Conflicting reports over whether Kazakhstan plans to buy back the minority stake in the listed upstream arm of KazMunayGas demonstrate the government’s acute dilemma over the national oil and gas company.

These reports have once again drawn attention to continuing disagreements between KazMunayGas and its London-listed production arm KazMunaiGas Exploration Production (KMG EP), as the debt-laden parent greedily eyes its subsidiary’s cash pile.

Yet any move to establish control over the listed company is potentially highly risky for Kazakhstan, which is struggling to attract investors to its ailing economy.

KazMunayGas floated about 35% of KMG EP in autumn 2006, raising over $2bn in order to fund purchases of local and foreign assets and investment projects.

In 2014 as oil prices started falling the heavily-indebted parent company tried to bring the well-heeled subsidiary under its full control by announcing plans to buy back the minority stakes.

However, authorities seem to have shelved these plans, according to the latest statement by KazMunayGas. Instead the government has started to put pressure on KMG EP by refusing to cut the mining tax on its its ageing assets and by slashing the price of the oil it is obliged to sell domestically.

This week Reuters and other international news agencies had to amend their reports that KazMunayGas plans to raise money to buy back shares held by minority shareholders.

“The issue of a buyout with a premium was discussed in 2014, for which we considered the possibility of attracting short-term financing that was to be repaid using the funds of our subsidiaries,” Reuters cited KazMunayGas in the amended article. “But now there is no need to raise funds ... The issue of a buyout and delisting [of KMG EP] is not on the agenda.”

Yet the parent company also argued that “it is not entirely logical to have two public companies in one group”, referring to government plans to privatise state-owned assets by floating 20-25% stakes when it establishes an “international financial centre” in Astana by 2018.

The Kazakhstan Stock Exchange (KASE) – where KMG EP floated its shares in 2006 in parallel to its global depository receipts (GDRs) on the London Stock Exchange – says it would be quite normal if KazMunayGas decided to go ahead with a buyback. More important, Alina Aldambergen, CEO of KASE, believes, would be the size of any buyback.

“I believe they [KazMunayGas] will prepare a public statement and explain the reason for such a buyback. Another issue is the size of the buyback because it is clear that there should be certain liquidity left for minority shareholders,” she told a news conference on April 27 in response to bne IntelliNews’s question. “When they carried out an IPO they placed at least 25% and this is a quite typical size of issuance and the issue here is how much they will reduce the share of [minority] shareholders because it is important for shareholders, both institutional and individual investors, to have an opportunity to be able to sell their shares [back].”

Resource nationalism

Heavily indebted KazMunayGas would dearly love to win back full control of it upstream arm because the latter is sitting on a pile of cash worth $3.1bn as of March 31, 2016. KMG EP has acquired a substantial cash surplus because the Kazakh government has repeatedly blocked it from acquiring assets in Kazakhstan, or from distributing dividend payments.

By contrast, KazMunayGas has accumulated significant debts because of Kazakhstan’s increasing resource nationalism. It has a mandate to invest in state-led downstream projects, including modernisation of the refining sector and launching a petrochemicals sector, as well as taking additional stakes in large expanding energy projects.

In 2015, KazMunayGas was forced to sell { http://www.intellinews.com/debt-problems-prompt-sales-of-oil-assets-in-kazakhstan-500447023/?archive=bne} half of its 16.81% stake to its own parent, the Samruk-Kazyna sovereign wealth fund, for $4.7bn in order to reduce its net debt worth $17.9bn at the end of 2014 and avoid breaching its debt covenants. It managed to bring down its debt to $10.7bn at the beginning of 2016, according to Samruk-Kazyna Managing Director Yelena Bakhmutova.

 “This bloated behemoth sees KMG EP, which is sitting on cash, albeit a diminishing pile, as an easy target,” Kate Mallinson of the London-based GPW consultancy tells bne IntelliNews. “This is now KazMunayGas’ primary motivating force for seeking to acquire KMG EP. Also, its renewed urgency to pursue a takeover of KMG EP reflects a desire to take advantage of KMG EP’s current low share price.” KMG EP’s GDRs traded at $6.65 on April 28 against $14.64 at the launch in autumn 2006.

The continuing difficulties between KazMunayGas and KMG EP have manifested themselves in a standoff between the two companies’ boards of directors. Over the last six months, under a newly proposed relationship agreement, KazMunayGas has effectively been asking KMG EP to stop behaving independently and operate solely on behalf of KazMunayGas and the Republic of Kazakhstan. “Any buy-out would therefore undoubtedly result in the removal of KMG EP's independent directors,” Mallinson believes.

Should the parent and subsidiary reach an agreement, the money to buy back minority shareholders would not be a big problem as KMG EP could use its own balance sheet to do so: this would cost approximately $1.2bn and appears “manageable”, Mallinson estimates.

“KazMunayGas could also arrange a soft loan or special financing agreement with the Chinese who are major minority shareholders. If, however, KazMunayGas does not reach an agreement with KMG EP, then Samruk-Kazyna should be able to raise the necessary funds – for example, through a bridging loan against the cash held by KMG EP –to launch a hostile takeover of KMG EP.”

Such a move would make an IPO of KMG in the longer term more likely, because the group’s structure would be simplified and its debt burden lightened.

However, KMG EP would come with costs because many of the assets are ageing. “Unless oil prices rise, there is a risk that by taking on KMG EP’s assets KazMunayGas may actually increase its medium-term burden,” Mallinson suggests.

A buy-back would also send the wrong message to other potential investors.

“The impression is that the state-controlled company is using its dominant position to squeeze the interests of minority shareholders,” Alex Nice, a Kazakhstan analyst at the Economist Intelligence Unit (EIU), tells bne IntelliNews. “This will make it more difficult for the government to conduct the planned privatisation of state assets over the next few years - not just of KMG itself but of other state assets, particularly if it intends to retain a stake in the company,” he says.