Is Nationalism a Threat to Western Oil Operations?

Kazakhstan is becoming one of the world's largest oil producers, and has had a share of regulatory issues with foreign companies. Kazakhstan has to balance the need for policy enforcement with the potential to profit from exploration and production endeavors.

Rosneft and Transneft will be using the extensive Kazakh E&P infrastructure to deliver oil from Russian oil fields to China. This is a long-term commitment that may not always include Kazakhstan as a third party due to increasing costs. In late November Kazakhstani officials cited various environmental violations against Chevron (NYSE: CVX) and Eni (NYSE: E) that put their operations at significant risk of being shut down. This bold move has come as a complete surprise and has resulted in billions of dollars paid in fines. What appears to be brinksmanship is actually based on environmentalism. It is unclear if any violations occurred. But, it is clear that the future of doing business will have to factor in the cost of protecting the environment in a nation that was the nuclear testing ground for the Soviet Union.

Where is the ROI?
Chevron has been doing business in Kazakhstan for over 20 years, playing a significant E&P role in the country. Two of the largest yielding investments are the Tengiz and Karachaganak projects.

As the largest private stakeholder in the Caspian Pipeline Consortium (CPC), it has invested over $7 billion in expansion projects to deliver crude from their Tengiz operation. This further demonstrates the commitment that Chevron has to its customers in European and Chinese markets.

Chevron has invested a lot of time and money into building opportunities in Kazakhstan with a questionable ROI. Part of the reason is the uncertainty of how policies are enforced by the government, which leads to unexpected production stoppages and fines. The seemingly capricious application of environmental laws makes doing business a lot more difficult. Kazakhstan has vast untapped resources. Yet, the cost of doing business is the problem -- that soon becomes an invisible hand making FDI (foreign direct investment) through companies like Chevron less likely.

Kazakh complications
Kazakhstan has proven to be one the more challenging places for oil companies to do business. The recent discovery of the Kashagan oilfield in the Caspian Sea has become the largest find in 40 years. Naturally, this has attracted oil majors to invest and develop this resource.

Problems with setting up the E&P for the Kashagan oil field have been ecological and administrative in nature. BBC noted that the development of the Kashagan oil field has been one the most complex oil deals ever seen. The unique ecosystem in the shallow Caspian Sea has imposed several engineering problems that have driven up costs for all the oil companies invested. One of Kazakhstan's primary concerns is that if an oil spill occurred, the unique ecosystem of the Caspian Sea would be damaged.

Since this is one of the largest oil finds in recent history, Kazakhstan has a unique leveraging point over foreign companies. It is also important to note that the Kashagan oil field is not the only opportunity for this country to develop its oil resources. The CPC depends on Kazakhstan, which also includes import and export from China to European markets. Such a leverage point could prove problematic for E&P activities.

Russia lately has started exploring other ways to get its oil to Chinese markets -- avoiding Kazakhstan. Due to existing trade agreements between Russia and Kazakhstan, the sale of oil to China has been costly for Russian companies. Instead, Russia is exploring an overland route through Mongolia using trucks and rail to transport oil to Chinese markets. Mongolia is willing to create favorable trade conditions while Kazakhstan is not.

The realities of working in Kazakhstan
Eni and Chevron are no strangers to criticism on its environmental record in Kazakhstan. In 2007 when Karim Masimov become prime minister, he vowed to enforce the rule of law over foreign oil companies. It is easy for a nation to point a finger at foreign companies and then levy a fine or a tax. This is done a lot in the oil business and has become part of the overall cost of doing business. Such practices cause a destabilizing effect within the oil industry. In Kazakhstan, this tactic, although it superficially seems to benefit the environment, in truth puts the very resources necessary to improve the environment at risk.

UNTAG reported that Kazakhstan is seeing an increase in FDI. Another way to say this is that Kazakhstan is actively courting FDI. The question remains, though, that if foreign investments occur, will they have favorable conditions to see ROI? Kazakhstan's past performance would suggest otherwise.

While poverty and lack of political cohesion plague this nation, they will not be able to sustain any internal business ventures that will be as promising as the potential that FDI offers. As a member of the Organization of Islamic Coordination (OIC), Kazakhstan has opportunities to do business with any of the 57 member nations. But, they too suffer from many of the same challenges that Kazakhstan is faced with.

If Kazakhstan is to grow as a nation and develop its resources, it will have to create favorable risk management structures that ensure FDI's return on investment.

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The article Is Nationalism a Threat to Western Oil Operations? originally appeared on Fool.com.

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