KAZAKHSTAN: A KCTS SCORECARD OF RISKS AND REWARDS

UNCLAS SECTION 01 OF 03 ASTANA 000748

SIPDIS

STATE FOR SCA/CEN, EAP/CM, EEB/ESC
STATE PLEASE PASS TO USTDA FOR DAN STEIN

E.O. 12958: N/A
TAGS: PGOV PREL ECON EPET EINV RS KZ
SUBJECT: KAZAKHSTAN: A KCTS SCORECARD OF RISKS AND REWARDS

REF: ASTANA 0675

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


2. (SBU) SUMMARY: From April 7-17, Energy Officer accompanied a
definitional mission from the U.S. Trade and Development Agency to
identify potential technical assistance projects in support of the
Kazakhstan Caspian Transportation System (KCTS). During the course
of that mission, Energy Officer traveled to Atyrau, Aktau, Kuryk,
and Bautino on the Kazakhstani shores of the Caspian, discussing the
cross-Caspian transportation of oil with international oil company
(IOC) executives, port authorities, shipping companies, local
government officials, and Western diplomats. Reftel reports on
current and future infrastructure investments associated with the
development of KCTS. This cable draws upon those conversations and
observations to provide an updated scorecard of the players, and
their positions, in KCTS. Negotiations among KMG, SOCAR, and the
IOCs have intensified in recent weeks and major decisions must be
made soon if the system is to be ready in time for first oil from
Kashagan in 2013. The most critical issues to be resolved are the
construction of tankers to transport Tengiz and Kashagan crude
volumes across the Caspian and the nature of IOC participation in
the project. It also remains to be seen whether Russia will
influence the development of KCTS, perhaps by building the large
tankers called for by the IOCs, or shipping vessel modules through
the Volga-Don canal. END SUMMARY.

KCTS IS IN THE EYE OF THE BEHOLDER


3. (SBU) KCTS is a simple concept, but an incredibly complex
project. Its success requires billions of dollars of investment,
concerted diplomatic effort, new institutions and infrastructure,
and a level of trust and cooperation among national oil companies,
government ministries, local officials, and international oil
companies not seen since the early days of the Baku-Tbilisi-Ceyhan
(BTC) pipeline. In its fullest form, KCTS will transport more than
one million barrels of crude each day by pipeline from Eskene near
the oilfields to Kuryk on Kazakhstan's Caspian coast, load it onto
large tankers, ship it to Baku, and pump it into the BTC pipeline,
where the crude will be sold on the world market. But KCTS means
different things to different people. Some argue, for example, that
existing infrastructure -- such as oil loading terminals at Aktau
and Baku -- should be excluded. Others say that smaller tankers
should continue to be used, at least in the beginning. There are
many permutations of the project, and the definition of KCTS depends
on who is talking, and what they have at stake.

INTERNATIONAL OIL COMPANIES


4. (SBU) The IOCs know that they need an outlet for future oil
production from Tengiz and Kashagan, even if pipelines via Russia
and China are expanded as planned. But the companies say they will
not commit crude volumes to KCTS unless they have equity in the
Eskene-Kuryk pipeline and the trans-Caspian project (the marine
portion from terminal to ship to terminal). Although the IOCs are
not in the shipping business, they insist that partial ownership of
vessels, buoys, and docks will help control risk, cost, and safety.
They are clearly wary of Azerbaijani assurances that fees and
tariffs will be transparent, fixed, and reasonable. Furthermore, if
there is an oil spill in the Caspian, they know that the media
spotlight will be on the Western majors, not the parastatal
bystanders. IOCs insist on using large, 63,000 deadweight ton
tankers with trained crews operating according to international
standards in order to increase safety and reduce risk. They will
likely end up financing the majority of the project, which could
cost as much as $9 billion, including the Eskene-Kuryk pipeline.

KAZMUNAIGAS


5. (SBU) KMG needs KCTS as much as the international companies do,
if not more so. As an equal partner in the Kashagan consortium, KMG
must export its production volumes as safely and efficiently as
possible. In addition, as a national oil company, KMG has a larger

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strategic interest in ensuring the development of an alternative
export route that is not controlled by any one country. KCTS, from
KMG's perspective, will provide that flexibility by theoretically
enabling Kashagan crude to be shipped in three directions: Baku,
Makhachkala (Russia),and Neka (Iran). The risk to KMG is that
SOCAR, its joint venture partner in the project, will squeeze
tariffs and extract rent from KCTS at every turn, severely reducing
the netback price for crude shipments from Kazakhstan. KMG is also
concerned about ceding control or majority ownership of KCTS
infrastructure assets that will be built in Kazakhstan, such as
ports and terminals.

THE STATE OIL COMPANY OF THE REPUBLIC OF AZERBAIJAN


6. (SBU) Azerbaijan is absolutely essential to the success of KCTS
and SOCAR knows it. SOCAR will hold out as long as it can, enjoying
the advantage of geography, comforted by the thought that
Kazakhstan's producers will become more willing to negotiate tariff
terms and service fees as the date of early oil from Kashagan
approaches. The risk for SOCAR is that if they wait too long, they
will own and operate a large -- and largely empty -- pipeline from
Baku to Ceyhan, as oil production from Shah Deniz and
Azeri-Chirag-Gunashli declines. In addition, KMG and Kashagan's
European partners Eni and Total have spoken openly about shipping
crude to Neka instead of Baku, although the MOU between Azerbaijan
and Kazakhstan requires "mutual agreement" on shipping destinations
other than Baku. Finally, it is worth noting that a number of
influential Azerbaijani shipping companies have a vested interest in
maintaining the status quo of a smaller, older tanker fleet. These
stakeholders will not be eager to go out of business and will want a
piece of the action even if new, large tankers are used.

MINISTRY OF ENERGY AND MINERAL RESOURCES


7. (SBU) Recent comments from Minister of Energy Mynbayev and Vice
Minister Kiinov indicate that Kazakhstan's Ministry of Energy (MEMR)
takes a more conservative, if not skeptical, view of KCTS. As a
government agency, it is keenly aware of the political implications
of developing an oil export route that circumvents Russia. The
Ministry is no doubt wary of needlessly annoying their neighbors to
the north with public statements extolling the virtues of
trans-Caspian shipping. MEMR is likely also concerned about the
fiscal and political wisdom of embarking on a multi-billion dollar
project during a severe economic crisis. Mynbayev struck a populist
pose when he insisted that the government will retain a majority (51
percent) stake in the pipeline portion of the project (i.e., the
Eskene-Kuryk pipeline). Nevertheless, if MEMR were to be convinced
of both the urgency and benefits of the project -- and if the IOCs
said they would pay for it -- MEMR could become an ardent champion.
Certainly, the Ministry understands the importance of finding an
outlet for oil from Kashagan, upon which so much of Kazakhstan's
future development depends. Unlike the 30-somethings who run KMG
and KazMorTransFlot, MEMR is managed by a trusted old guard of
veteran oilmen who will undoubtedly weigh in with President
Nazarbayev when he makes the final decision about when, where, and
whether to move forward with KCTS.

LOCAL GOVERNMENTS


8. (SBU) For the regional government of Mangistau oblast and local
officials there, KCTS is a gold mine waiting to be discovered -- and
divided. In their eyes, the project has the power to modernize
infrastructure, triple the population, create thousands of jobs, and
transform sleepy towns into bustling port cities. It will quite
literally put Kuryk on the map. The risk for local governments is
that the project will not go forward for political, financial,
technical, or other reasons -- a risk only increased by recent
reports of infighting among authorities. On April 24, Kazakhstan's
Procurator General annulled a decision by the mayor of Kuryk to
lease 16.77 hectares of coastal land to Ersai Caspian Contractors, a
50-50 joint venture of Italy's Saipem and Kazakhstan's ERC Holdings,
for 48.2 million tenge ($321,333). The head of the local
administration of neighboring Karakiyanski raion protested the

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decision and appealed to the Procurator General, who ruled that the
land is legally considered part of Kazakhstan's territorial waters
and therefore the rights to its use and disposition may be decided
only by the central government.

THE RUSSIAN TRUMP CARD


9. (SBU) Would Russia support a project that is designed to
circumvent its territory and reduce its control over energy exports
from the region? Russian sensitivities about alternative energy
export routes from Central Asia are indeed high. In a meeting with
the Ambassador on April 29, Russian Ambassador Mikhail Bocharnikov
alleged that the United States has urged that no oil should flow
from Kazakhstan through Russia and should instead be sent to China.
Yet Russian opposition to KCTS has been surprisingly muted, perhaps
because the project is largely undefined and unfunded. It is still
not clear, for example, what size tankers will be used, where they
will be built and assembled, and who will pay for them. The Russian
government would clearly prefer Kazakhstani crude to transit Russian
territory, which explains its support for the expansion of Caspian
Pipeline Consortium (CPC) pipeline, expansion of the Atyrau-Samara
pipeline, and establishment of a quality bank system for exports
from the Black Sea port of Novorossiysk. These measures will ensure
that, even once KCTS becomes a reality, the majority of Kazakhstan's
oil will continue to go through Russia. Nevertheless, there are
several ways in which Russia could participate in (and have leverage
over) KCTS. For example, Russian shipyards in Astrakhan, Nizhny
Novgorod, or St. Petersburg could be contracted to build the 63,000
dwt tankers. Alternatively, if the ships are built outside the
Caspian, for example in South Korea, the modules would have to be
delivered to the Caspian through the Volga-Don canal. No shipyard
on the Caspian currently has the capability to build the large
tankers that the IOCs insist are necessary to make the project safe
and commercially viable. Russia therefore holds a tanker trump card
that could determine the ultimate success of the project. It
remains to be seen how and when they will play that card, but it is
clear that the stakes will rise as Kashagan's production deadlines
near.

MILAS