KAZAKHSTAN: SHELL COMMITTED TO CONTINUED

UNCLAS SECTION 01 OF 03 ASTANA 002408

SENSITIVE
SIPDIS

STATE FOR SCA/CEN, EEB/ESC
STATE PLEASE PASS TO USTDA DAN STEIN

E.O. 12958: N/A
TAGS: EINV EPET KZ PGOV
SUBJECT: KAZAKHSTAN: SHELL COMMITTED TO CONTINUED
OPERATIONS THROUGHOUT CASPIAN REGION

REF: 08 ASTANA 02391


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


2. (SBU) SUMMARY: Shell Kazakhstan,s Asset Manager for
Kashagan, Devin Garrity, and County Chairman Campbell Keir
met with CDA Kevin Milas on December 3 to provide an update
on Shell operations in the Caspian Sea region. Offering a
generally positive assessment, Keir and Garrity said that
Shell plans to maintain its interests in the Arman, Pearls
(Zhemchuzhina),and Kashagan fields and were cautiously
optimistic that the CPC pipeline expansion agreement would be
signed with British Petroleum,s (BP) consent by the end of

2008. END SUMMARY.

SHELL CONFIDENT IN NEW CONSORTIUM


3. (SBU) As Shell,s top shareholder representative for the
North Caspian Production Sharing Agreement (PSA),which
includes the Kashagan field, and having been directly
involved in the renegotiation of the PSA for several months
in 2008, Garrity noted with relief that the "Kashagan
negotiations are now fully behind us." He added that having
KMG as a full partner invested at all levels should
facilitate overall communication and transparency in the
consortium. Garrity also expressed confidence that the
consortium now comprises a far more viable and equitable
model than the previous consortium. Both Keir and Garrity
shared their belief that KMG has the liquidity it needs to
honor the many financial commitments it has made, including
its greater equity stake in the PSA. According to the
payment plan, KMG has an 8.4% equity buy-in, but does not
have to pay for the shares until commercial production
begins, which is expected in "2013 or thereabouts," said
Keir. (NOTE: Keir and Garrity said that Shell is staffing up
its team and striving for first oil by 2012, although they
introduced the caveat that unforeseen "bureaucratic
procedures could lead to last-minute delays." END NOTE.)

ZHEMCHUZHINA EXPECTED ONLINE AS EARLY AS 2014


4. (SBU) In the Zhemchuzhina Field, Shell drilled its second
exploratory well in November, which according to Keir,
provided a clean flare and met necessary environmental
standards. Keir said that Shell has recently ceased activity
in the field because of ice buildup, but Shell plans to drill
another two wells in the area and conduct seismic tests in

2009. According to their latest forecast, Shell expects the
field to come online between 2014 and 2016.

FALLING OIL PRICES MAY IMPACT OPERATIONS


5. (SBU) Acknowledging the potential impact of falling oil
prices, Keir said that there could, of course, be a
theoretical point at which investment in Phase I of Kashagan
becomes problematic, and therefore cause a reconsideration of
Phase 2. However, Garrity pointed out that the exploration
cycles in general -- from first drilling to first oil
reaching the market -- can be as long as 10 years. Shell is
well positioned to weather the greater global financial
crisis said Keir, because it has "virtually no debt." Given
the long-term prospects for Kashagan, he added, Shell intends
to avoid any proposed efforts to push out development of the
field because of the associated increase in overall costs of
exploration and eventual delivery of oil to the market.
Should oil prices remain near $50 a barrel, he acknowledged,
it will ultimately impact the financial viability of
extraction from "less conventional" resources. "Fundamentals
indicate that the price of oil must remain between $80 and
$90 per barrel," said Keir, for the long-term viability of
these less conventional resources fields, such as those in
the Arctic. Kashagan, he added, is considered a less
conventional resource because of the technical, elemental and

ASTANA 00002408 002 OF 003


environmental challenges associated with extraction and
refinement.


6. (SBU) On a positive note, Keir mentioned that the current
economic situation may foster an opportune atmosphere for the
for equipment purchases. Noting that the drop in oil prices
had greatly reduced Russian exploratory operations, he added
that the crisis will likely improve the availability and
price of necessary hardware, including much-needed drilling
rigs.

MANGYSTAU AND ATYRAU PRESS FOR MORE LOCAL HIRING


7. (SBU) Regarding operations on the Caspian, Keir concurred
with the CDA that working with authorities in Mangystau is
easier than in Atyrau. Specifically, conditions for gaining
work permits are significantly easier, giving the impression
that Mangystau authorities are trying to compete for business
with wealthier Atyrau oblast. Keir said that in response to
growing rates of regional unemployment, authorities in both
oblasts are increasingly pressuring Shell to hire local
workers. However, officials in Atyrau often tell Shell whom
they must interview for available positions, most recently
informing Shell that it must hire an additional 1,500
workers. According to Keir, this makes it "an entirely
different game" and therefore "much, much tougher" than
operating in Almaty or Astana. (NOTE: Despite the implied
relative ease of hiring in Astana, many western businesses in
the capital area including General Electric, continue to cite
difficulties in hiring and obtaining work permits as an
ongoing barrier to trade. See Reftel. END NOTE.) Keir added
that as Shell staffs the operational portion of the PSA, they
expect growing pressure to meet increased local staffing
requirements. Keir noted that finding qualified local hires
is "not a trivial matter," but that the relationship with
local authorities can be "managed" to a certain degree. Keir
concluded that Shell must now decide whether or not to take
over the "administrative machine" created by AGIP to manage
hiring relations with local authorities, or develop a new
approach entirely.

CPC EXPANSION AGREEMENT EXPECTED BY YEAR,S END


8. (SBU) According to Keir and Garrity, Shell expects the
Caspian Pipeline Consortium (CPC) to sign an agreement on CPC
pipeline expansion by the end of 2008. With regards to
British Petroleum (BP),Keir believes that BP has two
options: BP will either collapse under the pressure of the
Russian government or sign the expansion agreement.
According to Keir, "BP wants out, which is understandable,"
but added that BP cannot expect the other consortium members
to break existing shareholder agreements on preemptive
rights. Shell and the other shareholders, said Keir, are in
agreement they the pipeline consortium should not be opened
to someone without an equity interest in the shipping process
as well.

SHELL LOOKING AT RAILWAY TRANSIT


9. (SBU) Lacking an interest in the BTC pipeline, Shell is
employing a multivector approach in its search for
alternative routes for future oil exports. Currently, Shell
is closely considering the possibility of using rail lines,
specifically the Bolashak rail system being built near
Atyrau. While this seems promising, Shell admitted that
funding the project will likely be a problem for the
Government of Kazakhstan. According to Keir, the Kazakhstani
government wants to own what it considers key infrastructure,
but also wants foreign financing for the projects. Keir
believes that Kazakhstani authorities do not understand the
current financial environment, noting that "the foreign
investment is simply not there." According to Keir, "they
think they can still just go to the markets and everyone will

ASTANA 00002408 003 OF 003


love Kazakhstan." He did, however, concede that for some
officials, the "unfortunate truth" about the foreseeable lack
of foreign financing "is sinking in." Reflecting on doing
business in Kazakhstan, Keir noted that the Kazakhstanis tend
to start business negotiations from very extreme positions,
but can often can be convinced to back down to more a
reasonable stance.


10. (SBU) COMMENT: Stress caused by the financial crisis in
Kazakhstan is not expected to significantly impact Shell,s
operations in the Caspian Sea region. A continued reduction
in commodity prices may in fact prove financially beneficial
to Shell as it accumulates necessary supplies and inputs for
ongoing operations. Rising levels of unemployment in western
Kazakhstan may, however, lead to intensified pressure from
regional authorities to increase the number of locally hired
staff. But in as much as Shell remains committed to
development and has the necessary financial reserves to
maintain its momentum, continued operations in the Caspian
Sea may provide a convenient buffer to the region, thereby
shielding it from some of the harsher effects of the
financial crisis likely to be felt in other parts of
Kazakhstan. END COMMENT.
MILAS