Legal Risks Related to Geological Exploration in Kazakhstan

During the recent 5-7 years, the Government of Kazakhstan represented by the Ministry of Industry and Infrastructure Development has shown excellent results in improving the investment climate in the area of exploration and production of solid minerals. In particular, a significant achievement was the adoption of the Subsoil Code, which incorporates the best international practices of state regulation of the industry. The licensing regime introduced by the Code for granting the subsoil use right based on the ‘first to file’ principle deserves special attention. Clear and comprehensive requirements have been established for obtaining licenses, validity periods, the procedure for conducting subsoil use operations, reporting and obligations of a subsoil user.

Despite this, the recent years’ experience has exposed a number of legal and enforcement issues that create significant risks for investment in the exploration of new deposits of solid minerals (SM) in Kazakhstan.

1. Land Disputes of Subsoil Users – a Threat to the Exclusive Right of a Subsoil User to Extract SM

In very simple words, the essence of the licensed subsoil use regime introduced in Kazakhstan can be described as follows:

The state issues licenses for the SM exploration to interested investors. The license provides an investor with the right to explore for six consecutive years. Further, if the investor has discovered an SM deposit in a subsoil plot, which reserves and resources have been confirmed by an appraisal report, then such an investor is granted a mining license.

Geological exploration is a high-risk business. Only a small part of investment in exploration leads to the deposits discovery. It is, therefore, important for the state to guarantee as clearly and unambiguously as possible the rights of an investor in an exploration project for the subsequent extraction of what he explores and discovers. In this regard, the Subsoil Code (Article 201) provides for the fundamental right of an investor – the exclusive right of a subsoil user to obtain a mining license upon successful completion of exploration.

In recent years, a problem has arisen in the law enforcement practice of akimats of some regions that poses a threat to investment in exploration, and may call into question the state-guaranteed right of an investor to obtain a mining license.

The problem is as follows. During the exploration period, an investor does not face any particular difficulties with land issues. He only needs to get limited rights to use the land (private or public easements). Akimats give public easements for areas free from land use. Thereat, in relation to used lands, a subsoil user has the right to get private easements and, even if the land user refuses the easement, the easement can be established through the court with the determination of a reasonable fee for the right to partially use someone else’s land.

The problem, however, arises at a later stage, when an investor has already carried out exploration, ‘proved’ the SM reserves and is going to register land use rights to the area where the deposit has been discovered. If such an area is already used by another individual or legal entity, then in practice the subsoil user negotiates with the current land user to buy out his rights to the land. However, there are often cases when the land user misassesses his losses and, when calculating compensation for the area, tries to take credits of the future income of the subsoil user from mining. In such cases, the land user abuses the rights and, obviously, overestimates his rights and legitimate interests.

First, the land user has the right to use the area only for its intended purpose (for example, agricultural use, etc.). It is very important to realise that the land user does not receive the right to use the subsoil of the land plot. The subsoil use right is granted only by the competent authority (the Ministry of Industry and Infrastructure Development of the Republic of Kazakhstan and the Ministry of Energy of the Republic of Kazakhstan – for minerals (SM, oil, gas, uranium)) and akimats – for common minerals (crushed stone, sand, clay, etc.). This also involve different forms of granting land use rights and subsoil use rights. If the land use right is granted by a deed for land use right, then the subsoil use right is based on a subsoil use contract or a subsoil use license.

Practice shows cases when land users, and sometimes even local executive authorities, are mistaken in believing that the subsoil of a land plot belongs to its plot owner/land user. Pursuant to the Constitution of the Republic of Kazakhstan, the subsoil belongs to the people of Kazakhstan. The state on behalf of the people grants subsoil users the right to use these subsoil in the manner specified by law.

Second, if for some reason the subsoil user did not agree with the land user, then the legislation in any case obliges the local akimat to provide the subsoil user with a land plot, where mineral reserves have been discovered. For this, a procedure is provided for the compulsory alienation of a land plot for state needs with the payment of compensation to the respective land user. Therefore, the issue of abuse by land users of their rights in any case have a legal solution.

Akimats either not fully understand their obligations under the legislation of the Republic of Kazakhstan, or do not want to be involved in land disputes, therefore are trying to recuse from such disagreements between subsoil users and land owners.  Despite the fact that the legislation of the Republic of Kazakhstan (Land Code, Subsoil Code) directly provides for the right of local executive authorities to seize a land plot, where a deposit has been discovered, for state needs, akimats of some regions refuse to withdraw a land plot for state needs. At the same time, they refer to the fact that the state authority does not have material resources to buy out the land plots, as well as to the provisions of the Land Code and the Law of the Republic of Kazakhstan ‘On State Property’ which provide that the seizure of a land plot for state needs cannot be recognised as seizure pursuing commercial purposes of non-state legal entities.

This gives rise to an almost hopeless situation. The legislation of the Republic of Kazakhstan does not establish a mechanism (and, accordingly, a legal basis), under which a subsoil user independently (without involving the akimat) can claim from the land user the rights to the land plot belonging to the latter with the payment of compensation (as, for example, is established in relation to a private easement for exploration purposes) . It turns out that on the one hand there is a state represented by the Ministry of Industry or the Ministry of Energy, which requires the subsoil user to perform obligations for the extraction of minerals found in the subsoil (that belongs to the people of Kazakhstan and provided to the subsoil user for use). On the other hand, the same state, but represented by akimats, refuses the subsoil user to withdraw a land plot, where a mineral deposit has been discovered, for state needs.

Such refusals by akimats threaten the investment attractiveness of the country. All the time while improving the subsoil laws, the Government declared the guarantee of the rights of investors making high-risk investments in the exploration of new deposits. Currently, subsoil users who have successfully completed exploration are guaranteed by the Subsoil Code the exclusive right to obtain a mining license. De facto, however, this right is under threat, since a subsoil user cannot start mining operations without obtaining a land use right to the land plot.

If such actions of akimats become systemic, then in addition to the well-known of not discovering a deposit there will be one more investment risks in the area of exploration in Kazakhstan of not obtaining rights to a land plot and, accordingly, the risk of losing the right to extract explored minerals. In such circumstances, no rational investor would start investing in exploration, as there is no guarantee that the land on which a deposit may be discovered in the future will be unoccupied. There is also no guarantee that it will be possible to negotiate with the land user who occupied this area.

We know judicial precedents, which allow us stating that in disputes between subsoil users and akimats the courts of Kazakhstan take the position of subsoil users and conclude that the refusals by akimats to initiate a procedure for the seizure of land plots for state needs are illegal, since state needs, among other things, include the discovery and development of mineral deposits. This means that even if the subsoil user and the land user have not reached an agreement on the sale and purchase of the land, akimats are obliged to initiate the forced purchase of the land and its transfer to the subsoil user for the purposes of mineral extraction.

Given that the legal solution to this problem has already been established by law and judicial practice and, perhaps, some akimats are unintentionally misinterpret certain provisions of the legislation of the Republic of Kazakhstan (refusing subsoil users), it is proposed to consider the following:

• Arrange interdepartmental coordination between akimats and the Government (in particular, the Ministry of Industry and Infrastructure Development and the Ministry of Energy), where once a month they would consider system problems/barriers that subsoil users face in the course of work on the ground;
• As the first example of interdepartmental coordination – to fix in a protocol decision that akimats should assist subsoil users and land users in mutually beneficial resolution of the land issue. Thereat, akimats shall take into account that in case of failure (failure to reach a compromise between the subsoil user and the land user), they will have to start the procedure for the forced purchase of the land plot. This should also be realised by land users, since they may be mistaken and, therefore, misassess their rights to a land plot.

2. State’s Attempts to Impose Responsibility for Its Own Mistakes on an Investor

In practice, unfortunately, there are often situations when the outcome of bureaucracy, low efficiency of state regulation and mistakes of state authorities are laid on the subsoil user.

One example is the recent initiative to verify the legal validity of issued licenses for SM exploration. At the end of 2022, the Prime Minister ordered to form a special working group to analyse the legality of decisions to issue exploration licenses.

We note that the Subsoil Code provides for an exhaustive list of cases when a subsoil use license may be terminated at the initiative of the state.

First, this can happen via the revocation of the license, where the ground is violations committed by the subsoil user himself (failed to obtain approvals for transactions with shares/participation interests, or violated the conditions of the issued license).

Second, this can be done through the invalidation of the license in a court. This option also involves an exhaustive list of grounds on which the court may invalidate the license. In all cases, the fault of the investor must be established (providing by the investor knowingly false information, or violation of the procedure for issuing a license due to a malicious agreement between an official of a state authority and the investor).

Thus, the license can be terminated (revoked or invalidated) only because of the proved guilty actions of the investor. If there were none and the violation of the law took place exclusively on the part of the state authority, the only consequence of this can only be the responsibility of the relevant officials, rather than the investor in the form of termination of the license for subsoil use.

The fact that Kazakhstan has signed over 50 international agreements on the promotion and mutual protection of investments also deserves special attention. The agreements bind Kazakhstan to provide the investor with a fair and equitable treatment for investments, guarantees of full protection and compensation in case of expropriation of investments caused by the actions or omission of state authorities, as well as access to international arbitration when considering investor claims against the Republic of Kazakhstan. In this case, the revocation by the state of a license for subsoil use due to violations committed exclusively by state authorities (not by the investor) will be treated as the nationalisation/expropriation of the subsoil use right belonging to the investor. This, in turn, will oblige Kazakhstan to compensate the investor for the losses incurred.

With its Subsoil Code based on the Australian model of subsoil use, Kazakhstan has shown a strong commitment to the world’s best practices for attracting, facilitating and protecting investments. However, the initiatives of certain state authorities in pursuit of indicators can erode the basis of the country’s investment attractiveness. The mere illegal revocation of a subsoil use license could pose a threat to the tremendous efforts made over the past 5 years to create a favourable legal regime for investment in Kazakhstan’s exploration.

President Tokayev has repeatedly stated the need to attract investment in the exploration of solid mineral deposits. This industry can really become the next growth engine for Kazakhstan’s economy. The country has achieved some success in the oil and gas sector. At present, however, the ‘global investor’ is more interested in solid minerals, especially in ‘green’ metals. Investor demand will only grow. There will be opportunities to attract investments through the IPO of Kazakh junior exploration companies on foreign stock exchanges. Although, the success of such IPOs will depend, among other things, on country risks. If the ‘global investor’ understands that in Kazakhstan the enforcement of the investor’s subsoil use rights is ambiguous and the subsoil use license can be revoked or otherwise terminated by the state due to circumstances beyond the control of the investor, then sane investors will never be interested in investing in exploration of new deposits in Kazakhstan.

3. Insurance of Subsoil Use Consequences

On 1 March 2021, the Subsoil Code was amended to tighten the requirements for ensuring the elimination of the subsoil use consequences. The goals pursued by such changes are clearly good. In practice, however, this led to serious distortions.

Due to the fact that a standard form of an insurance contract was introduced in order to ensure the obligations to eliminate the subsoil use consequences, insurance companies, when calculating their risks and, accordingly, when calculating the insurance premium, proceed from the fact that the subsoil user will strip the land and soil layer on almost the entire territory of the exploration area. At the same time, the exploration plan, according to which the subsoil user intends to carry out exploration, is not taken into account. Thus, this led to a situation when insurance companies receive insurance premiums almost equal to the amounts of the annual investment in the exploration of solid minerals. Below is a table of insurance premium costs incurred by subsoil users and a comparison with the annual minimum exploration costs that the state requires subsoil users to invest.

The Subsoil Code provisions in this matter should take into account the staging of exploration work, the no-need in operations that involve stripping the soil and soil layer (trenches, drilling, pits, etc.) in the first years of exploration. In this regard, the calculation of the sum insured (the risk that is insured) shall be based on the content of the exploration plan. This will reduce insurance premiums and make them close to reality. Most projects start with a geophysical study of an exploration area (for example, an airborne geophysical survey of the territory from a helicopter or drone). If the first years of exploration involves only such types of work, then there are obviously no consequences of subsoil use operations and, accordingly, there is no object of insurance.

In this regard, it is proposed the Subsoil Code to provide for the possibility for the subsoil user to amend the insurance contract taking into account the content of the approved geological exploration plan. This will cut the investor’s insurance costs to a level that really reflects and insures the risks of the state. Thus, the investor will be able to invest the released funds in geological exploration studies that are more necessary for the state.

The share of metallurgy and mining in the country’s GDP was 14.1% in 2021, 17.5% of Kazakhstan’s exports come from the metallurgy industry. Thereat, the geological exploration degree of the country’s subsoil is still at a low level and ten times lower than, for example, in Australia or Canada.

The investment climate is not only well-adopted laws (which is the Subsoil Code), but also their correct application, as well as government behaviour that encourages and facilitates investment in high-risk exploration projects. There is hope that the government machine will look at the SM industry with a common unified view, because otherwise all the calls by the country to invest in Kazakhstan, guarantees for the protection of investor rights, a progressive licensing regime for subsoil use – all this will not make any sense.