KAZAKHSTAN: AMBASSADOR TOURS TENGIZ AND KASHAGAN

UNCLAS SECTION 01 OF 04 ASTANA 002259

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SUBJECT: KAZAKHSTAN: AMBASSADOR TOURS TENGIZ AND KASHAGAN

REF: (A) ASTANA 01868 (B) ASTANA 02025


1. (U) Sensitive but unclassified. Not for public Internet.


2. (SBU) SUMMARY: The Ambassador toured the supergiant oil fields
Tengiz and Kashagan on November 11 and 12 respectively, discovering
in the process new facts about future production, transportation
options, public perceptions, labor relations, and government
pressure at these two mega-projects. END SUMMARY.

TENGIZ OIL AND GAS PRODUCTION


3. (SBU) According to Todd Levy, General Director of Tengizchevroil
(TCO),the Tengiz and Korolev oil fields currently hold about 12
billion barrels of recoverable oil; only 6 billion barrels are
covered in the current concession agreement with TCO, which expires
in 2032. Levy reported that in 2008, TCO had $7 billion in
earnings, paid $5.5 billion in taxes and royalties to the Government
of Kazakhstan, and spent $1.2 billion on Kazakhstani goods and
services.


4. (SBU) TCO's Levy estimates that, if the company's third
generation Future Growth concept is approved, Tengiz could produce
up to 1 million barrels per day by 2014. He said, however, that
national oil company KazMunaiGas (KMG) has not yet approved the
Future Growth concept, which would require the partners to invest
dividend payments in infrastructure improvements, reinject nearly
all of the field's associated gas, and forego the revenue from
natural gas sales for the time being. TCO's other consortium
partners, ExxonMobil and LukArco, have approved the Future Growth
concept.


5. (SBU) TCO exports up to eight billion cubic meters (bcms) of
natural gas each year, which it sends through the Central
Asia-Center gas pipeline (majority-owned by Gazprom) from Kazakhstan
to Russia and then to Ukraine for domestic consumption (Gazprom will
not permit transit shipment to Europe). TCO produces another two to
three bcms of natural gas, which it sells at below-market rates to
the government. "We supply all of the gas to western Kazakhstan,"
said Levy. In addition, according to Levy, TCO produces 25,000
British Thermal Units (BTUs) a day of butane and propane, which it
ships by rail through Russia to the Black Sea port of Novorossiysk.

KASHAGAN INITIAL PRODUCTION LOWER THAN EXPECTED


6. (SBU) Richard Fritz, Public Relations Manager for AgipKCO, the
lead operator of the Kashagan consortium, surprised us by saying
that Kashagan will not produce 1 million barrels per day (bpd) of
crude "before the end of the next decade." He told the Ambassador
that first commercial oil production will be 75,000 bpd on December
1, 2012. Fritz also disclosed that although AgipKCO plans to
reinject 80-90% of the associated gas, the company will export up to
8 bcms of natural gas per year.


7. (SBU) The size, complexity, and scale of the onshore and
offshore operations at Kashagan continue to amaze even the seasoned
observer. For example, to construct its onshore processing
facility, AgipKCO used six times the amount of steel used to
construct the Eiffel Tower. The facility has 70,000 tons of pipe in
a pipe rack 1.2 kilometers long and six stories high. And each of
its three onsite storage tanks, built locally by MontazhSpetsStroi,
holds up to 500,000 barrels of oil. AgipKCO has also invested more
than $250 million in local infrastructure, including water, power,
gas, roads, and a rail line used to ferry workers to and from the
onshore plant. After touring the extensive onshore facilities and
offshore drilling islands, it is almost possible to understand how
such a project could cost upwards of $38 billion -- for the first
phase alone.

EXPLORING ALTERNATIVE TRANSPORTATION


8. (SBU) TCO's Levy said that the delays in expanding the capacity

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of the Caspian Pipeline Consortium (CPC) pipeline to Novorossiysk
have led TCO to pursue other transportation options for new
production, such as increased rail shipments through Russia and
through the Caucasus. Currently, TCO ships two-thirds of its
expanded crude production (approximately 210,000 barrels per day)
through Russia to Odessa by rail and one-third (100,000 bpd) via
12,000 deadweight-ton, double-hull tankers to Baku, then by rail
through Azerbaijan and Georgia to Batumi or Kulevi. TCO currently
uses 8,200 rail cars to transport its crude, but negotiations are
underway to increase the number to 11,000.


9. (SBU) When asked about the importance of the Baku-Supsa
pipeline, Levy said that TCO has no need for it at the moment.
"We're fine with the current arrangement," he said. He did confirm
that TCO is moving Tengiz crude through the Baku-Tbilisi-Ceyhan
(BTC) pipeline, but due to its mercaptan content and concerns about
blending Tengiz with Azeri crude, TCO will restrict itself to less
than 10% (100,000 bpd) of the total volume of BTC.

ENVIRONMENTAL PROBLEMS AND PERCEPTIONS


10. (SBU) Although TCO's environmental standards and performance
have been "terrific," according to Levy, the local media have
created the misperception that the company is a major polluter and
contributes to the environmental degradation of the Caspian Sea's
fragile ecosystem. "It's been our biggest battle," he said. "The
local press bashes us and we have no recourse, because they're
controlled by the local government. Let's face it," he said, "they
view environmental issues as an opportunity" to extract rent. For
example, according to Levy, TCO has been well within its annual
permit for gas flaring, despite a recent increase due to the launch
of its sour gas injection plant. Nevertheless, the local government
has accused TCO of exceeding its authorized amount and TCO must
fight the charges in court.


11. (SBU) Levy also said that TCO has invested significantly in
scientific studies, monitoring technology, and expert advisors to
monitor air, soil, and water quality, but that has not alleviated
the pressure from the local press or the local government, even when
the environmental protection work is carried out together with the
Ministry of Environment. TCO Operations Manager Tim West said that
local NGOs invited to tour Tengiz have subsequently written
"inflammatory" letters accusing the company of unsafe practices. He
also claimed that local media routinely ignore positive
environmental reports, such as the World Health Organization's 2008
World Health Report, which notes improvements in longevity, health,
and diet for Kazakhstanis.


12. (SBU) TCO's Levy does not suspect the involvement of other
governments in spreading negative information about TCO's
environmental impact, but he did note that environmental fines
collected from TCO go to the local government, and he suggested that
it therefore has a vested interest in promoting popular
misperceptions.


13. (SBU) AgipKCO's Fritz echoed the comments of TCO's Levy on the
environment, noting that Agip has invested heavily in technology and
expertise to monitor and sample air, soil, and water quality since
the project began. Nevertheless, AgipKCO receives complaints from
the local government and negative press attention on a regular
basis.

SULFUR STORAGE AND SALES


14. (SBU) TCO continues to produce, store, and sell significant
quantities of sulfur, a by-product of the associated gas in the
Tengiz and Korolev reservoirs. In fact, Levy estimates that TCO
will supply 10% of the world's export market for sulfur by 2017.
TCO currently stores eight million tons of sulfur in the open air
and will produce 2.4 million tons in 2008. They have sold 1.1
million tons in 2006-2007 and will sell 3.5 million tons in 2008 (or
145% of production). Levy said TCO is committed to moving the

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sulfur. "Don't tell the markets this, but we'll sell regardless of
price," he said.


15. (SBU) Unfortunately, Levy said, it has not been easy to market,
sell, or transport TCO's sulfur, particularly because they insist on
transparency in the supply chain and sell only to end users. He
also confided that the local government regularly pressures TCO to
sell the sulfur, and if TCO cannot find its own buyers, the Akimat
will provide a list of companies willing to buy, some of them
connected to government officials such as Minister of Industry and
Trade Shkolnik or KMG President Kabyldin.


16. (SBU) AgipKCO's Fritz said they will avoid TCO's sulfur storage
troubles by reinjecting 80-90% of the associated gas back into the
well and selling the remainder. Any sulfur that must be stored will
be palletized and sealed, not crushed, to avoid sulfur dust coming
into contact with the atmosphere.

LOCAL LABOR RELATIONS


17. (SBU) More than 80% of TCO's 3,500 employees are Kazakhstani
citizens, including 77% of all managers and supervisors. Of the
approximately 700 expatriate staff, 300 are from Russia or other CIS
countries and 400 are U.S. citizens, with another 100 American
family members living off-site in Atyrau.


18. (SBU) Following a violent clash in 2006 between Kazakh laborers
and Turkish supervisors, TCO strengthened the monitoring and
oversight of project managers and adjusted the ethnic mix of its
workforce, replacing Turkish supervisors with Indian and Filipino
managers.


19. (SBU) TCO has also promoted local employees to management
positions, including three Kazakhstanis who joined the Ambassador
for lunch. Two of them have been with the company for 16 years and
one, a female health, environment and safety supervisor, has been
with TCO for eight years. "We set a standard and an example for
other companies to follow," she told the Ambassador.


20. (SBU) AgipKCO's Fritz expressed concern about the shortage of
skilled local labor and said this issue would become more acute as
Kashagan moved closer to commercial production. He was also very
skeptical of KMG's ability and capacity to become the lead operator
of the Kashagan project as the new agreement signed on October 31
anticipates, saying, "They're like school kids starting out with a
Ph.D. program." AgipKCO currently employs 12,000 workers.

GOVERNMENT PRESSURE


21. (SBU) Without going into detail, TCO's Levy made clear that the
company is besieged by letters, phone calls, and subpoenas from the
Atyrau Akimat. He said they employ 15 lawyers to handle corporate
cases, and "they are the busiest people in the company," appearing
in court every day of the week. "It's killing us to answer these
thousands of inquiries," he said.


22. (SBU) TCO is less concerned about national legislation and
regulations, such as the new tax code and crude export duty. When
asked if he thought TCO's contract would have to be approved by a
separate act of parliament in order to preserve its tax stability
clause, Levy said the draft tax code was modified so that TCO's
contract, which was approved by a presidential decree, would not
require a separate parliamentary review. As for the export duty,
Levy said simply, "We haven't been asked to pay it."


23. (SBU) AgipKCO's Fritz was much less cautious in his criticism
of the local government. He said the government at all levels
considers Kashagan as "a milk cow" and suggested that there is an
expectation that government officials involved in the project will
"get something out of it for themselves." He said AgipKCO receives
50-60 letters a week from the local government about environmental
and other issues. He estimated that 5-10 of the letters require

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company lawyers to appear in court. AgipKCO employs two expatriate
lawyers and six Kazakhstani lawyers. Surprisingly, Fritz said that
having the national oil company KMG as a major equity partner does
not help reduce the pressure from the government. "We get no
support or assistance from KMG on any of these issues," he said.

HOAGLAND