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Cablegate: Kazakhstan: Behind the Scenes of Karachaganak And

VZCZCXRO5046
OO RUEHIK
DE RUEHTA #0061/01 0220932
ZNR UUUUU ZZH
O 220932Z JAN 10
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 7245
INFO RUCNCIS/CIS COLLECTIVE 2385
RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEHBJ/AMEMBASSY BEIJING 1747
RUEHKO/AMEMBASSY TOKYO 2453
RUEHUL/AMEMBASSY SEOUL 1363
RHMFISS/DEPT OF ENERGY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEAIIA/CIA WASHDC
RHEFAAA/DIA WASHDC
RHEHNSC/NSC WASHDC 1943
RUEKJCS/SECDEF WASHDC 1793
RUEKJCS/JOINT STAFF WASHDC
RHMFIUU/CDR USCENTCOM MACDILL AFB FL
RUEHAST/AMCONSUL ALMATY 2209

UNCLAS SECTION 01 OF 04 ASTANA 000061

SENSITIVE
SIPDIS

STATE FOR SCA/CEN, EEB/ESC, S/EEE, S/CIEA
STATE PLEASE PASS TO USTDA

E.O. 12958: N/A
TAGS: PGOV PREL ECON EINV EPET SOCI RS KZ
SUBJECT: KAZAKHSTAN: BEHIND THE SCENES OF KARACHAGANAK AND
KASHAGAN

REF: (A) 08 ASTANA 2449
(B) 08 ASTANA 1646
(C) 09 ASTANA 0041
(D) 09 ASTANA 0352

ASTANA 00000061 001.3 OF 004


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

2. (SBU) SUMMARY: For more than 90 minutes on January 20, Maksat
Idenov, First Vice President of national oil company KazMunaiGas
(KMG), briefed the Ambassador on the ongoing dispute between
shareholders in the Karachaganak Petroleum Operating Company (KPO)
and KMG. In September 2009, KPO filed a claim at an international
arbitration court in Stockholm for $1.4 billion for reimbursement of
crude export duty payments. Speaking without notes -- but with
passion and conviction -- Idenov argued the government's case that
KPO has not provided sufficient justification or supporting
documentation for major expenditures since 2003. He said the
government has filed a counter-claim for $3 billion. Unable to
reach agreement at the level of corporate senior executive vice
president, Idenov stated that the parties have begun talks at the
level of corporate CEO. The case is scheduled to go to arbitration
on March 21. Idenov also summarized budget negotiations for the
massive, $150 billion Kashagan oil-exploration project. In both
cases, Idenov underlined that he only is asking international
companies to follow fundamental principles of good business
management. END SUMMARY.

BACKGROUND ON KARACHAGANAK

3. (U) KPO comprises Britain's BG Group (32.5%), Italy's ENI
(32.5%), Chevron (20%), and Russia's Lukoil (15%). One of the
largest oil and gas condensate fields in the world, with reserves
estimated at 1.2 billion tons of oil and 1.34 trillion cubic meters
of gas, it is the only significant oil exploration project in
Kazakhstan in which KMG does not have an equity stake (ref A).

4. (U) On September 18, 2009, Bloomberg reported that BG Group, as
the lead operator, initiated arbitration proceedings to seek
reimbursement of $1 billion for oil export customs duty payments
made from June 2008-January 26, 2009, when the government lowered
the crude export duty to zero (ref B). On December 29, 2009, Prime
Minister Karim Masimov told reporters that Kazakhstan wants to join
the Karachaganak project as an equity partner, reportedly with a 10%
stake. (NOTE: According to Idenov, the consortium claims $1.4
billion while the government had filed a counter-claim for more than
$3 billion. When asked to comment on reports that KMG has requested
10% of KPO, Idenov confirmed Masimov's statement, but concluded,
"You never know how an arbitration case will play out." END NOTE).


IDENOV IN THE LEAD

5. (SBU) Contrary to reports from ExxonMobil, which is not a member
of the KPO consortium, Idenov has retained the Karachangank
portfolio and is the government's lead negotiator on the dispute
(ref C). He told the Ambassador that he met in London on January 11
with executive vice presidents from the KPO shareholders, but they
were unable to reach an accord. As a result, Idenov said he will
appeal to the companies' CEOs in an attempt to resolve the dispute.
He implied that both sides are working in good faith to reach a
negotiated settlement before the case goes to an international
arbitration court in Stockholm on March 21.

SHOW ME THE RECEIPTS

6. (SBU) Idenov told the Ambassador that KPO has submitted requests
for reimbursement of hundreds of millions of dollars in expenses
from 2003-2008, without proper justification or supporting
documentation. Launching into his brief, he jumped to a white board
and began to make his case in graphic detail without the aid of
notes. According to Idenov, KMG retained the audit firm KPMG to

ASTANA 00000061 002.3 OF 004


review KPO's 2003-2006 statements and discovered that KMG reimbursed
KPO for $697 million during that period, without proper supporting
documentation. He also asserted that the audit firm Ernst and Young
reviewed KPO's statements from 2007-2008 and could not justify $347
million in expenses. Idenov told the Ambassador that when he
presented this information to KPO executives, they replied, "All
right, Maksat, we'll write you a check for that amount and just
recover those costs later." Idenov said he refused to do business
that way, and would pursue the matter further.

HIGH STAKES

7. (SBU) Idenov described in detail several situations dating to
2002, where -- in his opinion -- KPO management made unwise
decisions that cost KPO's shareholders dearly. (NOTE: Although KMG
does not own equity in KPO, Idenov considers KMG, as the authorized
agent of the Republic of Kazakhstan, a shareholder in the project.
END NOTE.)

-- In 2002, he said that President Nazarbayev attended the
inauguration of a major new gas processing plant. "There was a red
ribbon and big scissors, and smiles all around," he described. One
week later, according to Idenov, a gas leak due to poor quality
welding forced the plant to shut down and evacuate employees. The
plant remained idle for one year, "and the shareholders suffered,"
Idenov concluded.

-- Also in 2002, the Atyrau-Bolshoi Shagan pipeline became plugged
by caustic soda, because KPO pumped unprocessed condensate through
the pipeline. Idenov asserted that KPO cut off the damaged segments
and rebuilt the pipeline at a cost of $600 million.

-- In 2006, KPO's "Train 4," a processing unit that separates gas
from liquids, was estimated to cost $467 million to build. Idenov
said he approved the expenditure, and then was told later that the
project cost had escalated to more than $1 billion. "I understand
that the cost of construction can increase with time," he explained
, "but give me some justification!"

-- Idenov also mentioned KPO's $192 million purchase of new pipe
racks for the project, which arrived before the cement foundation
was laid on the platform. As a result, the piperacks were stored
outside, where they were punished by the severe climate of northern
Kazakhstan, deteriorated, and were rendered useless.

-- In 2006, Idenov said he authorized KPO to spend $478 million for
the front-end engineering design (FEED) of Phase III expansion
activities. Once these funds were spent, he claimed, KPO requested
another $300 million to fund a new design concept.

-- In 2008, Idenov approved a request for $450 million to procure
high-technology material (called X-60) that would resist corrosion
by sour gas. Later that year, KPO discovered that newer technology
(called F-22) had come on the market, and requested another $480
million to acquire the new material, abandoning the previous
material.

-- In 2009, according to Idenov, KPO submitted an annual budget for
2010 of $2.1 billion. Once Idenov reviewed the details, however, he
said he could only find justification for $950 million.

IMMEDIATE CONSEQUENCES

8. (SBU) Once KPO was presented with these findings, Idenov stated,
BG Group's Senior Vice President Mark Carns was immediately fired,
and other senior executives barely escaped a similar fate. He
asserted that BG Group's Peter Drunfield circulated an eight-page
letter to Masimov and Samruk-Kazyna Deputy Chairman Timur Kulibayev,
disputing Idenov's claims and asking for their support. However,
they refused to respond, and the KPO partners declined to support
Drunfield, who subsequently left BG Group. Idenov disclosed that

ASTANA 00000061 003.3 OF 004


KMG and KPO are now deep in negotiations on these issues, and
suggested that he would elevate the discussion to the level of
corporate CEO. Idenov admitted that KMG also could provided better
project oversight, and should have demanded the documents supporting
KPO's expense claims years earlier.

FIGHTING FOR FUNDAMENTAL PRINCIPLES

9. (SBU) Idenov mentioned complaints by KPO member companies --
with the notable exception of Chevron -- that he is causing trouble
and making unreasonable demands. "When they ask me, 'What are you
fighting for?,' I tell them, 'Serve the shareholders honestly, and
follow five simple business principles: Quality Decisions; Quality
Health, Safety, Security and Environment; Quality Technical
Integrity; Quality Project Management; and -- most importantly --
Quality Internal Controls. This is Kazakhstan's demand to KPO!'"
(NOTE: Idenov thanked the Ambassador for his September 28, 2009,
speech on corporate responsibility to the members of the American
Chamber of Commerce. He contended that was the first time any
Western ambassador has stressed publicly the theme in Kazakhstan.
"It has made a huge difference," he said, "and will help U.S.
companies, which set a good example for others." END NOTE).

AKSAI IN WONDERLAND

10. (SBU) Idenov highlighted KMG's demand that KPO's senior
management staff move to Astana from London in order to provide
proper oversight and supervision. He complained about KPO's
expenditure of $482 million on salaries and overhead expenses in
2009, but just $320 million on oil and gas production services.
"It's like Alice in Wonderland," he exclaimed. "They're making
their own rules, just like the White Rabbit. You can start wherever
you want, finish wherever you want, but there is one rule:
everybody gets a prize. Everybody gets paid."

A DISSENTING VOICE

11. (SBU) In a private meeting on January 20, Alex Verba, chairman
of Astana Law Partners LLP, strongly disputed the government's
claims that KPO lacks supporting evidence for cost reimbursement.
An auditor, Verba was a resident advisor on cost reimbursement
issues to the Karachaganak project in Aksai from 2000-2005. He
argued that the government is trying merely to counterbalance the
legitimate claim of KPO for reimbursement of illegal crude export
duties. Verba claimed that KMG has never done a professional audit
of the cost-reimbursable claims, and that they lack the expertise to
do a proper audit. Verba also alleged that KMG has its own reasons
for not conducting a full audit. "Their people were benefitting
from these subcontracts, and other arrangements, for years," he
claimed. Verba predicted that the government would lose its
arbitration case. "They haven't won one yet," he underlined.

KASHAGAN'S 2010 BUDGET

12. (SBU) Having finished the litany of charges against
Karachaganak, Idenov turned to Kashagan. He highlighted the
government's significant concern about the project to hook up the
drilling islands to the onshore processing plant, which is 30%
behind schedule and well over budget. The initial tender won, he
continued, with a bid of $196 million, but current costs have
reached $443 million. The original 2010 budget for Kashagan of
$10.5 billion was reduced to $8.2 billion after careful review by
KMG (ref C), he stated. To illustrate, he told the Ambassador that
the general director of the North Caspian Operating Company (NCOC),
detailed from Total, is paying $22,000 per month for an apartment in
Astana, and that other senior corporate executives are paying
similar amounts. Idenov said he approved these expenses, but warned
the executives that the amounts were excessive.

PHASE II UNDER REVIEW


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13. (SBU) Idenov asserted that he agreed to Kashagan's Phase I
budget of $38 billion, but has asked the consortium for supporting
documentation and justification of planned expenditures. In
addition, he has not approved the request for $15 billion to fund
Kashagan's Phase II development ($3.2 billion in 2010, $5 billion in
2011, and $7 billion in 2012), "because they (Agip/ENI) are
Italians. Because they messed up (on Phase I). Because I don't
trust them. They scared all of us with their management of Phase
I," he explained. Idenov expressed his preference for Phase II to
first undergo FEED, which would enable the consortium to develop a
more accurate and realistic project plan, but the partners
protested. According to Idenov, they said, "No! Give us the $15
billion and let's go!" Idenov claimed he merely was trying to
protect them from the Financial Police, who would likely launch an
investigation into the project if large investments could not be
justified. Idenov also invited the Ambassador to send a
representative to the next Kashagan budget meeting, claiming he had
nothing to hide. He even speculated that the private-sector
partners would protest this unusual display of transparency.

IDENOV'S FUTURE

14. (SBU) As the meeting came to a close, Idenov indicated that he
had received job offers from Shell (where he used to be a Vice
President for Strategic Planning), Agip, and Statoil. Idenov
dismissed these offers, saying it was just a way for the companies
to remove an obstacle in their way. "I'm not going away that
easily," he asserted. "But if the gentleman on the wall
(Nazarbayev) says we shouldn't follow these five fundamental
principles, then I will know that times have changed, and I will
start to consider my options."

15. (SBU) COMMENT: Maksat Idenov possesses a large and lively
personality. He clearly has critics in the government -- witness
his shrinking portfolio -- and among the international oil
companies. However, it is hard to argue with his basic business
principles, and reasonable to expect that projects as complex,
costly, and critical as Karachaganak and Kashagan could be managed
more efficiently. Nevertheless, we hope that in both cases, the
parties are able to reach accommodation without resort to legal
action. END COMMENT.

HOAGLAND

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