VZCZCXRO2417
RR RUEHDBU RUEHLN RUEHVK RUEHYG
DE RUEHTA #0277/01 0301200
ZNR UUUUU ZZH
R 301200Z JAN 07
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC 8338
INFO RUCNCIS/CIS COLLECTIVE 0021
RUEHAST/USOFFICE ALMATY
RUEHBJ/AMEMBASSY BEIJING 1295

UNCLAS SECTION 01 OF 04 ASTANA 000277 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
FROM CHARGE D'AFFAIRES TO EB ASSISTANT SECRETARY SULLIVAN 
 
E.O. 12958: N/A 
TAGS: PGOV PREL ECON ETRD KZ
SUBJECT: SCENESETTER FOR ASSISTANT SECRETARY SULLIVAN'S VISIT TO 
KAZAKHSTAN 
 
Ref: Astana 125 
 
ASTANA 00000277  001.2 OF 004 
 
 
¶1. (SBU) Summary: While recent Kazakhstani headlines have been 
dominated by discussion of the country's new government, its bid to 
assume the OSCE chairmanship, and a democratization initiative 
presumed to be in the works, the real, abiding story here is 
Kazakhstan's economy.  The country's natural resource wealth is 
well-known and, by and large, well-managed; much of the USG's 
attention in this arena is focused on the development of pipeline 
routes to carry oil and gas out of landlocked Kazakhstan.  While far 
from being Kazakhstan's top trading partner, the U.S. is the largest 
foreign investor.  The company executives you meet here will tell 
you about an investment climate that is, at times, challenging, 
while simultaneously discussing expansion plans - or, in private, 
bids for new oil blocks. 
 
¶2. (SBU) Summary, cont.: Kazakhstan has, to date, done an admirable 
job of managing its oil wealth.  President Nazarbayev seems 
determined to take the next, rational step of lessening the 
country's dependence on extractive industries; the ambitions of 
diversifying the economy and enhancing Kazakhstan's competitiveness 
rank high on the Kazakhstani government's agenda.  It is clearly in 
the USG's political and commercial interests to help Kazakhstan 
achieve those goals - through expanded U.S. trade, investment, and 
economic cooperation - while reinforcing market mechanisms. 
Finally, your visit here comes as the GOK grapples with a new sense 
of the country's regional role and responsibilities, earned by its 
relative prosperity and stability, and forced upon it by challenges 
and opportunities to the South.  Here, too, the U.S. can assist, by 
helping Kazakhstan find the opportunities and means to increase 
trade and infrastructure ties with its Southern neighbors, including 
Afghanistan.  End summary. 
 
The Political Context 
--------------------- 
 
¶3. (SBU) Your visit comes at a time of significant personnel changes 
in the government, but relative stability as regards economic 
policy.  President Nazarbayev appointed Karim Masimov as Prime 
Minister on January 10 (reftel).  Masimov, who had been Deputy Prime 
Minister since January 2006 and concurrently Minister of Economy and 
Budget Planning since April 2006, was already the most prominent 
economic policymaker in the cabinet.  In his first weeks on the job 
he has emphasized the need to diversify the Kazakhstani economy, 
including by attracting foreign investment, and to respect contract 
stability.  Masimov has also highlighted the need for streamlined 
GOK decision-making and improved organization.  Other new appointees 
include Foreign Minister Marat Tazhin (formerly head of the Security 
Council), Deputy Prime Minister Aslan Musin (who also retains his 
job as Minister of Economy and Budget Planning), Defense Minister 
Daniyal Akhmetov (former Prime Minister and Kazakhstan's first 
civilian defense minister), and Minister of Industry and Trade Galym 
Orazbakov (who as Deputy Minister from 2001-2003 used to head 
Kazakhstan's WTO negotiating team). 
 
¶4. (SBU) While Masimov is charting a relatively familiar economic 
policy course, significant changes are expected on the domestic 
political front.  (Note:  In the Kazakhstani system, the Prime 
Minister coordinates economic policy.  Foreign policy and domestic 
political issues are handled by the Presidential Administration. 
End note.)  President Nazarbayev has been consolidating the 
pro-presidential political parties into one grouping, Nur-Otan, 
which controls over 90% of parliamentary seats.  He is widely 
expected to give a public address in February or March outlining his 
vision of political reform, based on the recommendations of the 
Democratization Commission which met throughout 2006.  While no 
details are publicly known, participants in the Commission predict 
that while the rhetoric may be sweeping, the actual reform proposals 
will be fairly modest.  One frequently-heard measure is an increase 
in the number of seats in the Mazhilis (lower house of parliament), 
which would theoretically make room for more diverse party 
representation. 
 
 
The Macroeconomic Situation 
--------------------------- 
 
¶5. (SBU) Kazakhstan's economy (2006 GDP: $68 billion) is larger than 
those of all the other Central Asian states combined, largely due to 
the country's vast natural resources and a recent history - rare in 
the region - of political stability.  Kazakhstan also stands out 
among the post-Soviet Central Asian states in its record of 
macroeconomic reform. Financial reform has created a banking system 
comparable to those in Central Europe, for example, and Kazakhstan 
now aspires to be a regional financial center. Kazakhstan has the 
economic performance to match its policies, having enjoyed near 
double-digit growth (estimated at 10.6% in 2006) over the last six 
 
ASTANA 00000277  002.2 OF 004 
 
 
years, while keeping inflation in check and avoiding, to date, the 
"Dutch Disease" which has plagued many other extractive economies. 
 
¶6. (SBU) If there a reason for macroeconomic worry, it is tied to 
the fact that inflation rose a full point in 2006, to 8.5%.  This, 
combined with other signs of a potentially overheating economy - 
including skyrocketing rates of commercial lending; the emergence of 
a housing "bubble" in Almaty and Astana; and a rise in government 
spending, especially on salaries - has led many observers to preach 
fiscal restraint.  Any inflation-driven appreciation of the Tenge 
would, of course, hurt the competitiveness of Kazakhstan's 
non-extractive exports, thus blunting the GOK's drive to diversify 
the economy.  The GOK has defused these pressures to date by 
steering the vast majority of its oil revenues to the offshore 
"National Fund," which now holds over $14 billion in assets and an 
improved, rule-based link to the national budget. 
 
Energy: The Economic Engine 
--------------------------- 
 
¶7. (SBU) Kazakhstan's economy is dominated by the energy sector, 
with oil exports alone accounting for roughly a third of GDP. 
Kazakhstan produced 1.3 million barrels of oil per day (bpd) in 2006 
-- all from onshore projects - roughly the production volume as 
¶2005.  Overall production will be boosted near year-end 2007, as 
Tengiz (U.S. partners: Chevron, ExxonMobil) production doubles. 
Kazakhstan is likely to become a top-ten oil producer soon after 
2015, as offshore supergiant Kashagan (ExxonMobil, ConocoPhillips) 
reaches peak production and other offshore projects come on line. 
 
¶8. (SBU) The GOK actually closed 2006 by revising its 2015 
production estimates from 3 to 2.6 million bpd, due to delays in 
Kashagan field development.  Your GOK interlocutors may criticize 
the Kashagan consortium for delays and cost overruns at that 
project. They may also reference an October riot at the Tengiz 
field, pitting Kazakhstani against Turkish workers, which delayed 
Tengiz production increases by several months and triggered a broad, 
ongoing GOK investigation of wage discrimination against Kazakhstani 
employees.  GOK concerns over "local content" and equity issues in 
the oil and gas sector have never been higher. 
 
¶9. (SBU) While Kazakhstan possesses substantial proven gas reserves 
(3 billion cubic meters), it currently exports very little gas, 
serving principally as a transit country for Turkmen and Uzbek gas. 
The GOK has set ambitious targets for domestic gas production, 
forecasting 63 bcms by 2015.  Much of this gas will be reinjected in 
order to maintain oil field pressure, and the GOK would like to see 
some gas used to create a domestic petrochemical industry (most oil 
majors are  skeptical of the economics); remaining volumes will be 
available, later if not sooner, for export. 
 
¶10. (SBU) Kazakhstan has recently begun to pursue the possibility of 
building one or more nuclear power plants over the next decade, 
capitalizing on its enormous uranium reserves (Kazakhstan is 
currently the world's third leader producer of uranium), an 
experienced corps of industry professionals, and well-developed 
control systems left over from its Soviet-era nuclear industry. 
Kazakhstan and Russia have recently signed several joint nuclear 
agreements - most notably to establish an international center for 
uranium enrichment in Russia - but there appears to be ample room 
for further U.S.-Kazakhstani cooperation in this field, as well as 
potential commercial opportunities for U.S. firms. 
 
Gas and Oil Infrastructure Projects 
----------------------------------- 
 
¶11. (SBU) All of Kazakhstan's gas exports currently flow through 
Russia, leaving the country hostage to GazProm politics and prices. 
Two projects under GOK consideration - a Trans-Caspian gas pipeline, 
and a gas pipeline to China - would reduce this dependence.  The 
Kazakhstanis are currently undertaking a feasibility study of the 
China route, including a variation which would add Kazakhstani 
volumes to a pipeline originating in Turkmenistan.  While the GOK 
seems cognizant of the risks inherent in building a pipeline which 
would serve a single buyer, these concerns are partially offset by 
Chinese avidity and the GOK's desire to gasify Southern Kazakhstan 
along the pipeline's projected route.  If USTDA's feasibility study 
proves the viability of a Trans-Caspian pipeline, on the other hand, 
the GOK will have to confront Russian (and Iranian) opposition to 
the project.  Your GOK interlocutors are likely to be cautious in 
their support of the Trans-Caspian pipeline project, reflecting 
their (wise) reluctance to pick a fight with Russia before the 
feasibility of the project is proven. 
 
¶12. (SBU) Currently the bulk of Kazakhstani crude is exported via 
Russia, both through the Transneft system and the independent 
Caspian Pipeline Consortium (CPC) pipeline.  (Small, but growing, 
 
ASTANA 00000277  003.2 OF 004 
 
 
volumes are shipped East to China, while negligible quantities are 
"swapped" South to Iran.)  The majority of Kazakhstan's near-term 
oil production increases are projected to flow to market either 
through the Baku-Tblisi-Ceyhan pipeline or an expanded CPC.  Long 
delays in the CPC negotiations have left Tengiz producers scrambling 
for alternative export options.  (Don't be surprised if your GOK 
interlocutors blame one American company for the current impasse.) 
As a consequence, they have joined Kashagan producers in seeking the 
development of the Kazakhstan Caspian Transportation System (KCTS), 
which will join the Kazakhstani fields, by means of a new pipeline, 
terminals, and ships, to the BTC.  The oil producers signed an 
initial MOU with KazMunaiGaz (Kazakhstan's national oil-and-gas 
company, and a partner in both the Kashagan and Tengiz projects) 
last week; this document defines the technical work needed to launch 
the project, as well as defines how the investors will create a 
negotiating team which will conduct eventual Host Government 
Agreement (HGA) negotiations with the Kazakhstani and Azeri 
governments. 
 
On the GOK's Mind: Competitiveness and Diversification 
--------------------------------------------- --------- 
 
¶13. (SBU) Diversifying the economy away from its dependence on 
hydrocarbons is one of Kazakhstan's main challenges. At present, 
wheat is Kazakhstan's only significant non-mineral export.  GOK 
officials address this need, along with the more-amorphous goal of 
achieving the status of "one of the world's 50 most competitive 
countries," with regularity.  To date, the GOK has focused its 
diversification efforts on Harvard professor Michael Porter's 
"cluster" concept, identifying seven sectors of presumed natural 
advantage for priority development: tourism, construction materials, 
textiles, metallurgy, food processing, oil-and-gas machinery 
building, and transport and logistical services.  Prime Minister 
Masimov would be an excellent interlocutor with which to share our 
own vision of market-based diversification, enabled by improvements 
in Kazakhstan's investment climate and an expanded U.S. - Kazakhstan 
partnership. 
 
WTO Accession 
------------- 
 
¶14. (SBU) Kazakhstan has targeted 2007 as the year of its WTO 
accession.  WTO membership is important to Kazakhstan not only for 
the economic benefits it will bring, but also as a symbol of 
Kazakhstan's presence on the world stage. (Note:  Much like two 
other public GOK pursuits: the OSCE chairmanship and the Winter 
Olympic Games.)  To date, Kazakhstan has signed bilateral protocols 
with 16 out of the 39 members of its Working Group.  In the past, 
Kazakhstan's WTO experts have occasionally used high-level USG 
visits to lobby for relaxed "WTO Plus" provisions and explain the 
burdens of reducing Kazakhstan's agricultural subsidies.  Your 
conversation with the new Minister of Industry and Trade, Galym 
Orazbakov, will be the USG's first, and an important opportunity to 
understand his vision for Kazakhstani accession. 
 
Regional Integration 
-------------------- 
 
¶15. (SBU) Kazakhstan initially greeted Secretary Rice's October 2005 
call for increased regional integration in Central and South Asia 
with a certain degree of skepticism.  As we have clarified our 
goals, and reassured the Kazakhstanis that we are not proposing a 
political "Greater Central Asia," the Kazakhstani government has 
shown increased enthusiasm.  The reference to regional integration 
in the September 29 joint statement was an important milestone in 
this regard.  The GOK has long sought to remove trade barriers with 
its Central Asian neighbors and to help them improve their own 
investment climates.  Sustained USG engagement will be needed, 
however, to encourage a lasting GOK focus on the broader region -- 
not just Kazakhstan's immediate neighbors -- and to encourage the 
GOK to look at tougher issues such as electricity networks. (The 
American firm AES, Kazakhstan's leading electricity generator, is 
actively engaged in our efforts to increase regional electricity 
trades from surplus to deficit countries; to date, GOK interest has 
lagged.)  Your interlocutors may ask what became of the USG's summer 
2006 proposal to launch a Central Asia Regional Economic Integration 
Dialogue (CAREID). 
 
The Investment Climate 
---------------------- 
 
¶16. (SBU) U.S. companies doing business in Kazakhstan face an 
investment climate that is, at times, challenging.  Among their 
concerns are occasional GOK infringements upon contract sanctity; a 
growing tendency to "criminalize" civil disputes; what they view as 
overzealousness on the part of federal and local tax authorities, 
especially in the framework of ill-defined tax law; and difficulties 
 
ASTANA 00000277  004.2 OF 004 
 
 
in obtaining work permits for expatriate workers.  Particularly 
since the October "Tengiz brawl" (par. 8), the GOK has intensified 
its scrutiny of the hiring practices of foreign businesses. These 
concerns, while significant and worthy of our attention, should not 
overshadow the fact that foreign investment in Kazakhstan is growing 
at a healthy rate, and that the larger, multi-national corporations, 
at least, tend to find strategies for managing their legal and 
contractual risks. 
 
MILAS