KAZAKHSTAN: ENERGY DEPUTY SECRETARY PONEMAN BRIEFED ON

UNCLAS SECTION 01 OF 03 ASTANA 001858 SENSITIVE SIPDIS STATE FOR SCA/CEN, EEB/ESC, S/EEE, S/CIEA, EUR/WE STATE PLEASE PASS TO USTDA E.O. 12958: N/A TAGS: PGOV PREL ECON EPET EINV FR KZ SUBJECT: KAZAKHSTAN: ENERGY DEPUTY SECRETARY PONEMAN BRIEFED ON PIPELINE CONTRACT REF: (A) ASTANA 1438 (B) ASTANA 1449 ASTANA 00001858 001.3 OF 003 ¶1. (U) Sensitive but unclassified. Not for public Internet. ¶2. (SBU) SUMMARY: On October 6, during the visit of French President Nicolas Sarkozy to Astana, the government of Kazakhstan signed a memorandum of understanding with a consortium of French companies to study construction of a 730-kilometer, on-shore pipeline to carry crude oil from Eskene, near Atyrau, to the port of Kuryk, south of Aktau. International oil companies (IOCs) had been engaged in negotiations with the government for months prior to the announcement, and have expressed concern that the deal will delay the $2 billion project. Senior government officials told Deputy Secretary of Energy Daniel Poneman that the government will retain 100% ownership of the pipeline and guarantee tax stability, access rights, and market-based tariffs. Also during Sarkozy's visit, Total SA, Europe's third-largest oil company, and GDF Suez SA agreed to buy 25% of the offshore Khvalynskoye natural gas field from national oil company KazMunaiGas (KMG). END SUMMARY. THE ESKENE-KURYK PIPELINE ¶3. (SBU) On October 6, a consortium of predominantly French companies -- including Vinci SA, Entrepose Contracting SA, Spie Capag, Mannesmann France, Europipe GmbH, GTS Group, and ArcelorMittal -- signed an agreement with the government to study construction of an on-shore pipeline that would transport oil from Eskene, near the supergiant fields of Kashagan and Tengiz, to the Kazakhstani port of Kuryk, for onward shipment via tanker to Baku. The pipeline is a key component of the Kazakhstan Caspian Transportation System (KCTS) that will deliver Kazakhstani crude oil to Baku across the Caspian via tanker. The contract is expected to be worth as much as $2 billion. KAZAKHSTAN WANTS TO BE A COMMON CARRIER ¶4. (SBU) On October 7, KMG President Kairgeldy Kabyldin told Deputy Secretary of Energy Daniel Poneman that the French consortium received financial backing from the export credit agencies (ECA) of France and Japan for the construction of the Eskene-Kuryk pipeline. He also confirmed that the companies will not acquire equity in the pipeline. "It will be 100% owned by Kazakhstan. Besides," he added, "the international oil companies are not in the pipeline business." Kabyldin said the government's negative experience as a partner in the Caspian Pipeline Consortium (CPC) convinced him that this was not the best model to follow for the Eskene-Kuryk pipeline project. In particular, Kabyldin criticized the inefficiencies, delays, and cost overruns associated with the construction, management, and expansion of the CPC pipeline (ref A). ¶5. (SBU) Kabyldin said that before signing the agreement with the French consortium, KMG offered ExxonMobil and Chevron -- representing Kashagan and Tengiz respectively -- guaranteed access, preferential tariffs, and tax stability in exchange for a ship-or-pay commitment. Unfortunately, he said, they were not able to come to an agreement. Despite the MOU with the French consortium, Kabyldin said that KMG remains ready to continue negotiations with the IOCs on the KCTS project. However, he stressed that the government will insist on maintaining complete ownership of the transportation infrastructure. "If we own the system," he said, "we can guarantee equal access and fair treatment to all. We can act as a common carrier," and provide a service to all shippers, without discrimination or favoritism. MINISTER OF ENERGY EXPLAINS AGREEMENT WITH FRENCH ¶6. (SBU) During a private dinner at his residence in Astana on October 7, Minister of Energy and Mineral Resources Sauat Mynbayev told Deputy Secretary of Energy Poneman that Kazakhstan was ASTANA 00001858 002.3 OF 003 originally prepared to offer the IOCs a 49% equity stake in the pipeline (ref B). Mynbayev said that the government would have retained a majority stake of 51% and the right to purchase the remaining shares at any time. He also asserted that the government asked the IOCs to provide a loan to finance the share purchase, but they refused. When Poneman noted that President Aliyev had told him in Baku on October 5 that Azerbaijan would not object to the IOCs having equity participation in the KCTS, Mynbaev replied that the Government of Azerbaijan had insisted that the Kazakhstan and Azerbaijan governments would split their equity shares 50/50, and Astana was free to share the GOK's 50% share with the IOCs if it wished. ¶7. (SBU) According to Mynbayev, the government began in July to explore alternative financing arrangements to build the pipeline. The agreement signed with the French consortium on October 6 allows the government to borrow from France's export credit agency (ECA) to finance construction of the Eskene-Kuryk pipeline. If it takes the loan, the government will sign an exclusive construction contract with the French consortium to build the pipeline, and, according to Mynbayev, award France a "pre-emptive right" to negotiate an exploration and production contract for an unspecified block. However, Mynbayev said that if Kazakhstan is able to borrow from the Kashagan partners, or another source, then the government is not obligated to use the French companies, or negotiate an exclusive exploration and production contract with France. Mynbayev confirmed to Deputy Secretary of Energy Poneman that Kazakhstan will own 100% of the pipeline, but provide long-term, stable tariffs and guaranteed access. IOC CONCERNS ABOUT DELAYS ¶8. (SBU) On October 12, Patty Graham, Director of Government Relations for ExxonMobil Kazakhstan, told Energy Officer that the agreement with the French consortium may delay construction of KCTS and will be an unwelcome distraction for the Kashagan consortium, which must make critical decisions by the end of the year on Phase II production. "KMG now has a new opening to discuss third-party financing," she said. "Normally, that takes one or two additional years, because investment banks need more reassurance and guarantees." Graham said the French export credit agency will need at least six months to assess the risks and returns of the project before it commits financing for the pipeline. As a result, she said, KMG will wait at least that long before it responds to an IOC offer to build the pipeline in exchange for a minority equity stake. "We don't even know if we're in the ballpark," said Graham. The agreement with the French consortium "creates significant delays," she said, "even before we've settled on a business model. What if KMG decides at the end of the road that the terms are too onerous? The whole thing could unravel." Graham added that the French agreement was not completely unexpected, since Total has always had its eyes set on the transportation component of the Kashagan field. ¶9. (SBU) Graham said that the consistency of messages from Mynbayev and Kabyldin on IOC participation in the Eskene-Kuryk pipeline was a clear indication that the decision came from the top (indicating specifically, Timur Kulibayev, Deputy Chairman of Samruk-Kazyna). She also suggested that the terms that will be offered by the ECAs will be more stringent than those that would have been offered by the IOCs, and she believes that the Kazakhstanis will ultimately not be able to meet the terms of the ECA loan. SHIPPERS V. OWNERS ¶10. (SBU) Graham said ExxonMobil and the other Kashagan partners are willing to participate in KCTS, even if they do not own equity in the project. "Our concern is not that we might not be given ownership in the system," she said, "but rather that after months of negotiations, we still have not been able to agree on a business model." Graham said that if the Kashagan partners were to be ASTANA 00001858 003.3 OF 003 shippers only -- not owners -- they would need "a whole slew of guarantees on tariff stability and capacity access." KCTS COULD SHIP OIL TO IRAN ¶11. (SBU) On October 7, Jay Johnson, Managing Director of Chevron's Eurasia Business Unit, told Energy Officer that the French consortium will pay 85% of pipeline costs, but will not acquire an equity stake in the infrastructure. He said the government insisted on retaining 100% ownership of the pipeline, which it will transfer to KMG. Johnson also expressed concern that without the involvement of U.S. companies, the pipeline could be used to send oil to Iran. Although Graham agreed that the "Iran option" is an open possibility, she noted that the government's primary focus will be to build a transportation system to which all shippers will have access. DEAR FRIENDS ¶12. (U) According to wire reports, during the visit of French President Sarkozy on October 6, Total agreed to purchase a 17% stake, and GDF Suez an 8% share, of the Khvalynskoye gas field, jointly owned by KMG and Russia's Lukoil, which owns 50% of the field. "The gas will be sent to Russia," Total Chief Executive Officer Christophe de Margerie said, adding that the French companies will contribute about $1 billion of the $3.5 billion to $4 billion in estimated development costs. Output may start in 2016 and reach 8-9 billion cubic meters a year, he said. Sarkozy and President Nursultan Nazarbayev oversaw the signing ceremony and referred to each other as "dear friends" at a business forum held after the talks. Sarkozy praised Kazakhstan's role in securing stability in the volatile region and said Astana could help resolve the Afghan crisis. When asked about criticism Kazakhstan has faced over its human rights record ahead of chairing the Organization for Security and Cooperation in Europe (OSCE),Sarkozy said he was convinced Astana was moving towards OSCE standards. "We have made our political choice, my dear friend, and I hope you will see that when France makes a political choice it sticks to it to the end," he told Nazarbayev. ¶13. (SBU) COMMENT: The agreement with the French consortium is not a done deal. In fact, it is not a deal at all. It is simply a memorandum of understanding that allows the government, in theory, to borrow money from an ECA at favorable rates in exchange for hiring French companies to build the pipeline. As both KMG President Kabyldin and Minister of Energy Mynbayev made clear to Deputy Secretary of Energy Poneman, the government is eager to resume negotiations with the IOCs whose volume commitments are essential if KCTS is to become operational. Third-party financing from France's export credit agency may delay the government's negotiations with the IOCs, which in turn could adversely affect the pace of negotiations on CPC expansion. The government's determination to own what it considers strategic infrastructure is understandable, and its commitment to provide stable, predictable access to KCTS should be taken seriously. Despite a number of high-profile disputes -- most recently, BG Group's request for reimbursement of $1 billion in crude export duties -- the government has generally honored its commitments and kept its promises, particularly when the stakes are this high. END COMMENT. ¶14. (U) Deputy Secretary Poneman has cleared this cable. HOAGLAND