No. 3, 2004

Stanislav Roginsky ,
Cand. Sc. (Economy)


Russia and Uzbekistan step up their cooperation in oil and gas production

During the last decade Uzbekistan has been actively trying to increase its role in the regional energy dialogue, counting on the assistance of Russian companies in this matter. At present energy majors LUKOIL and Gazprom are getting ready to take part in modernizing the gas-transporting system and developing gas fields in Uzbekistan.

At a difficult stage

In the 1990s Uzbekistan, like nearly all the other former Soviet republics, lived through an economic crisis. In 2003, the per capita GDP in that once the richest of the Central Asian republics was, according to the estimates of the World Bank, merely $314. Its industrial sector accounted for about 15% of the country's GDP, while employment in its industry was approximately 1.2 mln. people, or 13% of the able-bodied population. The transition to a market economic system has greatly influenced the activities of companies from the viewpoint of corporative administration, financial performance, access to the credit facilities, debt payments, and the structural and managerial media. The majority of small and medium-size business enterprises have turned into various joint-stock companies. Nevertheless, the degree of restructuring in Uzbekistan varies with different sectors, and the largest industrial enterprises, established back during the Soviet time, are still held by the state. No well-planned strategy of transition to the market system has been elaborated and no efforts have been taken to create a favorable investment climate, which, together with a considerable manpower drain owing to a policy aimed at "promoting national personnel", did not serve to strengthen the economy of Uzbekistan.

Also, the unfavorable foreign-economic situation of the second half of the 1990s created additional difficulties. The Asian and then the Russian economic crises were largely responsible for the diminishing volumes of the republic's foreign trade.

The economic difficulties of the transitional period were accompanied by serious political problems within the Republic of Uzbekistan, threatening the integrity of the state.

By the mid-1990s, a radical Islamic opposition to the ruling regime made its appearance in Uzbekistan. Its main motive force is the so-called Islamic Movement of Uzbekistan. The opposition relied on the support of the Afghan Talibs and made use of the objective economic difficulties experienced by the Republic and the political mistakes of Uzbekistan's ruling elite in order to attract the public to its side.

The tragic events of September 2001 in New York made Uzbekistan one of the strong points of the United States in its struggle against the Talib regime, and one of the members of the anti-terrorist coalition. An American military base appeared in the town of Khanabad, and the United States began increasing its economic aid to the republic, allocating in 2003, for instance, $86.1 mln., of which $30 mln. was channeled into strengthening law enforcement bodies, and $18 mln. - into the development of economic and social reforms.

With the external enemy having been routed by the Americans, the Uzbek President Islam Karimov concentrated his efforts on solving the problem of raising the efficiency of the national economy through improving the investment climate in the Republic, attracting foreign capital and creating better conditions for the development of private enterprise. National oil and gas industry was named as one of the first sectors where the country's modernized economic policy was applied.

Overcoming the crisis consequences

The development of Uzbekistan's oil and gas industry began in the mid-1950s with the discovery of the Gazli gas field, the largest at the time, whose proved reserves exceeded 500 bln. m3. By the time the USSR disintegrated, the proved reserves of oil in the Republic were estimated at 40 mln. tons, and of natural gas - 1,820 bln. m3.

Due to significant Soviet heritage Uzbekistan's oil and gas complex was able to set a kind of record in the development under adverse economic conditions. Uzbekistan is the only former Soviet republic which, despite the difficulties of the last decade of the 20th century, has managed to attain an increase in the production of hydrocarbons. According to Uzbekneftegaz, in the period between 1991 and 2003 the production of oil went up from 2.8 mln. tons to 7.4 mln., and of natural gas - from 40 bln. to 57 bln m3 .

In the 1990s, Uzbekistan was among the world's ten biggest producers of natural gas. However, gas production was accompanied by a decrease in exploration costs, which, quite naturally, negatively affected the industry's resource base. As a result, in the 1990s the replenishment of the resource base of the gas industry alone was slightly over 50%. In 2003, experts estimated the proved reserves of gas in Uzbekistan at 1,620 bln. m3. As to oil, things were somewhat better: in the mid-1990s, the volume of proved oil reserves was doubled, reaching in 1996 the figure of 80 mln. tons. Up to the present, Uzbekneftegaz has managed to maintain this level.

To date, Uzbekistan has 190 oil fields, of which one half is being developed, and a further one-third have been prepared for development. This allows asserting that the Republic of Uzbekistan may become an important player on the regional energy market.

During the period of reforms the consumption of oil in Uzbekistan has gone down by almost 80% - from 11 to 6.5 mln. tons, which enabled the Republic to begin exporting the oil surplus, though rather insignificant, to neighboring countries.

At present, gas consumption totals 52 bln. m3, allowing Uzbekistan to export this hydrocarbon resource to southern Kazakhstan, Kyrgyzstan and Tajikistan. Meanwhile, Uzbekistan is quite near to world standards in gas supply level - approximately 85% in towns and cities, and 52% in rural areas.

Specialists note, however, that even given the present generally favorable state of affairs in the Republic's industry, in the medium term (five to seven years), owing to a dearth of investment in the modernization of equipment, Uzbekistan may face a fall in the production of oil and natural gas, while the requirements of the country, which is gradually overcoming from the economic crisis, may grow. This may cause Uzbekistan to lose its position as an exporting player on the CIS energy market and to switch over to importing fuels. In this situation the country's leadership had to consider the possibility of foreign companies taking part in the development of its oil and gas fields.

In search of reliable investors

In the 1990s the main blame foreign companies laid on Uzbekistan was the fact that potential investors had no available legal remedy to protect their interests. At that time the country tried to attract capital investment and offered some 50 projects to foreign investors. However, such an offer was made in the conditions of a certain legal vacuum, which foreign investors did not find attractive at all. The absence of a direct access to the regional and world markets also made the investors uncertain about the prospects of the development of the Republic's oil and gas complex.

As a result, by the year 2000 only one joint project in the Republic's oil and gas complex was realized - the construction of a refinery in Fergana where Uzbekistan's partner was the Texaco corporation.

The failure of the initial attempt to attract foreign investment compelled the country's leadership to review its actions. Adopted during the 1998-2003 period was a whole package of laws aimed at creating a legal and regulatory basis, and changes were introduced in the licensing system. Furthermore, as the situation over the law on Production Sharing Agreement (PSA) shows, the government entered into a broad dialogue with investors. The PSA law was adopted back in 2001, but in 2003 it was amended to make the terms of recoupment easier for investors.

Within the licensing system the law removed the bounds between Uzbek and foreign companies and reduced the time limits necessary for considering applications for licenses and the number of documents required for obtaining them.

In 2003, the trade in petroleum products was liberalized and the system of tariffs was modernized. Under the new terms, oil tank farms were granted the status of independent legal entities, as well as the right to choose their suppliers and to settle accounts with refineries.

The positive changes in the Republic's legislation did not go unnoticed beyond its borders. The turning point here was again the year 2001 when, after the adoption of the PSA law, the British company Trinity Energy signed the first-ever contract for conducting exploration on the territory of Central Ustyurt and at two fields in south-western Gissar. At present, oil production at those fields has been brought up to 100,000 tons. In the future, given a normal course of the investment process, it is planned to raise the annual production of hydrocarbons on the territory covered by the agreement up to 130,000 tons of oil and 2 bln. m3 of natural gas.

A second PSA project is aimed at the development of promising fields in the Bukhara-Khiva oil- and gas-bearing area, which contains about 40% of all the forecast resources of Uzbekistan. It is planned to realize the important project together with the Dutch company Chase Petroleum.

Foreign companies took part in the construction of several gas compressor stations at the Shurtan, Kokdumalak, and Zevardy fields and in some other places. The total cost of these projects is estimated at $400 mln.

However, despite some progress made by Uzbekistan in improving its investment climate, the world's largest transnational corporations are in no hurry to open their representative offices in Uzbekistan and to invest in its oil and gas industry, though their participation in the Republic's projects would appreciably raise its investment rating and general status. They continue to give preference to Kazakhstan and Turkmenistan due to the fact that these countries have more freedom in determining the export routes of their hydrocarbons. On the other hand, progressively greater interest in the development of Uzbekistan's hydrocarbon reserves is shown by the companies of the country whose representatives used to work in Central Asia back in the Soviet time within the USSR ministries of the oil and gas industry. It is clear enough that the country in question is Russia.

Mutual interests

The Central Asian region remains strategically important to Russia's foreign policy in view of its geopolitical interests and simply because there is a large Russian-speaking population in the former Soviet republics.

LUKOIL started operating in the Republic of Uzbekistan back in 2001, having concluded a tentative agreement with Uzbekneftegaz on developing the Kandym gas field whose reserves total 150 bln. m3. Later on, two neighboring gas field, Khauzak and Shady, were included in the project. At present, the reserves of the so-called "Kandym group" are estimated at 280 bln. m3 of gas and 8 mln. tons of gas condensate, while total investment is expected to reach $1 bln..

In accordance with the Production Sharing Agreement signed during President Vladimir Putin's visit to Tashkent, the annual gas production of the Kandym group's fields may come to 9 bln. m3. Furthermore, it is planned to produce about one-quarter of that amount at the first stage already. Developing the field will require an appropriate infrastructure, including a gas-chemical complex. The project is to be implemented within 35 years.

Initially, LUKOIL's share in the project was 70%, the remaining 30% were controlled by Uzbekneftegaz. It was expected that Gazprom would take part in the development of the Kandym group's fields, either directly - through the purchase of its shares, or indirectly - via Uzbekneftegaz, provided Gazprom took part in its privatization. However, in the final version of the PSA the shares of the participants in the project were established as follows: LUKOIL - 90%, Uzbekneftegaz - 10%. Still, the transportation of gas would be carried out over the trunk gas pipelines controlled by Gazprom.

To Gazprom, which pursues the strategy of diversifying the sources of gas delivery, Uzbekistan may become more than merely a new object of investment. Gaining a firm foothold in Uzbekistan may strengthen the positions of the leading Russian gas company in its far-from-easy dialogue with Turkmenistan. Since 2003 Gazprom has been operating Uzbekistan's trunk gas pipelines and, therefore, the company is objectively interested in the development of the Republic's gas-transporting system. Under the existing agreements, Gazprom's purchases of natural gas in Uzbekistan and Turkmenistan may, by the year 2010, reach 80 bln. m3. Then, increasing the throughput capacity of the Central Asian branch of the Integrated Gas Supply System will become a serious task for Gazprom. In this context, Gazprom's participation in the privatization of Uzbekneftegaz appears absolutely necessary. The company has also stepped up its efforts in the upstream sphere, concluding an agreement with Uzbekneftegaz on joint activities in Ustyurt. The first project to be implemented within the framework of the PSA regime, will be the development of the Shakhpakhty gas-condensate field whose gas will be brought to the Russian Federation.

It should be noted that the consolidated activity of two Russian participants in Uzbekistan's oil and gas complex may be quite productive in view of their joint projects in the Caspian sea area and their agreement on strategic partnership which may be extended to include the Republic of Uzbekistan.

On the whole, the Russian presence in Uzbekistan's oil and gas complex may today be regarded as an objective need for both sides. With the help of Russian capital, Uzbekistan is trying to alleviate the investment dearth in its oil and gas industry and to ensure the sales of its fuel, whereas to Russia that Central Asian republic appears to be a very important partner, second only to the Republic of Kazakhstan.

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Oil of Russia, No. 3, 2004
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