Central Asia Needs A Financing Solution To Low Oil Prices

The ongoing slide in global oil prices – catalyzed by the novel Coronavirus and fueled by structural issues including excess supply from oil giants like the U.S., Russia and Saudi Arabia, and slowing demand growth – is creating a new imperative for hydrocarbon revenue-dependent states to diversify their economies. This is particularly true for the oil and gas- producing nations of Central Asia led by Kazakhstan, Turkmenistan, and Uzbekistan, who are reliant on fossil fuel revenues to balance their budgets.

This could be the start of a new trend for so-called petrostates, exacerbated by increasingly cost competitive-renewable technologies. Solar, wind, and electric cars are eating into the market share of conventional fuel sources both for transportation and power generation. We are now seeing the beginnings of adoption of green tech throughout the historically fossil-fuel-reliant Central Asia region.

On market open at 9:30 am Monday March 16, WTI Crude was down 8.38% at $29.07, while Brent Crude dropped nearly 10% to $31.92. Border closures in Europe and global travel bans – include those announced by the United States – have brought oil prices to lows not seen since the doldrums of 2016.

What’s more, Q1 of this year is on pace to register the largest drop in oil demand ever seen – upwards of 4 million barrels per day (bpd) – which could lead to a crude glut of 5 to 10 million bpd by May. $20 oil may be on the horizon, which could be devastating to the economies of oil and gas revenue dependent states.

Economic Diversification Is the Way Forward

Oil producing countries, including Saudi Arabia, have been talking – and doing – a lot, as they recognize the looming dangers of hydrocarbon dependency. Suffice to mention Prince Mohammad bin Salman’s 2030 Program, and efforts in United Arab Emirates and Qatar to diversify into media and finances. Central Asia’s record is more mixed that the Gulf’s.

Kazakhstan, the wealthiest country in Central Asia, is an ideal candidate for an economic diversification in the face of falling oil prices and the rising viability of renewables. The country is home to the 11th largest oil reserves in the world. Energy revenues account for almost half of its GDP, and extractive industries are the primary beneficiary of foreign direct investment. But the landlocked country also boasts some of the highest wind potential on the planet, with moderate solar coverage as well.

But right now, most of the investment in Kazakhstan goes to extractive industries, including coal, oil, and natural gas industries (49.5%) and metal industries (14.6%). Coal-fired power plants generate about two-thirds of Kazakhstan’s electricity, while natural gas (21%), hydroelectric power (11%), and oil (2%) constitute approximately the rest. The renewable energy sector attracts only 2.2%, a small percentage of overall FDI flows. Solar and wind power jointly accounted only for 2% of electricity in 2016.

Nevertheless, Kazakhstan has made substantial commitments to the green economy through multiple policies, programs, action plans, and public statements on both international and domestic levels. It has been a party to a range of international tools, including the UN Framework Convention on Climate Change (the mid-1990s), Kyoto Protocol (2009), and Paris Agreement (2016). It is a member of the Green Bridge Partnership Program, which aims to promote cross-border partnerships for the green economy in both private and public sectors.

Domestically, Kazakhstan became the first country in Central Asia to build an institutional foundation for green growth through the adoption of key legislative pieces, including the Environmental Code (2007), the Law on Support for the Use of Renewable Energy (2009), the Concept for the Transition to Green Energy (2013). The Concept established important and ambitious targets for renewable energy’s share of electric power: from the current 2% to 30% in 2030 to 50% in 2050.

The country is attempting to evolve beyond its current model of raw materials production and exports model to one of raw materials processing and added value, development of services, and high added value, high-tech, Investment and financial services.

Financing the Green Transition Through Domestic Investment Vehicles

To meet these challenges the Astana International Financial Center (AIFC) opened its doors in 2018. Central Asia’s first state-of-the-art financial institution aims to uphold the government’s commitment to sustainable development and catalyze the transformation to more renewable energy sources.

“The AIFC was created as a regional financial hub, to connect investors with promising projects that require financing to realize their full potential” says AIFC Governor Kairat Kelimbetov.

The Center uses English law applied to both business transactions and adjudication. Recognizing the importance of high-quality dispute resolution services, AIFC has put leading UK jurists to helm the court and arbitration tribunal operated by the Center.

Kazakhstan’s homegrown financial institution aims to provide assistance in attracting investments into the country's economy by creating a business-friendly environment for financial services, developing the securities market of Kazakhstan, and ensuring its integration with international capital markets. AIFC also intends to develop the markets of insurance, banking services as well as the market of Islamic finance.

At its inception the AIFC launched the Green Finance Center, which aspires to become a future platform for green investment. The center assists the government and collaborates with a wide range of stakeholders, including issuers and investors, to prepare for the issuance of Kazakhstan’s first green bonds and green sukuks (Islamic bonds) on the AIFC Exchange trading platform.

The Persistent Role of International Institutions

In the past, the London stock exchange played the role of financial intermediator in the region. For a variety of reasons, this may not be the optimal financial market for this region, both because of the tightening regulatory environment, and because the lack of familiarity of the capital managers there with the region.

As such, the AIFC is courting regional partners like the Shanghai Stock Exchange – a 25% shareholder in Kazakhstan’s new Astana International Exchange (AIX)  – in order to strategically position itself as East Asia’s financial gateway to Europe and the Middle East.

In addition, the AIFC has requested European Bank for Reconstruction and Development (EBRD) to aid in developing its Green Financial Center. The institution helps the Center with both conceptual development and capacity building of the aspiring green finance hub.

The EBRD is the largest investor in Kazakhstan’s green economy that has invested a total of over USD 8.85 billion through 254 projects, including schemes to switch from coal to renewables and provision of clean energy public transportation within cities. It has been a part of Kazakhstan’s largest solar (Burnoye Solar Plant), wind (Yereymentau Wind Farm) as well as the Kazakhstan Renewable Energy Financing projects. The projects resulted in 10% energy savings and reduced greenhouse gas emissions by nearly 4,000 tons per year. In 2018, the European Bank promised to invest further USD 244 million in renewable energy in the country, including 52 new facilities to be built by 2020.

But over-reliance on international institutions like the EBRD, World Bank, and the Green Climate Fund can be risky. Homegrown financial markets such as AIFC are absolutely crucial for the region’s development, diversification, and in case of Kazakhstan, evading the middle income trap.

With assistance from James Grant and Raushan Zhandayeva