KAZAKHSTAN: THE POLITICS OF PIPELINES

UNCLAS SECTION 01 OF 04 ASTANA 000530

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TAGS: PGOV PINR ECON EPET EINV KZ
SUBJECT: KAZAKHSTAN: THE POLITICS OF PIPELINES

REF: (A) ASTANA 0283 (B) ASTANA 0131

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1. (SBU) Sensitive but unclassified. Not for public Internet.


2. (SBU) SUMMARY: On March 17-18, Energy Officer spoke with
representatives from Kazakhstan's national oil company KazMunaiGas
(KMG) and international oil companies about planned oil and gas
export projects, particularly the Caspian Pipeline Consortium (CPC)
pipeline and the Kazakhstan Caspian Transportation System (KCTS).
The general consensus is that these export projects will be
necessary by 2013 if oil production in Kazakhstan increases as
expected. Furthermore, the projects have continued to move forward,
despite the impact of the financial crisis and lower oil prices on
the cash position of the business partners. Several representatives
said they do not expect Russia to openly oppose or obstruct any of
the projects, even KCTS, which will give Kazakhstan an export route
that circumvents Russian territory. Nevertheless, negotiations are
expected to be difficult, particularly with Azerbaijan and the
international oil companies on KCTS. Both KMG and international
company officials expressed a keen interest in the status of
U.S.-Iranian relations and said normalization of ties with Iran
would be a "game changer" for crude exports from Kazakhstan. END
SUMMARY.

CPC EXPANSION UPDATE


3. (SBU) On March 17, Energy Officer met with Timur Rakhanov,
Director of KMG's Department for New Transportation Projects and
also a member of the Board of Directors of CPC. Rakhanov is an
impressive, articulate individual and one of KMG's rising stars. He
is young (early 30s),speaks fluent English, studied in London, has
represented KMG's interest in CPC for more than five years, and
prides himself on developing, mentoring, and delegating to junior
staff. He said that CPC expansion is likely to be approved by all
consortium members, although a final decision (sanction) is not
expected until December. At this point, he said, the consortium is
discussing "ship or pay" terms and is still seeking a legally
binding volume commitment from suppliers. He confirmed that the
plan is to expand capacity from 32 million tons/year to 67 million
tons/year, by installing 10 new pump stations throughout the
pipeline and replacing 700 mm pipe with larger 1000 mm pipe.
Rakhanov also confirmed that CPC will expand the off-loading
terminal at Novorossisyk and construct storage tanks with a capacity
of 100,000 tons.

LUKOIL AND BP IN A STALEMATE


4. (SBU) According to Rakhanov, CPC expansion will take three years
to complete. He added that this is a "perfect time" to carry out
expansion work, since the price of steel and other inputs is low and
the consortium has a fixed tariff of $38/ton. Rakhanov also
confirmed that BP and Lukoil were still in talks about the sale of
BP's stake in LukArco and implied that negotiations had reached a
stalemate. "BP says, 'Everything's OK, talks are continuing' but
Lukoil says, 'We can't see the light at the end of the tunnel.'"
He confided that within the next two weeks, KMG expects to complete
the purchase of BP's share of Kazakhstan Pipeline Ventures' 1.75
percent stake in CPC, which carries with it the right to ship 10.5
million tons of crude per year via the pipeline. However, he
dismissed the idea that KMG would acquire a portion of the 7 percent
stake in CPC that Russia purchased from Oman last year. "True, we
have the right to acquire 3.5 percent of Oman's stake, but why
should we? That 3 percent gives us nothing in terms of control or
capacity rights," he said.

CHEVRON CAUTIOUSLY OPTIMISTIC ABOUT CPC EXPANSION


5. (SBU) On March 18, Jay Johnson, Managing Director for Chevron's
Eurasia Business Unit, told Energy Officer that CPC expansion could
be sanctioned by the end of the year, but "it all depends on how
difficult BP wants to be." Zamira Kanapianova, Chevron's Country

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Manager for Kazakhstan, added that Lukoil is "more cautious" now
than in the past, partly for financial reasons and partly out of
deference to the Russian government. She suggested that Lukoil will
be careful not to make any moves without the approval of the
Kremlin. "Look what happened to Yukos," she said. Johnson echoed
Rakhanov's comments that the time is right for CPC capacity
expansion given the low price of steel, and he confirmed that the
necessary engineering work and feasibility studies are already
underway. Kanapianova added that the 0-116 kilometer segment of CPC
pipeline is now being replaced. Johnson said CPC expansion alone
would not be sufficient to accommodate all of the increased crude
volumes Kazakhstan expects to export beginning in 2013. "Once you
have Tengizchevroil's second generation plant fully operational,
plus Karachaganak's Phase III, and Kashagan production, you're going
to need all the pipelines you can get," he said.

IS KCTS A REAL PROJECT, OR JUST A PLOY?


6. (SBU) KMG's Rakhanov said some progress has been made on the
Kazakhstan Caspian Transportation System (KCTS),but he expressed
doubts about the ability to secure volume commitments for both
projects in the near term, suggesting that KCTS could actually
compete with CPC for crude supplies once it is completed in
approximately 2015. (NOTE: There are currently no crude volume
commitments to KCTS. END NOTE). Nevertheless, Rakhanov supports
the project, not least because the concept alone has given
Kazakhstan useful leverage in negotiations with Russia over CPC
expansion. Rakhanov said KCTS was "fifty percent responsible for
changing Russia's attitude" toward CPC expansion.

WHO WILL BUILD THE TANKERS?


7. (SBU) Chevron's Johnson supports the development of KCTS, but
considers the project incredibly complex and risky, particularly
from a maritime safety perspective. "Building a pipeline to Kuryk
doesn't do you any good," he said. "You still need to get the crude
across the Caspian. And there's a real issue around ships." He
noted that neither Kazakhstan nor Azerbaijan currently has the
capacity to build the 60,000 deadweight-ton tankers that would make
the project viable, and he suggested that Russia would oppose
efforts by either country to develop the infrastructure and
expertise to build ships that large. Johnson said that, ironically,
KCTS, which would circumvent Russian territory, might need the
support from Russia, which could build the ships in Astrakhan or
allow manufactured parts to travel down the Volga-Don for assembly
in the Caspian.

TENDER CONDUCTED FOR SMALLER TANKERS


8. (SBU) On February 25, the newspaper Vremya reported that
KazMorTransFlot (KMTF) conducted a tender to build three new 12,000
deadweight ton oil tankers. According to the article, KMTF received
seven bids: four from Russia, one from Ukraine, one from Bulgaria,
and one from Korea. The lowest price came from the Bulgarian
company MTG Dolphin, at 15.3 million euros per tanker, but the
article claimed that the company began building tankers just two
years ago and the terms of the tender require a minimum of five
years' experience. The Ukrainian company Okean, owned by German
shareholders, offered to build the ships for $21.7 million each.
Russia's Zelenodolsk bid $23.5 million, but the article notes that
KMTF previously ordered barges from this company and they missed the
delivery deadline. Russia's Krasnoe Sormovo bid $22.3 million, but
according to the article, one of their previous clients, a Turkish
firm, complained that the company was two years late and kept trying
to increase the cost per unit from $18 million to $26 million. The
Korean company Hyundai was willing to offer a price of $23.5
million, although a company spokesman said they have built similar
tankers for $30 million. Russia's Astrakhan shipyard offered a bid
of $24.8 million and Russia's Vyborg offered 28.7 million euros.
(NOTE: The Korean Ambassador to Kazakhstan told the DCM in
mid-February that Hyuandai has made a strategic decision to enter

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the Caspian region, despite the lack of a suitable shipyard in
Kazakhstan. On March 18, KMG's Arman Darbayev, Executive Director
for Oil Transportation and Service Projects, told Energy Officer
that Astrakhan's bid was accepted, although the winner of the tender
has not yet been publicly announced. END NOTE).

AZERIS WANT "MONEY FOR NOTHING"


9. (SBU) KMG's Arman Darbayev, Executive Director for Oil
Transportation and Service Projects, argued that the number one
question for KCTS -- an issue even more important than the tanker
fleet -- is whether or not international oil companies will be
allowed to take an equity stake in the project. He said the tanker
issue is a technical and commercial problem: "If you have enough
money, you can solve this." According to Darbayev, however, the
ownership issue is a "political problem" and therefore more
intractable. Darbayev said that Azerbaijan has asked for volume
commitments from the suppliers before work can begin on KCTS, but
the suppliers will not commit volumes without a minority equity
share that will give them greater control over project risk, cost,
schedule, and safety. Regarding the proposed pipeline from Eskene
to Kuryk, Darbayev said the government of Kazakhstan has agreed in
principle to 49 percent ownership by private sector partners and the
companies representing Tengiz and Kashagan have agreed to provide
expertise to develop the terms of reference for the necessary
feasibility studies. "I believe we are very close to signing an
agreement" with the companies to build the pipeline, he said.
However, Darbayev was clearly frustrated by the negotiating position
of Azerbaijan's SOCAR, which is firmly opposed to international oil
companies taking an equity stake, particularly if SOCAR must reduce
its 50 percent share in the new venture. He complained that the
lead negotiator for SOCAR, Vitaliy Bairlibayev, confessed he is not
authorized or empowered to compromise with the government of
Kazakhstan. "Azerbaijan is just a transit country, holding up KCTS
so they can maximize their tariffs. They're getting money for
nothing."

IRAN OPTION GIVES KAZAKHSTAN LEVERAGE


10. (SBU) Darbayev said the only leverage Kazakhsktan has over
Azerbaijan on the KCTS project is the threat to ship its crude to
"other directions," meaning Iran. He noted that the Heads of
Agreement negotiated with SOCAR includes a provision allowing
shipment to "other directions," but only by mutual consent, which
Darbayev said "means never. The Azeris are very worried about us
going to Iran instead."

RUSSIAN INFLUENCE OVER KAZAKHSTAN'S CRUDE EXPORTS


11. (SBU) When asked about Russia's attitude toward Kazakhstan's
multi-vector oil export policy, Chevron's Kanapianova argued that
Russia would prefer crude to travel through Russian territory, which
would naturally give Russia greater leverage over Kazakhstan. She
said that ten years ago, Russia "used to turn off the Atyrau-Samara
oil pipeline, citing 'technical reasons,' whenever President
Nazarbayev said something they didn't like. But they don't do that
anymore. Their methods are more sophisticated and more subtle." When
pressed to elaborate, Johnson suggested that Russia could introduce
a pipeline tariff tax and simply raise the rate to increase the
pressure on Kazakhstan. This would be particularly effective,
Johnson said, if Kazakhstan were limited to exporting all of its
crude via Russia.


12. (SBU) KMG's Darbayev acknowledged that Russia was not in favor
of KCTS: "Their intention is to block the project," he said.
However, he did not believe that Russia would take the extreme step
of blocking transit shipments of tanker components through the
Volga-Don, if the tankers were built outside the region and
assembled in the Caspian. "That would be too much," he said,
"especially considering the good relations we have with Russia."


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13. (SBU) Bolat Akchulakov, former Vice Minister of Energy, now
Managing Director for Oil and Gas at national welfare fund
Samruk-Kazyna, echoed Darbayev's remarks. On March 20, he told
Energy Officer that Russia might try to discourage oil exports that
circumvented Russia, but would ultimately respect Kazakhstan's
sovereignty. "They know that we will continue to ship most of our
crude through Russia and in fact have maximized the capacity of
Atyrau-Samara and CPC," he said, suggesting that Kazakhstan simply
needs other export options in order to accommodate increased
production volumes.

OPENING UP IRAN WOULD BE A GAME-CHANGER


14. (SBU) Johnson told Energy Officer that Iran is now building
ships of suitable size for KCTS at its northern port of Neka and he
suggested that normalization of relations with Iran would remove the
threat of a Russian veto over KCTS and help ensure the
diversification of crude export routes from Kazakhstan. "If we
could work with Iran," he said, "that would change the equation
entirely." Johnson added that both Total and ENI, partners in the
Kashagan consortium, intend to ship Kazakhstani crude to Iran once
full production begins in 2015. KMG's Darbayev said very much the
same thing: "If KCTS does not go forward as anticipated, the
European oil companies will ship their crude to Iran," he said.

MILAS