Regional and Country Risk/Reward Ratings

Kazakhstan Oil & Gas Report Q2 2012
Regional and Country Risk/Reward Ratings

BMI View: BMI's Central and Eastern European Oil and Gas ratings suggest a balance between producers and consumers. Whereas the upstream ratings benefit countries with large hydrocarbon resources, vast consumer markets often enjoy better downstream infrastructure and ratings. It is worth noting that Poland and Turkey are clear outperformers, while Russia could achieve a better rating pending improvement in its business environment. Russia's dominant position in Central and Eastern Europe (CEE)s oil and gas sector has always been very significant in terms of the risks and rewards. Caspian and Central Asian countries have tried to take advantage of growing tension between Russia and its Eastern European neighbours to export their production volumes to new markets. Meanwhile, Eastern European countries, while trying to diversify their sources of supply, are also keen to develop their domestic resources, particularly in the form of shale. Russia has reacted to these attempts to undermine its dominant position by adopting a set of strategies which include: Boosting its own domestic production and opening up exploration in frontier areas such as the Arctic; Increasing its control of trade routes via the construction of new pipelines, such as Nord Stream, or by acquiring midstream operators, such as Bulgaria's Beltransgaz, and even making a bid for Ukraine's Naftogaz; Modernising and expanding its refining capacity; and Reinforcing political ties with neighbouring countries in Central Asia to avoid direct competition, while also attempting to counteract the EU's pull in Eastern Europe. The most notable aspect of this strategy is Moscow's desire to strengthen the 'Eurasian Union', which includes Kazakhstan and Bulgaria, by enlarging it to Kyrgyzstan and Tajikistan and convincing Ukraine to join in exchange for cheap gas. This uneasy and constantly shifting balance of power between countries of the CEE region has created a paradoxical ranking structure in our Risk/Reward Ratings (RRRs). Indeed, although a clear premium exists for countries with vast hydrocarbon basins and large refining capacities, some countries have attempted to compensate for their smaller resource bases by encouraging foreign investment and establishing an open business environment.
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Poland: An Unlikely Leader

Central And Eastern European Oil & Gas Risk/Reward Ratings, Scores out of 100
Source: BMI
Several themes emerge from BMI's O&G Risk/Reward Ratings for the CEE region: Poland is at the top of our regional ratings table thanks to its open business environment, vast shale resources and sturdy downstream segment. Geopolitical dynamics favour investment in Caspian and Central Asian countries. This is quantified in our upstream ratings where these areas compare favourably to Russia, yielding higher scores for production growth. Eastern European countries compensate for their relatively small hydrocarbon resources with solid downstream ratings. Russia underperforms in both the upstream and downstream due to regulatory constraints and the uncertainty inherent in foreign investment in both sectors. Turkey thanks to its favourable business environment and its strategic location emerges as the regions downstream and midstream leader.
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Caspian And Central Asian Producers Take On Russia BMI's upstream ratings are largely dominated by Central Asian and Caspian countries. This is explained by these countries' large hydrocarbon reserves and growing investment inflows, which are prompted by booming demand from European markets that want to lessen their reliance on Russian hydrocarbon imports.
Table: CEE Upstream Risk/Reward Ratings Upstream Industry Rewards Upstream Country Rewards Upstream Industry Risks Upstream Country Risk Upstream R/R Ratings
Name
Upstream Rewards
Upstream Risks*
Rank
Kazakhstan Azerbaijan Poland Turkmenistan Croatia Russia Turkey Bulgaria Ukraine Slovakia Hungary Uzbekistan Romania Czech Republic Slovenia Average
79 63 39 65 35 63 31 39 39 16 14 41 20 13 13 38
75 80 75 45 55 30 65 50 50 70 80 40 55 70 55 60
78 67 48 60 40 54 40 42 42 30 30 41 29 27 23 43
55 75 75 40 70 30 70 45 45 65 60 45 65 55 40 56
38 39 75 33 64 42 56 58 41 68 71 27 59 76 78 55
49 62 75 37 68 34 65 50 44 66 64 39 63 62 53 55
69 65 56 53 48 48 47 44 42 41 40 40 39 37 32 47
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
*Higher rating = Lower Risk Source: BMI
Kazakhstan sits at the top of the ratings table which, in light of the recent protests in the oil province of Mangystau and contested parliamentary elections, appears at first glance to be somewhat counterintuitive. However, protests have reportedly only had a limited impact on production and parliamentary elections despite questions over their democratic credentials are likely to ensure political and regulatory continuity for the sector. Consequently, we believe the government will continue to encourage foreign investment. Nonetheless, we note the downside risk to this score because of the political turbulence. The December 2011 state acquisition of a 10% stake in Karachaganak has also resolved a long-standing dispute between Astana and its foreign partners.
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Despite having the largest resource base and producing the largest volumes of oil and gas in the region, with more than 70% of the total, Russia only ranks sixth. Some measures to spur investment, such as the cut in tax rates introduced in October 2011 and the exemption from the Mineral Extraction Tax (MET) offered to Yamal LNG, have improved the business environment. However, Russia remains wary of foreign independent investment in what Moscow considers to be a 'strategic' sector, barring tie-ups with state-run companies. A high level of regulatory risk also remains, given the Russian state's willingness to muscle-in on prized assets.
Former Soviet Union Does It All

Central And Eastern European Regional Oil Production, 000b/d
Source: BMI
Poland, with only 19,000b/d and 6bcm of production output, ranks third in our table. This achievement is explained by the country's open regulatory environment which encourages foreign investment and its willingness to develop domestic shale gas resources to ease reliance on imports. With the EIA estimating that the country holds nearly 5.3tcm of technically recoverable shale gas resources, there is outstanding potential for growth for both foreign and domestic operators. Eastern Europe Holds The Top Spot In our downstream ratings, Eastern European countries enjoy higher scores. Indeed, given their small, even non-existent natural resource bases, many of these countries have taken advantage of their consumer markets to develop efficient refining sectors. Meanwhile, large producers, often impeded by small domestic markets with subsidised fuels, have failed to attract profit-oriented investors to their countries.
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Table: CEE Downstream Risk/Reward Ratings Downstre am Industry Rewards Downstream Country Rewards Downstream Industry Risks Downstream Country Risk
Name
Downstre am Rewards
Downstream Risks*
Downstre am R/R Ratings
Rank
Turkey Poland Czech Republic Russia Hungary Slovakia Ukraine Romania Bulgaria Slovenia Turkmenistan Croatia Kazakhstan Azerbaijan Uzbekistan Average
49 43 32 47 30 33 40 31 37 17 36 29 34 26 24 34
72 72 52 74 42 36 52 48 40 36 36 32 44 50 36 48
55 51 37 54 33 34 43 35 38 22 36 30 37 32 27 37
80 90 100 25 95 85 60 70 60 85 40 60 20 25 40 62
52 59 62 55 61 62 45 50 51 64 47 50 57 59 58 56
69 78 85 37 81 76 54 62 56 77 43 56 35 39 47 60
59 59 52 49 48 47 46 43 43 38 38 38 36 34 33 44
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
*Higher rating = Lower Risk Source: BMI
Turkey ranks first in our downstream league thanks to its open and dynamic business environment and its strategic location. Ideally situated on the trade routes that link Middle-Eastern, North African, Central Asian and Caspian producers to consumer markets in Europe and the Mediterranean, Turkey has been able to secure stable feedstock and develop a strong position in the midstream and downstream segments. Despite having the largest refining capacity (around 55% of the total), Russia only occupies fourth in our downstream ratings. This is somewhat disappointing for a country with such large refinery runs and export volumes. This paradox can be explained by the low margins available in the domestic market and by the hegemonic position of Russian players in the sector, leaving little room for foreign investment. Furthermore, protectionist measures, such as the imposition of a de facto gasoline export ban, create a relatively unfriendly business environment for international investors.
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Russia And The Rest

2012 Refining Capacity, 000b/d
Source: BMI
Regional Complementarities
Central And Eastern European Upstream (Left) And Downstream (Right) Risk/Reward Ratings
Source: BMI
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Kazakhstan Upstream Rating Overview

Contributing to Kazakhstans unrivalled performance in the regional upstream risk/rewards ratings (RRRs) are particularly high scores for oil and gas reserves, oil and gas production growth potential and the oil/gas reserves/production (RP) ratios. Industry privatisation achieves a below-average score, and the countrys generally unattractive risk profile provides limited investor protection.
Kazakhstan Upstream Rating Rewards

Industry Rewards: Kazakhstan is particularly strong in the areas of hydrocarbons reserves, production and domestic supply growth outlook.
Country Rewards: There is a relatively poor country rewards rating. The state has a very significant role in the ownership of upstream assets, but the industry is highly competitive.
Kazakhstan Upstream Rating Risks

Industry Risks: Kazakhstan performs relatively poorly in terms of risk. The country achieves a relatively low score for industry risks because of the complex regulatory and licensing environment, and the fact there is continuing state ownership of upstream assets.
Country Risks: Kazakhstans broader country risks environment is unattractive. The states low scores for corruption, rule of law and physical infrastructure depress its overall performance. Continuity of policy across governments reduces the operational risks for private companies.
Kazakhstan Downstream Rating Overview

Kazakhstan has a weak position in the downstream industry ratings, reflecting its modest market size, countered by the market immaturity and considerable growth potential. State influence is significant in the downstream segment, with limited competition. Kazakhstans downstream rating benefits from some low risk factors such as short-term policy continuity, short-term economic growth risk and legal framework.
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Kazakhstan Oil & Gas Report Q2 2012