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 KAZAKHSTAN International Business Magazine №3, 2007
 Oil Pan: Porridge without Kashagan
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Oil Pan: Porridge without Kashagan
 
Editorial
 
Summer 2007 can hardly be described as successful for the Kazakh oil and gas sector, despite the steady growth of output and exports. On 26 July, the ENI company, acting as a single operator in the North Caspian Project, officially notified the Kazakh Energy and Mineral Resources Ministry about another postponement of the launch of industrial extraction in the Kashagan field.
 
History Repeating Itself
 
On 26 July Kazakh Energy and Mineral Resources Minister Baktykozha Izmukhambetov said that ENI had officially notified the Kazakh government about the postponement of extracting the first oil in the Kashagan field from 2008 until 2010. At the same time, the company explained this postponement by a need to conduct additional preparations in the field to ensure the safety of people who are living close to Kashagan, personnel and the environment. The former minister made public the ministry’s position: “We are starting to study the calculations on the new costs of the project to establish how sound they are. We are studying this issue to ensure environmental requirements to the fullest.”
 
This is not the first postponement of the launch of large-scale oil production at Kashagan. According to the Production Sharing Agreement, the Agip KCO international consortium, which is developing the field, was expected to start industrial extraction back in 2005. Since the provisions of the earlier signed contract had not been fulfilled by that time, the Kazakh government and the consortium held talks on the postponement. In February 2004, the sides reached accords which postponed the industrial development of Kashagan until 2007-2008. Moreover, Agip KCO had to pay a total of $150m to the country as compensation.
 
The OKIOC consortium (now Agip KCO) was set up to carry out the North Caspian Project soon after the Production Sharing Agreement was signed in 1997 for 40 years. In line with this agreement, the contract territory of the consortium includes a further three oil bearing structures – Kalamkas, Aktoty and Kayran – on top of Kashagan. In total, this is 11 offshore blocks covering an area of about 5,600 sq. km.
 
Agip KCO said that the recoverable oil reserves of Kashagan were estimated at at least 7-9 billion barrels and the total reserves at 38 billion barrels.
 
Agip KCO now includes ENI, Total, ExxonMobil and Royal Dutch/Shell with 18.52% of shares each, ConocoPhillips 9.26%, and Inpex and KazMunayGas 8.33% each.
 
And now the situation has reoccurred. Having recovered from the extremely unpleasant, though expected, news, the Kazakh government said that it might raise the issue of revising the provisions of the contract signed with ENI. “I call for approaching this issue in all seriousness and I warn through the media that we consider the change of the date on Kashagan as the change of the contract itself. Our actions will be adequate,” Kazakh Prime Minister Karim Masimov told a government meeting on 30 July. Moreover, official Astana decided to demand its share in profit production be increased from 10% to 40%, if the operator continues to insist on the postponement of the launch of the North Caspian Project.
 
Meanwhile, the management of ENI said that the postponement of the date was not on the company’s whim but a very serious objective circumstance – difficult natural and climatic conditions in the drilling zone. To back up their arguments the Italians said that the expected costs of the project would grow from $57bn to $136bn. Moreover, trying to offer a compromising solution, the head of ENI SpA, Paolo Scaroni, proposed that Kazakhstan’s share in profit production be increased from 10% to 25%.
 
However, judging by the reaction, ENI’s proposals did not satisfy the Kazakh side. On 21 August, Kazakh Environmental Protection Minister Nurlan Iskakov officially said at a government meeting that operations at Kashagan might be halted altogether. “We are auditing it now. There are all grounds to assume that the operator is not observing the requirements of environmental legislation. We have notified the Prosecutor-General’s Office about this. Moreover, taking into account the failure to fulfil obligations assumed earlier, in line with the law we should revoke the licence because continuing the operations will inflict irreparable environmental damage,” the minister said. He also said that the relevant material would be sent to the Energy and Mineral Resources, as a body authorised to decide on whether operations should be suspended.
 
According to the Environmental Protection Ministry, the main violations include the failure to observe the provisions of the mining licence, the systematic excess of quotas of emission, discharge, storage of production and domestic wastes during a number of years, as well as the failure to meet the requirements of the state environmental expert examination results on the project to develop the Kashagan field.
 
In addition, Nurlan Iskakov said that the inspection had shown that during prospecting the company had not devised environmentally friendly plans to solve the problems of utilising sulphur and was burning the waste in the sea. It has not yet prepared a detailed account on oil operations’ negative impact on the Caspian Sea’s fish stock, which is part of the contract. It does not monitor the activities of its subcontract organisations either, and this has often led to their constant violations of environmental protection legislation. The statement also said that the inspection of the company’s offshore facilities had shown that nitrogen compounds in the Caspian air exceeded permissible levels.
 
The minister also said that the Agricultural Ministry’s Fishery Committee did not rule out the link between the Agip KCO company’s activities in the contract territory and a sharp fall in the population of sturgeon fish and an increase in the en-masse deaths of Caspian seals and rare species of fish.
 
Nurlan Iskakov stressed that by its activities Agip KCO had joined the ranks of extracting companies that systematically violated the requirements of environmental protection legislation. If these violations are not corrected and the failure to comply with environmental standards and take environmental protection measures continues, the consortium’s operations in Kazakhstan, given their scale, may lead to irreversible catastrophic changes in the environment and the death of flora and fauna. Moreover, the fact that extraction is five years behind a schedule that was agreed earlier is increasing a period of a harmful environmental impact in form of pollutants.
 
For his part, Economy and Budget Planning Minister Bakhyt Sultanov told the government meeting that the delay in extraction at Kashagan might lead to significant financial gaps in the National Oil Fund.
 
From Words to Deeds
 
Having realised that verbal persuasions have had no effect on ENI’s position, the Kazakh government decided to take specific actions. As early as 27 August (precisely a month after the company announced the delay), the Environmental Protection Ministry said that as a result of environmental protection violations registered, the operations at Kashagan had been suspended for three months.
 
Nurlan Iskakov said that his ministry, putting forward these demands, was not pursuing any other aims, except for the elimination of environmental protection violations by the company: “Not all environmental protection requirements have been fulfilled, which is why we have taken such an unprecedented step.”
 
Independent experts regard Astana’s decision to suspend the operations as the beginning of a search for a new operator, especially when there will be many of those who want to come to Kashagan with its proven oil reserves of 1.5 billion tonnes.
 
However, the change of operator is a long and complicated process from both organisational and economic points of view. Conducting checks and audits that have to be carried out during this procedure, as well as confirming their results, may drag on for several months. In addition, the consortium has different members, which will create additional problems while coordinating and endorsing the candidacy of a new operator. On the other hand, there are no guarantees that potential bidders for operatorship in the North Caspian Project, having learnt the real conditions of operations, will not propose the same date of the launch of extraction as the present operator.
 
Nevertheless, every single day of mutual claims, disputes, discussions and ambiguity in the issue of an operator in the project automatically drags on the launch of commercial oil extraction. As a result, expected financial flows from oil exports are also being postponed, which is extremely disadvantageous both for Kazakhstan, as the owner of reserves, and the oil companies. In this respect, observers note that the answer to the question whether there will be a new operator at Kashagan or ENI and the Kazakh government will find another mutually-acceptable option will come very soon. It is quite possible that all problems will be solved by the winter.
 
It has not been ruled out that the role of operator will be shared between several players of the international consortium. This idea has already been put forward by the prime minister, who, on 6 September, said that the KazMunayGas national oil and gas company should become a co-operator of the North Caspian Project. However, the head of government did not elaborate whether KazMunayGas’s share would be increased as a result of possible changes of its role in the project. “Economic balance has been disturbed to the disadvantage of the Kazakh government… if the participants of the Agip KCO consortium do not agree with Kazakhstan’s demands, we have a plan B, and I will tell you about it later,” Karim Masimov stressed. He also said on 8 September that the government had estimated the damage inflicted by the postponement of oil extraction at Kashagan, but he did not specify this figure, saying that talks were still under way.
 
Official Astana made its point of view clear to foreign investors again during a meeting with ENI President Paolo Scaroni on 11-12 September. In particular, new Energy and Mineral Resources Minister Sauat Mynbayev said at this meeting: “I reiterate the Kazakh government’s adherence to the principle of stability of investment contracts. Kazakhstan is ready for an open dialogue that aims to solve the issue relating to fulfilling the Kashagan project, and I ask not to politicise our justified demands that oil companies fulfil their obligations.” In addition, he said that damage to the country’s economic interests was unacceptable and expressed concern over the systematic violations of national legislation by some foreign mining companies. “If these demands are not fulfilled, we will take all the necessary measures stipulated by our laws,” he said.
 
At the same time, the Kazakh government is against increasing the budget of the North Caspian Project. Sauat Mynbayev said that the feasibility study of the proposals, made by the contractor, carried out by an authorised body had shown that such a sharp increase in the costs and that the delay of commercial extraction would significantly damage the main economic indicators of the project compared with the project and budget for developing Kashagan, endorsed in 2004. “Collections from the project are falling and the balance of the parties’ economic interests on the Production Sharing Agreement is being disturbed,” the minister said.
 
The energy and mineral resources minister stressed that the delay of industrial extraction and the significant postponement of the period for recovering the project’s costs would considerably cut the expected growth rates of the national economy over the next decade and would undermine the implementation of long-term programmes of Kazakhstan’s economic development.
 
Karim Masimov did not conceal his concern over Kashagan at his meeting with Paolo Scaroni. He said that in line with the contract the sides still had time for friendly talks – until 22 October.
 
Let Sleeping Dogs Lie
 
Not only has the country’s executive branch expressed concern over the protracted problem of the North Caspian Project, but so have the newly-elected members of parliament’s lower house, the Mazhilis. In particular, they asked the prime minister on 12 September to clarify the situation around developing Kashagan. The chairman of the Mazhilis’s Environmental Protection Committee, Yerlan Nigmatulin, told a Mazhilis plenary session that MPs showed interest in the results of the activities of Agip KCO, all of its members, the volume of investment in the project made by foreign companies and the country’s ability to develop such field.
 
In addition, MPs asked the government whether it was studying foreign experience in dealing with dishonest companies that ignore the interests of countries they operate in. “We ask you to inform us of the results of checks by Kazakhstan’s controlling bodies and violations established. We ask to tell us about measures taken by the government to avoid damage to the country’s national interests,” Yerlan Nigmatulin said.
 
At the plenary session on the same day, a group of MPs proposed a package of amendments to the law On Subsoil and Subsoil Use. Mazhilis Deputy Valeriy Kotovich said that these amendments offered the government the right to demand that mining contracts be amended to protect Kazakhstan’s economic interests. He explained that the government would exercise this right when the activities of an oil company contradicted Kazakhstan’s economic interests and posed a threat to national security. In addition, the amendments authorise the government to define parts of resources (fields and deposits) which have strategic significance.
 
An explanatory note to the draft law On Introducing Amendments and Addenda to the Law of the Republic of Kazakhstan On Subsoil and Subsoil Use says that the amendments have been drafted to protect the country’s national interests in the mining sphere. The note also says that the amendments envisage expanding a list of grounds for revoking a mining contract by adding to Article 45-2, Point 2 of the law On Subsoil and Subsoil Use. As a result, grounds for revoking a contract are:
·  if within two months of receiving notification the oil company fails to agree to hold talks to change the provisions of the contract in writing or refuses to hold these talks;
·  if within four months of receiving the oil company’s agreement to hold talks, the parties fail to conclude an agreement;
·  if within six months of achieving a coordinated decision to restore Kazakhstan’s economic interests the parties fail to sign amendments to the provisions of the contract.
 
The initiators of these amendments believe that this approach with specifying the dates will enable investors to take the final decision within a year in total.
 
If these amendments are adopted, the government will decide which parts of resources (fields) have strategic significance in line with an addendum to Article 7 of the law On Subsoil and Subsoil Use.
 
The document also says that since the concept of revoking the contract is based on judicial procedures, a new article will be introduced to enable an authorised body to refuse unilaterally to fulfil the mining contract if there is a threat to national security as a result of the oil company’s activities.
 
“The draft law gives the retroactive force to contracts concluded earlier on developing or joint prospecting and developing fields or deposits that have strategic significance,” the explanatory note says.
 
Yerlan Nigmatulin believes that these amendments to mining legislation which increase mining companies’ responsibility are much needed. He thinks that if this law had already been in force in Kazakhstan, the situation, like the one with Agip KCO, would not have developed. “Kazakhstan is a recognised country and we should solve these issues in line with international standards,” he said.
 
Nigmatulin expressed his confidence that these amendments would not have an impact on Kazakhstan’s investment climate. “There is nothing extraordinary in proposals made by MPs because we demand only one thing: we want foreign investors operating in our country to observe our legislation,” he stressed.
 
In conclusion, MPs noted that Agip KCO’s failure to observe labour and environmental protection legislation might lead to social tension in the region.
 
Pipe to Expand
 
The shareholders of the Caspian Pipeline Consortium (CPC) approved increasing the tariff to transport oil, reducing interest rates on loans and expanding the pipeline’s capacity at a meeting in Almaty on 19 September 2007. The tariff grew to $38 a tonne and interest rates fell to 6%. In addition, the meeting decided that the document to expand the pipeline capacity would be signed by the end of 2008. However, the problem of issuing eurobonds to the tune of $5bn to restructure the consortium’s debts was not resolved.
 
The CPC operates the 1,580-km-long Tengiz-Novorossiysk oil pipeline, which links oil fields in Western Kazakhstan with the Russian Black Sea coast. It transported 31,121,000 tonnes of oil in 2006. The project plans to expand the pipeline capacity to 67 million tonnes of oil a year. However, the Russian government cast doubt on the project’s profitability and the feasibility of the scheme to fund it. In particular, Russian proposals included increasing the tariff for transporting oil and reducing interest rates on loans, provided to the consortium by oil companies to build the pipeline. The CPC made a profit for the first time in 2006. Its debts total about $5bn.
 
The CPC’s shareholders are the Russian, Kazakh and Omani governments who own 24%, 19% and 7% stakes respectively and private oil companies – Chevron Caspian Pipeline Consortium Company with 15% of shares, LUKArco B.V. 12.5%, Rosneft-Shell Caspian Ventures Limited 7.5%, Mobile Caspian Pipeline Company 7.5%, Agip International (NA) N.V. 2%, BG Overseas Holding Limited 2%, Kazakhstan Pipeline Ventures LLC 1.75% and Oryx Caspian Pipeline LLC 1.75%.
 
Oil Statistics
 
Kazakhstan extracted 36.48 million tonnes of oil and 8.18 million tonnes of gas condensate in the first eight months of 2007, up by 2.7% and 14.3%, respectively, from a year earlier. Gas output was 19.47 billion cu m in the given period (up by 13.6%). Natural gas output in gaseous state was 11.28 billion cu m (up by 19.2%), and its marketable volume totalled 5.77 billion cu m (down by 10.4%). The output of associated gas totalled 8.19 billion cu m (up by 6.7%).
 
The country produced 1,774,700 tonnes of petrol in January-August 2007, including aviation fuel (up by 19.3%). Fuel oil output fell by 29.1% to 1,595,400 tonnes, whereas kerosene output grew by 35.9% to 294,000 tonnes and gas oil output by 14.6% to 2,893,000 tonnes.
 
The National Statistics Agency said that Kazakhstan exported 36.1 million tonnes of oil and gas condensate in January-July 2007, up by 15% from a year earlier. In money terms, oil and gas condensate exports totalled $14,893.8m (up by 13.7%).
 
In addition, the country exported 2,209,500 tonnes of petroleum products in the first eight months of 2007 (16.2% up) to the tune of $732.7m (10.9% up). Petroleum products imports totalled 1,156,800 tonnes (up by 75%) worth $542.2m (a 67% rise). Kazakh natural gas exports fell to 8,462 million cu m (a 4.1% decrease) raising $350.2m (a 1.8% drop), its imports fell to 4,345.4 million cu m worth $218.6m (35.6% and 20.6% down, respectively).
 
Experts note that oil and natural gas extraction remains the most attractive sector in terms of placing investment. For example, in January-August 2007, this sector attracted 29.3% of the total investment in fixed capital, totalling 1,783.7 billion tenge. Significant part of foreign investment was placed in oil-rich Atyrau Oblast (68.2% of the total).
 
The highest growth in investment in fixed capital was in Akmola Oblast (90% up), West Kazakhstan Oblast (up by 53.3%) and Kostanay Oblast (up by 29.6%), as well as Astana (a 27.3% rise). Investment fell in oil-rich Mangistau Oblast (an 18.6% drop) and Atyrau Oblast (down by 4.3%). The reason for the fall in investment, experts suggest, is that a number of investment projects had already been completed in these regions.
 
The main sources of investment in fixed capital were economic entities’ own funds – 57.3%, and foreign investment 18.5%. Budget funds accounted for 12.6% and loans 11.6%.
 
Private enterprises made the bulk of investment – 63.3%, foreign enterprises operating in Kazakhstan invested 23.7% of the total. The public sector accounted for 13% of the total investment.
 


Table of contents
Corporate Finance: Bonds  Yerbolat Yeleshev 
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· 2010 №1  №2  №3  №4  №5/6
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· 2008 №1  №2  №3  №4  №5/6
· 2007 №1  №2  №3  №4
· 2006 №1  №2  №3  №4
· 2005 №1  №2  №3  №4
· 2004 №1  №2  №3  №4
· 2003 №1  №2  №3  №4
· 2002 №1  №2  №3  №4
· 2001 №1/2  №3/4  №5/6
· 2000 №1  №2  №3





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