KAZAKHSTAN: CONOCO-PHILLIPS DISCLOSES N BLOCK CONTRACT

UNCLAS SECTION 01 OF 03 ASTANA 002465 SENSITIVE SIPDIS STATE FOR SCA/CEN, EEB/ESC, EUR/CARC STATE PLEASE PASS TO USTDA FOR DAN STEIN E.O. 12958: N/A TAGS: PGOV EPET EINV KZ SUBJECT: KAZAKHSTAN: CONOCO-PHILLIPS DISCLOSES N BLOCK CONTRACT DETAILS REF: (A) ASTANA 1974 (B) ASTANA 2226 (C) ASTANA 1910 ¶1. (U) Sensitive but unclassified. Not for public Internet. ¶2. (SBU) SUMMARY: On December 12, Energy Officer met with Nick Olds (protect throughout),Caspian Region President for ConocoPhillips (COP),to discuss the status of negotiations for the N Block, an offshore hydrocarbon-rich reservoir in the North Caspian estimated to contain 270 million tons (2 billion barrels) of recoverable oil. Olds confirmed that a Heads of Agreement was reached on December 5 spelling out the basic principles for exploration and development of the field. According to that agreement, KazMunaiGas (KMG) will own 51% of the joint operating company and COP and Abu Dhabi's Mubadala Development Company will each own 24.5%. In addition, COP and Abu Dhabi will pay a signing bonus of $100 million and contribute 24.5% (each) of the staff for the new joint operating company. The parties extended the deadline for concluding a tax and royalty contract until January 31, 2009. Olds anticipates that under Kazakhstan's new Tax Code and Subsoil Law, the government will become much more directly involved in the details of project staffing, subcontracting, and exploration. He also said that COP will invest extensively in KMG's capacity development -- including assignments to development projects outside Kazakhstan -- to prepare KMG to become lead operator on the project. On transportation, Olds expects to export N Block oil via the Kazakhstan Caspian Transportation System (KCTS) and the Baku-Tbilisi-Ceyhan (BTC) pipeline. END SUMMARY. THE NEW DEAL ¶3. (SBU) ConocoPhilips pursued the N Block contract for several years and in November 2007, signed a contract to conduct a technical assessment of the field. Nick Olds, (protect throughout),Caspian Region President for ConocoPhillips, called the N Block "one of the most sought-after undeveloped assets in Kazakhstan." KMG estimates that the field, located 30 kilometers south of the southwestern Aktau shelf in the Caspian Sea and covering 8,184 square kilometers, contains 630 million tons of oil equivalent, with 270 million tons (2 billion barrels) designated as recoverable oil. In October, COP signed a memorandum of understanding (MOU) granting COP exclusive rights to negotiate a contract to develop the asset, beating out other major international oil companies interested in the opportunity, most notably Shell (see reftel A). ¶4. (SBU) On December 5, COP, Abu Dhabi's Mubadala Development Company, and KMG signed a Heads of Agreement defining the basic principles of a deal to explore and develop the reservoir. Under the terms of the agreement, Mubadala and COP will each initially provide 24.5% of the staffing and 50% of the financing for the project. Over time, KMG staff will replace expatriate staff as KMG transitions to the role of lead operator. In addition, COP and Mubadala will pay a $100 million signing bonus and provide KMG a "carry agreement" to provide financing for KMG's 51% stake in the new joint operating company. Olds said negotiations are still ongoing over the terms of this "equity percentage uplift," but he insisted the final agreement would include a provision that allows COP to stop production without penalty if KMG defaults on loan repayments. "This project requires a lot of upfront investment, but it is worth the risk," he said. ¶5. (SBU) Although all parties agreed to extend the deadline for completing a definitive agreement until January 31, 2009, Olds said KMG is "clearly under pressure to get the deal done. They do not want to extend the deadline past January 31." KMG President Kairgeldy Kabyldin said on December 9 that he expects the first well to be drilled in 2010 and the company to launch commercial production in early 2016, "if all the forecasts for raw hydrocarbons there are confirmed." A WHOLE NEW BALLGAME ¶6. (SBU) The N Block contract will likely be the first exploration and production contract negotiated in accordance with the provisions of Kazakhstan's new Tax Code and Subsoil Law. Among other things, the Tax Code introduces a new mineral extraction tax and a new rent ASTANA 00002465 002 OF 003 tax (reftel B),while the Subsoil Law discontinues production sharing agreements (PSAs) and requires separate contracts for exploration and production (reftel C). Olds acknowledged that the N Block deal will break new ground and said, "the whole nature of the game has changed." For example, Olds said it is unclear how the new rent tax will be applied and whether or not it will replace the crude export duty. In general, however, he said COP is not overly concerned about the new legislation, noting that certain provisions of their existing PSA will be grandfathered into the new tax and royalty agreement, such as the right to explore and develop the resource under a single contract. GOVERNMENT MORE DIRECTLY INVOLVED IN OPERATIONS ¶7. (SBU) Olds said that several issues remain to be negotiated before the final contract can be signed, including agreement on the composition, role, and authorities of the new joint operating company's management committee and review board. Under the previous subsoil law, a joint operating company would establish a management committee with one vote for the consortium and one vote for the government of Kazakhstan. The new subsoil law grants the government more authority in project management and oversight. ¶8. (SBU) Olds said that KMG First Vice President Maksat Idenov and Minister of Energy and Mineral Resources Sauat Mynbayev have already indicated they will be more involved in operational decision-making as the government's "competent authority" for the new project. For example, Olds said Idenov will approve the company's annual work plan and budget, as well as procurement decisions and contract terms. "Idenov and Mynbayev want to play a direct role in the N Block project," said Olds. For example, he said Idenov has asked to review each contract action, averaging 10-12 a week, for more than 40 contracts covering seismic acquisition, seismic processing, seismic interpretation, geochemical assessment, environmental impact assessment, drilling, etc. Olds noted that the management committee structure and voting rights and procedures for the N Block project are still under negotiation. KMG TO BECOME LEAD OPERATOR "IN TIME" ¶9. (SBU) The main theme of the December 5 meeting of the Foreign Investors Council, a biannual summit with President Nazarbayev and corporate CEOs doing business in Kazakhstan, was the government's desire to boost local content and develop local capacity. Olds said ConocoPhillips got the message and has proposed a three-tiered program for KMG's development that will lead "in time" to KMG assuming the role of lead operator on the N Block project. "This is well beyond what anyone else has ever done in Kazakhstan," he asserted. The development program would include enhanced technical training for KMG personnel, secondment of select KMG staff to COP projects outside Kazakhstan, and a gradual shift in project staffing over time, so that by the end of the 40-year contract in 2047, KMG will be the lead operator. PLANS TO EXPORT VIA TANKER TO BTC PIPELINE ¶10. (SBU) When asked how COP plans to export crude from the N Block, Olds said they would likely leverage the Kazakhstan Caspian Transportation System (KCTS) now under development and ship oil by tanker to Baku and onward to European markets via the Baku-Tbilisi-Ceyhan (BTC) pipeline. He did not mention other options. Olds suggested that, rather than transporting oil by pipeline from an offshore platform to the port terminal of Kuryk on Kazakhstan's Caspian coast, COP would explore the use of single-point mooring buoys that could load oil directly onto tankers for shipment to Baku. He also said that BTC would likely need to be expanded from 1.2 million barrels per day to 1.6 million barrels per day to accommodate increased volumes. ¶11. (SBU) COMMENT: The N Block is a big deal. In fact, it is so important to ConocoPhillips that CEO Jim Mulva visited Kazakhstan at least six times in the 12 months leading up to the signing of the October MOU granting COP exclusive negotiating rights. COP is well aware that they are taking a big risk and breaking new ground with the N Block, but they also know there are not many large, ASTANA 00002465 003 OF 003 N