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Kazakhstan reins in oil majors

The Kazakhstan government, concerned about runaway costs and repeated delays in the vast Kashagan oilfield, has increased its role in the Italian-led consortium charged with developing the most important oil reserves in the Caspian Sea Basin.

Under the terms of a newly amended North Caspian Sea Production Sharing Agreement (NCSPSA), the share in the Agip KCO consortium held by state-run KazMunaiGaz will more than double to 16.81%, equal to those of Italian company Eni, ExxonMobil, Shell, and Total. ConocoPhillips and INPEX retain 8.4% and 7.56% respectively.

Early next year a new North Caspian Operating Company (NCOC) will be created, taking over operatorship of the NCSPSA Consortium, currently managed exclusively by Agip KCO, an affiliate of Eni.

Failure to meet deadlines will also lead to swingeing penalties running into billions of dollars.

The government of Kazakhstan last August had suspended for three months work at the offshore oil field, with officials in the capital, Astana, saying it had to respond to increasing costs and delays in the implementation of production plans as well as violations of ecological legislation.

The consortium projected that costs originally estimated at US$27 billion could more than double to $60 billion, while the government estimated that ultimate costs could reach over twice that figure to $136 billion. Two months later, President Nursultan Nazarbaev approved parliamentary amendments to the governing national law, permitting the government to amend or annul natural-resource contracts if these were judged to threaten the country's national security.

The move was widely interpreted as a means of putting pressure on the foreign members of the consortium in the ongoing renegotiations. Just before expiry of the three-month suspension, the Western members of the consortium agreed in principle to increase the share held in it by KazMunaiGaz (KMG), the national energy company .

Nazarbaev later denied rumors that Kazakhstan was looking for KMG to replace Eni as consortium operator. Astana meanwhile was said to reject a reported counter-demand by a Western member objecting to increasing KMG's share and proposing to extend the consortium's contract beyond 2041.

Despite significant technical obstacles, which were all known in 2000 when the strike was confirmed, Kazakhstan has considered the Western members of the consortium responsible for delays in production.

After the strike at Kashagan was confirmed, the production start-up date was set for 2005. The KCO consortium later delayed that date to 2008, then to 2010. In January this year, the consortium and the government finally arrived at a framework agreement to indemnify Kazakhstan for increasing project costs and for the delay in production start-up, then set for 2010, and soon once more put off by the consortium to 2011.

When production was postponed again to 2013, the government sought a solution, finding one in June this year. It has always been the case that the consortium's sunk investment costs (amounting to US$17 billion by mid-2008) would be repaid to it in oil, once production begins. However, if investment is not completed by the beginning of October 2013, then that sum will now become, in the words of energy minister Sauat Mynbaev, "purely their loss". His understated conclusion was to consider that probably "this is the last time there will be a delay".

This condition represents a successful implementation of overall changes in national energy development doctrine announced earlier this year, two months after the initial memorandum of late 2007 was concluded that seemed to resolve differences over Kashagan at the time.

Those changes imposed a temporary suspension of all negotiations pending elaboration of a new tax code and the explicit declaration of the policy to "recover the balance of the country's interests" in "strategic objects". (The third new policy direction was the creation of a new state trust like KMG but focused on solid rather than liquid hydrocarbons, mainly coal. For details, see Kazakhstan announces new energy directions, 13 February 2008.)

In line with the new energy development doctrine, it is likely that there are as-yet-unwritten conditions concerning support for downstream projects and social infrastructure to diversity Kazakhstan's national economy.

Already on an emergency basis in response to the global financial crisis and its threat to continued economic growth, the government has announced the intention to spend up to $10 billion from the National Oil Fund
of Kazakhstan, set up analogously to Norway's fund but for different purposes, in order to promote agriculture and other non-energy economic development (see Kazakhstan does its own bailing, 30 October 2008, ).

Under the terms of the newly amended agreement, Kazakhstan will get US$4.8 billion as compensation for "potential economic losses", which will include payments for delays, profit from its priority stake and a reduction in the tax breaks it offers the partners, Bloomberg reported, citing KMG.

The partners will increase payments to $80 million for every year that output is delayed from 2008 through 2009, KMG said, without giving a comparative figure. That will rise to $100 million a year in 2010 and 2011 and to $120 million in 2012. The partners will also pay $250 million as a one-time bonus when production starts, the Bloomberg report said.

Eni remains in charge of Phase I of the project. Its responsibility for Phase II will be reduced to the onshore plant as ExxonMobil will run the drilling and Shell will manage offshore development and production after Phase I starts up. Total will be responsible for coordinating oil transport.

These companies will themselves run the operations for which they are directly responsible, managing them according to their distinct existing corporate structures and cultures. At the same time, KMG will increase its role and participate in every stage of project development. As time goes on, KMG's participation in Shell's offshore operations is set to increase.

Also KMG will supply the deputy managing director to assist the NCOC managing director, with the senior post to rotate among the consortium's members and be filled in the first instance by a representative from Total, who will implement his company's management system for the administration of NCOC itself, all partner companies contributing to the staffing.

This transformation, which involves creation of a new operating company to absorb the old one, is a potentially efficient restructuring of the existing administrative organization, involving as it does an apparent decentralization and probably greater transparency, in line with the requirements of the execution and management of complex energy projects.

At the same time, NCOC appears to emerge as a sort of "secretariat" for the manifold development and production operations, with KMG supplying the continuing "second secretary" to verify and oversee that the project development and administration are executed according to Astana's desired directions, as the formally superior, titular post of managing director itself rotates among foreign companies.

First published in Asia Times Online, 7 November 2008.

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