Cablegate: Karachaganak: Kazakhstan's Unsung Supergiant Oil and Gas

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OO RUEHAG RUEHAST RUEHBI RUEHCI RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW
RUEHLA RUEHLH RUEHLN RUEHLZ RUEHNEH RUEHNP RUEHPOD RUEHPW RUEHROV
RUEHSK RUEHSR RUEHVK RUEHYG
DE RUEHTA #2449/01 3460351
ZNR UUUUU ZZH
O 110351Z DEC 08
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 4087
INFO RUCNCIS/CIS COLLECTIVE 0916
RUCNCLS/SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEHBJ/AMEMBASSY BEIJING 0318
RUEHKO/AMEMBASSY TOKYO 1023
RHEBAAA/DEPT OF ENERGY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEAIIA/CIA WASHDC
RHEFAAA/DIA WASHDC
RHEHNSC/NSC WASHDC 0483
RUEKJCS/SECDEF WASHDC 0392
RUEKJCS/JOINT STAFF WASHDC
RHMFIUU/CDR USCENTCOM MACDILL AFB FL

UNCLAS SECTION 01 OF 03 ASTANA 002449

SENSITIVE
SIPDIS

STATE FOR SCA/CEN, EEB/ESC, EUR/RUS
STATE PLEASE PASS TO USTDA FOR DAN STEIN

E.O. 12958: N/A
TAGS: PGOV EPET EINV RS KZ
SUBJECT: KARACHAGANAK: KAZAKHSTAN'S UNSUNG SUPERGIANT OIL AND GAS
FIELD

REF: (A) ASTANA 2176 (B) ASTANA 1646

1. (U) Sensitive but unclassified. Not for public Internet.

2. (SBU) SUMMARY: On December 2-4, Energy Officer toured the vast
Karachaganak oil and gas field near the small town of Aksai (pop.
35,000), 40 kilometers from the Russian border in northwestern
Kazakhstan. Although less well-known than its supergiant neighbors
Tengiz and Kashagan, Karachaganak is one of the world's largest oil
and gas condensate fields and produces 49% of Kazakhstan's natural
gas and 18% of its oil. The Karachaganak Petroleum Operating BV
(KPO), co-operated by Britain's BG Group and Italy's Eni under a
40-year production sharing agreement (PSA), manages the field, which
contains 1.2 billion tons of oil and condensate and 1.35 trillion
cubic meters of natural gas. KPO's Business Governance Controller
Chris Circuit expressed concern to Energy Officer that Kazakhstan's
national oil company KazMunaiGas (KMG) would make a push in 2009 for
an equity stake in the project, which is the largest, most
profitable PSA in Kazakhstan in which KMG does not have ownership.
Field manager Tom Hanson said KPO has a "very cooperative"
relationship with Gazprom, the precursor of which initially
discovered the field in 1979 and established a symbiotic
relationship with the field that continues to this day. Constraints
on oil transportation capacity worry the consortium, particularly
with the slow pace of negotiations over the expansion of the CPC
pipeline, KPO's preferred export route. Managing Director Roger Fox
said relations with the regional government and the local population
are generally strong, although the oblast continues to levy heavy
environmental fines and at least one local newspaper regularly
accuses the company of violating environmental laws and standards.
To the residents of Aksai and Uralsk, however, KPO is an employer of
choice and a model corporate citizen known for investing in schools,
roads, and hospitals. END SUMMARY.

WILL KMG DEMAND AN EQUITY STAKE?

3. (SBU) KPO, which comprises Italy's Eni (32.5%), the United
Kingdom's BG Group (32.5%), Chevron (20%), and Russia's Lukoil
(15%), manages the Karachaganak field under a 40-year production
sharing agreement that began in 1997; BG Group and ENI alternate as
lead operators of the project. BG Group's Roger Fox is the current
managing director and will be replaced in October by a senior
manager from Eni. There is widespread concern among KPO partners
that KMG will pressure the consortium to grant it an equity stake,
particularly now that negotiations over Kashagan have concluded.
(NOTE: KMG insisted that the Kashagan partners increase KMG's
equity stake from 8.33% to 16.81% as compensation for cost overruns
and production delays. See reftel A. END NOTE). KPO's Business
Governance Controller Chris Circuit seemed resigned to the
inevitability of government ownership, telling Energy Officer,
"after Kashagan, we're next." According to Circuit, there are only
a few people in the government who can take on an issue of this
magnitude, such as KMG Vice President Maksat Idenov and Minister of
Energy and Mineral Resources Sauat Mynbayev, both of whom were
directly involved for several months in the Kashagan negotiations.
"Now that they have finished Kashagan," he said, "they will
undoubtedly continue to press us for a share. We need to stay
focused on our jobs, keep things running smoothly, and not give them
an excuse to make demands." Karachaganak is the largest, most
visible producing asset in which the government of Kazakhstan does
not have an equity stake.

OIL AND GAS PRODUCTION FIGURES

4. (SBU) Circuit was quick to emphasize that although KPO produces
49% of all natural gas in Kazakhstan, it not a gas project. "The
sole driver is to maximize liquids," he said, noting that half of
the gas produced at Karachaganak (6.6 billion cubic meters, or bcm)
is reinjected into wells to maintain pressure for pumping oil and
another 6.6 bcm is sold to Gazprom at rates as low as one-tenth the
European price. Less than 0.5% of all gas produced is flared, which
is well below the industry standard. The sprawling field covers 280
square kilometers and contains 300 wells, including 100 active wells
and 200 Soviet-era wells that KPO must plug and abandon. BG Group
alone has invested approximately $5.5 billion in the project since

ASTANA 00002449 002 OF 003

1997. There are three main operating facilities at Karachaganak:
Unit 3, the original production site established by the precursor to
Gazprom, remains the main production site, generating up to 470,000
barrels of oil equivalent per day (bpd), including condensate. Unit
2 uses groundbreaking technology -- including three powerful
compressors built by General Electric/Nuovo Pignone -- to separate
the oil from the gas and reinject the hydrogen-sulfur gas back into
producing wells. A third major facility, the Karachaganak
Processing Complex (KPC), stabilizes the oil and ships it by
pipeline 635 kilometers to Atyrau where it joins the CPC pipeline.
In November, BG Group and Eni announced they would delay Phase III
expansion, citing the capital-intensive nature of the project and
the high cost of inputs. Privately, KPO's Circuit confided that the
government of Kazakhstan was eager for KPO to continue current tax
and royalty payments, particularly in the current financial
environment, rather than allowing the consortium to make major new
capital investments that would defer royalty payments until the
costs were recovered, per the terms of the PSA.

SYMBIOTIC RELATIONSHIP WITH GAZPROM

5. (SBU) Karachaganak has a long-standing, mutually-beneficial
relationship with Gazprom. In fact, the field was originally
designed and developed by Soviet engineers in the 1980s as a single,
fully integrated facility with the Orenburg Gas Processing plant,
more than 150 kilometers to the north. To this day, according to
field manager Tom Hanson, KPO has a strong, cooperative relationship
with Gazprom, which owns the Orenburg Gas Processing Plant. (NOTE:
Former Gazprom CEO Viktor Chernomyrdin and current CEO Alexei Miller
are both former directors of the Orenburg facility. END NOTE).
Hanson said he or his staff are "on the phone every day - sometimes
several times a day" with Gazprom technicians in Orenburg and added,
"operationally, they are very easy to deal with." Hanson also noted
that all expatriate staff working at KPO have Russian visas and
senior managers travel to Orenburg and/or Moscow at least quarterly.
Hanson said he is aware of the government of Kazakhstan's desire to
build a new gas processing plant in Kazakhstan, but he is not aware
of any tangible progress.

TRANSPORTATION DILEMMA

6. (SBU) KPO exports more than seven million metric tons of oil per
year (up to 470,000 bpd) via the CPC pipeline. Company executives
are anxious for an expansion in CPC capacity, particularly once
additional production comes online under Phase III. KPO ships minor
volumes of crude via the Atyrau-Samara pipeline but prefers to use
CPC because it offers a quality guarantee and access to global
markets. Unlike Tengiz and Kashagan, KPO does not transport crude
by rail and does not own rail cars or loading facilities. KPO's
high-sulfur sour gas is transported to Orenburg, where it is
processed and sold, including to Kazakhstan. To avoid importation
of its own natural resource, the governor of the West Kazakhstan
region has pushed KPO to invest in a domestic gas processing plant
and domestic gas pipelines. KPO has resisted the former, but did
begin construction of a gas pipeline to Uralsk, which KPO's Circuit
called an "absolute nightmare" because there is no domestic network
for it to connect to.

GOOD RELATIONS WITH THE OBLAST AND LOCAL POPULATION

7. (SBU) Managing Director Roger Fox surprisingly said that, unlike
investors in Atyrau oblast, KPO has had no problem obtaining work
permits from West Kazakhstan oblast officials. He also proudly
noted that -- notwithstanding the highly-publicized environmental
fines KPO has paid -- it is the only subsoil user in Kazakhstan to
request and receive a three-year environmental permit and said that
the company recently received ISO 14001 certification for its
environmental management system, which will lead to a tax rebate in
2009. Fox praised the government's use of the "polluter pays"
principle, saying Kazakhstan is ahead of most European countries in
enforcing environmental standards. According to Fox, despite KPO's
strong environmental record, the company continues to pay fines,
particularly since the local government keeps all revenue collected
for environmental violations. In 2007, according to Fox, KPO paid
approximately $8 million in fines, while it expects to pay as much

ASTANA 00002449 003 OF 003

as $60 million in 2008, even though total emissions declined,
because the local government increased fines by a factor of 15. Fox
said that there is one "trashy newspaper" in Uralsk that regularly
criticizes KPO for alleged harm to the environment, but he noted
that it has toned down its rhetoric lately. Fox said relations with
the local population are excellent, citing KPO's multi-million
dollar investment in social projects in the region, including a
kindergarten, museum, hospital, and highway. Fox lamented that
since the oblast governor controls the allocation of KPO's social
investment funds, very little is invested in Aksai itself.

TAX AND LEGAL ISSUES AT THE NATIONAL LEVEL

8. (SBU) Commenting on the national regulatory environment, Fox
said that KPO has already paid $650 million in crude export duties
and continues to make quarterly payments -- "under duress," he
emphasized (see reftel B). As for the new Tax Code, which will
become effective January 1, 2009, Fox said that the new rent tax may
not be applicable to KPO because it has a tax stability clause,
although he wryly noted that this did not prevent the authorities
from imposing the crude export duty on KPO. Finally, Fox said that
the new requirement for parliament to ratify KPO's production
sharing agreement in order to guarantee its tax stability would
amount to "a unilateral renegotiation of the contract," which the
consortium would strongly protest.

HOAGLAND

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