It is a well-known fact that the motor fuel prices in Kazakhstan are lower than those in the neighboring Russia even though, during the past year, they had been constantly rising. It is no secret why. If, previously, the Kazakhstan state tightly controlled the retail motor fuel prices, then now it has let them float freely.

The state was controlling the retail prices in order to, first, contain the inflation and, second, not to ignite the negative sentiments among the millions of car owners. However, when the deficit of certain gasoline grades and the diesel fuel hit and KazMunayGaz NC, the main player in this field, was unable to solve the problem, Akorda was forced to let the retail prices float freely. 

In the Base Prospect of the the U.S.$10,500,000,000 Global Medium Term Note Programme published on April 5, 2017 by JSC NC KazMunayGaz (a joint-stock company incorporated in the Republic of Kazakhstan) and KazMunaiGaz Finance Sub B.V. (a limited liability company incorporated in the Netherlands unconditionally and irrevocably guaranteed by the JSC NC KazMunayGaz), the problem is described as follows (text in bold by Kazakhstan 2.0).

“The prices of crude oil and refined oil products internationally and in Kazakhstan have a significant impact on the Company’s results of operations”.

“The dynamics of refined oil product prices in the international and Kazakhstan markets are determined by a number of factors, the most important being the price of crude oil internationally, supply and demand for refined oil products, competition, distances separating markets from the refineries where the crude oil is refined into useable end or intermediate products and seasonal deficits in the supply of refined oil products, particularly in urban areas, due to agricultural activities and the associated reallocation of refined oil products supplies from cities to agricultural areas. Additionally, a disparity between high crude oil costs and lower prices of refined oil products may have an adverse impact on the financial results of the Company’s refining segment.

The mix of export and domestic sales of crude oil has also affected, and is expected to continue to affect, the Company’s results of operations. Historically, sales prices for exported crude oil have been significantly higher than domestic sales prices, primarily as a result of recommendations and mandates of the Government, being the Company’s sole, indirect shareholder, to sell domestic oil at below market rates. From time-to-time, the Government may issue such recommendations or mandates to prevent domestic price increases, particularly when there is not enough supply due to high demand, causing domestic prices to increase. The Company expects export sales prices to continue to remain at a higher level compared to domestic sales prices, and thus seeks to maximise the percentage of its total crude oil sales that are export sales, although it is not unilaterally able to do so. Should the percentage of export sales increase, this may have a positive effect on the results of operations of the Company, while, correspondingly, if the percentage of mandated domestic sales increases, the Company’s results of operations could be adversely affected”.

The Company’s income from refined oil products in Kazakhstan is affected by price regulation and the availability of domestic crude oil for refining. From time-to-time, the Government has, in the past, imposed temporary bans on the export of light distillates and products, carbon oil, gas oils and other petroleum derivatives, including in July 2014 and June 2015, which have prevented the Company from taking advantage of higher prices for the exports of its refined products from Kazakhstan. Although no such ban is currently in force, there can be no assurance as to whether further bans will be introduced or other measures will be taken that could restrict the Company’s ability to take advantage of such transactions”.

“In 2013, the refineries owned by the Company in Kazakhstan experienced a shortage of domestic crude oil to produce refined oil products, as a result of which these refineries were forced to import crude oil for refining at a higher cost to the domestic volumes historically provided by the Company’s subsidiaries. This had a negative impact on the financial results of the Company’s refining operations. Since 2014 and to date in 2017, the Company’s refineries have received sufficient supplies of crude oil to meet their budgeted production; however, there is no assurance that the Company’s refineries will not again suffer from shortages in domestic crude oil supplies in the future”.

“KMG RM, as the owner of the Atyrau Refinery, is required by the S-K Rules to make an annual tender for the supply of crude oil to be processed by the Atyrau Refinery. Pursuant to the Relationship Agreement, KMG EP undertook to participate in the annual crude oil procurement tenders until April 2016.

KMG EP and the Company agreed that such participation by KMG EP would be on the following terms:

• For the years 2006 to 2010, as stipulated in the Relationship Agreement, KMG EP was obligated to sell up to 1.9 million tonnes of crude oil per year, if so requested by Atyrau Refinery. For 2011 to 2015, the amount which KMG EP is obligated to provide under the Relationship Agreement is determined on an annual basis; and
• the price of any crude oil supplied by KMG EP shall be equal to the cost of such crude oil plus a margin of 3%, where cost is calculated as the production cost of one tonne of crude oil for KMG EP plus the transportation cost incurred by KMG EP, where:

(i) the production cost of one tonne of crude oil is the ratio of (A) the total crude oil production costs and all administrative and non-production costs (including general administration costs) under the procurement tender plan for the relevant calendar year to (B) the total volume of crude oil production at all production branches of KMG EP under the procurement tender plan for the relevant calendar year; and

(ii) the transportation cost of one tonne of crude oil is the ratio of (A) the total costs of crude oil transportation from all the branches of KMG EP to the Atyrau Refinery under the procurement tender plan for the relevant calendar year to (B) the total volume of crude oil supplies to the Atyrau Refinery from all production branches of KMG EP under the procurement tender plan for the relevant calendar year.

KMG EP has not participated in any procurement tenders since April 2016. Prior to April 2016, KMG EP sold a portion of the crude oil it produced to KMG RM in order to meet its domestic supply obligation. KMG RM further processed this crude oil and sold refined products. With effect from April 2016, KMG EP has instead provided volumes of crude oil for processing at the Atyrau Refinery and Pavlodar Refinery (and paid the corresponding processing fee) and then sold refined oil products for its own account, using KMG RM as a sales agent. On 1 January 2017, KMG EP ceased using KMG RM as its sales agent and has started marketing refined products for its own account”.

The Base Prospect also presents the figures that show the magnitude of the company’s losses which, in 2016, made Akorda abandon regulating the retail prices for gasoline and diesel fuel.

So, if, in 2015, KMG Exploration Production sold 2680 thousand tonnes of crude oil to KMG Refining and Marketing (with the average export crude oil price of 78434 tenge), then, in 2016, it was already only 830 thousand tonnes (with the average export crude oil price of 103659 tenge).

Further, the Base Prospect states the following.

“…From April 2016, KMG EP has instead provided volumes of crude oil for processing at the Atyrau Refinery and Pavlodar Refinery (and paid the corresponding processing fee) and then sold refined oil products for its own account, using KMG RM as a sales agent. On 1 January 2017, KMG EP ceased using KMG RM as its sales agent and has started marketing refined products for its own account”.

Thus, the 2016-2017 motor fuel deficit was the result of, primarily, these three factors:

• first, the undervaluation of the retail prices in Kazakhstan compared to the prices in the neighboring countries;
• second, the deficit of the own-produced motor fuel and the inability satisfy the domestic demand;
• third, the impossibility to increase the gasoline and diesel fuel import from Russia and the other neighboring states due to the indubitable unprofitability of such transactions.

The problem was solved in two steps. First, via the one-time shipment of the fuel on the state order with putting the losses in the books of the quasi-governmental agencies. Second, via abandoning the retail price growth containment. However, having solved the current problem, the state was forced to create a situation in which the Kazakhstan market is now heavily dependent on the deliveries from Russia. Meanwhile, Russia is already talking about the inevitable retail price growth due to the jump of the producers’ prices.