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Forbes: Kazakhstan Not Doing Eni Good

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Parmy Olson, 08.27.07, 12:45 PM ET

LONDON – Italian energy firm Eni has kicked off crucial negotiations with Kazakhstan at a time when one of its biggest-ever oil production projects appears to be in danger.

The Kazakh government announced Monday that it was suspending operations at its Kashagan oilfield for three months because Eni, the leader of a group of oil companies including ExxonMobil (nyse: XOM – news – people ), Total, Royal Dutch Shell (nyse: RDSA – news – people ) and CononoPhillips (nyse: COP – news – people ), which have stakes in the offshore project, had violated environmental regulations.

Its accusation has echoes of Sakhalin-2, the massive oil and gas project that the Russian government wrested control of from Shell late last year. (See: “Russia Shows Sakhalin Partners Who The Boss Is”) Though this time there may well have been some environmental violations by the project members, Kazakhstan’s real gripe with Eni (nyse: E – news – people ) has been the project’s string of delays.

Originally due to start production in 2005, initial oil production at Kashagan was first postponed to the end of 2007, and then again to the third quarter of 2010, each holdup spelling a slowdown in revenue for the government. “This is Eni’s ninth life here, so there’s no chance for further delays,” said Andrew Neff, a senior energy analyst at Global Insight.

Eni now not only faces the prospect of ceding part of its 18.5% stake in the project to the Kazakh government, through the state-controlled Kazmunaigaz, there’s the chance of a breakdown in relations with its fellow group members and the loss of its coveted position as operational leader. And according to one energy analyst, Eni may also have to pay compensation of between $1 billion and $2 billion.

A spokesman for Eni confirmed to Forbes.com that one of its representatives was at the Kazakh capital of Asdana on Monday, along with counterparts from other group members for talks with the government. “In the last days we have received a letter of friendly composition, and today the representative of the consortium will meet in Asdana with the local authorities in order to analyze the situation,” said spokesman Fillipo Cotalini. He could not say who would be representing Eni in talks, but Chief Executive Paulo Scaroni reportedly said last week that he would be traveling to Kazakhstan for talks in September.

The atmosphere at Monday’s meeting will likely not have been as friendly as the letter Eni received. As production at Kashagan has been delayed, the Kazakh government has angrily eyed the rising price of oil from $25 at the start the project, to nearly $70 today.

A recent report in the Italian press said that Kazakhstan now wanted its share of the sale from Kashagan to increase to 25% from 10%, but Eni’s chief executive Scaroni has dismissed that as pure speculation.

There’s no doubt that Eni is fretting about Kashagan, touted as the most important oil discovery of the last three decades, with up to 13 billion barrels of recoverable oil. Once production gets started, the field would pump out 1.5 million barrels of oil per day, to be shared amongst the investment group. Eni produces 1.7 million barrels per day globally, on average.

It was seen as a spectacular Italian coup when Eni became operational leader, but the thanks to a poor infrastructure for exploration in the northern Caspian sea, costly regulations about the burning off of gas at oil wells, and the rising costs of oil extraction, production was slowed and costs overrun. The Kazakh government’s estimates that costs for the 40-yeary project have soared to $136 billion, from $57 billion.

“At this point the Kazakh government is questioning why they chose Eni as operator,” said Neff. The original timetable had been wildly unrealistic to target oil production to start in 2005. The consortium of western oil majors went into the project knowing this, but, according to Neff, they didn’t realize just how slow and costly the project would become.

What appears to have irked the Kazakhs even more has been Eni’s nonchalant attitude towards the delay of production. In February the company’s management confirmed the second postponement in the project to their shareholders, before doing so with Kazakhstan. “They were taking the project for granted,” said Neff. “Eni was very good at wooing the government and initially marketing themselves. But with the cost overruns and now the second delay they haven’t done very well in keeping the Kazakh government happy since then.”

Now, somewhat unsurprisingly, Italy’s prime minister, Romano Prodi, is due to visit Kazakhstan in October. “This is clearly related to the Kashagan dispute. But by then it might be too late that,” said Neff. While Eni would rather quietly pay off the Kazakh government with cash than give up its role as project leader, a withering of support from its consortium peers could mean just that.

Shell, for one, may want to make up for its Sakhalin-2 losses by taking control of Kashagan. Total could also take the mantle, but while ExxonMobil has a history of timely efficiency in its projects, the Kazhak government probably fears a loss of bargaining power by letting the biggest oil and gas company in the world take control of its gas field.

A likely scenario is that Eni will pay hefty compensation to Kazhakstan, and also give up some of its stake to the state-owned gas company Kazmunaigaz, which currently has a 8.3% holding in the project. The loss of control is yet another possibility, but it’s one that for Eni will be an absolute last resort.

 http://www.forbes.com/2007/08/27/eni-kazakhstan-kashagan-markets-equity-cx_po_0827markets10.html?partner=alerts

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