Abstract
Formerly centrally planned countries may be especially vulnerable to institutional degradation and revenue volatility as sources of a resource curse. This paper examines these issues through case studies of six former Soviet republics and Mongolia, focussing on the methods of involving foreign partners in exploration and exploitation of natural resources. Kazakhstan in the 1990s was a prime example of rent-seeking institutional degradation, but an exceptionally positive conjuncture in the 2000s triggered institutional and policy evolution, while Uzbekistan had less resource-rent-driven institutional degradation in the 1990s, but stagnated in the 2000s. Turkmenistan and Mongolia highlight the missed opportunities from not involving foreign partners, while Azerbaijan and the Kyrgyz Republic illustrate the less predictable outcomes following quick deals with foreign investors. Institutions matter, but the case studies suggest more complex relationships than revealed by simple correlations between indicators of institutional quality or of ownership patterns.
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Notes
The theme is old, but the modern resource curse literature was stimulated by Sachs and Warner (1995). In the 1980s and 1990s the focus was on Dutch Disease effects, but more recent contributions emphasize volatility or institutions. Volatility issues are emphasized in Gelb (1988), and by Eifert et al. (2002) and Papyrakis and Gerlagh (2004). Tornell and Lane (1999) model the perverse impact of rent-seeking after a resource windfall. Tsalik (2003), Sala-i-Martin and Subramanian (2003) and Bulte et al. (2005) highlight the deleterious impact of poor institutional quality. Mehlum et al. (2006) find that resource abundance is a boon with good (producer-friendly) institutions and a curse with bad (rent-grabber-friendly) institutions, while Boschini et al. (2007) emphasize the interaction between the appropriability of resources and quality of institutions.
Esanov et al. (2001) argued that resource abundance was particularly harmful in the Soviet successor states because it allowed reform to be postponed and encouraged rent-seeking behaviour, but that paper was written before the booms of the 2000s. Brunnschweiler (2009) reaches the opposite conclusion, that among former Soviet and Eastern European countries in transition oil had a positive impact on growth between 1990 and 2006.
For more background on the five Central Asian countries’ economies see Pomfret (1995, 2006a). Tajikistan's high growth in the period 2000–2004 was recovery from the civil war, which caused massive output decline in the period 1992–1996; growth was slow in the period 1997–1999, as the government sought to assert control over the entire country. Note that national accounts data for the Central Asian countries should be treated with caution, especially for the 1990s, and that data for Turkmenistan are especially dubious.
Of the seven countries covered here, only Mongolia (in 1997) and the Kyrgyz Republic (in 1998) have joined the World Trade Organization (WTO). Uzbekistan (1994), Kazakhstan (1996), Azerbaijan (1997) and Tajikistan (2001) have applied for WTO membership, but all of the accession negotiations are currently stalled or moving very slowly. Turkmenistan is one of the few countries not to have or have applied for WTO membership.
The suspicion was based on concern about multinationals’ use of transfer-pricing to minimize the share of rents accruing to the host country and fear of the threat to sovereignty if the host tried to change the profit-sharing arrangement; evidence of the latter came from the overthrow of the Mossadegh government in Iran in 1953 and of the Allende government in Chile in 1973. Many developing countries sought to replace direct foreign investment (DFI) by loans in the 1970s, but after the 1982 debt crisis they came to appreciate the benefits of DFI in terms of risk-sharing and provision of complementary inputs. The economic success of China and other countries in the 1980s and 1990s further highlighted the potential benefits of DFI in providing technical, management and marketing expertise.
In 2009, approximately 200 cases were under arbitration, of which the biggest was the case in the Hague between foreign investors in Yukos and the Russian government. An example of controversy was the case won by a French investor in water in Ecuador whose assets were expropriated after price increases led to riots; the social implications of the firm's behaviour were not relevant to judgement on the legitimacy of the state's actions.
The PSAs signed by former Soviet states often followed World Bank advice and involved complex formulae based on output and profitability, such that if the project were successful the host country would eventually receive a larger share of revenues than under previous models. Critics argue that the host also bears most of the burden of delays and cost increases (Muttitt, 2010; Kennedy and Nurmakov, 2010, p. 5), although this cost is in foregone revenues rather than increased expenditures. The PSAs also gave significant contractual guarantees to the foreign companies, and have been criticized as neo-colonial (Muttitt, 2007, p. 20). These features reflected the increased acceptance of investors’ rights as well as specific concerns about instability in new independent states.
Many of the large producing nations in the Middle East nationalized oil production in the 1950s or early 1960s once the exploration and initial exploitation had been completed.
The most hard-line reaction came from Russia, which effectively scrapped PSAs in a 2003 amendment to the law governing PSAs, which would henceforth only be permissible if development of the resource under the licensing procedure defined in Russia's Subsoil Law could be proven to be implausible. At the same time the Russian government used various pressures to terminate existing PSAs. After cancellation of environmental permits for the largest project, Sakhalin-2, the foreign operators sold 50% of shares plus one share to Gazprom for $7.5 billion in 2006. Similar pressures were placed on Exxon, operator of Sakhalin-1.
Azerbaijan's crude oil production declined from just under 15 million tonnes in 1980 to 11 million in 1992 (IMF, 1993, p. 53). Kalyuzhnova (2008, pp. 77–78) provides an eyewitness account of the dilapidated state of some SOCAR facilities over a decade later.
Since the ceasefire Armenia has occupied both the disputed territory and 9% of Azerbaijan's territory lying between Nagorno-Karabakh and the Armenian border.
In January 2003, SOCAR's charter was revised by presidential decree so that the company retained ownership over oil it produces (previously it relinquished ownership once the oil went to be processed). SOCAR's payroll of 50,000–70,000 employees is considered bloated and the oilfields that SOCAR operates are generally high-cost due to depletion and aging equipment, but with increasing output of oil and gas and increasing energy prices, SOCAR's financial position strengthened after 2003 – as did the assets of the State Oil Fund.
The connection between SOCAR and government was not new. Ilham Aliyev had been Vice President of SOCAR since 1994, participating in the Deal of the Century negotiations. The oil card influenced the US decision in 2002 to lift economic sanctions on Azerbaijan (imposed soon after independence in response to the Azeri blockade of Armenia). Pressure in 2009 on Turley to ease up on its rapprochement with Armenia and on the EU not to support that rapprochement was explicitly linked to gas supplies.
CASE (2008, p. 121) contrasts this with Kazakhstan and Russia, which both saved over half of their 2003–2007 windfall in their oil funds. However, SOFAZ assets increased significantly in 2008 due partly to the oil price peak, but more to PSAs reaching the point where the operators had recouped up-front costs and a larger share of revenues accrued to the host country.
Foreign debt, which had been zero at independence, amounted to over 90% of GDP by 2008 and after the February 2009 devaluation of the tenge the debt/GDP ratio exceeded 100% (Barisitz and Lahnsteiner, 2010).
In contrast to Azerbaijan, whose main PSAs have been published, Kazakhstan's remain secret, although according to Muttitt (2010) the terms are known to all major oil producers.
However, the use of environmental regulations to push out PetroKazakhstan's Canadian owner was reminiscent of Russian policy in Sakhalin; after purchase of PetroKazakhstan, CNPC offered KMG a share in the company. The disposal of MangistauMunaiGaz (MMG) had echoes of the Yukos affair (see below). Karachaganak is the only major energy project in which KMG does not have a share; a government threat to halt production if increased export duties are not paid (putting pressure on the existing partners British Gas, Eni, Chevron and Lukoil to give a share to KMG) is currently under arbitration.
KMG's substantial 2006–2008 investments in Georgia were negatively affected by the August 2008 Russia–Georgia war. KMG has also invested in Romania, buying the country's second largest oil company, Rompetrol, for $3.6 billion in 2007.
In particular, legislation tightened the definition of which development costs are covered by PSAs. The government also introduced a rent tax on oil exports in 2004 and increased royalty payments on oil and gas in 2005. In 2009, royalties were replaced by a natural resources extraction tax as part of a major tax reform aimed at easing the burden on small- and medium-sized enterprises and on the non-extractive sector while increasing revenues from extractive industries (Kennedy and Nurmakov, 2010, p. 7).
Eni, the operator, announced that the costs of first-stage development had increased from $10 to $19 billion, and production would be delayed from 2008 to 2010, with peak output being reached in 2019 instead of 2016. The exceptionally large cost over-runs threatened to reduce Kazakhstan's state revenues by as much as $20 billion over the decade 2007–2017 (Kennedy and Nurmakov, 2010, pp. 5–6).
It was also reported that Eni and its partners would make an additional payment to Kazakhstan of $5 billion in compensation for lost revenue due to the delays. Meanwhile, adding to the pressure on the foreign companies, in September 2007 Kazakhstan's parliament passed a law giving the government the power to renegotiate contracts deemed a threat to national security, although political leaders made clear that they were not intending to nationalize resources (as had happened in Venezuela, Bolivia and Russia).
The MMG case was complicated by the involvement in MMG of the president's son-in-law, who was under investigation for criminal activities. Domjan and Stone (2010) liken the case to that of Yukos in Russia, where a previously powerful oligarch was displaced after falling out of political favour, but the MMG takeover was conducted by a more accepted legal process and did not result in a simple state takeover (although KMG's share of the deal was 51% and CNPC's 49%).
Kalyuzhnova (2010) argue that involving Samruk-Kazyna in bailing out large banks was primarily about gaining financial control in order to direct credit towards diversification of the productive sector, rather than to real estate as had happened before 2008.
The reduced output in 1997 and 1998 was due to Turkmenistan cutting supplies to Ukraine in a dispute over unpaid bills.
Investor confidence was not helped by contractual disputes with Bridas over a transAfghanistan pipeline; the Argentinean company's contract was terminated in favour of one with Unocal, but US support ended in 2007 when relations with the Taliban government deteriorated. Burren was purchased by Eni in November 2007.
The China deals improved Turkmenistan's bargaining position relative to Russia, as did the opening in January 2010 of a pipeline to Iran. Russia and Turkmenistan remained mired in a price dispute for most of 2009, but President Berdymukhammedov seemed unwilling to antagonize Russia by bringing in western oil firms; despite strong lobbying by western majors, contracts worth $9.7 billion to develop the South Yolotan gasfield were awarded in December 2009 to firms from China, South Korea and the United Arab Emirates.
Two onshore (Khazar and Nebitdag) and three offshore projects are being developed under PSAs (Kalyuzhnova and Nygaard, 2008, p. 1835), but it remains unclear how much progress has been made.
Eni purchased Burren Energy in late 2007, but this may have been primarily to acquire Burren's African interests. The Turkmen government was annoyed that it had not been involved in the negotiations and in 2008 refused to issue visas to Eni personnel. The bad blood reportedly also reflected information-sharing between Kazakhstan and Turkmenistan, with Kazakhstan warning that it was disappointed with Eni's performance as lead operator of Kashagan.
Tajikistan is the poorest of the former Soviet republics and independence was accompanied by a civil war, which was not settled until 1997. Even today the government's hold over parts of the country is tenuous.
Their support helped leverage private bank involvement in the project, which in 1995 included Chase Manhattan Corporation, Republic National Bank of New York, ABN AMRO-Bank of Canada, Bank of Nova Scotia, Chemical Bank, Royal Bank of Canada and Credit Lyonnais.
Mongolia lacks processing facilities, and insufficient Soviet funding led to delays with the first shipment until 1988 (Dorian, 1991, p. 47). By the late 1980s the Russian workforce numbered about 200, and between 700 and 1,300 Mongolians were in the town.
In 2008, the World Bank estimated an effective tax rate (ETR, the present value of all taxes, fees and other imposts paid by a mine to the state) of over 60%, higher than any other country, except Burkina Faso, and about equal with the ETR in Uzbekistan and Côte d’Ivoire (World Bank, The Mongolia Minerals Sector – Key Issues, unpublished paper).
The initial exploration rights were obtained by Magma Copper, a US company, which was acquired by BHP Billiton in 1996. BHP began exploration at Oyu Tolgoi in 1997 and undertook a second phase of drilling in 1998, but when these holes failed to return significant mineralization the project was suspended. In 1999 further exploration at Oyu Tolgoi by BHP was discontinued due to cutbacks in BHP's exploration budgets (and a drop in copper prices from $1.25 in 1995 to 65 cents in 1999), and Ivanhoe Mines bought the Oyu Tolgoi Concession in May 2000. The Magma acquisition that cost BHP over $4 billion by the time BHP wrote off the last of Magma's US assets in 2003 was one of the most disastrous takeovers in the mining history, but if BHP had persevered with Oyu Tolgoi it could have been a major success, illustrating the uncertainties and risks that allow even the biggest of mining companies to make major errors of judgement.
Nevertheless, in 2006 mining giant Rio Tinto took a 9% share in Ivanhoe, which was an indication of the seriousness and size of Oyu Tolgoi.
South Gobi's Ovoot Tolgoi coalmine is expected to produce 8 million tonnes a year by 2012, and located close to the Chinese border it has a ready market.
‘Genuine savings’, defined as the difference between total investment and total disinvestments in all types of capital, have been estimated for many countries by the World Bank. Positive genuine savings are often linked to long-run economic sustainability, but Asheim et al. (2003) have challenged this link to the Hartwick rule.
The Kyrgyz Republic, however, had a negative experience in the 2000s when the second-biggest gold mine project, Jerooy, was abandoned by Oxus, a British company, in frustration at the continuous corruption and intimidation; International Crisis Group (2008, p. 11) estimated that in the period 2006–2008 the country lost $88–$98 million per year in foregone revenues. Oxus's representative Sean Daley was shot at his home in Bishkek on 7 July 2006, and 2 weeks later the government announced that the licence had been transferred from Oxus to a little known Austrian-based company called Global Gold, which was believed to be in cahoots with the President's son Maksim Bakiyev (http://lenta.cjes.ru/?m=2&y=2007&lang=eng&nid=152). Residual claims by Oxus were settled in 2007. In November 2009, the Kyrgyz Republic Development Fund announced that the mine was for sale; a feasibility study had been concluded, but no gold had been produced.
Speed may also lead to mistakes in the choice of partner, as in the Kashagan debacle where Kazakhstan came to rue its choice of Eni as lead operator. It is unclear whether over-hastiness contributed to lack of due diligence in assessing Eni's technical merits or whether lack of transparency in negotiating PSAs camouflaged the full nature of negotiations.
Kalyuzhnova and Kaser (2006) and Kalyuzhnova (2006, 2008) provide assessments of the oil funds of Azerbaijan, Kazakhstan and Turkmenistan. Franke et al. (2009) argue that the Azeri and Kazakh oil funds are intended only to promote stability in order to ensure regime survival. See also the companion articles by Lücke and Seuring and by Nygaard and Kalyuzhnova.
Kazakhstan appears to have been more successful in this respect, at least before the 2007 financial crisis, whereas Azerbaijan saved little of the windfall revenues. Between 2003 and 2006 Azerbaijan's government borrowed abroad an amount equal to about 4% of the 2006 GDP, which made little financial sense when SOFAZ funds were being invested internationally to fetch 3%–4% in nominal dollar terms. By contrast, Kazakhstan was paying off external debts to reduce future obligations. Azerbaijan was using its oil windfall to finance public expenditure, including poverty alleviation through water and irrigation projects, but it was doing so in an inefficient, and to some extent non-transparent, way. Esanov (2009) finds diminishing efficiency of expenditures as spending on health, education and social policy increased. He also examines the spending patterns across regions, concluding that Kazakhstan, in contrast to Russia, was successful in avoiding increased regional inequality during the 2003–2007 resource boom.
Extractive Industries Transparency Initiative (EITI) commitments can provide a signal of transparency, although EITI endorsement does not reduce corruption if the government makes no implementation effort. Őlcer (2009) found that in the 6 years after the launching of the EITI in 2002, countries endorsing EITI principles experienced deteriorating standards, as measured by World Bank Governance Indicators or Transparency International's Corruption Perception Index, and performed worse than the global average on these indicators. Azerbaijan joined the EITI in 2002, became a pilot country in July 2004 and in February 2009 was the first country to be validated as EITI compliant, which sent a positive signal about transparency and accountability. Mongolia, which committed to implement EITI in December 2005 is currently rated ‘close to compliant’, whereas both Kazakhstan and the Kyrgyz Republic made earlier commitments but have failed to obtain validation (status obtained from the EITI website: http://eiti.org/, accessed 15 July 2010). The EITI only relates to how revenues are collected, but in April 2008 the World Bank proposed a new initiative (EITI++) focusing on the generation, management and distribution of revenues, rather than just on the relationship between companies and governments as in the original EITI.
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Pomfret, R. Exploiting Energy and Mineral Resources in Central Asia, Azerbaijan and Mongolia. Comp Econ Stud 53, 5–33 (2011). https://doi.org/10.1057/ces.2010.24
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DOI: https://doi.org/10.1057/ces.2010.24