Kazakhstan: Oil Consortium Wrangles with Government Officials over Kashagan Oil Field

There is trouble is Central Asia's energy paradise. Italian energy company Eni SpA is locked in a dispute with the Kazakhstani government over the development of the Kashagan oilfield. Astana is reportedly seeking at least $10 billion in compensation for production delays and cost overruns, as well as alter terms of a production-sharing agreement.

The trouble began in June, when Eni, which heads a multi-national consortium that is developing the Kashagan field, informed Kazakhstani officials that production costs would be dramatically higher than originally envisioned. For example, the cost of the first phase of development, involving the production of about 300,000 barrels of oil per day, would double to roughly $19 billion. The company also said the overall cost of the project would balloon to $136 billion, as opposed to the initial figure of $57 billion.

The higher production costs stand to delay royalty payments into Kazakhstani government coffers. Under the production-sharing agreement (PSA), the Eni-led consortium is not obligated to make payments to Astana until development costs are recovered. This means it could be years before President Nursultan Nazarbayev's administration receives one tenge from Kashagan. As it currently stands, Kashagan is not expected to begin pumping oil until 2010.

Any delay could threaten the realization of Nazarbayev's pet project, turning Kazakhstan into one of the world's 50 most competitive economies by 2015. [For background see the Eurasia Insight archive]. In addition, officials had been counting on Kashagan output to vault Kazakhstan into the world's top 10 oil producing nations by 2015.

Kazakhstan responded to Eni's unwelcome news on August 27 by ordering a three-month suspension in Kashagan operations. Authorities cited ecological concerns as the basis for their decision, but local observers saw political and economic motives in the action. Even before the announcement of the suspension, Kazakhstani leaders were complaining about the delays and rising costs, as well as agitating for Astana to receive a higher share of the profits, up from 10 percent to 40 percent. Kazakhstani Prime Minister Karim Masimov announced that a comprehensive government statement on the Kashagan situation would be forthcoming on September 6.

In early September, government officials and Eni representatives met to discuss their differences. While company officials publicly have tried to remain upbeat about prospects for an amicable resolution of the dispute, individuals with ties to consortium members privately have expressed concern that the issues will not be so easy to resolve.

The consortium is "analyzing the [complaints] made by Kazakhstani authorities," said a source with direct knowledge of the dispute, adding that consortium members "disagree with most of them [the Kazakhstani complaints] because they are not the kind that can justify a suspension in operations."

The source added that the Eni-led consortium has already provided a detailed, point-by-point response to Astana's concerns. Another source, also with detailed knowledge of the discussions, suggested that Astana's true aim is to alter the terms of the PSA. "The goal of the Kazakhs is to put pressure on the consortium to renegotiate," the second source said. Kazakhstani officials have denied trying to use ecological issue as an instrument of pressure.

A senior manager for one of the consortium members empathized with Kazakhstan's position – but only to a certain point. The manager added that Kazakhstan had to learn to abide by the rules of market economics. "We can understand the Kazakh's position," the manager said. "They worry about their profit, which will come late, and they don't know if crude will still be sold at $70 per barrel when Kashagan starts to generate a profit for them."

"In the meantime, Kazakhs have to understand that Kashagan is a very difficult deposit to develop, and that the [costs of] oil services and steel incredibly increased these last years," the manager added. "Nobody can control that."

Peak production at the Kashagan field, located in a shallow area of Caspian Sea, is projected to reach 1.5 million barrels per day. However, before that peak is reached, the consortium must overcome unique challenges created by geological conditions. For one, Kashagan oil contains dangerously high levels of hydrogen sulfide, which can be fatal if inhaled. In addition, the shallowness of the surrounding water creates an ice-floe hazard during the winter season. "Usually, oil companies work with benchmarks on their new projects," said a representative of one of the sub-contractors involved in the project. "On Kashagan, it is impossible because we everyday have to invent new solutions."

The Kazakhstani government recently reshuffled officials involved in the discussions with the consortium, a sign that Western energy executives interpret as an expression of interest by Astana in reaching a solution.

At the same time, reports in Kazakhstan have circulated that Astana could turn to Russian oil giant LukOil to take over the project, in the event that talks with the Eni-led consortium collapse. On August 27, the same day that Kazakhstan announced the Kashagan suspension, the Russian daily Gazeta quoted a LukOil representative as saying that they conglomerate might have interest in developing Kashagan, adding that the company's involvement would "depend on the terms of the offer." Later the same day, LukOil Chairman Vagit Alekperov stressed that "no such offer has been received," the Vzglyad business daily reported.

Other members of the Kashagan consortium include Royal Dutch Shell, Exxon Mobil Corp., Total and ConocoPhillips. An Eni subsidiary, Agip Kazakhstan North Caspian Operating Co. NV, is leading development efforts.