Kashagan and the New Great Game

The decision of the government of Kazakhstan to seek more favorable terms of the production sharing agreement to develop the Kashagan oil field seems to be the latest instance of resource nationalism in oil-producing countries. However, unlike Russia or Venezuela, Kazakhstan is unlikely to push for increased influence over the operational role in the project. Kazakhstan and the state-owned oil company KazMunaiGas have suggested that they may want to seek an increase in their share of profits from the field but they badly need the expertise of the foreign oil companies to extract oil from the notoriously difficult Kashagan field.

Background

First discovered by the Soviets more than 30 years ago, the Kashagan oilfield, named after a Kazakh poet, is a giant geological structure consisting of a huge limestone reef around 75 kilometers (km) in length and 35km wide nearly 5,000 meters (m) below the seabed in the shallows of the Kazakhstan sector of the north Caspian Sea. Temperatures in this region can fall to below minus 30°C in winter and the sea is frozen to a depth of several meters for many months each year. The whole of the landlocked Caspian Sea itself lies some 28m below sea level and although the average water depth is measured at 208m, the sea bed rises towards the north east. The Kashagan field is located 75km from Atyrau in a total water depth of just 3.7m.

Kashagan is claimed to be the largest and most challenging oilfield development project of the decade. Possibly the fifth largest in the world and the largest outside the Middle East, the Kashagan field is the most important discovery since the North Slope in Alaska and the North Sea. The vast new Caspian field has estimated reserves ranging up to 38 billion barrels with up to 50 per cent recoverable and a potential production rate of around 1.5 billion barrels per year.

The production sharing agreement between the government of Kazakhstan and the Offshore Kazakhstan International Operating Company (OKIOC) - now known as Agip KCO - has been signed in 1997 for forty years. Besides the Kashagan project, the contract encompasses three other exploration projects in the North Caspian: Kalamkas, Aktoty, and Kairan. Overall, the contract covers a territory of 5.6 thousand square meters. The consortium is made up of seven companies consisting of Eni (18.52%), Shell (18.52%) , Total (18.52%), ExxonMobil (18.52%), ConocoPhillips (9.26%), KazMunayGas (8.33%), Inpex (8.33%). The original group included BG Group instead of KazMunayGas; however BG sold its stake to the partners in 2004.

Development of Kashagan

Due to its geographical location, the Kashagan field poses enormous logistical, technical and environmental challenges for the operators. Eni faces cold winter weather, shallow waters, ice and sea-level fluctuations that require use of new technologies specifically designed for the conditions in the northern part of the Caspian Sea. The Kashagan field is the first to be developed with wells drilled offshore from artificial islands. Due to the shallow water depths, Eni has opted to site the central production complex on two man-made islands, rather than using conventional platforms. Linked by bridges, the islands not only house drilling facilities and risers, but will also be used to locate a significant proportion of the oil and gas processing facilities. While the wells are drilled in waters of 1.5-10ms (average depth of the North Caspian is 3.3ms), the drilling can reach up to 6,000ms below the seabed (average drilling depth is 4,300ms) and through a salt layer.

The high hydrogen-sulphide content of the Caspian oil and management of byproducts, such as sulphur, is another challenge not only for Eni but also for other operators of Northern Caspian oil fields. The storage of these byproducts has been a contentious issue for years, and the government of Kazakhstan and local officials have been trying to leverage the environmental concerns to put pressure on the oil field operators.

However, the main issue that indirectly caused the delays and cost overruns is the very uniqueness of the project. To industry analysts, these problems came as no surprise as the initial projected date of 2005 and estimated price of $29 billion were considered overly optimistic form the start. As a greenfield project, the time and costs needed for its development proved to be very difficult to assess, and the difficult conditions and the relative inexperience of Eni in similar types of projects further contributed to the delays.

This is also already the second announced delay in the project. In 2004, the consortium signed a deal with the Kazakh government agreeing to delay the production until 2008. At that time, this deal concluded months of uncertainty after the initial announcement when the consortium allegedly agreed to pay hundreds of millions of dollars in compensation of the delay.

Analysis

Despite the rhetoric, the government of Kazakhstan is unlikely to resort to any sort of drastic actions. Kashagan is the only giant oil field discovered in the last 30 years and as such every major oil company want a piece of action. However, they will only stay as long as the development of the field is profitable. For Kazakhstan the development of the field is much more important than for the oil companies. Kashagan is not only a source of future revenues but it is also an important political tool in the so-called New Great Game. And for that Kazakhstan desperately needs Western oil companies and their expertise.

The fears that the latest statements by Kazakhstan's government officials imply that KazMunaiGas, the Kazakh state oil company, has been tapped to take over the project are exaggerated. KazMunaiGas simply does not have the necessary expertise to develop the field on its own. Kazakhstan will probably seek financial compensation for the delays, and may even renegotiate the terms of the contract to make it more favorable to Kazakhstan. But there is no doubt that both sides will tread very carefully as to not endanger the agreement that is already in place.

The presence of western oil companies gives President Nazerbayev the opportunity to court and play against each other the three powers struggling for influence over access to Caspian oil - the US, Russia and China. Should he overplay his hand and cause the Western oil companies to leave Kashagan and Kazakhstan, he would loose a significant bargaining chip. With Russia on the one side and China on the other, Kazakhstan would be stuck between a rock and a hard place. However, judging by Nazerbayev's past prowess in the Caspian political game, this is unlikely to happen.

An additional problem that Kazakhstan has been facing is its reliance on Russia in bringing its oil on the world market. Kazakhstan is connected to the Russian pipeline system and besides the CTC (which also goes through Russia) it is completely dependent on the Russian pipeline operator Transneft (and subsequently on Kremlin). It has been Nazerbayev's goal throughout his tenure as a president to change this dependency and develop new pipeline links to China and to Europe avoiding the Russian territory. However, it is extremely unlikely that additional pipelines would be built, should the Kashagan project be aborted.

Conclusion

While Kazakhstan is obviously not happy about the delay in and the rising costs of the Kashagan project, it does not have the luxury to force the consortium out of the project. The Kashagan field is simply too challenging to have KazMunaiGas develop it on its own, and at the same time too important for Kazakhstan's economic and political stability. The government could find itself loose not only its future revenues but also any leverage among the major oil players interested in its vast untapped reserves.