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Financial Times: A Caspian halt shows oil giants face fresh political perils

By Isabel Gorst
Published: September 4 2007 03:00 | Last updated: September 4 2007 03:00

When a delegation of executives from five of the world’s biggest oil companies led by Italy’s Eniwent to Kazakhstan last week to seek to resolve a dispute at the giant Kashagan oilfield, they were met with news that the government had halted work on the development on environmental grounds and had launched a criminal inquiry into alleged tax evasion on equipment imports.

It was an inauspicious start to what Paolo Scaroni, Eni’s chief executive, had said would be “friendly talks” about the future of Kashagan. Irked by surging costs and sliding production deadlines, Kazakhstan is demanding improved terms.

The dispute erupted after Eni presented the central Asian country with a revised development plan for the Caspian Sea field – delaying the start of production by two years until late 2010 and doubling to $19bn (£9.4bn, €14bn) the cost of the first, 300,000-barrel-a-day stage of the project. Separately, Kazakhstan revealed that estimates for the full cost of the 40-year project had climbed from an earlier $57bn to reach $136bn – which could make Kashagan the most expensive industrial endeavour undertaken anywhere.

The revised plan will deprive Kazakhstan of substantial revenues and hold back its aim to treble oil production and enter the ranks of the world’s top 10 oil exporters. The dispute, coming at a time of growing resource nationalism worldwide, may provide Kazakhstan with a pretext to exert greater control over Kashagan, one of the few untapped fields in the world capable of producing 1.5m b/d.

Kashagan is crucial as a future source of non-Opec supplies to western governments, which have urged Kazakhstan to join projects to transport Caspian oil to the west rather than through Russia or Iran or direct to China.

For western oil majors, increasingly at risk of being marginalised by assertive state oil companies, Kashagan is an important foothold in the promising north Caspian, where Kazakh and Russian companies dominate.

The European Union warned last week that it would intervene if investors’ rights were violated at Kashagan. Andris Piebalgs, energy commissioner, said the EU would “take adequate measures if the legal rights of European companies were put at risk”. Romano Prodi, prime minister of Italy, may bring forward a visit to Kazakhstan planned for early October.

Analysts say Eni, which has staked its future growth on Kashagan, carries the blame for promising more than it could deliver when it won the coveted operatorship of the field in 2001. Richard Gordon, president of Gordon Energy Solutions, an oil extraction consultancy, says: “Eni was excessively exuberant about costs and production schedules early on and created expectations that are coming back to bite it very hard.”

Other consortium members including ExxonMobil, Conoco-Phillips, Royal Dutch Shell, Total and Japan’s Inpex will also suffer as what Mr Gordon calls the “rolling thunder of cost inflation echoing high oil prices” forces up the cost of Kashagan, as at mega-oil projects elsewhere. “Kashagan is not going to yield the kind of stellar returns that that oil majors usually require,” he says. But the size of Kashagan’s reserves would ensure the companies “stay with the programme” despite the difficulties.

Kashagan, described by one geologist as “mad, bad and dangerous to know”, is one of the most difficult oil projects ever tackled. Its oil, laced with poisonous hydrogen sulphide, lies deep beneath the seabed under huge pressure, presenting the risk of explosion. The waters are shallow and difficult to navigate, particularly during winter ice.

The complications do not end there. Even the environmentally lax Soviets banned drilling in the north Caspian, a natural habitat for numerous rare birds and fish, including the Beluga sturgeon. Kazakhstan’s ecology ministry, which has withdrawn environmental permits at Kashagan for three months, says the project may have caused the death of seals on the coast last winter.

There are parallels between the Kashagan dispute and Russia’s row last year with a Shell-led group at Sakhalin-2 off Siberia – which ended when foreign investors caved in to Gazprom’s demand for a majority stake after objections about cost overruns and environmental abuse at the liquefied natural gas project.

Kazakhstan’s policy is to bolster the state’s role in the oil industry. Recent legislation entitles KazMunaigas, the state oil company, to a majority interest in all future Caspian Sea developments. But even if the ultimate goal is to take over Kashagan, KazMunaigas has neither the technical nor financial muscle to do so now. “Why would they take it away from us now, when we are spending so much money?” asks one top oilman.

Terms at the field will almost certainly change. Kazakhstan, like Russia, is disenchanted with production-sharing contracts that allow investors to defer royalty payments until after the groups involved recover their costs – a model that is fiscally unattractive for host governments at a time when cost inflation is high.

Kazakhstan’s dissatisfaction with Eni could make room for KazMunaigas, currently a minority stakeholder in the group, to step in as leader. There is speculation that ExxonMobil, which recently relocated its Kazakh headquarters to Atyrau, a town on the Caspian, might bid to be operator. But people close to the US group say the job would be a poison chalice until Kashagan was clear of the quagmire.

Karim Massimov, prime minister, who earlier pledged that Kazakhstan would respect all existing oil deals, interpreted the delay at Kashagan as a change to the contract itself, entitling Kazakhstan to renegotiate terms.

The perception that western groups squeezed the government too hard during negotiations in the 1990s, when the former Soviet republic was desperate for investment, underlies the dispute and may threaten other projects. Oraz Jandosov, co-leader of the opposition All National Social Democratic party, says contracts at the huge Tengiz and Karachaganak fields are more biased in favour of foreign investors than Kashagan, which “should not be the first to be singled out for contract change”.

Kazakhstan is being courted by others keen on Caspian acreage, particularly foreign state oil companies, driven by political as well as commercial concerns. China, having last month agreed to help Kazakh-stan build an oil export pipeline linking the Caspian with China, is expected to step up its search for opportunities.

Copyright The Financial Times Limited 2007

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