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