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