Karachaganak and the Future of Petrochemical Industry in Kazakhstan

The Karachaganak gas condensate field has kept itself out of the headlines lately. That is something that its operators, the Karachaganak Petroleum Operating B.V. (KPO) surely appreciate given the negative exposure that the two other major oil and gas projects in Kazakhstan received in the recent months.

The Karachaganak field lies in northwestern Kazakhstan about 150 kilometers east from the regional capital Uralsk, and is one of the world’s largest oil and gas condensate fields. Covering an area of over 280 square kilometers, it holds more than 1.2 billion tons of oil and condensate and over 1.35 trillion cubic meters of gas.

While Karachaganak and KPO had their own share of controversy in the past, compared to the environmental difficulties of the Tengiz field operated by Chevron and the well-publicized troubles of Eni, the operator of the giant Kashagan field, the Karachaganak project can be regarded as a success story. Last week, KPO, the international consortium developing the field celebrated the 10th Anniversary of the signing of the Karachaganak Final Production Sharing Agreement (FPSA). The project itself - currently the biggest internationally funded project in Kazakhstan - has so far met deadlines and cost estimates stipulated in the FPSA, and it will exceed the planned gas production by 20 percent during the third phase of development of the field.

However, despite these successes (which certainly helped to keep off Kazakhstan’s tax police and environmental authorities), Karachaganak faces many of the same problems that all oil and gas producers, especially foreign once, are exposed to.

The main challenge is the geographic location of the field and the lack of distribution options for the natural gas extracted from the field. Due to the Russia-centric nature of the Soviet gas pipeline network, the only existing export option for Karachaganak gas is to Russia, more specifically the Orenburg Gas Processing Plant just across the border. Currently, KPO sells its gas to KazRosGas, a joint venture between Gazprom and KazMunaiGas, which in turn exports the gas to Orenburg and then to other CIS states through the Russian gas pipeline network. This arrangement leaves KPO in a vulnerable position because of the lack of any alternatives. Thus, KPO itself is unable to market its gas in Western Europe and is forced to sell its gas to KazRosGas at a significant discount to European market prices. This disadvantage has been somewhat alleviated when a new delivery price for Karachaganak gas was negotiated earlier this year at $140-145 per tcm. However, since natural gas prices in Western Europe currently stand at around $250, this arrangement is still much more advantageous for KazRosGas and especially Gazprom than for KPO.

Another challenge is the structure of the field; like the majority of Kazakh gas fields, it is a gas condensate field. Due to the lack of viable export options for gas, the focus at the development of the field has been on liquid hydrocarbons (oil and condensate) which can be exported to Western markets via the CPC pipeline (all Karachaganak partners hold shares in the pipeline). For a long time, gas was seen as a semi-useless byproduct rather than a valuable export commodity like oil. One reason for this is the above described lack of export routes for the gas; another reason is the low quality and high sulfur content of the gas that requires further purification before it can meet contractual specifications as to export quality.

KPO has responded in slowing down the development of the natural gas portion of the field and has tried to find alternate uses for the natural gas it extracts.

First, it reinjects significant quantities of gas into the ground to maintain crude wellhead pressure for liquids extraction - at this point about 6 billion m3 of gas per year. Reinjected gas can then be recovered at a later date.

Second, it uses the extracted gas as power generator for its own facilities at Karachaganak.

Third, just last week, KPO launched the construction of the Karachaganak-Uralsk pipeline that will deliver gas to the Western Kazakhstan Region (WKO). This “will reduce the WKO’s (dependence on Russian gas supply and will bring an important source of locally produced and competitively price natural gas to towns and villages”. While this deal will, without a doubt, strongly favor Kazakhstan, it should help KPO avoid or reduce the kind of attacks that other Western consortia tend to face in Kazakhstan.

Fourth, KPO sells gas to KazRosGas to export it through the Russian gas pipeline network.

The lack of export options and the low quality of the Karachaganak natural gas (and the need for further refinement) has so far made the development of the field with respect to natural gas relatively difficult.

In a new development, however, according to the Kazakh business weekly Business & Power, a meeting between the management of KPO and KazMunaiGas and the Ministry of Energy and Mineral Resources is planned for next week in London that may complicate the delicate relationship between KPO, Kazakhstan (and KazMunaiGas) and Russia (and Gazprom). In it, Kazakhstan is expected to demand from KPO the construction of a gas processing plant in Karachaganak in order to diminish the Russian influence over Kazakh gas that is prevalent today. While no details were made public, it is likely that Kazakhstan will require KPO to participate in the construction of the plant and also guarantee gas deliveries at below market prices.

It was only a few months ago, however, when Kazakhstan announced the creation of a joint venture between KazMunaiGas and the Gazprom-owned Orenburg refinery to process the Karachaganak gas at the Orenburg plant. According to the preliminary plans, KazMunaiGas was expected to invest $350 million in exchange for 50 percent of the plant and each of the partners was to contribute another $250 million to expand the capacity of the plant to process Karachaganak gas and build two pipelines from Karachaganak to Orenburg. The gas processed at the joint venture would be partially exported abroad through the Russian pipeline network and partially transported back to Kazakhstan to supply the northwestern part of the country with natural gas. While the final agreement has not been signed yet, according to sources involved in the negotiations, a conclusion seemed imminent.

Even though the timing is unexpected, the idea of having a gas processing plant at Karachaganak is not new. It has been floated several times in the past and was supported mainly by the KPO as a way to break away from the dependency of the Orenburg plant. However, according to the FPSA, Kazakhstan would face the responsibility to shoulder the greater part of costs to build the plant, and with a price tag of $1.2-1.5 billion, this would be no small venture. On the other hand, Kazakhstan would benefit tremendously from having a gas processing plant at Karachaganak. Its domestic gas infrastructure is undeveloped and neglected, and even though Kazakhstan is a net natural gas exporter, it relies on Russia and Uzbekistan to deliver gas to consumers in the north and the south of the country. In the past year, Kazakh authorities issued several statements in which they outlined the importance of developing domestic petrochemical industry and gas infrastructure to achieve self-sufficiency and to diversify its export routes.

Yet, as of now and for the foreseeable future, all gas export routes go through Russia. Kazakhstan has been playing a very delicate game of trying to promote its interests and reduce its dependence on Russia without completely alienating its powerful Western neighbor. Gazprom is unlikely to give up its influence over Karachaganak gas, though; especially since its own production is decreasing and its contractual obligation in Europe are increasing in the coming years. However, it will be interesting to observe the development of this matter. Is Kazakhstan simply trying to put pressure on Gazprom to improve its future negotiating position? Or is this indeed the beginning of a coordinated push to become more self-sufficient in providing natural gas to Kazakhstan’s population?