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MarketWatch: Eni’s Kashagan oil field faces hurdles

EXTRACT: Last December, oil giant Royal Dutch Shell PLC was forced to cede control of the massive Sakhalin-2 oil and gas project to Gazprom. The Russian state achieved its goal with a campaign of constant environmental and safety inspections and lawsuits.


By Polya Lesova

NEW YORK (MarketWatch) — Italian oil giant Eni SpA said that development of the gargantuan Kashagan oil field in Kazakhstan will be delayed by three years and that the project would cost billions of dollars more than previously expected as it struggles with major technical and logistical challenges.

Eni is now expecting to begin pumping oil at Kashagan, widely considered to be the world’s most important new oil field, in the third quarter of 2010, five years later than its original projection. The cost of the project has jumped to $19 billion from $10.3 billion, Eni (EENI S.p.A.

Two-thirds of the cost hike is based on changes in project scope; the remaining third is due to cost inflation and foreign-exchange losses. Kashagan’s peak gross production is forecast at 1.5 million barrels a day by 2019.

Eni is the sole operator of Kashagan and has an 18.52% stake in the North Caspian Sea Production Sharing Agreement, which also includes Exxon Mobil (18.52% stake) (XOMexxon mobil corp com.

COP ) ; the national oil and gas company of Kazakhstan, JSC NC KazMunayGas (8.33%); and Japan’s Inpex Holdings (8.33%).

Despite the delay and cost hikes of the Kashagan project, Merrill Lynch said it’s sticking with its buy recommendation on Eni shares.

“Eni has its fair share of challenges, but nothing that does not already look fully discounted in today’s shares,” Merrill Lynch said in a research note Monday. “We point to a 10% to 15% relative valuation discount to the large-cap European oils (BP, Total and, to a lesser extent, RD/Shell) and a dividend yield that has reached an all-time relative high to both the sector and the market.”

Delay will hurt

Gordon Gray, a J.P. Morgan analyst, said additional spending on the Kashagan project is a negative, since, with higher costs to recover, it will take longer before the development reaches the profit oil phase. “This could result in strained relations with the Kazakhstan government, similar to the problems Shell experienced with the Russian government over Sakhalin-2,” Gray said.

Last December, oil giant Royal Dutch Shell PLC was forced to cede control of the massive Sakhalin-2 oil and gas project to Gazprom. The Russian state achieved its goal with a campaign of constant environmental and safety inspections and lawsuits.

Gregory J. Vojack, head of Kazakh operations with the U.S. law firm Bracewell & Giuliani, an adviser to both the government and multinationals operating in the country, said the Kazakh government is concerned because it had certain estimates of how much oil the country would be producing and how soon. “It’s disappointing, yes, but everybody understands that these are very complex structures,” Vojack said from the Kazakh capital, Almaty.

Major hurdles

In contrast to Sakhalin-2, which was led by a much smaller consortium, Kashagan is owned by a consortium of seven of the largest oil and gas producers in the world, Vojack said. Not only Eni but the other companies in the consortium “will push and work to solve the issues, because they have all their money in it.”

Discovered in 2000 and located in the northern part of the Caspian Sea, Kashagan poses enormous logistical, technical and environmental challenges. Kashagan holds up to 38 billion barrels of oil-in-place, of which 13 billion are potentially recoverable with the use of gas re-injection, according to current estimates.

“From the beginning, people were overoptimistic as to the amount of time it would take to develop Kashagan,” Vojack said. “Kashagan is a truly virgin field. This is just a tremendous undertaking to serve this field in a part of Kazakhstan that was totally underdeveloped. There was zero infrastructure in place.”

The cold winter weather, shallow waters, ice and sea-level fluctuations in the northern part of the Caspian Sea pose serious logistical challenges to the development of Kashagan. The high hydrogen-sulphide content and management of byproducts, such as sulphur, are only two of the technological challenges Eni faces.

An economic force

Kazakhstan, whose population numbers 15 million, is a vast country with a land mass as big as the whole of Western Europe. It shares borders with Russia, Uzbekistan, Kyrgyzstan, Turkmenistan and China.

The country has fared relatively well economically since gaining independence from the Soviet Union in 1991, mostly due to its large reserves of oil, natural gas and minerals. Gross domestic product growth has come in above 9% for the past five years. The country enjoys large deposits of petroleum, coal, iron ore, nickel, copper and uranium, among other commodities. It produced just over 1 million barrels of oil a day in 2005.

Morgan Stanley expects annual oil and gas revenue to rise about 2.5 times over the next five years even with no price increases. On top of this, the Kazakh government is planning to triple uranium production by 2009.

Despite signs of delays to major oil-field projects and the weakness of the non-commodity-tradable sector, the long-term outlook for exports and the balance of payments remains formidable, said Oliver Weeks, an analyst at Morgan Stanley, in a recent note.

“The most significant risk to the outlook would seem to be a disputed transfer of power,” Weeks said. “This seems a low-probability event, while the president remains healthy and living standards keep rising, but a nonnegligible factor given the absence of any clear arrangement or mechanism for succession, and the high stakes for the current nomenklatura.”

In 2000 Kazakhstan became the first former Soviet republic to repay all its debt to the International Monetary Fund, doing so a full seven years ahead of schedule.

However, President Nursultan Nazarbayev has been reproved for failing to implement democratic reforms. In December 2005 he was re-elected in a landslide that the Organization for Security and Cooperation in Europe said failed to meet international standards. 

Polya Lesova is a MarketWatch reporter based in New York. and its sister non-profit websites,,,,,, and are owned by John Donovan. There is also a Wikipedia feature.

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