OIL COMPANIES AND AMBASSADORS DISCUSS OIL AND GAS

C O N F I D E N T I A L ASTANA 000206 SIPDIS SIPDIS E.O. 12958: DECL: 02/04/2018 TAGS: EPET EINV ECON PREL KZ SUBJECT: OIL COMPANIES AND AMBASSADORS DISCUSS OIL AND GAS ISSUES WITH ENERGY COORDINATOR AMBASSADOR MANN Classified By: Ambassador John Ordway, Reasons 1.4 (b) and (d) -------------- SUMMARY -------------- ¶1. (C) Foreign oil company representatives told visiting Eurasian Energy Diplomacy Coordinator Ambassador Mann on January 25 that much remains to be worked out in finalizing the details of the new Kashagan agreement, including the role of KazMunaiGaz (KMG). The EC head of delegation to Kazakhstan told Mann that there are serious doubts about the availability of sufficient quantities of Caspian gas for a new gas pipeline. TengizChevrOil (TCO) executives in Atyrau explained to Mann on January 26 that TCO will use rail to move the additional crude production from TCO's second generation expansion, which is scheduled to come on line later this year. Further TCO expansion would necessitate expanding the CPC pipeline or building a new pipeline route. TCO is continuing to reinject most of its gas production and thus has very limited volumes to bring to market. TCO has paid its $300 million sulfur-related environmental fine, but will take the whole matter to arbitration, if necessary, including the issue of TCO's right to deduct the fine from royalties paid to Kazakhstan. ExxonMobil Kazakhstan's General Manager in Atyrau stressed the importance of moving forward on the Kazakhstan Caspian Transportation System (KCTS) to export Kashagan's future production. End Summary. ¶2. (U) This cable contains sensitive proprietary business information. -------------- MANY DETAILS TO WORK OUT ON KASHAGAN -------------- ¶3. (SBU) At a January 26 meeting in Astana, Eurasian Energy Diplomacy Coordinator Ambassador Steven Mann briefed local representatives of ExxonMobil, Chevron, ConocoPhilips, Shell, Eni, British Gas, and Statoil on the State Department's revived energy coordinator's office and USG policy for the second phase of Caspian oil and gas development. New Shell Country Chairman Campbell Keir noted that the recent Kashagan deal consisted of a "one and quarter page MOU," and thus that many details still need to be worked out in finalizing the agreement over the coming months. What exactly KazMunaiGaz (KMG) wants to do regarding an enhanced Kashagan role -- as well as what they are actually capable of doing -- remains to be seen, Keir stressed. Chevron Eurasia Managing Director Jay Johnson said that the GOK's efforts to renegotiate Kashagan's terms raised serious concerns that the GOK might challenge other contracts, such as TengizChevrOil (TCO). Johnson added that there has been some positive movement on CPC expansion, though he acknowledged that expansion would not happen soon, which is why Chevron is also focusing on southern routes to get Kazakhstani oil to market. ConocoPhilips Country Manager Nick Olds noted that the GOK had recently instituted a new protocol under which in-country oil company representatives will henceforth only be received at the vice minister-level, not at the minister-level, as in the past. From now on, ministers will only meet with more senior company officials from headquarters. Olds and several other attendees said that this will make it more difficult for the companies to expeditiously resolve problems with the GOK. -------------- DOUBTS ABOUT AVAILABILITY OF GAS -------------- ¶4. (C) At a subsequent January 26 meeting with several European ambassadors, EC Head of Delegation Adriaan van der Meer told Mann that "2007 was a bad year for us on pipelines," complaining specifically that the Bulgarians "shot us in the foot." A trans-Caspian gas pipeline, he argued, would certainly be the cheapest option to bring gas from Kazakhstan and Turkmenistan to Europe, but there are serious questions about the availability of sufficient quantities, especially because for the foreseeable future, most Kazakhstani gas has to be reinjected. He argued that 30 bcm would be needed to make such a pipeline profitable. On the more positive side, van der Meer noted that the EU's European Investment Bank now has a Central Asia mandate, which means that it could be an additional funding source for a pipeline. Van der Meer also contended that the Kazakhstanis would much rather make deals on gas with Russia than with Turkey. They appear to have struck a bad deal with the Turks in the past and are still upset about it. The attendees agreed that there should be regular meetings in Astana of the U.S., UK, French, German, Italian, and Dutch ambassadors and EC head of delegation to share ideas and coordinate policy on oil and gas issues. -------------- TENGIZCHEVROIL: CHEVRON'S MOST VALUABLE ASSET -------------- ¶5. (SBU) TengizChevrOil (TCO) General Director Todd Levy and his team gave Ambassador Mann a detailed briefing on TCO's operations and future plans during a January 27 meeting in Atyrau. Levy noted that TCO is Chevron's most valuable asset -- worth $24 billion to the company - and its largest revenue generator "by a wide margin." Chevron made $2.7 billion in profit from TCO in 2007. Levy explained that TCO produced just under 14 million tons of crude in 2007, which was mostly exported through the CPC pipeline, with just 1 million tons shipped by rail (to Odessa). TCO's second generation expansion is expected to come on line this summer, as a result of which production should rise to 25 million tons by ¶2010. The additional volumes will be exported by rail. TCO Strategic Planning Manager Norman Hansen explained that TCO had constructed "a world class rail station" at Tengiz and would have 13,000 rail cars for crude transport, enabling TCO to move by rail 15 million tons of oil annually -- 10 million north through Russia, and 5 million south to Aktau. He said that the southern route is cheaper for TCO than the northern one, and added that TCO will be quiet about the large volumes it will move north through Russia, so as to not draw too much attention from the Russians. -------------- FUTURE GROWTH -------------- ¶6. (SBU) A TCO "future growth option" (i.e., a third phase) could theoretically raise crude production to 40 million tons by 2015, Levy explained. To export those volumes, a CPC expansion or an additional pipeline would be necessary. (Note: With CPC's current capacity, TCO can move between 11.5 and 17.5 million tons of crude annually through CPC. End Note.) Hansen explained that the netback from exporting via CPC is currently $50 per ton higher than by rail through Russia. He also noted that the Atyrau-Samara pipeline, which has half of CPC's capacity, has no room for additional volume. ¶7. (SBU) Discussing the southern rail route, Hansen noted that the Kazakhstanis had expanded rail capacity at Aktau. This crude is expected to be transported by 12,000 DWT, St. Petersburg-built tankers, making approximately 400 voyages annually across to Baku. From Baku, the crude will be moved to the Black Sea via the Baku-Tbilisi-Ceyhan (BTC) pipeline, or from Baku to Supsa or Batumi. Hansen said that TCO believes a good portion of the volume can go through BTC, though TCO does not have preferential access, since it is exactly 50 percent, rather than majority-owned, by Chevron. -------------- GAS PROSPECTS -------------- ¶8. (SBU) Levy explained to Mann that TCO's current gas production is quite limited -- approximately 4 bcm, with about 2.3 bcm sold for Kazakhstani domestic consumption and the rest exported to Russia. With the second generation expansion, production should rise, but only to 7 bcm. Most gas is being reinjected into the reservoir to promote crude production. Levy said the Kazakhstanis are not happy with TCO's decision to reinject, because they would like to sell more gas to Europe. (Note: GOK Vice Minister of Energy Kiinov had argued to Levy that it does not make sense to reinject, because TCO is not replacing sufficient volume. TCO clearly disagrees with this assessment. End Note.) Levy told Mann that he did not believe TCO would be producing sufficient gas to justify even a small pipeline to Turkmenistan that would link up with a trans-Caspian pipeline. Levy also noted that Kashagan initially will be reinjecting as well. As far as Levy was concerned, "an oil pipeline is an order magnitude higher pri ority for TCO than a gas pipeline." -------------- BENEFITS TO KAZAKHSTAN -------------- ¶9. (SBU) Levy told Mann that through the end of 2007, TCO has paid out over $21 billion to Kazakhstani entities (including taxes and royalties paid to the government, tariffs and fees paid to state-owned companies, purchases of Kazakhstani-produced goods and services, and salaries to local employees). In the next quarter, quarterly royalties to the GOK would rise to $600 million, from $300 million previously. -------------- SULFUR AND TCO'S ENVIRONMENTAL FINE -------------- ¶10. (SBU) Levy explained to Mann that TCO is finally exporting more sulfur than the operation is producing. Last year, TCO exported just over 2 million tons of sulfur, mostly to China and Russia, with the rest shipped primarily to the Mediterranean region. Sulfur prices, he noted, are at a historic high. If there were not a CIS-region shortage of railcars -- of open gondolas -- TCO would export more. The GOK, Levy explained, was still pushing for central storage of the sulfur. TCO's overall sulfur strategy is to export as much as possible to reduce the "backlog" further, work parallel on a central repository, and move forward on a pilot project testing several types of covers for its sulfur stacks. ¶11. (SBU) Levy also discussed the $300 million fine for environmental damage from sulfur storage that Kazakstani courts had upheld against TCO. Levy contended that the stacks have, in fact, caused no environmental damage whatsoever. There has been little sulfur loss from the stacks, and no sulfur at all has been detected outside of TCO's sanitary zones. He explained that TCO had obtained all the appropriate permits for sulfur production, and that there was no permit available or necessary for continued sulfur storage. TCO had nevertheless paid the fine and had not withheld any royalties to the GOK to offset it. However, TCO intended to take the matter to arbitration, if necessary. It would insist on both its right to store sulfur without penalty as well as its right to consider the fine as an exaction and thus to offset it against royalties. Chevron and ExxonMobil attorneys, together with outside counsel, would be arriving soon to work on the issue. It was critical for Chevron and ExxonMobil to be completely linked up, Levy explained. This is a sanctity of contract issue, which is why it is so important to the companies, he emphasized. -------------- LABOR PERMIT ISSUE -------------- ¶12. (SBU) Levy said that local prosecutors intend to take TCO to court to force it to get work permits for its foreign employees. He explained that under TCO's formation agreement -- which was signed by President Nazarbayev, though, in accordance which Kazakhstani law at the time, was apparently not ratified by Parliament -- such work permits are not required. The companies, he insisted, are not going to allow TCO to request permits because, once again, this touches on sanctity of contract. -------------- EXXONMOBIL: KASHAGAN MAY NEVER BE PROFITABLE -------------- ¶13. (SBU) In a separate January 27 meeting in Atyrau, ExxonMobil Kazakhstan General Manager Steve Rose told Mann that the Kashagan deal was a "very expensive one" for ExxonMobil for a project without a lot of profitability. "We will have to wait and see if it ever makes money," Rose argued. (Note: Kashagan may turn out to be less profitable than ExxonMobil's normal standards for investment, but we have not heard elsewhere that Kashagan could be a money loser for the companies over the lifetime of the project. End Note.) The deal should lead to ExxonMobil increasing its Kashagan presence, though it is unclear where the new operating model will end up, he contended. Rose said that with the Kashagan agreement, a proposal ExxonMobil had previously made to do joint onshore exploration with KazMunaiGaz (KMG) north of the Caspian is now back on, though it will probably take two or three years for this to turn into something meaningful. The key for Kashagan is getting the transport agreements nailed down, Rose explained. It is important for Azerbaijan and Kazakhstan to move forward on the Kazakhstan Caspian Transportation System (KCTS) to move crude by tanker across the Caspian. With small tankers, the system could transport up to 1.2 million barrels per day, and with large ones perhaps up to 1.8 million. Rose explained to Mann that it would be difficult to bypass tankers and move straight to a trans-Caspian pipeline for a variety of reasons, including Kashagan phasing issues, the time needed to build a pipeline, as well as the unresolved issue of Caspian sea delimitation. Rose said that Nazarbayev believes he can get a deal on CPC expansion because he is allowing Turkmen gas to flow through Kazakhstan to Russia, but the prospects for expansion remain iffy. ORDWAY