Kashagan — a just settlement?

CGES | JANUARY 2008 | SOURCE: Global Oil Insight

The dust has settled, disaster has been avoided and work goes on in the North Caspian to develop the huge Kashagan oilfield.

While the newswires were humming with stories of resource nationalism and comparisons were made with the nationalisation of oil assets in Venezuela and Russia, the consortium of companies developing the Kashagan oilfield hammered out a deal with the government of Kazakhstan that was a triumph for pragmatism and allowed all sides to claim that a good result had been achieved.

Trouble surfaced after the ENI-led consortium revealed last year that the estimated cost of the first phase of development of the Kashagan oilfield had nearly doubled, from $10 bn to $19 bn, and that first production would be further delayed from 2008 to late 2010.

The government of Kazakhstan demanded substantial compensation from the consortium for lost earnings resulting from both the cost increase and the start-up delay, an increased stake for state-owned Kazmunaigaz (KMG), together with a greater say in how the field is developed, possibly through some form of joint-operatorship.

As seems to have become the norm in the FSU these days, the demands were accompanied by a barrage of accusations against the consortium.

These came from the Finance Ministry alleging tax evasion, from the Emergency Ministry alleging breaches of safety regulations and, perhaps most damagingly, from the Environment Ministry, alleging breaches of the country’s environmental protection legislation. This final allegation was accompanied by the suspension of the consortium’s environmental permit, effectively bringing to a halt development operations at the project.

While the negotiations were underway the government hinted darkly that it was prepared to resort to an undisclosed ‘Plan B’ if an amicable solution could not be reached. Deadlines passed, company CEOs and national leaders travelled to Kazakhstan and everybody put a brave face on the negotiations.

Finally, in mid-January a deal was reached that was accepted by all parties after ExxonMobil was persuaded to accept Kazakhstan’s terms to increase KMG’s stake in the project.

Under the terms of the agreement, KMG has raised its stake in the consortium developing the field to match those of the other four major shareholders (Agip, ExxonMobil, Shell and Total). To facilitate this increase all the other shareholders will reduce their stakes on a pro rata basis (see Table 1).

KMG’s additional 8.48% stake in the project will cost the company $1.78 bn, but it will not pay for this stake until production commences and will then settle its debt in three instalments. It will presumably assume its higher proportional share of the ongoing investment cost immediately.

The consortium also agreed to compensate the government of Kazakhstan for lost revenues, but reports of the amount of compensation vary. It appears that the compensation will come in the form of a one-off payment of $300 mn when first production is achieved and increased royalty payments amounting to between $2.5 bn and $4.5 bn over the first phase of the project, depending on the level of oil prices at the time.

The government of Kazakhstan has said that it has been agreed that it will receive compensation of $20 bn over the life of the Kashagan development licence, which runs to 2041, but this has not been confirmed by the consortium.

On the operational side, Agip will lose its sole-operator status, but not immediately. The Italian company will remain as operator, ‘acting under the auspices of the new operating company’, according to Kazakhstan’s Energy Minister Sauat Mynbayev, until completion of the so-called ‘experimental’ phase of the project, which should see production reaching 375,000 bpd by 2012.

Subsequent development of the field, which is expected to raise production in stages to a plateau level of 1.5 mbpd by 2020, will be undertaken by a new operating company comprising the four major foreign partners in the project.

The settlement reached by the consortium and the government of Kazakhstan has allowed both sides to put a positive spin on the outcome. The Kazakh government has increased KMG’s stake in the project and the government’s share of future revenue.

The oil companies have retained sizeable stakes in the project to develop the world’s largest oil discovery of the past 30 years and have been compensated, if not particularly generously, for the equity they have relinquished.

Losing its role as sole operator of the project will be a blow to Agip, but persistent rumours of criticism of its handling of the project from within the consortium suggest that it may have struggled to maintain this role in any case.

The oil companies will hope that their willingness to deal with the government’s complaints, combined with the larger stake now held by state-owned KMG, will secure the project an easier ride in the future. It has already secured government acceptance of yet another delay to first production, which has now been put back to late-2011.

It had earlier been suggested that the government of Kazakhstan was seeking a role for KMG as joint operator of the project, but this seems to have been dropped from the final agreement. Such a role would have made the state-owned company partly responsible for any future delays or cost increases, which — given the size and complexity of the project — appear almost inevitable.

KMG is estimated to have paid less than $1.6 per barrel of recoverable reserves for its stake in Kashagan, substantially less than the $2.7/boe paid to Shell, Mitsui and Mitsubishi by Gazprom for its 50% plus one share stake in the Sakhalin 2 project in December 2006, but far more than the $0.1/boe that Gazprom paid TNK-BP for its 62.7% stake in the 1.98 trillion m 3 of gas reserves at the Kovykta field in June 2007.

The differences in the prices paid take account, at least in part, of the investments already made in each of the projects.

The companies developing the Kashagan field have put a brave face on the agreement reached with the government, accepting, and rightly so, that the outcome could have been far worse. The project is once again moving forwards, the foreign shareholders have seen their stakes reduced by 9%, but many of the difficulties that suddenly arose last year are expected to quietly melt away.

While the agreement will be a dent in the reputation of Agip, the other major foreign investors have secured joint operatorship of subsequent development phases of the project. It remains to be seen whether this will be a good thing for Kashagan.

When deciding on a project operator in 2000, the consortium favoured the selection of a single company over the creation of a joint operating company, as will now be created for later phases of the field’s development. Agip appeared as a compromise candidate for the job after Shell, BP, ExxonMobil and Total effectively vetoed each other’s bids for the job.

It is now being penalised for delays and cost increases that were only partly under its control. In truth, mistakes were undoubtedly made, not least in agreeing to a politically motivated 2005 start-up date, which left no time for proper assessment and planning of the field’s development.

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