Kazakhstan’s subsoil contract system, investment risks

By Wang Jihong and Chen Haobi, Zhong Lun Law Firm
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Kazakhstan is rich in mineral resources and mining is the backbone of its national economy – tapping more than 90 types of mineral deposits, 1,200 types of mineral raw materials and vast reserves of tungsten, chromium, uranium, copper, iron ore and oil ranked among top 10 in the world.

Subsoil use rights in Kazakhstan can be acquired by obtaining a a subsoil use licence or subsoil use contract, last updated in 2017 under the Code on Subsoil and Subsoil Use.

This article explains the subsoil use contract system and related legal risks as a reference for enterprises investing in mineral-rich Kazakhstan.

SCOPE OF APPLICATION

Pursuant to the code, subsoil use rights are proprietary and indivisible, subject to regulations on property ownership. The subsoil use contract system mainly applies to the exploration and production of strategic minerals, specifically the following three types of mining activities: (1) exploration for and production of hydrocarbons including oil, crude oil and native bitumen; (2) production of hydrocarbons; and (3) uranium production.

CONTRACTING ENTITIES

The parties to a subsoil use contract include the grantor, represented by Kazakhstan’s Ministry of Energy (MOE), and the grantee, either an individual, enterprise or multiple entities requiring clear specification of shares. In 2018, the MOE issued three versions of standard contract texts, in Kazakh and Russian, corresponding to the three above-mentioned types of mining activities.

ACQUISITION METHODS

Subsoil use contracts may be executed in the following three ways to acquire corresponding subsoil use rights:

Wang Jihong , Zhong Lun Law Firm, Kazakhstan’s subsoil contract system, investment risks
Wang Jihong
Partner
Zhong Lun Law Firm

Original acquisition. An individual or enterprise becomes the grantee of subsoil use rights after winning an auction organised by the MOE, or negotiating directly with the MOE and securing approval to execute a contract with it.

With respect to exploration and production of hydrocarbons, the auction system may be applied to determine the grantee. The MOE holds auctions pursuant to applications by individuals or enterprises and enters into a subsoil use contract with the winner.

The direct negotiation system applies to national companies, namely state-controlled joint stock limited companies established by the government. The system may be applied when a national company is to participate in exploration and (or) production of hydrocarbons; and only via direct negotiation where a national company is to participate in production of uranium. Depending on the outcome of direct negotiations, the MOE will decide whether or not to enter into a contract.

Acquisition by assignment. Namely, the assignment of subsoil use rights (or its shares) in accordance with transaction rules under Kazakhstani civil law. Under the subsoil use contract system, the transfer of subsoil use rights (or its shares) requires revision of the subsoil use contract. Once the buyer and seller arrive at an intention of transaction, the buyer submits an application to the MOE to amend the subsoil use contract – and the MOE ultimately decides whether or not to give approval.

Acquisition by succession. This method is only applicable where a legal entity is restructured. It refers to a situation where the post-restructuring legal entity succeeds to the subsoil use rights of the pre-restructuring legal entity. The acquisition of subsoil use rights by way of succession does not require approval of the competent authorities.

LEGAL RISKS

Chen Haobi, Zhong Lun Law Firm, Kazakhstan’s subsoil contract system, investment risks
Chen Haobi
Associate
Zhong Lun Law Firm

Equity share restriction on transferring uranium rights. Only the National Atomic Company Kazatomprom Joint Stock Company (Kazatomprom) has the right to produce uranium. But once Kazatomprom executes a contract with the MOE, it is free to transfer the acquired subsoil use rights to a third-party company.

Pursuant to the code, Kazatomprom may only transfer its uranium production rights to a company in which it directly or indirectly holds more than 50% of equity shares. If a non-state company wishes to participate in mining Kazakhstan’s uranium, it may do so by establishing a joint venture with Kazatomprom, which must control more than 50% of the shares.

Pre-eminent right of the state. The Kazakhstan state has a strong pre-emptive right over parcels of land classified as strategic subsoil plot, including the state’s priority for shared acquisition of the alienated subsoil use rights related to a strategic plot – as well as shares and other securities, namely those associated with subsoil rights to the strategic plot to be issued on the organised securities market.

Kazakhstan’s strategic subsoil includes plots with oil reserves of more than 50 million tonnes or natural gas reserves of more than 15 billion cubic metres – in the Kazakhstani region of the Caspian Sea – and subsoil plots with uranium deposits.

Pre-emptive government contract termination. The MOE may unilaterally decide to terminate a contract in advance if the subsoil use contract is deemed to be detrimental to the state’s interests, or if the grantee fails to comply with its obligations specified in the code or the contract.

For example, in February 2022, the government decided to terminate 148 solid resource contracts and 27 hydrocarbon contracts in advance due to unsatisfactory performance of the contractual obligations.

INVESTOR ADVICE

Before investing, a prospective investor in Kazakhstan’s subsoil sector should pay attention to selecting the appropriate method of acquiring subsoil use rights in accordance with local regulations for different types – and reasonably arrange its investment structure in advance, in accordance with relevant restriction requirements, such as equity percentage restriction.

It should also take into consideration the legal risks associated with the state’s pre-emptive right and early contract termination by the government.

After securing a subsoil use contract, investors should strictly comply with laws and the contract, and fully perform their obligations to avoid any early contract termination by the government.

Wang Jihong is a partner and Chen Haobi is an associate at Zhong Lun Law Firm

Zhong Lun Law Firm

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Beijing 100020, China

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Fax: +86 10 6568 1022

E-mail:

wangjihong@zhonglun.com

chenhaobi@zhonglun.com

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