).

The Law provides for a two-level system: at a lower level - the 'ceiling tariff' (when power producers may set their own tariffs up to the regulated maximum), and at an upper level - the 'estimated tariff' and 'individual tariff', which can exceed the ceiling tariff subject to the approval of the appropriate government agency. Special regulations were adopted for the ceiling, estimated and individual tariffs.

In accordance with the Law 'On the Electric Power Industry', a generating company may ad arbitrium set its tariff by virtue of a contract with a counterparty. Such a tariff shall in no way exceed the ceiling-regulated tariff set for sales by generating companies.

The ceiling tariff varies according to the group to which a given generating company belongs, and we can ascertain the ceiling tariff applicable to the end of 2015. However, starting from 2016 the current system of ceiling, investments and estimated tariffs will be abolished as a result of the formation of a 'capacity market', as described below.

For now, while Kazakhstan's capacity market is not yet functioning, if the investment commitments of a generating company cannot be discharged through sales based on the ceiling tariff, Kazakhstani law allows generating companies to seek and apply the estimated or individual tariff.

It should be noted that according to the Law 'On Electric Power Industry', the wholesale electricity market of Kazakhstan is divided into three types: (a) decentralised market, (b) balancing market, and (c) centralised market.

A decentralised market is meant for the purchase of electricity based on agreements freely made, but at prices not exceeding the ceiling tariffs.

A balancing market is for hourly financial and physical control over power imbalances on a single grid. Participation in the balancing market is obligatory for all participants in the wholesale electricity market.

A centralised market is an electricity market governed by a special purpose company to ensure communication between buyers and sellers. Sales in the centralised market are also divided into three types: (a) short-term sales (outright sales), (b) medium-term sales (week, month), and (c) long-term sales (quarter, year).

 

Possible Project Implementation Options

Concession Agreement

From the legal perspective, one option for implementing a project for financing and construction of a power plant in Kazakhstan (hereinafter - the 'Project') is the 'concession' defined as: "activities aimed at the creation (reconstruction) and operation of concession objects and performed at the expense of the concessionaire or with co-finance by grantor" (Article 1.6 of the Concession Law).

Concession benefits are the following:

ü   an adjusted and clear legal framework as well as definite, though not clearly positive, experience in applying a concession agreement.

ü   state concession liabilities are protected against sequestering.

ü   concessionaires, who are subjects of a 'natural monopoly', may enjoy special tariffs (which can be determined according to the calculation formulas specified in concession agreements) and will be exempted from the general tariff regulation of natural monopolies (i.e., a concessionaire will be better protected against the risk of default on its obligations to repay credit debt as a result of insufficient income from the Project due to, for example, inadequate tariffs for thermal energy).

ü   a concessionaire may rely not only on the sale of goods produced as a source of compensation for its costs and income, but also on (i) government subsidies in cases established by the laws of Kazakhstan and (ii) a fee for availability (availability payment) of a concession object, which includes payments from the national budget to compensate for the investment and the concessionaire's operating costs.

ü   the possibility of one or more of the following forms of government support:

1)       government guarantees on infrastructure bonds within concession agreements;

2)       government guarantees on loans raised to finance concession projects;

3)       transfer of exclusive rights to a government-owned IP object to a concessionaire;

4)       in-kind grants in accordance with the Kazakhstani law;

5)       co-financing of concession projects;

6)       guarantees of government consumption of a certain volume of goods (works, services), when a principal consumer of goods (works, services) produced by a concessionaire is the state.

However, the concession mechanism has significant disadvantages and risks, including, as stated in Article 14.2 of the Concession Law, when a concession object not transferable to state ownership (not Built-Transfer-Operate) is created, government support measures provided for in subparagraphs 1), 2) and 5) above shall not be granted to a concessionaire.

Moreover, a guarantee of state consumption of a certain volume of goods as a measure of government support is declarative in nature, because, first, it is not clear when the principle consumer of goods is the state and, second, the implementation mechanism of government support is specified.

A mechanism for making an availability payment for a concession object has not yet been defined. Moreover, the availability payment cannot apply for the purposes of the Project in the area of power since, according to Article 7.3 of the Concession Law, the availability payment can only apply to concession projects categorized as socially significant projects. These projects are initially sunk objects on construction and operation of motorways, water pipe lines, buildings of schools, pre-schools, hospitals, clinics, but not power stations.

Please note that if either a company that will act as a concessionaire for the Project or a potential concessionaire is a new legal entity created for Project purposes, the Consortium (founders) must meet certain qualifications:

1)         possess sufficient funds and resources to perform obligations under the concession agreement;

2)         be solvent, not under liquidation, possessing property free from seizure, and not be engaged in activity suspended under Kazakhstani legislation;

3)        not be subject to a court ruling for failure to perform obligations under a concession agreement concluded in the last three years;

4)         have equity capital of at least 10% of the cost of the creation (reconstruction) of a concession object. This means equity, money and other assets belonging to a potential concessionaire directly involved in the concession project.

Concession is also less attractive in terms of project financing because a concession object (i.e., the power plant itself) cannot be a pledged subject during the validity period (Article 5.5 of the Concession Law).

In general, excessive regulation of concession relations and conditions of concession agreements reduce flexibility of the parties in determining Project conditions, which are  important for the successful structuring of 'bankable project'.

The process of granting concessions in Kazakhstan is quite bureaucratic and time-consuming.  In practice it will take at least a year.

Finally, for many investors the main weakness of a concession is the need to participate in a concession tender and the risk of not winning the Project despite the time and resources required to prepare the tender.

 

Agreement for Construction of Generating Plants

Beginning in 2016 a preferred alternative to a Project concession agreement will be an 'agreement for construction of generating plants' with the Ministry of Investment and Development based on a new 'Capacities Market' model.  Up to the end of 2015, according to information published by the Government, ceiling tariffs will be used in Kazakhstan (as described above), while from 2016 the 'capacities market' model will be used (i.e. the energy market and capacities market will operate in parallel).

It is expected that Kazakhstan's capacities market will consist of two segments: a market of long-term contracts (for new power-producing organisations) and of short-term contracts (for existing producers).

New power plants will have a guaranteed return on investment (i.e. guaranteed capacity sale), because the system operator (KEGOK) undertakes to procure certified capacity volumes (i.e. the equivalent of the availability payment) from these plants on a priority basis at prices specified by the tender, while existing plants will operate at market rates  without benefits and with ceiling tariffs. It is assumed that most investment will be worked out by the investor through the capacity payment, which will be fully redeemed by KEGOK.  This will be approximately 80% of cash flow, with the remaining 20% received by a generating company from the sale of electricity on the free market (i.e. with no guarantee of electricity sales).

In particular, the effective legislative regulation obliges KEGOK to annually develop the forecast balance of electricity and capacity for the next seven-year period each year by 15 October and to publish it in the media.

Based on the KEGOK forecasts, the Ministry of Energy will annually determine an anticipated deficit of electric power, as well as develop and approve a promising layout of electrical capacities.  This information will be provided on the Ministry's website. Moreover, to meet the forecast deficit of electric power, the Ministry of Energy must hold tenders for the construction of newly-commissioned generating plants.

The Ministry of Energy signs the agreements for construction of newly-commissioned generating plants with the tender winner, fixing the commissioning date of the generating plants and the tender-winner's liability for failure to perform or improper performance of the terms of the agreement.

Within thirty calendar days after the signing of the above agreement, KEGOK signs the agreement with the tender-winner to purchase services to maintain the electrical capacity of the newly-commissioned generating plants at a price, volume and on the terms specified by the appropriate government agency.

It should be noted that if KEGOC defaults under the service agreement on the terms for maintaining electrical capacity due to financial difficulties, it is expected that the Government will provide financial assistance to KEGOK from the national budget (i.e. an indirect government guarantee for the obligations of a single capacity buyer). Unfortunately, this legal provision is not entirely clear, so how this indirect state guarantee would work in practice remains in question.

In general, however, the capacities market will make it possible to structure the investment for  attractive projects (bankable projects) in the electric power industry. A potential investor may  accordingly consult (even now, in 2014) the Ministry of Energy and KEGOK on the terms for the next tender and participation options with the goal of implementing the Project.

 

Shaimerden Chikanayev, Partner

GRATA Law Firm

 

Article was published in Investor's Voice (December 2014)

See article here

Shaimerden Chikanayev

Partner, Director of Banking & Finance Department