PROJECT OPERATOR ANNOUNCES MASSIVE DELAYS AND COST OVERRUNS AT KASHAGAN

The government of Kazakhstan is considering imposing severe penalties on the company or companies responsible for cost overruns and production delays at the supergiant Kashagan offshore oilfield.

Deemed the largest oil discovery worldwide in the last 35-40 years, Kashagan is estimated to hold almost 2 billion tons of recoverable oil (an estimate upped recently from 1.2 billion). It is being developed by the Agip KCO consortium, which includes Italy’s ENI-Agip as project operator with an 18.52% stake; Shell, Total of France, ExxonMobil of the United States, and the Anglo-Dutch company Shell, also with 18.52% stakes each; ConocoPhillips of the United States with 9.26%; and Japan’s Inpex and Kazakhstan’s KazMunayGaz with 8.33% each. The offshore contract area includes Kashagan and three other fields.

Operator Agip recently informed Kazakhstan’s government officially that the start of commercial production has been postponed from the second half of 2008 to the second half of 2010 and that the investment budget must be raised from $57 billion to $136 billion for the entire life of the project. The cost of the first phase of commercial production — now delayed to the 2011-2015 period — is being upped from $10 billion to $19 billion. The start of the second phase — the “plateau” of stable, full-capacity production — is being delayed until 2019. However, the output projection for that phase is being raised from 60 million tons per year to almost 75 million tons

Apparently on the consortium’s behalf, Agip announced a “revision and reconfiguration of the project,” citing unanticipated geological and technical complexities in oil recovery from the field, higher costs of material acquisitions and inputs, the declining value of the dollar, and rising costs of environmental protection at the field.

These just-announced delays are not the first in this project. The consortium (initially named OKIOC) was created in 1997 and signed a production-sharing agreement (PSA) with Kazakhstan that year for a 40-year period. In 2000 it made Kashagan the richest oil find anywhere in the world since the opening of Alaska’s North Slope. Commercial production at Kashagan was due to start in 2005. However, in 2004 the consortium requested a delay from 2005 to 2008 and agreed to pay compensation to Kazakhstan in the amount of $50 million for each year of delay — thus, a total of $150 million so far.

While that compensation looks meager to Kazakhstan, the implications of the further delays and cost overruns are damaging to the country and negative for the global market as well. Kazakhstan’s prospects to become a world-class oil exporter depend largely on Kashagan. The country’s total output in 2006 was approximately 65 million tons. Kashagan could double that output.

Under the PSA, Kazakhstan would not receive its share of oil from Kashagan until the consortium members had recouped their investments. That prospect would now be delayed for years through production delays and cost overruns, if Agip’s proposals are accepted as such. This would put Kazakhstan’s national budget calculations, economic development plans, and oil export commitments under question marks.

The government is pondering its response. Prime Minister Karim Masimov and Energy and Natural Resources Minister Baktykozha Izmukhambetov have outlined possible countermeasures in their latest interviews (Interfax, July 26, 30, August 6; New Europe, August 4; Wall Street Journal, August 8). The government will, at first, review ENI-Agip’s calculations to assess their validity. It may then demand compensation in several forms:

1. An increase in Kazakhstan’s share of profit oil (extracted commercially) from the PSA-stipulated 10% to as much as 40%;

2. Full compensation for revenue that was due but would not be forthcoming to Kazakhstan during 2008-2010;

3. Taxing the exploration and production of oil from now onward, under a proposal pending in parliament, applicable generally but triggered by the situation at Kashagan (only the sale of oil was being taxed until now).

The Kazakh government regards ENI-Agip’s proposals as a unilateral change of the contract. According to Masimov and Izmukhambetov, the government is “deeply disappointed” and suspects either “planning errors, or execution errors, or deliberate intent” on the operator’s part. The government “does not rule out” demanding that ENI-Agip be replaced with another operator in the consortium.

Replacing Agip could necessitate a search and negotiations for another operator, thus delaying the start of commercial production even further. More likely, Astana could demand an increase in KazMunayGaz’s stake in the consortium at the expense of Agip and possibly other companies therein, as well as compensation commensurate to the revenue losses that Agip projects for Kazakhstan.