07ASTANA2586, KASHAGAN: THUS FAR, COMMERCIAL DISPUTE, NOT

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Reference ID Created Released Classification Origin
07ASTANA2586 2007-09-18 23:57 2011-08-30 01:44 CONFIDENTIAL//NOFORN Embassy Astana

VZCZCXRO1192
RR RUEHDBU
DE RUEHTA #2586/01 2612357
ZNY CCCCC ZZH
R 182357Z SEP 07
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC 0715
INFO RUCNCIS/CIS COLLECTIVE 0259
RUEHAK/AMEMBASSY ANKARA 2101
RUEHBUL/AMEMBASSY KABUL 0353
RUEHNE/AMEMBASSY NEW DELHI 0474
RUEHRO/AMEMBASSY ROME 0365
RUCPDOC/DEPT OF COMMERCE WASHDC

C O N F I D E N T I A L SECTION 01 OF 03 ASTANA 002586 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR SCA/CEN 
DEPT PASS TO OPIC - BALLINGER 
DEPT PASS TO TDA FOR STEIN, EXIM, FOR GLAZER 
DEPT PASS TO AID - EE PHILIPS/RUSHING 
USDOC FOR 4231/ITA/MAC/MLONDON, 4201/BISNIS 
USDOC FOR 6110/ITA/TD/BI/RHALPERN 
ANKARA FOR CFC 
 
E.O. 12958: DECL: 09/19/2017 
TAGS: ECON EIND ENRG EPET EFIN EINV KZ
SUBJECT: KASHAGAN: THUS FAR, COMMERCIAL DISPUTE, NOT 
SAKHALIN II 
 
Classified By: AMBASSADOR ORDWAY FOR REASONS 1.4(B) AND (D) 
 
1. Summary: (SBU) Spurred on by further delays and rising 
costs at Kashagan, the Government of Kazakhstan (GOK) has 
made clear to the international consortium developing the 
huge oil field of its dissatisfaction with the current 
profit-sharing scheme.  The GOK leadership has indicated that 
it seeks a significant increase in Kazakhstan's share of 
profits under the production sharing agreement and immediate 
compensation "in the billions of dollars" for the latest 
delays. In the interim, development at Kashagan is suspended 
for three months because of environmental violations at the 
site.  With talks underway, both government officials and oil 
company representatives characterize the current conflict as 
a commerical dispute likely to be resolved.  End Summary 
 
Kashagan: Further Delays, Rising Costs 
-------------------------------------- 
 
2. (SBU) In June, the North Caspian Project consortium Agip 
KCO officially notified the GOK of delays and cost overruns 
on Kashagan, one of the world's largest oil projects, with 
estimated reserves of 13 billion barrels.  Commercial 
production is to be delayed from 2008 to 2010 and the costs 
to increase from $56 billion to $136 billion over the life of 
the forty-year contract.  Costs for the first phase of 
development will nearly double, from $10 billion to $19 
billion. 
 
 
3. (SBU) The June announcement was only the latest setback on 
the Kashagan project.  Originally, commercial production was 
to have started in 2005. In February 2004, AGIP KCO and the 
GOK agreed to delay production until 2007-2008. At the time, 
AGIP paid the GOK $150 million for the delays in commercial 
production. Some experts have criticized Eni, the project's 
operator (the consortium also includes Exxon Mobil, Shell, 
Total, Conoco Phillips, and IMPEX) for an overly exuberant 
forecast of costs and production schedules for an extremely 
difficult project. 
 
Kashagan Shut Down, New Terms Sought 
------------------------------------ 
 
4. (SBU) Agip's difficulties have continued through the 
summer.  On August 27, the Ministry of Environmental 
Protection declared that it was suspending work at Kashagan 
for three months due to environmental violations.  Serzhan 
Duysenbayev, acting Chairman of the Finance Ministry's 
Customs Control Committee, announced that several criminal 
cases have been initiated against Agip's affiliates for 
evading customs duties.  The Ministry of Emergency Situations 
stated that it will shut down Agip's oil and gas processing 
facility, which is under construction, for non-compliance 
with fire norms. 
 
5. (SBU) Most significantly, Agip has faced a GOK clearly 
displeased with the latest developments and dissatisfied with 
the terms of its production sharing agreement (PSA).  Prime 
Minister Masimov stated publicly that "the change in the 
terms of the Kashagan development means the contract's 
change." Kazakhstani officials have declared in discussions 
that they seek to raise Kazakhstan's share of profits under 
the PSA from 10% to 40%.  The GOK has also bemoamed the 
near-term detrimental effects of further delays.  According 
to Vice-Minister of Finance Yergozhin, the GOK had been 
expecting $1.2 or 1.3 billion in revenue from the project 
starting in 2008. Kazakhstan, he told the media, is expecting 
compensation in "the range of billions of dollars." (Note: 
Under the terms of the PSA, Agip is not obligated to make 
payments to the GOK until development costs are recovered. 
End Note) 
 
6. (SBU)  Eni's position as operator of the Kashagan project 
has also been made tenuous by the delays and cost overruns. 
At the Eurasia Energy Forum in Astana on September 6, Masimov 
suggested a larger role for KazMunayGas. "In line with our 
 
ASTANA 00002586  002 OF 003 
 
 
targets and requests voiced by the president of our country, 
KazMunayGas has to become a second operator of the project. 
If consortium members decline Kazakhstan's terms, we have 
plan 'B,' about which I will tell you later," he said. 
Yergozhin stated to the media that Kazakhstan would "look 
positively" on a proposal to put a local company in control 
or to operate the project jointly. 
 
7. (SBU) On September 11, MasimNO)6nnounced that negotiations with 
Agip will last until October 22. 
 
8. (SBU) On September 12, Yerlan Nigmatulin, head of the 
Mazh
ilis (lower house of parliament) Committee on Ecology and 
Mineral Resources, stated that the Mazhilis is considering an 
amendment to the "Law on Subsoil and Subsoil Use." The 
proposed amendment gives the GOK the right to annul or amend 
contracts in cases of "national security threats caused by 
investors' actions." The new law would apply retroactively. 
The basis for the move was "the Kashagan conflict", he said. 
Nigmatulin expects the amendments to be adopted by October 
22, the end of the 60 day period of "friendly negotiations" 
between the GOK and Agip KCO. 
 
 
GOK: Foreign Investors Have No Cause For Concern 
--------------------------------------------- --- 
 
9.(C) In a meeting with the Ambassador, Prime Minister 
Masimov emphasized that Kazakhstan is "not trying to push 
foreigners out."  Masimov described Kashagan as a commercial 
dispute, noting that according to GOK analysis Kazakhstan 
will net nothing under the current PSA because of the rising 
costs. Masimov also said that "everyone agrees that Eni has 
been totally incompetent." Nevertheless, no criminal charges 
will be brought, and foreign investors have no cause for 
concern.  Masimov laughed at a rumor that Lukoil might take 
the lead at Kashagan.  In a separate meeting with the DCM, 
Minister of Finance Yergozhin said that the environmental 
inspections at Kashagan have been part of normal 
investigations. 
 
10. (C) Representatives from Conoco Philips told the 
Ambassador that the GOK is seeking compensation outside of 
the PSA.  They were not panicked about the conflict, saying 
that everyone agrees it will be settled and noting that, in 
comparison to Russia, they still feel welcomed in Kazakhstan 
("it is always refreshing to come here").  Nick Olds, 
Conoco-Philips Kazakhstan Country Manager, did not refute 
criticisms that have been levelled at Eni.  "Eni is not doing 
a lot to redeem themselves," he said. 
 
11. (C) In a September 17 conversation with the Ambassador, 
First Vice President of KMG Maksat Idenov, who is now the 
GOK's chief negotiator with the consortium, acknowledged that 
the GOK cannot, under the terms of the PSA, change the 
operator.  He noted, however, that the companies in the 
consortium can and are now interested in doing so.  Idenov 
played down the September 12 expulsion of a Conoco Philips 
representative from a GOK-consortium meeting.  The 
Kazakhstani side, Idenov explained, had asked consortium 
members to send to the meetings executives empowered to make 
decisions ("not notetakers") which, he asserted, Conoco 
Philips failed to do.  Speaking to the Ambassador, a Conoco 
Philips representative blamed the episode on a 
misunderstanding of the company's corporate structure. 
 
12. (C) Comment: The GOK has strong reason to be displeased 
with events at Kashagan.  Despite the public fireworks, 
however, we expect the matter will be resolved in a manner 
acceptable to all parties, although likely after the October 
22 date established for the end of negotiations.   While the 
GOK will seek better terms, and is almost certain to receive 
them, it is unlikely to make any rash moves that will 
 
ASTANA 00002586  003 OF 003 
 
 
negatively impact the foreign investor climate in Kazakhstan, 
particularly when Kazakhstan is aggresively seeking 
investment in its non-extractive sectors.  Furthermore, 
Kazakhstan has generally proven itself a reliable partner in 
the energy sector; while Kashagan has gathered most of the 
recent publicity, the country's two other huge oil projects, 
Tengiz and Karachaganak, continue to proceed smoothly and to 
the satisfaction of all parties involved. End Comment 
ORDWAY

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