KAZAKHSTAN - SPECIAL ENVOY GRAY DISCUSSES ENERGY

C O N F I D E N T I A L SECTION 01 OF 04 ASTANA 001381

SIPDIS

E.O. 12958: DECL: 08/01/2018
TAGS: EPET EINV PGOV PREL KZ
SUBJECT: KAZAKHSTAN - SPECIAL ENVOY GRAY DISCUSSES ENERGY
ISSUES WITH GOVERNMENT AND MAJOR COMPANIES

Classified By: Pol-Econ Chief Steven Fagin, Reasons 1.4 (b) and (d)

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SUMMARY
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1. (C) During July 22 meetings, Kazakhstani government
officials expressed optimism to visiting Special Envoy Boyden
Gray regarding the restructuring of Kashagan. They explained
that Kazakhstan was moving forward with Azerbaijan and the
companies on the Kazakhstan-Caspian Transportation System
(KCTS). They indicated that there had been forward movement
on expansion of the Caspian Pipeline Consortium (CPC)
pipeline. The officials reminded Gray that Kazakhstan has
only limited quantities of gas available. Western oil and gas
companies stressed the high costs of energy exploration and
development in Kazakhstan. End Summary.

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OPTIMISM ON KASHAGAN
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2. (C) Special Envoy for Eurasian Energy Issues Boyden Gray
met in Astana on July 22 with Prime Minister Karimov Masimov,
Deputy Energy Minister Lyazzat Kiinov, KazEnergy Chairman
Timur Kulibayev, Samruk Deputy Chairman Kairgeldy Kabyldin,
KazMunaiGaz (KMG) First Vice President Maksat Idenov, KMG
Vice President Daniyar Berlibayev, and representatives of
U.S. and other western oil and gas companies. Gray was
accompanied by Eurasian Energy Diplomacy Coordinator
Ambassador Steve Mann, SCA Deputy Assistant Secretary George
Krol, and Ambassador Ordway. Gray explained to his
interlocutors that he was particularly interested in
discussing the latest developments in Kazakhstan's oil and
gas sector, including the status of Kashagan, relations
between the Kazakhstani government and the international
energy companies, and energy transport issues.


3. (C) Gray's Kazakhstani government interlocutors stressed
that Kazakhstan by and large enjoys good relations with the
international oil and gas companies. The officials expressed
optimism regarding Kashagan. Prime Minister Masimov
explained that he had several days previously spoken by
conference call to all the Kashagan partners. The key issues
have been resolved, with the project ready to move forward.
He noted that under the latest terms, the companies will bear
all the costs for any additional delays of first oil beyond

2013. Providing additional details, KMG Executive Vice
President Idenov said that Eni, which last year had fought
furiously to remain sole Kashagan operator, would lose that
status within a matter of weeks. Idenov's vision is for
ExxonMobil to operate onshore activities and Shell offshore,
with Total managing the Kashagan joint operating company and
ConocoPhillips taking the lead on budget issues. Inpex, he
noted, does not want to play a lead role. Idenov explained
he had recently raised the needed $3 billion for KMG to meet
upcoming Kashagan cash calls, claiming that investors had
actually oversubscribed, offering $6.4 billion in total.
Deputy Energy Minister Kiinov complained that Kashagan's
delays had forced Kazakhstan to make significant revisions to
its development plans. The country had expected to be
producing 130 million tons of crude by 2015. With the latest
delay in Kashagan's first oil, that figure has been lowered
to 100 million tons -- a big difference for Kazakhstan, he
stressed.

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KAZAKHSTAN-CASPIAN TRANSPORTATION SYSTEM
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4. (C) KazEnergy Chairman Timur Kulibayev (who is also
President Nazarbayev's son-in-law) reminded Gray that
Kazakhstan and Azerbaijan had signed an Inter-Governmental
Agreement (IGA) on the Kazakhstan-Caspian Transportation
System (KCTS) in 2007. KCTS, he maintained, enjoys the
support of Azerbaijan's President Aliyev, and KazMunaiGaz and
Azerbaijan's SOCAR have agreed to exchange "task forces" to
hash out further details, which will also require close
consultations with the international companies.


5. (C) Kulibayev said the Kazakhstanis have been in
discussions with Chevron on the pipeline portion of KCTS --
i.e., the pipeline to bring crude from the oil fields to
Kazakhstan's Caspian coast. Chevron is prepared to move
forward now, finance half of the pipeline's construction, and
take an initial share of 50 percent while also agreeing to
reduce that later to 10 or 15 percent to allow other
companies to gain ownership shares. ExxonMobil, with its
stakes in both Tengiz and Kashagan, is also positive on the
pipeline, Kulibayev maintained, but not all the other
companies in the Tengiz and Kashagan consortiums are on board

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yet. (Note: Idenov claimed that Total was a particular
problem, as it would not be able to export to Iran if U.S.
companies had equity stakes in KCTS oil terminals. End
Note.) Kulibayev recognized that this is an issue for the
companies to resolve, but said Kazakhstan would welcome USG
assistance in getting them to resolve their differences.
With a lack of agreement among the companies, Kazakhstan is
constrained in negotiating with the Azeris on the
trans-Caspian portion of KCTS and with the Azeris and
Georgians on transport from Baku onward. In the meanwhile,
TengizChevrOil is losing money by having to ship large
volumes by rail, Kulibayev argued.

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TRANSPORT FROM BAKU ONWARD
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6. (C) Gray's interlocutors touched only briefly on the issue
of moving crude from Baku onward. Masimov noted that
Kazakhstan had committed to use the Baku-Tbilisi-Ceyhan (BTC)
pipeline in 2006. Kazakhstan is pleased with how things have
been developing. Masimov said the Kazakhstanis were
discussing with the companies the possibility of building an
additional pipeline from Baku, and did not think this would
be a problem for the Azeris or Georgians. Kulibayev said the
Georgians were vocally supportive of Kazakhstan moving its
crude through Georgia -- and also welcomed KMG's acquisition
of the Batumi oil terminal. The Georgians, he explained,
were willing to give Kazakhstan all opportunities to use
existing pipelines and build new ones.

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CPC EXPANSION MOVING FORWARD?
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7. (C) Masimov told Gray that Kazakhstan's success in moving
forward on KCTS is leading to progress on expansion of the
Caspian Pipeline Consortium (CPC) pipeline. KMG Vice
President Berlibayev said that Russia's approach had changed
on CPC and was now closer to that of the companies. The
Kazakhstanis and Transneft had reached agreement. What is
needed now is a political decision from the Russian
government, Kulibayev explained, adding that Kazakhstan hoped
to get it soon. Kiinov argued that CPC expansion is
particularly important in handling future Kashagan volumes,
as Kazakhstan considers a trans-Caspian pipeline to be a
no-go for now for political reasons, as well as because of
the topography of the sea-bed. He also suggested expanding
CPC to Odessa, to make the Odessa-Brody pipeline more
commercially viable. This would require giving Russia a
small share in CPC, perhaps 5 or 10 percent -- but that
should not cause any problems, Kiinov argued.

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LIMITED NATURAL GAS
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8. (C) The Kazakhstani government interlocutors explained to
Gray that Kazakhstan produces only limited quantities of gas,
most of which is used for domestic consumption. Prime
Minister Masimov argued that Kazakhstan had made a mistake in
not focusing more on gas when it signed contracts for Tengiz
and Kashagan that allowed the companies to reinject most gas.
He said Kazakhstan would respect the sanctity of those
contracts, but would separate oil and gas components in
future contracts. Masimov noted that Kazakhstan actually has
a shortage of gas in the south, because its gas is mostly
found in the west, as a result of which it imports gas from
Uzbekistan and is building a pipeline to bring gas from the
west to the south. Masimov noted that Kazakhstan had started
negotiations with ConocoPhillips and the UAE regarding "N
Block," which may be a promising area for gas. Kulibayev
noted the importance of a Kazakhstani gas pipeline to China,
explaining that it will give Kazakhstan two gas customers.
That said, gas is a very sensitive issue for the Russians, in
a way that crude is not, he stressed. Kazakhstan has good
relations with Gazprom, and both the Russian and Kazakhstani
governments support Gazprom-KMG cooperation. Every year,
Kazakhstan is getting a better price for the gas it sends to
Russia, Kulibayev argued.

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KMG RESTRUCTURING
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9. (C) Idenov provided Gray with details on his efforts to
restructure KMG. The company, he explained, owns many fields
that are depleted, at the tail end of their production lives.
KMG needs to focus more on mega projects that will provide
large, long-term cash flows. KMG received $1.4 billion in
profit from Tengiz in 2007 (which yielded a total of $7.2

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billion in profit for the whole consortium). Idenov alleged
that former KMG President Uzakbai Karabalin had made a
fortune through contracts KMG had with a company he owned.
Karabalin had, in fact, tried to oust Idenov from the
company, but in the end, President Nazarbayev supported
Idenov, and Karabalin wound up losing his job.

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TURKMENISTAN
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10. (C) Mann requested to Masimov that the Kazakhstanis
explain to Turkmen President Berdymukhamedov the importance
of developing partnerships with the international energy
companies, as Kazakhstan had done. Masimov promised to pass
this request to President Nazarbayev. Kulibayev said there
had been positive changes in Turkmenistan, and good relations
between Berdymukhamdov and Nazarbayev, with the former
willing to learn from the latter. He expressed doubts about
Turkmenistan's capacity to meet all the commitments it had
made on gas.

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VIEWS OF THE WESTERN COMPANIES
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11. (C) Kazakhstan-based representatives of international oil
and gas companies told Gray that there is a very challenging
backdrop to the exciting opportunities in Kazakhstan's energy
sector. Campbell Keir, General Manager of Shell Kazakhstan
Development, argued that the complexity of Kazakhstan's oil
and gas projects, together with the fact that the country is
essentially landlocked, results in very high operating costs,
such that many projects are only worthwhile pursuing if crude
is priced above $85 per barrel. Project development is also
hindered by a lack of infrastructure and of domestic human
capital, he argued. Keir said that companies and governments
should encourage the Kazakhstanis to package their energy
development projects, as offering each project separately
makes them too expensive. Keir pointed out the difficulties
of offshore operations in the Caspian, where depths range
from very shallow (1.5 meters) to very deep, with work
particularly complicated below the salt layer. Steve Rose,
General Manager of ExxonMobil Kazakhstan, said that there is
still "lots of oil and gas" likely to be discovered in
Kazakhstan; the question is the timeframe for mobilizing the
resources to develop new fields, as well as whether it will
be profitable to do so. Oil and gas transport is complicated
too, with export routes largely having to cross multiple
countries, Rose explained.


12. (C) Rose maintained that the Kazakhstani government was
sending "mixed signals" on KMG. On the one hand, it wants
the company to be an international leader. On the other
hand, the crude export duty it recently introduced hits KMG
very hard. The government is taking away KMG's cash flow at
the same time KMG just increased its stake in Kashagan, which
will not yield positive cash flows for many years.
Responding to a question from Mann, Keir maintained that the
Samruk state holding company, which is KMG's sole
shareholder, plays an influential role in KMG when it wants
to, noting it had reversed some of the personnel changes new
KMG President Burkitbayev wanted to make.


13. (C) Mann asked the group how Turkey is regarded in
Kazakhstan. Zamira Kanapyanova, Chevron Kazakhstan Country
Manager, said that in general, relations with Turkey are
good. There is appreciation for Turkey's early recognition
of and support for Kazakhstan. That said, sometimes Turkey
wants to play big brother, which does not go over well,
Kanapyanova contended.


14. (C) Gray asked the company representatives on what issues
the USG could be of assistance to them. Steve Rose responded
that it is important that the companies be able to engage
with the Kazakhstani government on its plans to introduce a
new tax code. He also contended that the companies are being
"eaten alive" by changing regulations, as a result of which
Todd Levy, General Manager of TengizChevrOil, spends 75
percent of his time dealing with such issues, rather than
with oil and gas. The central government, Rose argued, needs
to find a way to better fund regional governments, so the
regional governments do not have to raise revenues by finding
ways to fine the companies for alleged regulatory violations.
Rose also expressed the concern that with their growing
income flows from increased production and higher prices,
Kazakhstan and Azerbaijan would become complacent, satisfied
with what they have, and not move forward expeditiously in
resolving issues like transport.


15. (U) Ambassadors Gray and Mann have cleared this cable.

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ORDWAY