EurasiaNet Business & Economics - Oil Companies on the Defensive in Kazakhstan

BUSINESS & ECONOMICS

OIL COMPANIES ON THE DEFENSIVE IN KAZAKHSTAN
Joanna Lillis 10/10/07

Development of the Kashagan oil field appears close to getting back on track, as the Kazakhstani government and a consortium led by the Italian oil company Eni SpA make progress in settling grievances surrounding the project.

On October 8, Italian Prime Minister Romano Prodi visited Kazakhstan, and, in talks with Kazakhstani President Nursultan Nazarbayev, apparently succeeded in repairing the breach between the government and the Eni-led consortium. Kazakhstan ordered the suspension of Kashagan development operations in late August, after the consortium announced that the oil field would probably not begin pumping oil until 2010, and it would cost $136 billion overall to complete the project � more than double the original estimate. [For background see the Eurasia Insight archive].

Astana cited environmental concerns in justifying its decision to suspend operations. Officials also announced an intention to seek $10 billion in damages, and hinted darkly that they might cancel the 1997 contract. Foreign analysts believe the suspension was politically motivated, in effect a sign of the Kazakhstani government’s displeasure over the production delay and rising costs. Other participants in the Eni-led consortium include ConocoPhillips, ExxonMobil, Royal Dutch Shell, Total, Inpex and Kazakhstan’s state energy company, KazMunayGaz.

Technically, the two sides face an October 22 deadline to resolve their differences. But in the aftermath of Prodi’s visit, that timeframe appears flexible, as both sides seem interested in a negotiated solution. Eni chief Paolo Scaroni, who also was in Kazakhstan on October 8, said he expected a new deal to be in place by the end of 2007.

Rhetoric on both sides has grown less heated of late. Nazarbayev left no doubt that he wants the Eni-led consortium to remain in place. "We are not talking about revising the contract signed 10 years ago," Nazarbayev told Prodi on 8 October in remarks quoted by Kazinform state news agency. "I hope the Eni group will not go back on its words."

Prodi said he was "very happy" to receive Nazarbayev’s "assurances," the Interfax-Kazakhstan news agency reported October 9. According to some reports, Prodi urged Eni and other consortium members to redouble efforts to begin production at Kashagan before 2010.

Nazarbayev indicated that one of Kazakhstan’s chief concerns with the Kashagan delay is the impact on budget revenue. The president is intent on transforming Kazakhstan into one of the world’s 50 most competitive economies, as well as one of the top 10 oil producers, by 2015. The Kashagan delay could hurt Kazakhstan’s chances of accomplishing both these goals. [For background see the Eurasia Insight archive]. Kashagan, with estimated reserves of 13 billion barrels, is the largest oil discovery of the last 35 years.

While signaling a desire to work out existing differences, Nazarbayev held out the possibility that the consortium could face a breach-of-contract suit. "If investors violate an agreed contract, Kazakhstan reserves the right to take measures according to our domestic legislation," the Kazakhstani president said.

In the days leading up to Prodi’s visit, there were indications that the administration was softening its line. Speaking at a flagship energy conference in Almaty on October 3, Energy Minister Sauat Mynbayev said he was confident a deal could be reached without resorting to the courts. "We very much hope we will not have to apply legislative measures, and � as throughout the history of independent Kazakhstan � we will seek to resolve all problems via negotiations. � We think the interests of all sides should be taken into account," he told delegates at the annual Kazakhstan International Oil and Gas Conference (KIOGE).

Mynbayev said many grievances had been addressed, but some remained outstanding � most significantly, the consortium has not presented a plan to deal with toxic sulfur contained in the oil it extracts.

Mynbayev reiterated the government’s concerns over costs: "By 2005 all the problems that could arise were already known about. � How the costs managed to rise in 18 months from $57billion to $136 billion raises significant questions with us."

Amid continuing pressure on oil companies from Kazakhstan’s administration � which is pushing through amendments to a law on subsoil use that would allow it to revoke contracts to protect national interests � foreign oil executives used KIOGE to pursue a dual strategy of gently reminding the government that it needs outside investment to make its oil industry viable, and explaining the benefits foreign companies bring.

Umberto Carrara, the director of Agip KCO, Eni’s gas distribution wing, said the consortium employs strategies that "demonstrate the commitment to sustainable development in Kazakhstan," including health, environmental and social programs, a "state-of-the-art waste management plan," water-quality monitoring and investment in schools and hospitals. "[The consortium] operates in one of the most environmentally-sensitive areas to be found anywhere. � Environmental concerns underpin our operation," he told conference attendees.

The buzzwords among foreign executives at KIOGE were "sustainable development" and "local content" � a strategy intended to counter criticism that oil companies are the chief beneficiaries of operations. Local content signifies job creation for Kazakhstani nationals, and business for local goods and service providers. The consortium awarded almost 3,000 contracts to local companies in 2006, Carrara said.

Other oilfield operators were also on the defensive after a government announcement on October 3 that it had slapped a $609 million fine on a Chevron-led venture for environmental breaches � including storage of sulfur stocks � which it denies. TengizChevroil (TCO) � set up to develop the Tengiz oilfield and 50 percent owned by Chevron � was forced to defend its record and insist that the environment is a top priority. "Environmental excellence is one of Chevron’s and TCO’s goals," said Ted Etchison of the Eurasian Business Unit at Chevron International Exploration and Production.

Stressing the benefits to the country and local community, TCO general-director Todd Levy spoke of "a moral commitment," with a focus on maximizing local employment and capacity-building. "The message is being received by many international companies that if you want to do business with TCO, you are going to have to increase your local content," he said, adding that training Kazakhstani managers was a key company strategy. "A skills transformation is critical to the building of local content and local skills."

TCO was in the spotlight last year when a brawl broke out involving employees of a TCO subcontractor, sparked by discontent over disparities in working conditions between local and expatriate staff. [For background see the Eurasia Insight archive]. Asked what had been done to address those concerns, Levy was short on specifics, but stressed that TCO was scrutinizing employment procedures among contractors. "[There is] a focus on making sure that all of our contractors, as well as all of our employees, are paid fully in line with the labor laws and that they are paid a full and competitive salary." He was unable to specify the average salaries of local staff employed by TCO.

While oil executives defended their records, European energy envoys called on Kazakhstan to maintain a positive investment climate amid concerns that large-scale contract re-negotiations are in the offing. The country needs to ensure it remains an "attractive option" for investors, the UK’s special representative for international trade and investment, the Duke of York, said, urging the government to consider how legal amendments to the subsoil law "might impact on Kazakhstan’s reputation as a good place for investment."

Dutch energy envoy Jan-Meinte Postma followed up with a call for "openness, security, transparency and trust�, cooperation and dialogue instead of power play."

Kazakhstan accepts the needs for foreign expertise to help it extract the oil from areas that offer logistical challenges. However, indications are that Astana means business about gaining more advantageous conditions for itself.

There is a lot at stake. Kazakhstan has 3.3 percent of world’s proven hydrocarbon reserves, with recoverable oil reserves of 4.8 billion tons, Deputy Energy Minister Lyazzat Kiinov told KIOGE. Kazakhstan has set oil extraction targets of 75-80 million tons for 2010, rising to 120-130 million tons in 2015. With oil prices hovering at $80 per barrel � against a figure of 20-30 dollars per barrel when Kashagan was discovered � there are hefty profits at stake.

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