KAZAKHSTAN: CHEVRON CAUTIONS CPC EXPANSION NOT YET A DONE

UNCLAS SECTION 01 OF 02 ASTANA 000131 SENSITIVE SIPDIS STATE FOR SCA/CEN STATE PLEASE PASS TO USTDA FOR DAN STEIN E.O. 12958: N/A TAGS: PGOV ECON EPET EINV KZ SUBJECT: KAZAKHSTAN: CHEVRON CAUTIONS CPC EXPANSION NOT YET A DONE DEAL REF: (A) 08 ASTANA 2144 (B) 08 ASTANA 1910 (C) 08 ASTANA 2226 ASTANA 00000131 001.2 OF 002 ¶1. (U) Sensitive but unclassified. Not for public Internet. ¶2. (SBU) SUMMARY: Chevron is pleased with the December 17, 2008, agreement to expand the capacity of the Caspian Pipeline Consortium (CPC) pipeline, but is concerned that the deal could still fall through before the project is sanctioned. Although there are no technical obstacles to the Kazakhstan Caspian Transportation System (KCTS),critical details still needed to be negotiated, particularly on Caspian maritime logistics and safety. Since Tengizchevroil (TCO) more than doubled its production in 2008, it needs greater transportation capacity and is in talks with the State Oil Company of the Azerbaijan Republic (SOCAR) to use the Baku-Supsa pipeline. Chevron said recent changes to the investment climate in Kazakhstan jeopardize the principles of tax stability and the sanctity of contracts. END SUMMARY. CHEVRON PLEASED WITH AGREEMENT TO EXPAND CPC... ¶3. (SBU) Jay Johnson, Managing Director of Chevron's Eurasia Business Unit, told Energy Officer on January 15 that he was pleased with the agreement reached on December 17, 2008, to expand the capacity of the Caspian Pipeline Consortium pipeline from 32 million tons (approximately 700,000 barrels per day, or bpd) to 67 million tons (1.34 million bpd). Johnson said he was pleasantly surprised that BP, the only consortium member that did not sign the expansion agreement, nevertheless signed a series of technical agreements that allowed the project to move forward, including one that reserves cash for the requisite engineering studies. He confirmed that BP requested, and was denied, permission to negotiate the sale of its 6.6% share in CPC with investors outside the consortium. BUT "IT'S NOT A DONE DEAL YET" ¶4. (SBU) Despite BP's acquiescence, Johnson cautioned that "CPC expansion is not a done deal." He said the consortium has one year - until December 2009 - to sanction the project, by which time BP plans to sell its shares and exit the consortium. BP does not own sufficient upstream assets to justify further investment in CPC and its business operations in Kazakhstan are fundamentally misaligned with the expansion endeavor (reftel A). Johnson does not believe that BP will deliberately drag out negotiations over the sale of its shares until the last minute. On the contrary, he said Lukoil, which has a right of first refusal as BP's main joint venture partner, "will squeeze BP hard on this deal." In fact, Johnson said his biggest fear is if "BP gets burned, then they'll refuse to sanction the expansion." KCTS FUNDAMENTALS ALREADY AT WORK... ¶5. (SBU) Commenting on the Kazakhstan Caspian Transportation System, Johnson said there are no technical obstacles to building the first segment of the project, a pipeline from Eskene (near the supergiant Tengiz oil field in Atyrau oblast) to Kuryk (south of the port of Aktau). He confirmed that Chevron is representing Tengizchevroil (TCO) in the negotiations, while ExxonMobil is representing the so-called G-6, or Kashagan consortium. Johnson said the pipeline could be built in 18 months "if we just quit screwing around." In fact, Johnson said that an embryonic KCTS is already operational: TCO currently ships Tengiz crude by rail to the port of Aktau, where it is loaded onto 12,000 deadweight ton tankers, shipped to Baku, and loaded onto rail cars to the Georgian port of Batumi or pumped directly into the Baku-Tbilisi-Ceyhan (BTC) pipeline. KCTS COMPLEXITY COULD CREATE DIFFICULTIES AND DELAYS ¶6. (SBU) Johnson cautioned, however, that this is an extremely complex, multifaceted project with many potential bottlenecks. For example, TCO has voluntarily limited exports via BTC to 5% of that pipeline's capacity, due to the high mercaptan content of Tengiz ASTANA 00000131 002.2 OF 002 crude. (NOTE: Higher volumes of Tengiz crude would impact the quality of the blend and restrict refining options and the product mix. For example, jet fuel cannot contain mercaptans. END NOTE). In addition, Johnson said the small tankers currently in use would be insufficient to accommodate the increased volumes expected from TCO and Kashagan by 2013. "We've done a logistical study," he said, "and determined that you cannot run enough smaller ships to carry all the crude. It just would not be safe. We definitely need the bigger ships with safety features like inert gas systems and double hulls." According to Johnson, other potential problems for KCTS include the capital costs of dredging and modernizing the port of Kuryk, the training and accreditation of crews, legislation to govern the administration of ports, and the amount of paperwork required to move ships across the Caspian. Johnson said it would be a mistake to underestimate the importance of the latter, noting that the current procedures are paper-based and can take several days to process a single ship. NEGOTIATING WITH SOCAR TO USE BAKU-SUPSA ¶7. (SBU) Johnson said that TCO doubled production at the end of 2008 - from 270,000 bpd to more than 540,000 bpd - and confirmed that TCO is in talks with Azerbaijan's national oil company SOCAR to ship up to 100,000 barrels per day of Tengiz crude via the "westward route", or Baku-Supsa pipeline. He said that TCO plans to expand even further in the next five years. Although TCO's Future Growth (Phase III) expansion has not yet received final approval from the Board - "the government of Kazakhstan wants to take a close look at it" - Johnson called it "an active project currently under development." Future Growth would expand TCO's production to more than 1 million barrels per day. INVESTMENT CLIMATE CONCERNS ¶8. (SBU) When asked if Chevron is pursing new development opportunities in Kazakhstan, Johnson shook his head no and said, "There are some areas we are interested in, but we are not actively exploring anything, not in this business environment." He said it is very expensive to explore in Kazakhstan's unforgiving climate - "it costs $50 million to drill a well in the Caspian" - but emphasized that legal and regulatory changes were more of a deterrent than cost. For example, Johnson noted that the draft Subsoil Law no longer grants investors the right to go to international arbitration in case of a dispute with the government (reftel B) and said the new Tax Code raises real questions about the government's respect for the sanctity of contracts, particularly the tax stability clauses of existing agreements with international oil companies (reftel C). Finally, Johnson said that the Karachaganak consortium - in which Chevron owns 20% -- has paid under duress more than $760 million in crude export duties in the last nine months alone. (NOTE: Although the government recently cancelled the crude export duty effective January 26, it is not clear if this is a permanent or temporary suspension. END NOTE). HOAGLAND