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European presence in the Karachaganak project of Kazakhstan: history, production volume, delivery routes, opportunities and risks

Friday, September 30, 2011 - 16:19

Oil and gas condensate field "Karachaganak" (West Kazakhstan region, north-western part of Kazakhstan) was opened in 1979 under the Soviet government program to search for prospective oil fields. This field is considered to be one of the largest in the world. Its proven recoverable reserves are 1.2 billion tons of oil and about 1.35 trillion cubic meters of natural gas. "Karachaganak" provides about 49% of the total gas production and about 18% of the total liquid hydrocarbon production in Kazakhstan.

The Project’s Chronology
Development of "Karachaganak" began in 1984. At that time, the work in this field was done by "Orenburggazprom" - a structural subdivision of the Ministry of Gas Industry of the USSR. In 1989, this Ministry was reorganized into the Russian company "Gazprom". After the collapse of the Soviet Union in the conditions of chaos and economic collapse, "Gazprom" was not able to effectively manage the development of "Karachaganak," and in 1992 the mine became the property of the Republic of Kazakhstan (RK). That same year, Kazakhstan started actively searching for investors for further development of this field. Moreover, European companies were the first to express interest in it.
In 1992, the Kazakh government announced a tender on the project of "Karachaganak", and it was won by the British BG Group Plc. and Italian Eni SpA. In 1995 they signed an agreement on the principles of production sharing (APPS), which allowed these companies to suspend the rapid decline of production and to improve the technical safety of the field. The same year "Gazprom" joined the project: Kazakhstan and European investors themselves suggested the Russian company a share in "Karachaganak," taking into account the fact that the pipelines connecting the field to the Orenburg gas processing plant were owned by the Russian Federation. However, in 1997, "Gazprom" ceded the right of participation to the company "LUKOIL". At the same time the member of the project was the American Chevron Texaco.
In November 1997, during the visit of President Nazarbayev to Washington DC the participants of consortium signed the final agreement on Production Sharing (FAPS), which entered into force in January 1998. The project participants did not include the Kazakhstan state company "KazMunayGaz", and the parameters of the agreement were never officially disclosed: obviously, it was made by mutual agreement of investors and the Kazakh side. Validity of FAPS - 40 years (the period of 1998-2038).
The above companies were founders of the international consortium Karachaganak Petroleum Operating BV (KPO), which became the project operator. European companies took leading positions in the Karachaganak project. At the beginning of 2011 the European share (BG Group Plc. - 32,5% and Eni SpA - 32,5%) in the consortium was 65%. Moreover, under the terms of the FAPS, both European companies are the sole operator of the project. The remaining 35% belong to other foreign companies: Chevron Texaco (USA) - 20% and "Lukoil overseas" (Russia) - 15%.
By the terms of the FAPS, new taxes and levies on members of KPO must not be distributed. However, due to the fact that the FAPS was signed by the Kazakh government in the condition of haste and secrecy, it was not fully developed and for this reason the foreign companies were left a number of "legal loopholes" that allowed them not to comply with the terms of the contract that caused significant economic damage to Kazakhstan. Therefore, the Kazakh government after 12 years after the conclusion of the FAPS started attempting to adjust the agreements with foreign partners in order to be able to influence the decisions on the project.
To do this, Kazakhstan needed a big shareholder and operator, which could be achieved through the purchase of shares from foreign companies, including European ones. In this regard, on the basis of a new Tax Code, which entered into force on January 1, 2010, the Kazakh authorities expressed their intention to revise a number of PSA: up to the time mentioned above, foreign companies paid taxes under the legislation, which operated at the time of signing the contract. PSA revision will concern the projects to develop major fields, including the "Karachaganak".
It appears that the leadership of RK wants to achieve the priority right for the national company "KazMunayGaz" to buy stakes in projects and in general greater opportunities for the state to influence the subsoil. The objects of special attention of the Kazakh authorities became major (strategic) field located in the active stage of production: such as "Karachaganak" and "Tengiz".
Back in December 2009, officials of Kazakhstan voiced the desire to get a stake in the Karachaganak project, or to review previous agreements with foreign investors. At the same time the Kazakhstan government announced plans to buy 10% of the stake from British BG Group Plc. and Italian Eni SpA (5% from each company) in a KPO for 1 billion dollars.
In order to induce the aforementioned companies to the decision taking, there were used a variety of leverage. So in February 2010, the prosecutors of the West Kazakhstan region fined KRO on 3 billion tenge (about 20 million dollars) for violation of environmental laws. By the end of March 2010 the Financial Police of RK demanded the KPO paid the sum of 104 billion tenge (708 million dollars) due to the fact that in 2008 a consortium illegally sold 1.1 million tons of oil and 94 thousand tons of condensate. In addition, the KPO was accused of deliberately overstating financial costs of development of the field: according to Kazakh law enforcement agencies during 2002-2007 the KPO misappropriated 1.25 billion dollars. Also Astana presented claims to AOC about the breach of labor and immigration laws in Kazakhstan: according to law enforcement agencies of Kazakhstan, a number of foreign employees illegally obtained work visas and work permits in the Republic. In parallel, in March 2010, Kazakh authorities opened a criminal case against KPO, but it was suspended under the pretext of cross-checking facts.
At the beginning of 2011, BG Group Plc. and Eni SpA continued negotiating about the sale to "KazMunayGaz" a share in the Karachaganak project. According to some reports, the parties reached a preliminary agreement on the fact that BG Group Plc. and Eni SpA agreed to cede 10% of the shares on condition that a 5% stake will be transferred to Kazakhstan for waiver of financial claims, or for refusing to export customs duties on KPO. The other 5% of stakes Kazakhstan will have to buy.

Production volumes
Volumes of production of hydrocarbons from the field grew steadily until 2007, and in the period of 2007-2009 they stabilized at current levels: about 12 million tons of liquid hydrocarbons (oil and gas condensate) and about 14 billion cubic meters of gas annually. In 2007 the production volumes reduced.
So in 2007, the production at the field "Karachaganak" was 11.6 million tons of liquid hydrocarbons and 14.2 billion cubic meters of natural gas, in 2008 – these numbers were about 12.1 million tons of oil and gas condensate and 14.3 billion cubic meters of gas. In 2009, the mine produced 12 million tons of liquid hydrocarbons and 14.5 billion cubic meters of gas. In 2010, production volumes declined by 5% if to compare it to the previous year: there was produced about 11.4 million tons of oil and gas condensate, and about 13 billion cubic meters of natural gas. In total for the period of 1995-2010 there were produced over 97 million tons of liquid hydrocarbons and about 113 billion cubic meters of natural gas.
Currently Karachaganak project is at the end of the second phase of development, during which the production volumes of hydrocarbon were brought to 12 million tons of oil and condensate and 14-15 billion cubic meters of gas annually at the expense of the reinjection of produced gas into the reservoir.
Before the global financial crisis, by 2012 the consortium planned to drill about 120 new wells and to bring the level of production of oil and gas condensate to 16 million tons per year, natural gas to 15-16 billion cubic meters. In general, for the 40-year period of the FAPS, consortium expected to produce about 320 million tons of oil and gas condensate and about 800 billion cubic meters of gas.
At the same time the global financial crisis will likely lead to the deceleration of the implementation of any plans. So the members of the consortium have already appealed to the Government of the Republic with the request to reconsider the pace and timing of further development of the field.

Supply routes
The main volume of liquid hydrocarbons is exported through a pipeline system "Caspian Pipeline Consortium", where in 2002 was commissioned the 635 kilometer pipeline "Karachaganak - Bolshoi Chagan - Atyrau", which connected the mine to the CPC "Tengiz - Novorossiysk". Small volumes of Karachaganak oil since 2006 have also been implemented through the pipeline "Atyrau - Samara." About 40% of gas from the field "Karachaganak" is pumped into the reservoir for the partial restoration of pressure there. The remaining volumes of natural gas are delivered to the Orenburg Gas Processing Plant for treatment and further export through a pipeline system in Russia.

The volumes of investment
During the period of 1998-2010 the project was invested with about $ 6.2 billion (including about $ 4 billion of European investment). According to others, the volumes of foreign investments to the field "Karachaganak" were much higher - the amount of investment to the project only by the beginning of 2009 could amount to 10.7 billion dollars.

Prospects and Risks
Prospects for further participation of European companies in the development of Karachaganak field are not completely clear. On the one hand, the project was invested with sufficiently large financial resources of foreign, primarily European companies, and there is an active hydrocarbon production. On the other hand, there is the fact that the European members of the consortium of KPO obviously do not want to force a third phase of the project, which envisages increase in annual production of liquid hydrocarbons up to 15 million tons. In general, European participation in the Karachaganak project will be influenced by the complex of factors that form a number of risks.
Firstly, there is a risk that stocks of the Karachaganak field were originally exaggerated or even that the field entered a stage of declining production. This idea is suggested by the fact that the consortium of KPO for several years (since 2007) under various pretexts delayed the beginning of implementation of activities under the third phase of the project. Initially, before the global crisis, shareholders of the KPO justified it with the desire to recoup the costs from the export of raw materials. Then, foreign investors began to motivate their actions using the crisis. In addition, the fact of a quite significant decline in oil production from the field in 2010 (more than 5% compared to 2009) also reinforces the suspicion that the situation, surrounding the production of hydrocarbons, is very obscure.
Secondly, a certain risk for European companies is the unpredictability of the Kazakh authorities. Today, RC is putting pressure on the consortium of KPO to get a 10% of stakes in the project. But where is the guarantee that in future "KazMunayGaz" does not want to "oust" the European (and Russian) investors? It seems that this circumstance makes the European company doubt the wisdom of more investment in the operation of the field.
Thirdly, an important group of risks is associated with the prospects of development of the situation in the gas market of RK. So, "KazMunayGaz" is going to be the sole operator of the gas market in Kazakhstan. If this happens, foreign companies, including European, will need to negotiate with "KazMunayGaz" on a number of complex issues related to transportation, processing and realization of gas. This seems to be a powerful tool of the Kazakh authorities to press foreign oil and gas companies. We should take into account the fact that gas production in Kazakhstan is directly "tied up" for oil, as "the lion's share" of the Kazakh gas – is the associated gas in the extraction of liquid hydrocarbons.
As a result, these risks in the near future may be adversely affect the European investment activity in the POK, and perhaps all Central Asia, given that the fundamental economic interests of the EU and European business in the region has been associated with Kazakhstan. It is unlikely that the same European oil and gas companies will be ready to sacrifice their commercial interests in favor of long-term development of the RK. Moreover, the Kazakhstan’s government has already made it clear to foreign investors that "if the economic interests of the RK are violated, the country can raise the issue about the termination of contracts."



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