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RUEBAAA/DEPT OF ENERGY WASHDC

C O N F I D E N T I A L SECTION 01 OF 03 ASTANA 000817 
 
SIPDIS 
 
NOFORN 
SIPDIS 
 
DEPT FOR EB/ESC; SCA/CEN (O'MARA) 
 
E.O. 12958: DECL: 12/11/2015 
TAGS: ENRG EPET KZ CASC
SUBJECT: KAZAKHSTAN: PETROKAZAKHSTAN LEGAL CASE WINDS DOWN 
 
REF: A. 05 ALMATY 3150 
 
     ¶B. 05 ALMATY 3857 
     ¶C. ASTANA 90 
 
Classified By: Pol-Econ Chief Deborah Mennuti; reasons 1.5 (b) and (d). 
 
¶1. (C) Summary:  On November 14, an Almaty district court 
convicted three expatriate former executives (two AmCits) of 
PetroKazakhstan (PK) of criminal violations of Kazakhstan's 
anti-monopoly law.  The judge simultaneously granted the 
defendants amnesty and lifted a travel ban that had been in 
place since the criminal charges were filed in April 2005. 
The only AmCit defendant remaining in Kazakhstan, Tom Dvorak, 
plans to depart Kazakhstan on December 17. 
 
¶2. (C) Summary (continued):  PK's controversial October 2005 
sale to the Chinese National Petroleum Company (CNPC) 
recently came two steps closer to closure, as Kazakhstan's 
national oil and gas company, KazMunaiGaz (KMG), finalized a 
deal on November 16 to purchase 50% of PK's Shymkent 
refinery; and Lukoil won an October 30 arbitration ruling 
granting it a preemptive right to acquire PK's half of the 
Turgai oil field (at the price paid by CNPC).  An argument 
can be made that the legal case of the PK executives was 
manipulated to enhance the GOK's leverage in its post-sale 
negotiations with CNPC to acquire a share of the PK assets. 
While PK's ten-year experience in Kazakhstan has arguably 
been unique, it nevertheless offers several perspectives from 
which to evaluate Kazakhstan's investment climate. End 
summary. 
 
PK Executives Convicted -- and Amnestied 
---------------------------------------- 
 
¶3. (C) On November 14, after an intermittent 8-month trial, 
an Almaty district court convicted three former expatriate 
executives of the Canadian oil company PetroKazakhstan (PK) 
of criminal violations of the anti-monopoly law, sentencing 
them to three years' imprisonment.  (In addition to the two 
American citizens, Tom Dvorak and Robert Goldsmith, and a 
Canadian, Clayton Clift, the court also convicted twelve 
Kazakhstani PK employees.)  All the PK employees were then 
granted amnesty under a January 2006 "Independence Day" 
Amnesty Law, and the court lifted a travel ban in place since 
April 2005.  (Note: Of the three expatriates, only Dvorak 
remained in Kazakhstan through the trial's end. Dvorak told 
Econoff on November 29 that he plans to leave Kazakhstan on 
December 17.  End note.)  The defendants have appealed the 
conviction. 
 
¶4. (SBU) Note: Another AmCit PK employee, Dan Hermann, was 
granted amnesty in January 2006 in what was, legally, an 
unrelated case.  Hermann was charged with violating the terms 
of PK's exploration license (Ref A). 
 
Origin of the Criminal Charges 
------------------------------ 
 
¶5. (SBU) The criminal charges stem from activities PK 
undertook, beginning in 2002, to sell refined products from 
PK's Shymkent refinery at prices higher than those 
established by Kazakhstan's Agency for the Regulation of 
Natural Monopolies.  PK executives attempted to avoid the 
application of the Monopoly Law by dividing the sales of its 
refined products, previously undertaken by a single business 
entity, among seven newly-created companies.  Each of the 
seven companies allegedly managed the volumes of its regional 
sales, selling into one another's respective regions, to 
avoid establishing the 35% market share required to apply the 
monopoly price ceilings. 
 
¶6. (C) Dvorak told Econoff on November 29 that, 
notwithstanding the conviction, the Procurator's case "was 
full of holes." One example, he explained, was the fact that 
he, Dvorak, did not even begin working for PK until August 
2003, and thus could hardly have contributed to the alleged 
"conspiracy" begun in 2002 to evade the law.  Further, he 
argued, the refinery's privatization agreement, drafted in 
the late 1990's when the State first sold its interest in the 
refinery, guaranteed that the refinery's products would not 
be subject to future price controls.  And finally, Dvorak 
said, the Procurator had never established in court that PK's 
distribution scheme had resulted in higher prices for the 
refined products. 
 
¶7. (C/NF) However, Dvorak admitted, in retrospect PK "clearly 
should have done things differently."  The defendants' case 
 
ASTANA 00000817  002 OF 003 
 
 
had been undermined, he noted, by the exposure of an internal 
memo, written by PK's lawyers, warning that creating the new 
distribution companies would make the company vulnerable to 
charges of anti-monopoly violations. 
 
"Why Us?" -- Making Sense of the Past 
------------------------------------- 
 
¶8. (C/NF) In seeking to explain the cause ("why us?") of 
their legal problems, the PK executives have favored 
different hypotheses at different times. Prior to the 
company's announced sale to CNPC, Dvorak and Goldsmith often 
defended the thesis that PK's legal problems were the result 
of a GOK plot (perhaps in collusion with Lukoil) to drive 
down PK's share price prior to a planned bid to buy the 
company.  According to this theory, KMG had long coveted the 
Shymkent refinery.  Dvorak and Goldsmith tended to see most 
of the company's legal problems in this light, including 
several legal disputes with its joint venture partner Lukoil, 
and the GOK's enforcement of gas flaring restrictions which 
forced a 30% cut in PK's 2005 oil production. 
 
¶9. (C/NF) Following the announcement of PK's sale to CNPC, 
Goldsmith and Dvorak found hope that the legal case against 
them would be dropped -- after all, as they argued at the 
time, there was no further reason for the GOK to target PK's 
stock price.  As the legal case against them moved forward, 
however, they adopted a different hypothesis: that the GOK, 
taken by surprise by the sale, was using the legal case as 
leverage in post-sale negotiations to acquire key PK assets 
from the Chinese.  (Note:  Much evidence points to the fact 
that the GOK was caught unprepared by the sale, the most 
dramatic of which was a series of amendments which the GOK 
rushed into law before the deal was finalized (Ref B), which 
extended the GOK's "preemptive rights" and thus strengthened 
its negotiating position with CNPC.  A KazMunaiGaz (KMG) 
contact told us at the time that the GOK had been 
unpleasantly surprised by the high price paid by CNPC -- a 
price KMG would have to match, under the preemptive right 
legislation, to acquire the PK assets.  End note.) 
 
Refusing Amnesty and Other Legal Oddities 
----------------------------------------- 
 
¶10. (C) The guilt or innocence of the executives aside, the 
anti-monopoly case took more than one questionable turn in 
the Winter and Spring of 2005-06, which fed the executives' 
sense that they were pawns in a bigger game. The most curious 
of these was the Procurator's refusal to apply the Amnesty 
Law in January and February 2006, before the case went to 
trial, despite PK's repeated legal appeals and Embassy 
requests for close consideration.  (The Embassy also voiced 
concern about the tendency, present both in this case and in 
recent AES  disputes, of the authorities to file criminal 
charges in what are essentially civil cases.)   In Spring 
2006, the trial judge also refused, during pre-trial motions, 
to dismiss the case on the basis of the amnesty -- only to do 
so at trial's end. 
 
¶11. (C/NF) As further evidence that his case was being 
manipulated for larger purposes, Dvorak cites the fact that 
the list of alleged victims of PK's "monopolistic" activities 
-- companies which allegedly overpaid for refined products -- 
grew in apparent synchrony with the reported intensity of the 
GOK's negotiations with CNPC.  (The dollar amount of these 
alleged damages reached, at one point, approximately $750 
million, before shrinking throughout the summer of 2006, 
under examination of the court, to approximately $55 million. 
 These damages represent PK liabilities which CNPC legally 
assumed upon purchasing the company.  Dvorak, who remained on 
PK's payroll even after the company's sale to CNPC, told 
Econoff that this (inflated) dollar figure was being used as 
a bargaining chip in the GOK-CNPC negotiations.)  Dvorak also 
asserts that the list of alleged victims of the crime was 
populated by numerous brand-new companies created, 
presumably, in order to file claims and make a buck from PK's 
legal problems. PK's lawyers, Dvorak claims, were able to 
establish that fourteen of the allegedly unrelated victimized 
companies, in fact, shared a single bank account.  Dvorak 
believes that the courts may have refused to grant amnesty in 
January 2006 in order to allow these "victimized" companies 
the opportunity to collect in court.  (In denying application 
of the Amnesty Law, the Procurator's office cited a need to 
gain the consent of all injured parties before applying the 
amnesty.)  And, finally, Dvorak believes that his own 
conviction may have been "necessary" as evidence in the 
ongoing legal case to collect the $55 million from CNPC. 
 
ASTANA 00000817  003 OF 003 
 
 
 
¶12. (C/NF) Comment:  While it is easy to blame Kazakhstan's 
weak judicial system for many of the recent legal cases 
involving Western investors -- and we readily do so, here, in 
the instance of the non-applied amnesty -- it is worth 
pointing out that companies take on different level of "legal 
risk," by virtue of adopting conservative or aggressive legal 
and accounting practices, just as they take on differing 
levels of financial risk in making their investments. 
PetroKazakhstan, it appears to us, may have pushed the legal 
envelope.  Even without taking a hard position on the justice 
of the anti-monopoly verdict, however, we clearly decry one 
of the more insidious aspects of the current investment 
climate in Kazakhstan -- the discretion of authorities to 
file criminal charges in cases which are essentially civil in 
nature, without meeting Western standards for establishing 
criminal intent. 
 
¶13. (C) Comment (continued):  With the recent sale of PK and 
Nelson Resources, the ongoing CITIC bid to buy NationsEnergy 
(Ref C), and growing rumors of a Chinese bid for 
MangistauMunaiGas, we may be witnessing the end of the 
ownership of Kazakhstan's mid-sized oil fields by private 
investors and mid-sized foreign companies.  As these 
investors move out, cashing in on high oil prices, KMG is 
likely to exercise its preemptive rights to take a share of 
the assets, thus expanding its onshore presence in parallel 
with its legislatively-prescribed requirement to take part in 
all offshore projects.  Perhaps paradoxically, KMG's growing 
presence is likely to improve the investment climate for 
project partners.  As KMG's Kashagan partners tell us, having 
KMG as a partner is helpful when addressing legal or fiscal 
issues raised by the GOK.  While KMG's new role, onshore and 
off, is usually seen as a means to develop the national 
company, and gradually expand State ownership and control 
over Kazakhstan's hydrocarbon reserves, it may also serve as 
means to institutionalize, and thus tame, the "Wild West" 
characteristics of Kazakhstan's oil patch.  End comment. 
MILAS