KAZAKHSTAN - KARACHAGANAK FACES DIFFICULTIES AND

UNCLAS ASTANA 001646

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EPET EINV PGOV KZ
SUBJECT: KAZAKHSTAN - KARACHAGANAK FACES DIFFICULTIES AND
OPPORTUNITIES


1. (SBU) Summary: Kazakhstan's Karachaganak field has large proven
reserves of natural gas, but further Karachaganak expansion (i.e., a
Phase III) faces obstacles, including administrative delays. The
Karachaganak consortium, KPO, maintains that it was recently
pressured into paying an environmental fine, as well as to begin
paying Kazakhstan's new crude export duty. British Gas recently
presented a national gasification strategy to KazMunaiGas (KMG) for
developing downstream markets. The strategy was well-received and
will be presented at the December Foreign Investors Council meeting.
End Summary.


2. (U) Karachaganak is one of the world's largest oil and gas
condensate fields, covering an area of over 280 square km and
holding more than 1.2 billion tons of oil and condensate and 1.35
trillion cubic meters of gas. KPO, Karachaganak's operating
consortium, has four international partners: British Gas (BG Group)
and Italy's Eni, each with a 32.5 percent interest; Chevron, with a
20 percent stake; and Russia's LUKOIL, with a 15 per cent share.
Karachaganak provided 25% of British Gas's annual profit for 2007.



3. (SBU) KPO's plans for Karachaganak's Phase III expansion
anticipate increasing condensate production from 7 million tons per
year to 10 million tons and natural gas production from 14 billion
cubic feet to 25 billion cubic feet. Kazakhstan's state oil and gas
company, KazMunaiGas (KMG),has not yet approved the expansion
plans. Peter Flowers, Branch Director for British Gas Kazakhstan,
told us on August 20, that KMG would prefer a smaller expansion and
has hesitated to approve KPO's proposal. (Note: Under the current
PSA revenue-sharing formula, the larger KPO's capital expenditures,
the less initial revenue will accrue to the Kazakhstanis. End
Note.) Flowers does not expect KMG to grant its approval before the
end of this calendar year. If no approval is received by January,
the situation would become critical, as KPO must provide advance
notification to the Orenburg gas processing facility in order to
lock in new gas sales contracts, he explained.


4. (SBU) According to Flowers and ENI's Resident Manager Claudio
Cogliatti, KPO was also recently pressured by the government to pay
a large environmental fine and Kazakhstan's new crude export duty,
both of which, they contend, it should not have to pay. An
environmental fine for 1.8 billion KZT ($8.5 million) was levied by
local tax officials, despite reduced emissions and the company's
willingness to pay a smaller fee, Flowers explained. The local
authorities, however, refused to accept KPO's proposed lower amount
and suspended the consortium's Kazakhstan bank accounts. KPO has
appealed the fine and the matter is now pending with the local
courts.


5. (SBU) Flowers claimed that customs officials refused to allow KPO
to export gas in July unless the consortium paid the new crude
export duty. The consortium initially refused to pay, claiming that
its PSA made it exempt and noting that KPO did not appear on the
Ministry of Finance's initial list of companies and projects subject
to the export duty. (Comment: Prime Minister Masimov relayed a
very different story to the Ambassador. He said that unlike
Tengizchevroil (TCO),KPO is not exempt from the export duty
because, in fact, its PSA does not explicitly provide for an export
duty exemption. He said this fact was discovered in a review of the
contract conducted by the GOK's U.S. attorneys and came as a bit of
a surprise. End Comment.) Customs officials insisted that KPO pay
the duty and, under pressure to meet contractual commitments to
clients, KPO ultimately paid the duty for July. Customs officials
then reviewed KPO's exports from the previous month and insisted KPO
pay for June as well, which they did. To date, KPO has paid $230
million for three months (June, July, and August),Flowers reported.
KPO has been able to pass along the cost of the export duty through
the net back chain, which ultimately means that the Government of
Kazakhstan receives a lower return on KPO profits. According to
Flowers, KPO is pursuing various means of resolving this dispute and
has not ruled out taking the matter to international arbitration in
Stockholm.


6. (SBU) Flowers said that as part of its broader, long-term
strategy in Kazakhstan, British Gas has established a working group
with KMG to develop the domestic gas market -- an idea that was
well-received by KMG and will be presented at the December Foreign
Investors Council meeting. British Gas is proposing to use gas from
Kazakhstan, compressing it for utilization in vehicles such as taxis
and buses. The pilot phase calls for establishing a network of 6-10
compressed natural gas (CNG) refueling stations in Almaty, where the
local government has expressed enthusiasm about using domestic
reserves while simultaneously reducing pollution in the city. In
addition, KPO itself would convert its 300 buses and vehicles to CNG
(Karachaganak spends $600 million on diesel fuel annually). British
Gas and KMG will share a booth to showcase the project (together
with a CNG Mercedes-Benz) at the Kazakhstan International Oil and
Gas Exhibition (KIOGE) in October.

ORDWAY