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Power Putsch. Dale Perry and AES-Ekibastuz case study


After an armed seizure, years of criminal investigations and millions of dollars in suspicious fines, U.S. power company AES Corp. is retreating from Kazakhstan–the latest American victim of cronyism in poor, resource-rich nations.

Without warning, 24 foot soldiers of the Pavlodar Oblast Financial Police showed up, carrying AK-47 Kalashnikov automatic rifles. Their target: the Maikuben coal mine in northern Kazakhstan, owned by the American firm AES Corp. Demanding documents connected to a tax case in Kazakh courts, the troops brandished their weapons to remove AES employees and seize the mine’s administration building, according to internal AES e-mails. With no cellular service in the area, AES managers in the country struggled to communicate with their staff as the occupation dragged into a second day. They negotiated an end to the standoff with regional officials, who persuaded the goons to pull back. AES never told investors or the press about the armed takeover. Operations at the open coal pit continued, and the company got slapped with a tax fine.

That scary incident took place in June 2005–hardly the first confrontation with the Kazakhs and certainly not the last. Still, AES soldiered on. In a 12-year sojourn in the former Soviet republic, it invested at least $200 million, becoming one of Kazakhstan’s largest providers of electricity. But now, three years after the Financial Police raid and facing $200 million in potential fines, AES is largely throwing in the towel. It is closing a deal to sell its main assets in Kazakhstan for what appears to be a fire-sale price.

A $14 billion (sales) firm with headquarters in Arlington, Va., AES is in the business of supplying power, for the most part in developing countries (among them: Cameroon, Brazil, Colombia and Pakistan). So it has had plenty of experience dealing with nasty legal regimes and expropriations of foreign capital. But Kazakhstan, where it had not just contract and regulatory disputes but also the threat of criminal investigations, was too much for it.

AES’ hosing in Kazakhstan is a distressingly familiar sign of the times for U.S. and European corporations trying to do business in poor but resource-rich countries. Venezuela, Bolivia and Ecuador badly need foreign investment and know-how. Yet they’re making it tough for outsiders to make a decent return on investment. ExxonMobil has been in a tense legal standoff over frozen assets with Venezuelan President Hugo Chávez since last year. Ecuador is using its court system in an attempt to extort as much as $16 billion from Chevron as compensation for environmental damage that was caused mostly by the Ecuador national oil company after Chevron left. Russia has come to rely on spur-of-the-moment environmental laws and fines as leverage to force Western partners to sell at depressed prices. Thus was Royal Dutch Shellsqueezed out of its majority stake in the Sakhalin oil bonanza for pennies on the dollar.

Kazakhstan’s 30 billion barrels of reserves make it the world’s eleventh-largest repository of oil. This vast Central Asian nation of 15.3 million also has coal, gold and uranium. It has attracted $15 billion in U.S. money, most of it oil-related. President Nursultan Nazarbayev, a former Soviet official, has ruled with a tempered-steel grip since independence in 1991 by focusing on the economy–Kazakhstan’s GDP last year jumped 8.7%–and opening doors to outside investors. “It’s a lot easier to do business in Kazakhstan than Russia,” says a Western diplomat in the region.

But that official policy hasn’t kept authorities from hassling foreign operations. In November a regional Kazakh environmental regulator fined Chevron’s Tengiz oilfield project $310 million for alleged violations involving the improper storage of sulfur. Chevron insists it has dealt with the sulfur safely and legally, and is contesting the fine.

The Tengiz problem is a mere puddle next to the troubles at Kashagan in the remote North Caspian Sea, the world’s largest oilfield discovery in the last three decades. Citing production delays and cost overruns, and threatening new laws and fines to protect the wilderness, the Kazakh government has extracted critical concessions from Western companies developing the field. In January the chief executives of Exxon, Shell, France’s Total and Eni of Italy flew to Astana, the new northern capital decreed in 1997 and built almost from scratch. There, in a nine-hour meeting at La Rivière restaurant, the oil giants agreed to fork over $5 billion to compensate Kazakhstan for delays and potential lost revenue, and let KazMunayGas, the state oil company, double its stake in Kashagan to 17% for the bargain price of $1.8 billion.

It doesn’t stop there. Foreign firms in Kazakhstan, which pay a maximum tax rate of 30%, plus value added taxes, have come to expect frequent visits from the regional taxman. ArcelorMittal, the world’s biggest steel company, has been fighting $2.5 billion of tax claims associated with its coal- and steel-producing assets in the country. The Ministry of Finance claimed that ArcelorMittal should, among other things, be paying Kazakh taxes on the income of a subsidiary in the United Arab Emirates. ArcelorMittal says it has paid taxes in accordance with the original privatization agreement and recently won court victories in the case. (Unrelated to the tax cases, ArcelorMittal has had serious safety issues: 71 Kazakh miners have died in two accidents in the last three years.)

Houston contractor Parker Drilling has had its share of woes since building Sunkar, a barge designed to drill in the icy, shallow waters of the Caspian. Parker has spent five years defending itself against Kazakh accusations that it did not pay taxes on reimbursements for upgrading the giant barge, even though most of the modifications were completed outside Kazakhstan. Total fines: $126 million, most of which Parker passed on to its oil clients. In March Parker itself finished paying a $51 million tax bill related to Sunkar. That’s serious coin for a company that last year earned $104 million on revenue of $655 million.

Does Kazakhstan really want to lure U.S. companies? That is its paramount concern, says Galym Orazbakov, Minister of Industry & Trade. He traveled to the U.S. in December to raise funds for infrastructure projects. Since then the government has taken out an ad in the Wall Street Journal to highlight its keen interest in “deepening economic ties with the U.S.”

AES entered Kazakhstan in 1996, paying $3 million for Ekibastuz gres-I, the nation’s biggest power plant. While that may sound like a steal, the investment required a leap of faith. A relic of Soviet engineering, the coal-fired plant in northern Kazakhstan was designed to generate 4 gigawatts. At the time, it was producing less than a tenth of that. Still, AES embraced the risk, immediately buying enough coal to ensure that Ekibastuz could produce power through its first winter. The company ended up investing $200 million to increase capacity at the plant. It also purchased a nearby coal mine to stoke the plant and concessions on two hydro power producers in eastern Kazakhstan. At its peak AES produced 25% of Kazakhstan’s power.

AES executives like Dale Perry, regional director in Kazakhstan until last year, were impressed with miners who dug coal in freezing temperatures, taking quick tea breaks every other hour to warm up before venturing out for another shift. Kazakh employees always showed up for work on time, Perry recalls. With their technical abilities, they could meet any task or challenge. AES supervised 6,500 Kazakhs with only five to seven expat managers. Most customers paid on time, even in the face of rate increases as high as 20% a year to 3 cents per kilowatt-hour, still among the lowest energy prices in the world.

But AES had more than extreme weather and decrepit equipment to tangle with. Work visas for out-of-country employees were rejected. In the early days the government reneged on a $150 million electric bill. So, Perry says, AES took the government to arbitration in London. No decision was reached. But in a settlement AES won the right to move its power over government-owned transmission lines to the more lucrative Russian market.

During his time in Kazakhstan things never went smoothly for Perry, a Dartmouth graduate with degrees in engineering and Russian and a former U.S. Navy lieutenant. He simply became accustomed to shakedowns. Once, he recalls, an environmental inspector claimed that AES had stored rock and soil it had removed from its mine without proper authorization. The entire matter could be cleared up if the company bought some spare parts from the bureaucrat. AES wound up paying a $2.8 million fine instead of a bribe.

Tax auditors showed up, looking for documents that might reveal improper expense writeoffs. Perry says he was forced to show evidence he had landed in Moscow to prove he had properly expensed a $400 airplane ticket. He reserved a line item on the books for “ad hoc taxes.” A more serious problem arose in 2005 when Kazakhstan stopped granting AES access to the transmission grid that moved its electricity to Russia. AES again took the government to arbitration in London (it won in December 2007; Kazakhstan has paid an undisclosed penalty). Often Perry felt regional officials were just trying to find ways to meet their budgets. But sometimes, he says, the visits oddly coincided with calls from authorities in Astana who demanded increased amounts of power without paying more for it. He heard rumors that officials in the east were angling for a way to snatch AES’ hydro assets there. Kazakh officials claim that AES has not always lived up to its contractual obligations to upgrade plants.

In 2004 Kazakh authorities accused AES of trying to avoid paying $1.5 million in taxes by transferring funds between its units in eastern and northern Kazakhstan. Perry tried to explain that the Ekibastuz plant in the north had signed a reserve contract to guarantee electricity to AES businesses in the east for times when there was insufficient power–an insurance policy the eastern unit paid for with a fixed fee, plus variable costs, when it drew down electrons. Convinced this was a tax scam, the authorities targeted some of AES’ general directors and chief accountants who, under Kazakh law, can be held personally liable for any wrongdoing of the entities they manage. Business managers can also be placed in jail while they are under investigation, say people familiar with Kazakh law.

Three AES executives who had already left the country for routine career changes–two citizens of the U.K., one from New Zealand–were placed under investigation in connection with the tax probe. Kazakh authorities said they were wanted for questioning and threatened to alert Interpol, according to an internal AES e-mail. Ten Kazakh workers at AES were interrogated for eight hours a day over several days. They were grilled about the political affiliations of AES employees, says an internal company e-mail, and accused of being unpatriotic. “Why do you work for Americans who steal from us?” they were asked. The harsh questioning so traumatized one Kazakh accountant, says Perry, that she suffered a nervous breakdown and checked into a hospital. She and another woman were convicted in 2005 of tax evasion but were released under an amnesty. “These are personally distressing things,” says Perry, who worked to get one of the convictions overturned.

AES enlisted the help of Vice President Dick Cheney, who met in Astana with Nazarbayev in 2006. (At the press conference then, Nazarbayev commended U.S. commercial interests in his country, citing AES’ contributions.) Separately, Perry reminded Kazakh officials that AES had lost money during its early years in Kazakhstan, had paid out at least $300 million in taxes over a decade and had taken out only $200 million in profits.

Last summer AES was fined $200 million for allegedly using a trading company to inflate electricity prices in eastern Kazakhstan, in violation of an antimonoply law. In securities filings AES says it has done nothing wrong but adds that its assets in the country could be seized if it loses the appeal process and does not pay. The company disclosed that Kazakhstan initiated criminal proceedings against two of its managers, seeking $13 million from them, and that the case had been settled.

Since the investigation AES executives have had to bail out of Kazakhstan. Late last year a U.S. citizen left on holiday but did not return, fearing he’d be slapped in jail because of the antitrust case. Early this year another AES executive involved in the same case, a British citizen, fled Kazakhstan after hearing he was under criminal investigation and potentially faced prison. Both men are still working for AES–but in the U.K. Perry retired from the company earlier this year.

Imprisonment is a real threat. Mark Y. Seidenfeld, a U.S. citizen and telecom executive, served 19 months after being accused of embezzling $43,000 from the Kazakh firm he led. He had left Kazakhstan and was working in Russia when law enforcement there honored a Kazakh warrant and shipped him back on a prison train, a trip lasting 32 days. Seidenfeld says he was set up by a vengeful Kazakh minority shareholder who tried and failed to buy the company Seidenfeld ran at a big discount. “What is troubling in Kazakhstan and the former Soviet Union is it used to be taboo to imprison foreigners there on false charges,” says Seidenfeld, who was acquitted by a Kazakh judge and released last summer.

In February AES announced it was selling the Ekibastuz power plant and its coal mine for $1.1 billion and a $381 million contract to manage the assets for three years. The buyer is Kazakhmys, a mining powerhouse controlled by Vladimir Kim, a Kazakh businessman worth $4.7 billion.

Was Kazakhstan worth the trouble? The company expects to record a $900 million gain on the deal. “We believe the sale of the coal plant Ekibastuz and the coal mine of Maikuben is good for AES, Kazakhmys and Kazakhstan,” says Paul Hanrahan, AES chief executive, in a circumspect statement. Wall Street loved the deal. Merrill Lynch figured it was priced at 16 times operating income (earnings before interest, taxes, depreciation and amortization). That looks like a fantastic price, given that Consolidated Edison trades at 9 times Ebitda. But New York doesn’t have anything like the growth potential of Kazakhstan, where electricity sales per capita are one-quarter those of the U.S.

In a free market the Kazakh properties would be worth much more. A November Deutsche Bank report suggested that Ekibastuz and the mine could be worth more than $2 billion. UniCredit Aton, a Moscow investment bank, opined in February that AES was selling at as much as a 50% discount. “We believe the low price could be due to the strong pressure from the Kazakhstan government on AES,” says its report. No way, says Erlan Idrissov, the Kazakh ambassador to the U.S., who says his country “strives to provide as beneficial and liberal business climate as possible” to foreign investors.

As AES packs it in, other American companies in Kazakhstan brace for more hits. Not long ago President Nazarbayev declared that his government would take greater control of energy resources. Soon after, the environmental protection minister announced new taxes on foreign oil companies.

Source:  http://www.forbes.com/forbes/2008/0602/084.html

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