Thursday, July 10, 2008

Kazakhstan's Flagship Oil Company "KazMunaiGas" E&P Expected to Significantly Increase Reserves and Production

KazMunaiGas Exploration & Production ("KMG E&P", ticker (GDR) KMG.L) is the publicly held subsidiary of National Company (NC) KazMunaiGas, the national oil and gas company of Kazakhstan. KazMunaiGas E&P went public on both the London Stock Exchange and the Kazakhstan Stock Exchange in 2006, and, at the current date of the writing of this article, has a market capitalization of slightly under $US12Bn (and enterprise value of approximately $US9Bn, with approximately $US3Bn in net cash) and a P/E ratio on market capitalization of approximately 8x. KMG E&P produced approximately 242,000 bpd of oil in the first quarter of 2008, up 26.4% year over year. KMG E&P's proved and probable reserves of oil and gas were approximately 2.1 Billion barrels of oil equivalent at year end 2007, an increase of 43% year over year.

The key question for interested investors is, will the public KazMunaiGas E&P serve as the government of Kazakhstan's main acquisition vehicle for Kazakhstan's domestic oil and gas industry? This question is relevant in that if the answer is "yes," then KMG E&P has a higher probability of being equivalent in Kazakhstan to, for example, Petrobras in Brazil and Gazprom in Russia -- both public, majority state owned oil and gas firms which have increased substantially in market capitalization over the past few years due to their country's large reserves of petroleum wealth. This article will argue that there is a high probability that KazMunaiGaz will be the major acquisition vehicle for onshore Kazakhstan, and has a moderate probability of serving as the main acquisition vehicle for offshore Kazakhstan.

Oil and Gas Potential in Kazakhstan:

The oil and gas potential within Kazakhstan has been well documented -- Kazakhstan contains the second largest area of oil reserves outside of OPEC according to the EIA -- so only a few brief points will be included here. Kazakhstan as a whole has 24 fields according to the EIA with reserves close to 1 billion barrels or more, which are shown at this page at the EIA. Kashagan -- the offshore oil development which has very large reserves (over 20 billion, with close to 9bn barrels estimated recoverable) but has been repeatedly delayed -- and Tengiz -- operated by Chevron -- are largest and the most well known oil fields within Kazakhstan, but there are several other areas of large potential oil and gas reserves within Kazakhstan. Kazakhstan's section of the Caspian Sea is estimated to hold the largest reserves of any country around the Caspian, and the Caspian Sea is estimated to be one of the largest oil reserve regions in the world. Overall, more reserves are estimated to lie in offshore Kazakhstan than onshore, but both areas are expected to produce large volumes of oil. Kazakhstan is not a mature oil producing country by any means, with production only starting up on a large scale in the early 2000's. Historical and projected oil production to 2009 is presented in Figure 1 below.

Source: EIA

In the future, Kazakhstan holds very good potential for new oil and gas discoveries, as Kazakhstan is as large in terms of territory (as large as Western Europe and/or three and a half times the size of Texas), and the country is relatively lightly explored.

Overview of Kazmunaigas E&P:

KazMunaiGas E&P is 61% owned by KazMunaiGas National Oil Company, which, in turn, is 100% owned by the Kazakhstan government. KazMunaiGas National Oil Company (the parent of KMG E&P) was formed in 2002 by the combination of Kazakhoil (Kazakhstan's state owned upstream assets prior to 2002) and NC Oil and Gas Transportation (Kazakhstan's state owned downstream oil assets prior to 2002). KazMunaiGas E&P's ownership structure is potentially somewhat more confusing than, for example, Petrobras' ownership structure, as there is an additional firm between the government ownership and the public oil company. That is to say, Petrobras is directly, 55.7% owned by the government of Brazil, while KazMunaiGas E&P is 60% owned by KazMunaiGas NA which is owned by the government. Currently, there is only one state owned national oil company of Kazakhstan -- KazMunaiGaz NA -- and only one publicly owned, majority state owned national oil Company in Kazakhstan, KazMunaiGaz E&P.

As KazMunaiGaz NA (the parent firm) is well entrenched as the national oil company of Kazakhstan, the one of the main questions for investors -- above stated above -- is the extent to which KazMunaiGaz E&P (the public subsidiary) will own the current and future holdings of KazMunaiGaz NA. KazMunaiGas NA, by law within Kazakhstan, must hold a percentage of all oil and gas projects in Kazakhstan, and therefore future oil and gas reserve growth at the parent level is very likely. There are several indications that KazMunaiGaz E&P will hold a large percentage of future oil and gas fields from the parent company. The evidence for this assertion is presented as follows.

In KazMunaiGaz's investor relations sector of its website, in the May 08 KMG E&P investor presentation titled "Acquisition Strategy Strong Foundation for Future Growth" KMG E&P comes close to outright stating that it will be able to acquire assets with certainty from the parent. The presentation states at the end that KMG E&P will be the "producer and developer onshore" with an "interest offshore" and mentions an "Article 71" in Kazakhstan oil and gas law that states that KMG E&P first rights to "request" to bid on any of the parent's existing or future assets. The language of this Article 71 is taken by the author to encourage but not outright guarantee future transfer of assets from the parent KMG NA to the public KMG E&P.

Further, in the KazMunaiGas E&P's 2007 annual report, the chairman of KMG E&P Uzakbay Karabalin stated that the publicly held KazMunaiGaz E&P is the "flag carrier of the oil industry in Kazakhstan" and indicated that one of its main strategies is to acquire oil and gas properties within Kazakhstan from the parent firm. Further supporting the relationship between the national oil company and KMG E&P, on page 12 of the Annual Report, KMG E&P stated that it has a "strong relationship with its parent company, NC KMG, which gives KMG EP preferential access to onshore assets in Kazakhstan."

KMG NA and KMG E&P have stated that there role model firm is the Norwegian Statoil (ticker STO), which is majority owned by the Norwegian government, but the majority operator of Norway's oil and gas reserves. According to Rice University (large pdf warning) the government's purpose in making KMG E&P public in 2006 was for the government to "realize the value" of KMG's oil onshore assets. As such, this implies a sensitivity to market valuations by Kazakhstan's government for its oil and gas reserves. Also note, that several analysts, including the Economist's Intelligence Unit, have compared KMG E&P with Rosneft -- both went public in 2006 -- and both are majority owned by their respective governments but strong forces in the consolidation of the country's respective oil industries. These factors suggest a large role for KMG E&P in the future oil and gas industries of Kazakhstan.

Kazmunaigas E&P Producing Fields:

KMG E&P mainly holds two major oil fields - Uzenmunaigaz (where the majority of reserves and production occurs) and Embamunaigaz. Over the last year Kazmunaigas E&P has acquired 50% ownership in Karazhanbasmunai and Kazgermunai -- which are both currently relatively minor oil producing regions , but with solid reserves Uzen and Embamunaigaz are both relatively mature production areas, although outlook appears for relatively stable production over through 2013. KMG E&P also acquired two additional oil operations within Kazakhstan in 2007, a 50% share in
Kazgermunai in April and a 50% share in CCEL(Karazhanbasmunai) in December. The impact of of the 2 acquisitions was an increase in production by 25% and an increase in proved and probable reserves of 20%, according to KMG E&P's 2007 annual report.

KMG E&P Potential Acquisitions:

Going forward, KMG E&P has specifically targeted several acquisitions within Kazakhstan, which are explored in this presentation dated May 2008. KMG E&P has targeted a 33% stake in PetroKazakhstan for the second half of 2008. PetroKazakhstan, partially owned by PetroChina, produced approximately 123,000 bpd of oil in 2007.
In the Feb 08 investor presentation, KMG E&P has targeted "Kazakholl Aktobe" which has proven reserves of 275M barrels of oil equivalent, but according to the EIA link above has reserves of a bit more than 1 billion barrels, and is starting up production. Potentially the strongest acquisition target for KMG E&P by production and reserves in the near term is Mangistaumunaigas, which produced 174,000 bpd in 2007, and which, according to the EIA, holds 1.4 billion barrels of recoverable oil equivalent of reserves.

Table 2: Near Term Acquisition Targets for KMG E&P:

Firm Name

Reserves (est)

Production (2007)

KMG E&P Ownership Percentage


1.4 Billion BOE

114,000 bpd


Kazakholl Aktobe

275M BOE

20,000 bpd



550M BOE

144,000 bpd




7,000 bpd


Will KMG E&P Move Into Offshore Projects in the Caspian Sea?

In an interview with CEO Askar Balzhanov of KMG E&P in October 2007 (reference: Kazmunaigas E&P Looks to Tap into Caspian Offshore, NEFTE Compass, October 11, 2007), Balzhanov stated that he is targeting offshore work in the Caspian Sea, and will present this idea formally to KMG NA. Originally KMG E&P was set up to target onshore oil and gas fields in Kazahkstan. Askar Bakzhanov previously was the CEO of the parent KMG NA's offshore oil activities before his appointment to the CEO position of KMG E&P, and knows offshore Kazakhstan's oil fields very well. The acquisition by KMG E&P of the offshore activities of KMG NA would be a natural fit according to Balzhanov.


The main risk for investors is the relationship between the parent company KMG NA and KMG E&P, as discussed above. The risk exists that KMG NA could deny oil and gas projects or even create a completely separate oil and gas company to represent the state's interests in Kazakhstan's oil and gas sector. This risk is partially mitigated by the factors discussed above.

Taxation issues represent another risk to the operating performance of KMG E&P. In early 2008, Kazakhstan issued new oil taxes, which represent approximately 12% of the revenue from oil at $130 per barrel. The taxes were motivated by the government to increase revenues to support Kazakhstan's domestic spending and country credit rating. It is possible, with a downturn in economic activity within Kazakhstan, that the country could continue to increase the tax burden on the oil sector to bring in revenues. This risk is partially mitigated by the fact that Kazakhstan's economy is currently performing strongly, with approximately 8% growth in 2008. Further, Kazakhstan's debt to GDP is a relatively low 14% in 2007.

The third risk is risk of a lower oil price, which is a risk shared by KMG E&P with almost all other upstream oil and gas firms. According to KMG E&P's 2007 Annual Report, the Company does not hedge its exposure to oil and gas prices.


KMG E&P represents the flagship oil firm of Kazakhstan, and, as such, represents a strong long term buy at the current market capitalization of $US12Bn. KMG E&P has made statements that it has a first priority on future onshore oil and gas activities in Kazakhstan, and has a good chance to move into offshore oil and gas projects in the Caspian Sea. As Kazakhstan holds high reserves of oil and gas, KMG E&P will benefit alongside Kazakhstan's oil and gas industry. Risks include political risk, including the risk of a change in the relationship between KMG E&P and the government of Kazakhstan, but this risk is mitigated by the Oil and Gas law of Kazakhstan, which specifically states that KMG E&P has a first right of refusal for oil and gas projects in Kazakhstan, and the stated relationship by KMG E&P and KMG NA management on the close ties between the two companies. Taxation risk is partially mitigated by the relatively strong growth and debt position of Kazakhstan.

Note on Purchasing GDR's by US Citizens:

KMG E&P trades as a GDR in London, and almost all GDR's (Global Depository Receipts) have restrictions on their purchase by individual investors who are US citizens. American institutions can buy GDR's -- and in fact, approximately 9% of the total float of KMG E&P is owned by American institutions. Interested individual American investors in KMG E&P (and other GDR's) are encouraged to ask several brokerages to find one that has the capability to purchase GDR's.

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