KASHAGAN UPDATE: GOK CONFIRMS DELAY OF COMMERCIAL

C O N F I D E N T I A L ASTANA 001209

SIPDIS

STATE FOR SCA/CEN M. O'MARA

E.O. 12958: DECL: 06/24/2018
TAGS: PGOV PREL EPET KZ
SUBJECT: KASHAGAN UPDATE: GOK CONFIRMS DELAY OF COMMERCIAL
PRODUCTION

REF: A. DOE FOR EKIMOFF

B. COMMERCE FOR HUEPER

Classified By: AMBASSADOR ORDWAY FOR REASONS 1.4(B) AND (D)

1.(C) Summary: Representatives from the Kashagan consortium
met with their Kazakhstani counterparts in Astana the week of
June 23 in an effort to reach final agreement on a new
commercial development plan for Kashagan. The two sides
reached a tentative understanding in January, but the
Kazakhstanis subsequently disagreed with a draft budget
submitted by the consortium. On June 27, the parties signed
two memoranda, one postponing the start of commercial
production until 2013, the other confirming the fixed tax
regime for the consortium. A prolonged standoff was unlikely,
with both sides negotiating from vulnerable positions. End
Summary


2. (C) Representatives from the Kashagan consortium travelled
to Astana on June 23 to resume negotiations with the GOK.
The two sides reached a tentative agreement in January, with
the consortium agreeing to pay Kazakhstan up to $5 billion
for project delays, double the stake of KazMunayGas, and
replace Eni as sole operator of the project. In May,
however, Kazakhstan asked for "more money and more value,"
ExxonMobil General Relations and Public Affairs Director for
Kazakhstan Patty Graham told Poloff on June 19. Nevertheless,
both sides have demonstrated good faith in trying to finalize
an agreement, Shell's Country Manager Campbell Keir told the
Ambassador on June 23.


3. (SBU) On June 28, Energy Minister Sauat Mynbayev announced
that the GOK has agreed to postpone the start of commercial
extraction at Kashagan from 2011 to 2013. If extraction is
delayed beyond October 1, 2013, Kazakhstan will not
compensate the consortium for its subsequent expenses, he
said. According to Mynbayev, the two sides also signed a
second memorandum on the tax regime for the PSA. The
agreement calls for "old taxes plus new estimates of
royalty." The tax regime for the PSA will thus remain
unchanged and not affected by new export duties and
extraction taxes, but the royalty rates will be increased.


4. (C) Several western oil company representatives close to
the negotiations noted that KazMunayGas is under increased
financial pressure. Graham described KMG as "in survivor
mode" as they cope with a number of significant projects,
including the purchase of a stake of MangistauMunaiGas (MMG),
the acquisition of RomPetrol, the development of the "N"
Block and String of Pearls fields, and the construction of
the Pri-Kaspisky gas pipeline. John Dabbar, Conoco Phillips
Transportation Manager for Russia and Eurasia, told DCM on
June 26 that the Kazakhstanis are maintaining a confident
attitude in public, but that "when the door closes, the
begging starts." Shell Country Manager Campbell Keir told the
Ambassador that KMG seems short of money and that rumors
abound that changes will occur after the July 6 national
holiday, including KMG increasing its share of MMG from 51 to
71 percent (Comment: KMG may need to tighten its belt, but it
is hardly headed for the poorhouse. Just last week, KMG
floated five- and ten- year bonds worth three billion
dollars) .


5. (C) The western oil companies are not in a better
bargaining position, as they face damaging production delays.
During the final weeks of negotiations, ConocoPhillips'
Country Manager Nick Olds reported that the Kazakhstanis were
only approving two to three weeks of work at a time and
withholding approval of the overall budget. According to
Shell's Keir, costs are increasing at Kashagan because of the
mounting costs of transporting and operating equipment,
ironically because of rising oil prices. Like Olds, he noted
that the Kazakhstanis had not approved the new budget and
called it one of the factors delaying first oil production
(Comment: If, as we expect, KMG now approves the budget, it
in fact will have no impact on any further delays).
ExxonMobil's Graham said that without action the consortium
risks losing steel mill slots for 9-18 months. She estimates
that the eroded value of the project is already 50%
(Comment: Graham did not explain how she reached this figure,
and much, if not all, of the blame for the delays rests with
the consortium)


6. (C) The two sides are moving forward on finalizing an
operating agreement, said Keir. According to Olds, Total will
run the new joint operating company, with Shell responsible
for phase two offshore development and ExxonMobil subsoil and
drilling. Eni will complete phase one development and remain

responsible for phase two onshore activity. KMG will assume
operatorship when they are capable (Comment: A date not
likely in the near future).


7. (C) Although the new operating structure appears set, the
road ahead for the troubled project remains difficult. Graham
told Poloff that the Kazakhstanis assumed that when Eni was
replaced Shell and ExxonMobil would assume the operatorship
and "carry things home" on the project. Such an easy
solution is not realistic at this point, said Graham, which
displeases the Kazakhstanis. Keir told the Ambassador that
"getting from where we are now to where we want to be is not
going to be pretty, especially for Eni."


8. (C) Comment: The GOK and the Kashagan consortium took the
first steps to resolving their conflict in January, but
reaching a final agreement has proven difficult.
Nevertheless, with both sides now increasingly exposed,
pressure is escalating to find common ground. The positive
developments of the last week are a hopeful sign that the GOK
and the consortium are ready to move beyond the acrimony of

2007. Ultimately, both the GOK and the IOCs need each other,
and have too much riding on the project to let it fail. End
Comment.

ORDWAY