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The Wall Street Journal: Kazakhstan Toughens Oil-Project Stance

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•  What’s New: Kazakhstan may remove Italy’s Eni as operator of a key project after production delays and cost overruns.

•  The Trend: Kazakhstan’s stance comes as resource nationalism is on the rise in other oil-rich nations, such as Venezuela and Russia.

•  What’s Next: Firing Eni is unlikely because of the project’s complexities, but Kazakh authorities may demand a bigger and possibly earlier take from revenue.

Threat to Fire Eni Group
Over Delays, Rising Costs
Aims to Gain Concessions
By GUY CHAZAN
August 8, 2007; Page A2

ASTANA, Kazakhstan — Ratcheting up the rhetoric over a cost-overrun dispute at one of the world’s largest oil fields, the prime minister of Kazakhstan said his government might remove Italy’s Eni SpA as operator of the project.

“We are very disappointed with the execution of this project,” Karim Masimov said in an interview in the Kazakh capital, Astana. “If the operator can’t resolve these problems, then we don’t exclude their possible replacement.”

Mr. Masimov’s comments signify intensifying brinkmanship ahead of a face-off this week between the government and the Eni-led consortium developing the strategically important Kashagan field. Oil-industry observers and regional insiders have said Kazakh authorities aren’t likely to take the extreme step of firing Eni as operator because of the project’s complexities. But they will probably demand a bigger and possibly earlier take from revenue.

Once seen as a significant new source of crude at a time of escalating global demand for oil and tightening supply, Kashagan has been dogged by holdups, technical hitches and rising procurement costs.

An Eni spokeswoman said the consortium is in contact with the Kazakh authorities and is confident the issue will be successfully resolved.

“Kashagan is a very important project that will be central to the Kazakh economy and the world energy market for decades to come,” she said. “All members of the consortium are working together toward the success of the project.”

Kazakhstan’s toughening stance toward foreign investors comes with resource nationalism on the rise in other oil-rich nations, such as Venezuela and Russia. Last year, Royal Dutch Shell PLC was forced to sell a majority stake in its Sakhalin-2 energy project in Russia’s Far East to the state gas company after announcing its costs had doubled.

The growing assertiveness is, in part, a backlash against agreements reached in earlier decades when oil prices were low, prompting countries to agree to less-advantageous terms with oil companies and other investors.

Some have suggested Eni might share a fate similar to Shell. But many analysts note that Kazakhstan still lacks the capacity to manage huge, technically challenging operations like Kashagan and so will probably have to make do with the current setup.

Indeed, Mr. Masimov was careful to note that despite its quarrel with Eni, Kazakhstan remains open for business. “Without foreign investment and the sanctity of contract, Kazakhstan can’t develop,” he said.

With declining production in traditional oil nations such as Mexico, Venezuela and Iran, Kazakhstan has been a rare bright spot in the global oil industry and one unusually welcoming to Western oil majors.
 
Kashagan, the largest oil field outside the Middle East by reserves, was key to the Central Asian nation’s ambitions of tripling its oil output to three million barrels a day by the middle of the next decade, making it one of the world’s top 10 exporters of crude.

Located in the Kazakh section of the Caspian Sea, Kashagan was the biggest oil find in 30 years when it was discovered in 2000. Eni estimates its recoverable reserves at 13 billion barrels, roughly the same as the previous biggest discovery, Alaska’s Prudhoe Bay in 1968.

But the Kashagan consortium — which includes Exxon Mobil Corp. and ConocoPhillips of the U.S., Shell of the U.K. and the Netherlands, France’s Total SA, the Kazakh national oil company KazMunaiGaz and Inpex Holdings Inc. of Japan — has encountered huge technical problems. Kashagan’s high-pressure oil contains abnormally high levels of deadly hydrogen sulfide.

The shallow waters of the northern Caspian, a breeding ground for rare seals and beluga sturgeon, freeze for nearly five months of the year.

Eni originally said it would start pumping at Kashagan in 2005, a deadline that slipped to 2008. Then in February, it was pushed back to the end of 2010. Eni also increased the price tag for the first stage of the project to $19 billion from $10 billion. It said it had underestimated Kashagan’s scope, saying the field’s peak production would be 1.5 million barrels a day in 2019 rather than 1.2 million barrels in 2016 as previously thought. It also blamed the weakening of the U.S. dollar and rising procurement costs.

The company presented its revised estimates to the Kazakh government at the end of June. Last week, Mr. Masimov accused the consortium of breaching the terms of the 1997 contract that governs the project and threatened “appropriate measures.”

Kazakh officials have claimed Eni had raised the overall investment over the life of the 40-year contract to $136 billion from $57 billion. Eni won’t confirm those figures, which have been greeted with some skepticism by analysts.

“When the costs increase by 5%, by 10%, that’s one thing,” Mr. Masimov said in the interview. “But when they rise by 2½ times, either the planning was wrong, or the execution is wrong, or it was deliberate.”

Kazakh anger is focused on the terms of the 1997 agreement that, like Shell’s deal in Sakhalin, allow the investors to recover their costs from Kashagan’s revenue before they have to start sharing large proportions of their income with the government.

Meanwhile, because KazMunaiGaz has an 8.3% stake in the consortium, which it acquired in 2005, the Kazakhs will themselves be forced to come up with nearly one-tenth of the additional investment.

“This means fewer schools, fewer hospitals,” said Mr. Masimov. “There is real discontent in society about what is happening.”

Write to Guy Chazan at [email protected]

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