ANALYSIS: Oil firms’ deal with Kazakhs over Kashagan is a temporary reprieve

After more than a year of often-tense negotiations, the Kazakh government is due to finalise an agreement with the consortium developing the enormous Kashagan oilfield in September.

(more…)

Kazakhstan to revise Kashagan PSA

(SRI) - Kazakhstan will revise the Production Sharing Agreement with the consortium of oil companies developing the Kashagan field to reflect new arrangements reached last month, Kazakh Minister of Energy and Mineral Resources said on Wednesday.

(more…)

Kashagan production delayed until 2013

Production at Kashagan, the giant Caspian field developed by a consortium of oil companies, will begin in October 2013. The Kazakh government and AgipKCO, the Eni-led consortium, signed a memorandum of understanding to this effect on Friday, announced KazMunaiGas, the Kazakh national oil company and a shareholder in the project.

(more…)

Eni group may delay Kashagan oil output until 2013

Eni SpA, Italy’s largest oil company, and partners developing the Kashagan oil field in the Caspian Sea may delay production by as much as two years, the fourth postponement at the 7 billion to 9 billion-barrel discovery.

(more…)

Kashagan execs meet in Kazakhstan to advance plan

Executives from a Western oil consortium developing the Kashagan field sat down for talks with Kazakh officials on Thursday to push on with the project’s new development plan, said a source close to the talks.

(more…)

ExxonMobil Seeks a Bigger Piece of Action at Kashagan

The American oil giant ExxonMobil expressed the desire to take over as operator of the Kashagan project from the Italian Eni. According to sources in the government of Kazakhstan, this question that has been officially floated last week would need to be solved by the beginning of next year.

According to Interfax-ANI, the idea of ExxonMobil taking over the projects was first discussed by the U.S. Secretary of Energy Samuel Bodman and the Kazakh Minister for Energy and Mineral Resources Sauat Mynbayev last week at the World Energy Congress in Rome. In return for ExxonMobil winning the operatorship, the American official promised technological and financial aid in the execution of project. While there were no figures stated on what it would take for ExxonMobil to seal the deal, a compensation of up to tens of billions of dollars may not be unreasonable. This would be in line with the damages for the delay in oil production from the field repeatedly sought by the Kazakh authorities. As Dmitriy Aleksandrov, an analyst with the Russian brokerage Financial Bridge, noted in an interview with the business weekly Business and Power “the size of compensation is a question of negotiation. And if ExxonMobil takes upon itself any future financial expenses, then Astana will go with their proposal. It is clear that the sum will be in billions of dollars, and the final figure will depend on proportions of shares and conditions for the participation of all sides in the project.” The spectrum of possible outcomes is quite wide, the analyst reckons.

Of course, ExxonMobil (at that time just Mobil) vied for operatorship of the project throughout the negotiations leading to signing the Production Sharing Agreement in 1997. At that time, Eni was chosen as the operator of the field, mainly as a compromise choice for being the least contentious candidate among the companies in the consortium. ExonMobil apparently revisited this desire early in September this year when its representatives met with Prime Minister Masimov and President Nazarbayev in Astana following the Kazakh government’s announcement of its displeasure with Eni’s progress. At about the same time, the representatives of Total, the French oil company, met with Kazakh authorities as well to propose Total for the role of the operator. It is clear that these two rival bids will strengthen Kazakhstan’s negotiating position in talks with Eni, Exxon and Total about their future roles in the consortium. According to observers, however, ExxonMobil should have the upper hand in any serious negotiations given its deep pockets and the expertise of operating large-scale projects like Kashagan.

Until now, there were no public discussion on the planned increase in KazMunaiGas‘ share in the project. As Kazakh authorities indicated Kazakhstan will seek a greater involvement for the national oil company - an increased share in the project is nearly a given and a role as cooperator of the filed highly likely. According to some sources, Eni will probably give up some of its share instead of a penalty it will face as a result of the delays and cost overruns. And given that the consortium partners and the Kazakh authorities already came to a preliminary understanding of an increased share of KazMunaiGas in the consortium, it is likely that the process of redistribution has been discussed and will be completed soon.

“Technically, the change of operators is fully realistic,” emphasizes Mr. Aleksandrov. “And the conditions will be hardly unfavorable for Kazakhstan: Astana has numerous advantages in active negotiations with the Americans. For the United States, Kashagan oil is a strategic objective; therefore it is possible to try to pressure the Americans.” As far as further status of Eni is concerned, Mr Aleksandrov noted that the Central Asian market was too attractive to simply pack up and leave. “I do not think that Eni will decide to fully drop out from participation in the project, even if it is deprived of its status as operator”, recons the analyst.

Meanwhile, ExxonMobil chairman and CEO Rex Tillerson noted in the course of World Energy Congress that “the dialogue between the oil companies and the government of Kazakhstan about the participation in the development of the Kashagan field is proceeding very actively”. Answering a question from a journalist about whether the consortium partners will agree to increase KazMunaiGas’ share in the project to as that the government of Kazakhstan wants or whether they are intended simply to pay the (likely very steep) fine, Mr. Tillerson only repeated that “the negotiations go very actively in all aspects”.

Evan Feigenbau, the Deputy Assistant Secretary of State of the United States for South and Central Asia refused to elaborate on the fresh news from Rome while visiting Astana last week. “We would like the situation around Kashagan to be decided favorably for all. This sector is very important both from the point of view of the development of Kazakhstan and from the point of view of global energy “, commented Mr. Feigenbaum.

So far, both the Kazakh authorities and Eni have never suggested publicly that Eni’s position as the main operator would be seriously at risk. There has not been any reaction from either side to the latest news of ExxonMobil’s advances to gain the operator role either. And while the Energy Secretary Bodman may have lobbied on behalf of the company at the Rome energy summit, Deputy Assistant Secretary Feigenbaum’s response suggests that this was not a part of a new unified political front on behalf of the United States.

Analysis of Possible Outcomes of the Kashagan Dispute

Summary

The dispute over the development of the Kashagan field and the future of Eni as the operator of the field quickly escalated over the last month. Kazakhstan has been expressing its displeasure with Eni’s management of the project and at the same time trying to renegotiate the PSA originally signed in 1997. While some analysts compare the dispute to that over the Sakhalin II project last year when a consortium led by Shell was basically forced to give up control of the natural gas project to Russian Gazprom, I argue that the Kashagan phenomenon has to be examined rather in the context of Kazakhstan itself than in the context of resource nationalism as seen in Russia. There are two main differences between the Sakhalin and the Kashagan situations. First, Kazakhstan, due to its location and relatively small population size, has to balance the interest of its two powerful neighbors—-Russia and China–and of the United States. As it does not have the resources to develop the field on its own through the national oil company KazMunaiGas, removing the current consortium would mean ceding control to either Chinese or Russian companies which would significantly affect the equilibrium that Kazakhstan has been trying to maintain over its strategic resources. Second, it is in Kazakhstan’s best interest to have the project up and running as soon as possible, and presently the best option is to keep the current consortium and the operator in place.

Background

At the end of July, Italian Eni SpA, the operator of the Kashagan project, announced that the cost of the project would more than double, while the projected date of when commercial production was to begin would be delayed for two years until 2010. This is already the second announcement of cost overruns and delays on this notoriously difficult field. As a result, in 2005, Eni was supposedly forced to pay Kazakhstan $150 million in fines.

This time, however, it can be said with certainty that the costs for the consortium will be much higher. Various Kazakh government officials spoke about consequences ranging from fines in excess of $10 billion to an increase of Kazakhstan’s share in the PSA from 10 percent to 40 percent to removal of Eni as the operator of the field.

The dispute intensified during the month of August when Kazakhstan’s authorities accused the consortium of not following Kazakhstan’s environmental laws and fire codes. At the same time they began criminal investigation of a subsidiary of Agip KCO for tax fraud in connection with importing two helicopters. On August 27, Kazakhstan suspended all work on the field, initially for three months, citing environmental and fire safety violations. This escalation occurred just prior to the negotiations between the Agip KCO and the Kazakh government scheduled to begin this week.

Generally, Kazakhstan analysts believe that the above mentioned allegations (while possibly true) and the timing are of political nature and serve the Kazakh authorities to establish a strong negotiating positions prior to talks with the representatives of the consortium.

Allegations of Environmental Violations

As many energy analysts in the former Soviet Union pointed out, (random) enforcement of environmental and tax laws is becoming the favorite weapon to put pressure on international (Shell in Sakhalin) as well as domestic operators (Yukos). Until recently, this approach was to a greater extent limited only to Russia, but it seems that Kazakhstan has decided to use the blueprint as well.

The Kashagan field is extremely complex–it’s located several thousand meters deep under the shallow water of the northern Caspian Sea where the volatile temperatures range from -40 degrees Celsius in the winter to +40 degrees Celsius in the summer. In addition to this complexity, it is located in the complicated and endangered ecosystem of the Caspian Sea that was ravaged for years by the Soviets and again in the free-for-all years after the fall of the Soviet Union. The endangered beluga sturgeon and Caspian seal are among the species that have their home on the northern shores of the Caspian Sea.

Consequently, it is virtually guaranteed that some violations of environmental laws will take place regardless of the efforts of the operator. It is the selective application of those laws that raise questions about the intentions of Kazakh authorities. The Ministry of Environmental Protection accused Agip KCO of long-term systematic abuse of environmental codes and blamed the company for a dramatic decline in the number of certain species of fish and birds and Caspian seals. While this “environmental watchdog” did not (yet) make the claim officially, it marks a drastic turnaround from previous treatment of the issue. As late as in April 2007, when hundreds of Caspian seals washed up dead on Kazakhstan’s Caspian coast, their deaths were blamed on the unusually warm winter and not on the oil industry. As far as the Kashagan field is concerned, in 2006 the Ministry of Energy and Mineral Resources awarded Agip KCO a prize for its environmental protection program.

Kashagan vs Sakhalin

While the use of environmental protection laws as a tool for putting pressure on international oil and gas companies in Russia and Kazakhstan appear nearly identical, I believe that it would be shortsighted to compare the two directly. The method may be the same, but Russia and Kazakhstan find themselves in completely different positions when dealing with foreign investors. There are several reasons for the differences, but the three main factors are technical expertise, location and infrastructure.

When Gazprom took over the Sakhalin II project from a consortium led by Shell, many energy analysts doubted Gazprom’s ability to develop the field. In case of Kashagan, there is a near unanimous consensus that the Kazakh national oil company simply does not have the means and expertise to develop the field alone or as a sole operator of the consortium. The Kashagan project is crucial for Kazakhstan since only the development of thie field will allow the country to reach its economic agenda set by central authorities. This obviously weakens Kazakhstan’s negotiating position significantly.

Second, Kazakhstan is a landlocked country located between energy-rich Russia and energy-starved China. Russia tends to see Kazakhstan as competitor for international markets and as a potential weak point in its natural gas influence over Europe, and subsequently tries to use it for its own geopolitical objectives. China, on the other hand, sees Kazakhstan as the potential source of fuel for its enormous economic engine. So far, Kazakhstan has been very skillful in neutralizing these powers, and the continuous interest and presence of Western countries and oil companies contributed greatly to its ability to maintain its role.

Third, almost all the oil and gas pipelines transporting oil and gas from Kazakhstan to international markets go through Russian territory. In order to bring Kashagan oil to markets, new pipelines will have to be built. The presence of a Western-led consortium developing the field favors the construction of a route that will bypass Russia and will allow Kazakhstan to diversify its export routes.

Possible Outcomes

There are several possible outcomes of the current negotiations between the consortium and the Kazakh government. I would argue that it is a given that the consortium will pay a steep fine – maybe not in excess of $10 billion as suggested by the deputy finance minister Daulet Ergozhin - but significantly more than the $150 million it paid in 2005. And the PSA will be renegotiated to give Kazakhstan a bigger share of the revenues.

The real question is whether Eni will maintain its current position as the operator of the field, and if not, who will replace it. The following are possible scenarios:

1) Eni remains the only operator.
2) Eni remains the operator but KazMunaiGaz joins in at the co-operator of the project.
3) KazMunaiGaz becomes the sole operator.
4) Another member of the consortium becomes the only operator.
5) Another member of the consortium becomes the operator and KazMunaiGaz joins in at the co-operator.
6) A company from outside the consortium becomes the only operator.
7) A company from outside the consortium becomes the operator with KazMunaiGas joining as the co-operator.

While in theory all these outcomes are possible, I believe that the first, second and fifth are probable and the second most likely. The ultimate goal for Kazakhstan is to have Kashagan developed as early as possible. Therefore, I don’t believe that major changes like bringing in an operator from outside the consortium are very likely. On the other hand, Kazakhstan will likely want KazMunaiGas to take a more active role in operation of the field, if only to develop its own technical expertise. These assumptions would favor the scenario in which Eni remains the operator of the field and KazMunaiGas joins as the co-operator.

Conclusion

Throughout the hysteria over resource nationalism and the possibility that a Western company may be removed as operator of the biggest oil field outside the OPEC, it is important to keep in mind all facts:

• 1. Agip KCO was unable to honor the terms of the PSA – whether through its own fault or just because of the sheer complexity of the project. The fact that Kazakhstan wants to renegotiate the PSA and threatens the removal of Eni as operator may not be within its rights as far as the PSA goes, but from a neutral point of view is certainly understandable.
  2. Kazakhstan needs the Kashagan oil field to be developed in order to reach its own economic objectives and to be included in the prestigious club of the top ten oil producing countries in the world.
  3. Kazakhstan’s location and existing infrastructure strongly favor Russia to exert her influence. While Kazakhstan cooperates with Russia closely on many levels, it simultaneously works very hard to neutralize the influence and to diversify its oil and gas export routes. The presence of Western oil companies is absolutely necessary to reach this goal.
  4. The allegations of violations of environmental, fire safety and customs laws are clearly used selectively in order to improve Kazakhstan’s position prior to negotiation with the consortium.

These conclusions point to the outcome outlined above that Kazakhstan is unlikely to make any dramatic changes to the current status quo. Kazakhstan needs Kashagan, and Eni is still the best option as the operator of the field. Kazakhstan will also probably push for KazMunaiGas to take the role of a co-operator in order to increase the share of its revenues and also to gain technical expertise which would allow it to develop other technically challenging fields on its own.

Kazakhstan Stepping Up Pressure Over Kashagan

Last Monday, the government of Kazakhstan and Agip KCO began negotiating the conditions of the cost overruns and delays in commercial production of the giant Kashagan oil field. The goal of the negotiation that could take several weeks is the review of the production sharing agreement that was signed almost ten years ago in November of 2007. It is the second time Agip KCO announced that it could not fulfill the conditions of the PSA - this time, however, it is widely expected that the consortium will have to pay a heavier price than the $150 million in fine it was forced to pay in 2004 when the first delay in production became public. This time, it is reported, the authorities are determined to put the consortium under significant pressure and aim to seek not only a fine and a bigger share of the revenues but may also demand a new operator of the project or introduce the Kazakh national oil company KazMunaiGas as a cooperator.

At the end of July when Agip KCO first time announced the delay in commercial production, Kazakhstan energy and mineral resources minister Bakhtykozha Izmukhambetov announced that Kazakhstan will seek to increase it shares of revenues from the project from 10 percent to 40 percent. Last week on Wednesday, Kazakhstan’s prime minister Karim Masimov admitted in an interview to The Wall Street Journal that Kazakhstan may seek the removal of Eni as operator of the Kashagan project as a consequence of its failure to develop the project on the terms specified in the PSA. Mr Masimov was very sceptical about the proposed increase in costs to $136 billion; according to his statements made to The Wall Street Journal the more than twofold increase can be either a result of poor planning ot execution, or of bad intention.According to some Kazakhstani analysts, it is highly unlikely that the government will actually go ahead and replace Eni as operator of the project. It is almost certain that the government will impose a fine on the consortium and will seek a greater share of the future revenues - but a replacement of the operator would only lead to further complication and delays in commercial production. The government and Agip KCO have held an open dialogue on this topic ever since the the consortium announced the first delay in production in 2004. However, it is clear to both sides that finding and putting in place a new operator would hardly be beneficial for the whole project. In order to estabish a new operator of the field, the entire operational procedures would have to renegotiated - the timeline, budget, management… All in all, regardless of Eni’ shortcomings, if alleged or true, this far into the project there is hardly any alternative if the field is to be developed in a foreseeable future. The recent bashing by the energy minister and the prime minister of Kazakhstan can therefore be seen rather as another form of exercising pressure on the consortium than as a serious attempt to remove Eni from the project.

The other scenario that has been floated in Kazakh media is the establishment of KazMunaiGas as the cooperator of the field alongside Eni. This would give KazMunaiGas (and Kazakhstan) a greater share of the profits without having to bear the operation burden of the project. As I argued in an earlier article, KazMunaiGas does not have the necessary expertise to develop this notoriously difficult field entirely on its own; however, acting as a cooperator alongside an experienced Western company is an entirely different story.

The roots of the repeated delays could also lie in the still unresolved question of how the oil from the Kashagan field will be transported to the Western markets. Even though Kazakhstan and Azerbaijan signed a declaration of cooperation on creation of the Kazakhstan Caspian Transportation System (KCTS) as a part of the Baku-Tbilisi-Ceyhan pipeline, the construction of the Eskene-Kuryk pipeline that is to bring the oil from Kashagan to the tanker port of Kuryk and is an essential part of the project has not even begun. Besides the Eskene-Kuryk pipeline, the KCTS project consists of two tanker terminals in Turyk and in Baku and a system of tanker transportation across the Caspian. Sofar, however, KazTransOil, the Kazakh national oil transporation company, only announced a preliminary study of the project.

As it seems now, there is no final strategy on how Kashagan oil will get to the markets, especially considering that even in the best case scenario that the KCTS projet is up and running by the time Kashagan is ready to pump oil, it still would not solve the oil transport problem entirely. At the current state of affairs, only four companies of the consortium (ConacoPhiLlips, INPEX, Eni and Total) will be allowed to use the capacity of KCTS. And as the Tengiz field is also nearing its peak, by the time Kashagan is in production there will be vast quantities of oil in dire need of transport , and it seems reasonable to expect that the issue of a planned increase in capacity of the CPC pipeline and the Atyrau-Samara pipeline both of which go through Russian territory will not be solved in the near future.

As of now, the consortium has not commented on the issue besides a statement that it puts an emphasis on long-term cooperation with the Republic of Kazakhstan and will take part in talks on the future of the project scheduled for the month of August.

Kashagan and the New Great Game

The decision of the government of Kazakhstan to seek more favorable terms of the production sharing agreement to develop the Kashagan oil field seems to be the latest instance of resource nationalism in oil-producing countries. However, unlike Russia or Venezuela, Kazakhstan is unlikely to push for increased influence over the operational role in the project. Kazakhstan and the state-owned oil company KazMunaiGas have suggested that they may want to seek an increase in their share of profits from the field but they badly need the expertise of the foreign oil companies to extract oil from the notoriously difficult Kashagan field.

Background

First discovered by the Soviets more than 30 years ago, the Kashagan oilfield, named after a Kazakh poet, is a giant geological structure consisting of a huge limestone reef around 75 kilometers (km) in length and 35km wide nearly 5,000 meters (m) below the seabed in the shallows of the Kazakhstan sector of the north Caspian Sea. Temperatures in this region can fall to below minus 30°C in winter and the sea is frozen to a depth of several meters for many months each year. The whole of the landlocked Caspian Sea itself lies some 28m below sea level and although the average water depth is measured at 208m, the sea bed rises towards the north east. The Kashagan field is located 75km from Atyrau in a total water depth of just 3.7m.

Kashagan is claimed to be the largest and most challenging oilfield development project of the decade. Possibly the fifth largest in the world and the largest outside the Middle East, the Kashagan field is the most important discovery since the North Slope in Alaska and the North Sea. The vast new Caspian field has estimated reserves ranging up to 38 billion barrels with up to 50 per cent recoverable and a potential production rate of around 1.5 billion barrels per year.

The production sharing agreement between the government of Kazakhstan and the Offshore Kazakhstan International Operating Company (OKIOC) - now known as Agip KCO - has been signed in 1997 for forty years. Besides the Kashagan project, the contract encompasses three other exploration projects in the North Caspian: Kalamkas, Aktoty, and Kairan. Overall, the contract covers a territory of 5.6 thousand square meters. The consortium is made up of seven companies consisting of Eni (18.52%), Shell (18.52%) , Total (18.52%), ExxonMobil (18.52%), ConocoPhillips (9.26%), KazMunayGas (8.33%), Inpex (8.33%). The original group included BG Group instead of KazMunayGas; however BG sold its stake to the partners in 2004.

Development of Kashagan

Due to its geographical location, the Kashagan field poses enormous logistical, technical and environmental challenges for the operators. Eni faces cold winter weather, shallow waters, ice and sea-level fluctuations that require use of new technologies specifically designed for the conditions in the northern part of the Caspian Sea. The Kashagan field is the first to be developed with wells drilled offshore from artificial islands. Due to the shallow water depths, Eni has opted to site the central production complex on two man-made islands, rather than using conventional platforms. Linked by bridges, the islands not only house drilling facilities and risers, but will also be used to locate a significant proportion of the oil and gas processing facilities. While the wells are drilled in waters of 1.5-10ms (average depth of the North Caspian is 3.3ms), the drilling can reach up to 6,000ms below the seabed (average drilling depth is 4,300ms) and through a salt layer.

The high hydrogen-sulphide content of the Caspian oil and management of byproducts, such as sulphur, is another challenge not only for Eni but also for other operators of Northern Caspian oil fields. The storage of these byproducts has been a contentious issue for years, and the government of Kazakhstan and local officials have been trying to leverage the environmental concerns to put pressure on the oil field operators.

However, the main issue that indirectly caused the delays and cost overruns is the very uniqueness of the project. To industry analysts, these problems came as no surprise as the initial projected date of 2005 and estimated price of $29 billion were considered overly optimistic form the start. As a greenfield project, the time and costs needed for its development proved to be very difficult to assess, and the difficult conditions and the relative inexperience of Eni in similar types of projects further contributed to the delays.

This is also already the second announced delay in the project. In 2004, the consortium signed a deal with the Kazakh government agreeing to delay the production until 2008. At that time, this deal concluded months of uncertainty after the initial announcement when the consortium allegedly agreed to pay hundreds of millions of dollars in compensation of the delay.

Analysis

Despite the rhetoric, the government of Kazakhstan is unlikely to resort to any sort of drastic actions. Kashagan is the only giant oil field discovered in the last 30 years and as such every major oil company want a piece of action. However, they will only stay as long as the development of the field is profitable. For Kazakhstan the development of the field is much more important than for the oil companies. Kashagan is not only a source of future revenues but it is also an important political tool in the so-called New Great Game. And for that Kazakhstan desperately needs Western oil companies and their expertise.

The fears that the latest statements by Kazakhstan’s government officials imply that KazMunaiGas, the Kazakh state oil company, has been tapped to take over the project are exaggerated. KazMunaiGas simply does not have the necessary expertise to develop the field on its own. Kazakhstan will probably seek financial compensation for the delays, and may even renegotiate the terms of the contract to make it more favorable to Kazakhstan. But there is no doubt that both sides will tread very carefully as to not endanger the agreement that is already in place.

The presence of western oil companies gives President Nazerbayev the opportunity to court and play against each other the three powers struggling for influence over access to Caspian oil - the US, Russia and China. Should he overplay his hand and cause the Western oil companies to leave Kashagan and Kazakhstan, he would loose a significant bargaining chip. With Russia on the one side and China on the other, Kazakhstan would be stuck between a rock and a hard place. However, judging by Nazerbayev’s past prowess in the Caspian political game, this is unlikely to happen.

An additional problem that Kazakhstan has been facing is its reliance on Russia in bringing its oil on the world market. Kazakhstan is connected to the Russian pipeline system and besides the CTC (which also goes through Russia) it is completely dependent on the Russian pipeline operator Transneft (and subsequently on Kremlin). It has been Nazerbayev’s goal throughout his tenure as a president to change this dependency and develop new pipeline links to China and to Europe avoiding the Russian territory. However, it is extremely unlikely that additional pipelines would be built, should the Kashagan project be aborted.

Conclusion

While Kazakhstan is obviously not happy about the delay in and the rising costs of the Kashagan project, it does not have the luxury to force the consortium out of the project. The Kashagan field is simply too challenging to have KazMunaiGas develop it on its own, and at the same time too important for Kazakhstan’s economic and political stability. The government could find itself loose not only its future revenues but also any leverage among the major oil players interested in its vast untapped reserves.