KASHAGAN: THUS FAR, COMMERCIAL DISPUTE, NOT

C O N F I D E N T I A L SECTION 01 OF 03 ASTANA 002586 SIPDIS SENSITIVE SIPDIS DEPT FOR SCA/CEN DEPT PASS TO OPIC - BALLINGER DEPT PASS TO TDA FOR STEIN, EXIM, FOR GLAZER DEPT PASS TO AID - EE PHILIPS/RUSHING USDOC FOR 4231/ITA/MAC/MLONDON, 4201/BISNIS USDOC FOR 6110/ITA/TD/BI/RHALPERN ANKARA FOR CFC E.O. 12958: DECL: 09/19/2017 TAGS: ECON EIND ENRG EPET EFIN EINV KZ SUBJECT: KASHAGAN: THUS FAR, COMMERCIAL DISPUTE, NOT SAKHALIN II Classified By: AMBASSADOR ORDWAY FOR REASONS 1.4(B) AND (D) ¶1. Summary: (SBU) Spurred on by further delays and rising costs at Kashagan, the Government of Kazakhstan (GOK) has made clear to the international consortium developing the huge oil field of its dissatisfaction with the current profit-sharing scheme. The GOK leadership has indicated that it seeks a significant increase in Kazakhstan's share of profits under the production sharing agreement and immediate compensation "in the billions of dollars" for the latest delays. In the interim, development at Kashagan is suspended for three months because of environmental violations at the site. With talks underway, both government officials and oil company representatives characterize the current conflict as a commerical dispute likely to be resolved. End Summary Kashagan: Further Delays, Rising Costs -------------- ¶2. (SBU) In June, the North Caspian Project consortium Agip KCO officially notified the GOK of delays and cost overruns on Kashagan, one of the world's largest oil projects, with estimated reserves of 13 billion barrels. Commercial production is to be delayed from 2008 to 2010 and the costs to increase from $56 billion to $136 billion over the life of the forty-year contract. Costs for the first phase of development will nearly double, from $10 billion to $19 billion. ¶3. (SBU) The June announcement was only the latest setback on the Kashagan project. Originally, commercial production was to have started in 2005. In February 2004, AGIP KCO and the GOK agreed to delay production until 2007-2008. At the time, AGIP paid the GOK $150 million for the delays in commercial production. Some experts have criticized Eni, the project's operator (the consortium also includes Exxon Mobil, Shell, Total, Conoco Phillips, and IMPEX) for an overly exuberant forecast of costs and production schedules for an extremely difficult project. Kashagan Shut Down, New Terms Sought -------------- ¶4. (SBU) Agip's difficulties have continued through the summer. On August 27, the Ministry of Environmental Protection declared that it was suspending work at Kashagan for three months due to environmental violations. Serzhan Duysenbayev, acting Chairman of the Finance Ministry's Customs Control Committee, announced that several criminal cases have been initiated against Agip's affiliates for evading customs duties. The Ministry of Emergency Situations stated that it will shut down Agip's oil and gas processing facility, which is under construction, for non-compliance with fire norms. ¶5. (SBU) Most significantly, Agip has faced a GOK clearly displeased with the latest developments and dissatisfied with the terms of its production sharing agreement (PSA). Prime Minister Masimov stated publicly that "the change in the terms of the Kashagan development means the contract's change." Kazakhstani officials have declared in discussions that they seek to raise Kazakhstan's share of profits under the PSA from 10% to 40%. The GOK has also bemoamed the near-term detrimental effects of further delays. According to Vice-Minister of Finance Yergozhin, the GOK had been expecting $1.2 or 1.3 billion in revenue from the project starting in 2008. Kazakhstan, he told the media, is expecting compensation in "the range of billions of dollars." (Note: Under the terms of the PSA, Agip is not obligated to make payments to the GOK until development costs are recovered. End Note) ¶6. (SBU) Eni's position as operator of the Kashagan project has also been made tenuous by the delays and cost overruns. At the Eurasia Energy Forum in Astana on September 6, Masimov suggested a larger role for KazMunayGas. "In line with our ASTANA 00002586 002 OF 003 targets and requests voiced by the president of our country, KazMunayGas has to become a second operator of the project. If consortium members decline Kazakhstan's terms, we have plan 'B,' about which I will tell you later," he said. Yergozhin stated to the media that Kazakhstan would "look positively" on a proposal to put a local company in control or to operate the project jointly. ¶7. (SBU) On September 11, MasimNO)6nnounced that negotiations with Agip will last until October 22. ¶8. (SBU) On September 12, Yerlan Nigmatulin, head of the Mazhilis (lower house of parliament) Committee on Ecology and Mineral Resources, stated that the Mazhilis is considering an amendment to the "Law on Subsoil and Subsoil Use." The proposed amendment gives the GOK the right to annul or amend contracts in cases of "national security threats caused by investors' actions." The new law would apply retroactively. The basis for the move was "the Kashagan conflict", he said. Nigmatulin expects the amendments to be adopted by October 22, the end of the 60 day period of "friendly negotiations" between the GOK and Agip KCO. GOK: Foreign Investors Have No Cause For Concern -------------- --- 9.(C) In a meeting with the Ambassador, Prime Minister Masimov emphasized that Kazakhstan is "not trying to push foreigners out." Masimov described Kashagan as a commercial dispute, noting that according to GOK analysis Kazakhstan will net nothing under the current PSA because of the rising costs. Masimov also said that "everyone agrees that Eni has been totally incompetent." Nevertheless, no criminal charges will be brought, and foreign investors have no cause for concern. Masimov laughed at a rumor that Lukoil might take the lead at Kashagan. In a separate meeting with the DCM, Minister of Finance Yergozhin said that the environmental inspections at Kashagan have been part of normal investigations. ¶10. (C) Representatives from Conoco Philips told the Ambassador that the GOK is seeking compensation outside of the PSA. They were not panicked about the conflict, saying that everyone agrees it will be settled and noting that, in comparison to Russia, they still feel welcomed in Kazakhstan ("it is always refreshing to come here"). Nick Olds, Conoco-Philips Kazakhstan Country Manager, did not refute criticisms that have been levelled at Eni. "Eni is not doing a lot to redeem themselves," he said. ¶11. (C) In a September 17 conversation with the Ambassador, First Vice President of KMG Maksat Idenov, who is now the GOK's chief negotiator with the consortium, acknowledged that the GOK cannot, under the terms of the PSA, change the operator. He noted, however, that the companies in the consortium can and are now interested in doing so. Idenov played down the September 12 expulsion of a Conoco Philips representative from a GOK-consortium meeting. The Kazakhstani side, Idenov explained, had asked consortium members to send to the meetings executives empowered to make decisions ("not notetakers") which, he asserted, Conoco Philips failed to do. Speaking to the Ambassador, a Conoco Philips representative blamed the episode on a misunderstanding of the company's corporate structure. ¶12. (C) Comment: The GOK has strong reason to be displeased with events at Kashagan. Despite the public fireworks, however, we expect the matter will be resolved in a manner acceptable to all parties, although likely after the October 22 date established for the end of negotiations. While the GOK will seek better terms, and is almost certain to receive them, it is unlikely to make any rash moves that will ASTANA 00002586 003 OF 003 negatively impact the foreign investor climate in Kazakhstan, particularly when Kazakhstan is aggresively seeking investment in its non-extractive sectors. Furthermore, Kazakhstan has generally proven itself a reliable partner in the energy sector; while Kashagan has gathered most of the recent publicity, the country's two other huge oil projects, Tengiz and Karachaganak, continue to proceed smoothly and to the satisfaction of all parties involved. End Comment ORDWAY