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)

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SUMMARY
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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.

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MANY DETAILS TO WORK OUT ON KASHAGAN
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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.

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DOUBTS ABOUT AVAILABILITY OF GAS
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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.

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TENGIZCHEVROIL: CHEVRON'S MOST VALUABLE ASSET
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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.

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FUTURE GROWTH
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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.

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GAS PROSPECTS
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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."

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BENEFITS TO KAZAKHSTAN
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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.

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SULFUR AND TCO'S ENVIRONMENTAL FINE
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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.

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LABOR PERMIT ISSUE
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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.

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EXXONMOBIL: KASHAGAN MAY NEVER BE PROFITABLE
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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