Kazakhstan's Renewable Energy Quest
Astana will face a number of practical and political issues in promoting renewable energy sources.
Kazakhstan’s track record in energy is famously linked to fossil fuels. The discovery of massive reserves of oil and gas in fields such as Tengiz and Kashagan in the late 1990s and early 2000s set the stage for robust economic development in Kazakhstan after the breakup of the Soviet Union. The country is also home to abundant quantities of anthracite and bituminous coal. Indeed, some 75 percent of Kazakh electricity and heating is generated by coal plants located in close proximity to coal mines in northeast Kazakhstan.
Given these factors, it may come as news to some that Kazakhstan is also the leading proponent of renewable energy in Central Asia. The country has been home to conventional renewable energy sources (RES), primarily large hydro and geothermal projects, since the Soviet era. But in the late 2000s it began to pursue more liberal policies designed to make use of the country’s fortuitous topological conditions for the development of wind, small hydro, and solar projects.
The first meaningful step was taken in 2009 when the Kazakh government adopted a law to support the development of renewable energy projects. This first iteration was vague and lacked a strong regulatory component. Since then, however, existing legislation has been amended. Competitive feed-in-tariffs were introduced in 2013 and subsequently refined, and a Green Economy law was enacted in 2015. The Kazakh government has also set ambitious decarbonization and energy efficiency goals: it intends to make RES 50 percent of its power generation mix by 2050 and to increase energy efficiency in heavy industry, the largest source of CO2 emissions in Kazakhstan, by 3 percent annually.
Along the way, the Kazakh government has worked closely with a number of development finance institutions (DFI) such as the European Bank for Reconstruction and Development (EBRD) and the Asian Development Bank (ADB) to bring its policies in line with international standards and reduce the incidence of corruption in key sectors. This commitment to renewable energy has been welcomed by potential investors in the sector as a rational means of diversifying its energy mix and spurring economic growth. Even so, significant questions related to aging and insufficient infrastructure, a dynamic regulatory outlook, and corruption and legal risks remain. These issues must be adequately addressed if renewable energy in Kazakhstan is to take off.
Kazakh Power Infrastructure: A Brief History
The methodology and priorities of the Soviet Union are manifest in the Kazakh power system. The three power networks that constitute the grid are tied in northern Kazakhstan to the Russian power grid and in southern Kazakhstan to the United Energy System of Central Asia, a Soviet-era regional power network which promoted intraregional electricity trading as a means of offsetting seasonal electricity deficits throughout Central Asia.
However, the fall of the Soviet Union precipitated the end of this model and gave rise to one based on increased energy self-sufficiency throughout the region. Consequently, the regional electricity market has all but disappeared, as countries in Central Asia have instead chosen to prioritize new generation capacity. In Kazakhstan officials invested heavily in new thermoelectric power infrastructure as a means of meeting increased demand and promoting energy security, but did little to modernize existing generation or transmission and distribution (T&D) infrastructure. For instance, the construction of north-south transmission lines linking the country’s largest city, Almaty, to generation sources in northern Kazakhstan went some way in reducing the country’s dependence on its neighbors in the late 1990s and mid-2000s. But it failed to address entrenched efficiency issues which have only worsened in the intervening years as these lines have aged in step with the infrastructure they connect.
The consequences today are a centralized and inflexible system which is overly reliant on inefficient thermoelectric plants and T&D infrastructure that routinely registers efficiency losses of between 15 and 33 percent. Total available installed capacity falls below national energy consumption and although the country imports electricity from Russia, Kyrgyzstan, and Uzbekistan to make up for deficits, brown outs (planned blackouts) are not infrequent in Almaty or Astana, the capital of Kazakhstan.
An Evolving Electricity Market
Additional installed capacity from RES is seen as a potential panacea for electricity shortages in Kazakhstan. However, their success will depend on the modernization and expansion of T&D infrastructure as well as the development of new installed capacity. As the Kazakh government cannot meet the steep capital requirements implicit in such an effort, one might expect that institutional investors would be eager to assume a more prominent role. The reality is that grid modernization is a capital-intensive affair that has historically been an unprofitable one in Kazakhstan.
The root cause for this is political in nature. Both the tariffs imposed on industrial energy consumers and the taxes paid by residential consumers have intentionally been kept at below-cost return levels by the Kazakh government, which has subsidized the difference. While some of this can be explained by the fact that Kazakhstan’s aging generation fleet has long relied on abundant domestic quantities of cheap coal, the crux of the matter is that dramatic increases in electricity prices entailed by new capacity from RES could lead to significant unrest in a country where mean monthly wages fall below $600.
Maintaining artificially low electricity prices has come at a cost. While the country has managed to keep political unrest in check, it has driven away most investment in its power sector and led to the electricity shortages described above. There is some indication, however, that the government is beginning to take a shift to a competitive power sector seriously. In 2013, for instance, the Kazakh government introduced fixed, 15-year feed-in-tariffs (essentially, a policy mechanism which guarantees the purchase of electricity from RES at a competitive rate) for electricity generated from wind, solar, and small hydro plants as a means of guaranteeing returns to investors. These and other policies adopted between 2013 and 2015 were developed in conjunction with the EBRD to address lingering investor concerns such as mandatory connection to T&D infrastructure and the priority transmission of electricity generated from RES.
Even so, their ability to promote significant investment in the Kazakh power system is unproven at best. Most of the largest wind and solar projects developed in Kazakhstan, such as the Yereymentau wind farm in north-central Kazakhstan and the Burnoye solar power plant in southern Kazakhstan, have been financed by Kazakh state companies, the EBRD, and/or other DFIs. Renewable energy projects have failed to catalyze significant investment from institutional investors, which prioritize returns above all and have no great interest in contributing to piecemeal development of Kazakhstan’s renewables sector.
Part of this relates to the recent instability of the Kazakh tenge. The country’s shift to a floating currency in 2016 led to sharp decreases in the value of fixed tariffs, limiting potential return on investment and jeopardizing future development of RES. New tariffs, which appear to take currency risk more seriously, were introduced by the Kazakh government in April 2017 but it is still too early to gauge their effectiveness.
Operational Costs
Kazakhstan’s topography is suitable for the development of RES. More than 50 percent of the country, particularly in the country’s northern regions, has average wind speeds of between four and six meters per second, making them suitable for utility-scale wind farm development, whereas southern Kazakhstan receives consistently high levels of solar irradiation. This is meaningful, as Almaty is located in the country’s extreme south and far from the majority of Kazakhstan’s existing power generation fleet. Developing new capacity from RES in both the north and south could limit the need to transmit electricity over large distances, reduce efficiency losses and eliminate mandatory electricity imports from other states in Central Asia.
As in other countries with RES capacity, however, the locations best suited to development are in rural areas far from existing T&D infrastructure. The costs of developing new installed capacity from RES will therefore be high, and project developers will have to negotiate infrastructure development and grid connection agreements with Kazakh grid operator KEGOC, power utility Alatau Zharyk, and other federal and regional bodies. The high costs posed by development, particularly that of high-voltage grid connection, have already led to the postponement or cancellation of several otherwise promising wind energy projects in north and northwest Kazakhstan. And even when they have not, obtaining a grid connection can be a lengthy and byzantine process which, despite some improvement, still ranks poorly compared to other emerging and frontier markets with significant renewables potential.
The costs of import and transportation of components used to construct RES projects will also be higher than in other countries. This is because Kazakhstan currently lacks an indigenous manufacturing sector suited to developing specialized components used in wind turbines and has only a limited ability to develop wafers or other components used in solar panels. Developers will therefore have to assume the additional transportation and logistical costs which come with importing these components instead of producing them in-country. This puts Kazakhstan at a disadvantage vis-à-vis other potentially more attractive investment destinations like China, Uruguay, Kenya, and Zambia, which in addition to setting lofty RES development goals, have also established comparatively viable local supply chains.
Country Risks
The realization of Kazakhstan’s renewable energy potential will not be possible if corruption concerns are not adequately addressed. Poor governance, a lack of transparency, and inconsistent enforcement of legislation have long acted as deterrents to investment in the Kazakh economy, and will impact investments in RES if left unaddressed. As recently as 2016, these concerns were cited as the number one impediment to large-scale investment in Kazakhstan. The feeble amount of investment from firms in Europe and the United States bears this out. Although the countries have invested more than $30 billion in the Kazakh economy over the last 12 years, this amount is only a fraction of Kazakhstan’s investment potential.
One of the primary reasons for this is Kazakhstan’s legal framework. While robust in comparison to many other former Soviet countries, existing legislation falls short of international standards. The country’s overall investment climate is governed by a series of six laws that were implemented between 2003 and 2011, while additional power sector-specific legislation was enacted in 2004 and amended in 2009 to attract investment into the sector through a more competitive tariff system.
The country’s utilities laws set out the two primary means — government concession or direct agreement with the Kazakh Ministry of Investment and Development — by which international investors or project developers may participate in the Kazakh power sector, as well as how a company may access any existing incentives made available by the Kazakh government. The country’s general investment framework establishes statutory limits on the Kazakh government’s ability to appropriate or interfere in the operations of international companies, and sets out transparency norms for government contracting.
Between 2014 and 2015, the government enacted four additional pieces of anti-corruption legislation, which define bribery and other corruption as criminal offenses and establish standards of conduct for government officials. These measures were enacted as part of a broader governance initiative called the 100 Concrete Steps, which was designed in part to reduce the incidence of corruption and streamline government contracting processes.
The existence of this program notwithstanding, Kazakhstan ranked 131st in Transparency International’s 2016 corruption perceptions index. Irregular and inconsistent implementation of the country’s laws and regulatory norms is still widespread. Enforcement of legislation that governs energy auctions, local content requirements, and power concessions are viewed as arbitrary and non-transparent measures that tend to favor those close to the Kazakh government. The EBRD’s most recent assessment of laws that govern public-private-partnerships (PPPs) found them to be lacking in several key respects and only moderately effective.
Adding to this are tactics such as arbitrary fines and unannounced audits meant to pressure foreign companies into capitulating during a dispute or paying bribes to government officials. Recourse to international arbitration is noticeably absent from most Kazakh legislation and the judicial branch is neither independent nor particularly reliable.
Anti-corruption concerns have not, in fairness, been completely disregarded by officials in Astana. The country’s 100 Concrete Steps initiative is an example of its commitment to reducing the incidence of corruption in the country, and organizations such as the World Bank, the World Economic Forum, and the Heritage Foundation have recognized the Kazakh government’s efforts to reduce bureaucracy, streamline licensing procedures, and introduce legislation that effectively combats corruption. Kazakhstan improved in seven of the 10 categories that make up the World Bank’s most recent Doing Business index, and it ranked above Turkey, Costa Rica, and Colombia in the World Economic Forum’s 2017 Global Competitiveness index.
The Path Ahead
Kazakhstan’s promotion of RES is an ambitious move and one that could redound to a significant increase in foreign direct investment and the diversification of the country’s power generation mix. It has introduced legislation promoting RES as a generation source and worked with development finance institutions like the EBRD and the ADB to enact policy mechanisms and anti-corruption legislation to assuage investor concerns and bring its legal framework into line with international standards.
The success of the sector is not guaranteed, however, and it will almost certainly face obstacles that threaten to derail its development. Many of these are legacy issues related to the country’s Soviet-past and post-independency emphasis on energy self-sufficiency, and will therefore be difficult to address. Even so, the country has charted a potentially auspicious path forward. It must persist down this path if the development of renewables in Kazakhstan is to be a success.
By Eric Wheeler
Eric Wheeler is a senior associate at The Risk Advisory Group, a global risk management consultancy headquartered in London.
