KAZAKHSTAN: PRIME MINISTER DISCUSSES OIL SECTOR

C O N F I D E N T I A L SECTION 01 OF 02 ASTANA 001240

SIPDIS

NOFORN
SIPDIS

DEPT FOR EB/ESC; SCA/CEN (O'MARA)

E.O. 12958: DECL: 05/07/2017
TAGS: ENRG EPET KZ
SUBJECT: KAZAKHSTAN: PRIME MINISTER DISCUSSES OIL SECTOR
DEVELOPMENT STRATEGY, AUDITS OF CONTRACT COMPLIANCE

REF: A. ASTANA 684

B. ASTANA 908

C. ASTANA 848

D. ASTANA 443

E. 06 ASTANA 738

F. 06 ASTANA 501

Classified By: Ambassador John Ordway; reasons 1.5(b) and (d).


1. (C) Summary: In back-to-back April 26-27 conversations
with Commercial and Business Affairs Special Representative
(S/R) Frank Mermoud and the Ambassador, Prime Minister
Masimov discussed his government's strategy for developing
Kazakhstan's oil and gas sector, its intent to audit existing
subsoil users for compliance with their contracts, and its
plan to review all (historical) privatization deals, to
ensure that beneficiaries have fulfilled their contractual
obligations. Masimov confirmed that action on the "N Block"
(Ref A),as well as all other oil tenders, has been
suspended, "for a maximum of six months," while the
Kazakhstani government figures out how to leverage the deals
to achieve economic diversification and to increase
value-added in hydrocarbon production. In an April 26
conversation with S/R Mermoud, Masimov's Advisor Yerlan
Sagadiyev added that a lack of oil and gas transportation
routes rendered further development of the Caspian
problematic. A Kazakhstani government initiative to select
thirty domestic corporations as "national champions" and
entrust them with large-scale investment projects as a means
of spurring economic diversification will be reported septel.
End summary.

New Oil Project Negotiations Suspended -- Six Months Maximum
-------------- --------------


2. (C) On April 27, Masimov elaborated on his April 9
conversation with the Ambassador (Ref B),telling the latter
that the GOK had temporarily suspended action, not only on "N
Block" negotiations, but on all ongoing oil tender
negotiations. (Including, presumably, ExxonMobil's efforts
to secure rights to onshore acreage -- Ref C.) The
suspension would last "six months maximum," Masimov assured
the Ambassador, while the GOK figured out how to leverage the
tender process to achieve economic diversification and
capture more value-added from hydrocarbon production. (On
April 17, Energy Minister Izmukhambetov commented publicly on
one way in which this might be achieved, suggesting that the
GOK might amend the hydrocarbon legislation to obligate
subsoil users to construct refineries and other processing
facilities. The current, 2005 Production Sharing Agreement
law indicates that bidders who undertake such projects will
get preference in the allocation of offshore assets, but
stops short of requiring them.) The Ambassador observed
that, if not carefully administered, such a policy could lead
to the construction of "uneconomic" projects -- subsidized,
in effect, by the production of crude oil. Masimov
acknowledged the point.


3. (C) On April 25, Yerlan Sagadiyev, Masimov's Advisor,
painted a somewhat starker picture of the GOK's latest
thinking in a meeting with S/R Mermoud. "The problem," he
explained, is that the government "has too much money" that
it pours into a broad range of sectors, such as energy,
telecommunications, and healthcare. This, Sagadiyev
continued, creates an unpredictable environment for the
private sector, "scaring it away" and causing it to invest
abroad. Sagadiyev made clear what the government sees as the
culprit: "we've got a mess with oil and need to figure
things out." Further development of the oil sector in any
case looks problematic, he added, as the infrastructure for
transporting oil, "such as roads and port terminals," is
lacking. Moreover, Sagadiyev quoted President Nazarbayev as
saying "I don't think we can do the Caspian without Russia."
Finally, Sagadiyev added, no one knows how ecologically
dangerous off-shore drilling really is. "Too many people
from the U.S.," he concluded, "come to Kazakhstan and say
'Drill more, build more pipelines.' But it is not possible to
do this."


Reviewing Privatization Deals and Subsoil Contracts
-------------- --------------


4. (C) Masimov briefed the Ambassador on two additional GOK
initiatives to ensure that the state's interests were
respected by private sector entities. First, the GOK would

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review all past privatization deals in which the beneficiary
had agreed to perform certain obligations -- for example, to
create a certain number of jobs, or invest a defined quantity
of money -- to see if the buyer had, indeed, performed those
obligations. Second, the GOK would review all subsoil use
agreements, again to ensure that the contract terms were
being respected.


5. (C) While the GOK's intended review of privatization deals
has not (yet) been publicized, Masimov has spoken publicly
about the initiative to review subsoil contracts, and several
Western oil companies have already experienced what they
believe to be its effects. In some contexts Masimov has
focused his criticism on companies which obtain subsoil
licenses but fail to invest and develop the field according
to the agreed-upon schedule, presumably because the
license-holders' interests are speculative, and their intent
is to "flip" the asset rather than develop it. (The GOK
recently passed legislation to stem this trend -- Ref D --
but appears to be making this issue a focus of its contract
audits as well.) In the same context, Masimov has also
alluded publicly to the production delays and cost overruns
bedeviling Kashagan field development (Ref E),perhaps laying
the groundwork for a GOK attempt to penalize Kashagan
partners for the disappointing results -- a battle which the
Kashagan partners believe could happen as early as late
summer, on the occasion of a broad project review. Masimov
has also pledged publicly to enforce contractual obligations
to protect the rights, including wage equality, for
Kazakhstani employees of foreign companies and joint ventures
-- a hot topic, especially in the oil and gas sector, since
the October 2006 "Tengiz riot" (Ref F). (ConocoPhillips, for
one, recently underwent a full-scale audit of its labor
practices.)


6. (C) The other area of recent increased GOK scrutiny has
been in the area of environmental compliance.
TengizChevrOil's (TCO) April 4 signature of a three-year,
$800 million environmental spending plan against the backdrop
of Ministry of Environment threats to revoke TCO's operating
license is only the most-publicized example. ExxonMobil's
Government Relations Director, Patty Graham, told Energy
Officer on April 25 that ExxonMobil has seen "a vast
increase" in Environmental Ministry activity in 2007. Other
subsoil users -- CNPC Aktobemunaigas, KazakhOil Aktobe,
Karachaganak Petroleum Operating Company, Karazhanbasmunai,
PetroKazakhstan Kumkol Resources -- have all been cited in
recent cases, most of which have been announced in the press.


7. (C) Several oil industry analysts have taken the GOK's
initiative to review subsoil contracts as a sign of its
intent to maximize GOK revenue and force a revision of
contracts which may have been signed on terms less favorable
to the government than prevail in today's market for the
country's oil assets. Masimov, however, has been careful to
underscore the GOK's respect for contract sanctity. On April
24, for example, when summing up his government's first 100
days, Masimov declared that, "should both parties to a
contract be fulfilling it, the contract will not be revised."


8. (U) This cable has been cleared by S/R Mermoud.
MILAS