08ASTANA91, KAZAKHSTAN: ALL SIDES SMILING WITH KASHAGAN DEAL

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Reference ID Created Released Classification Origin
08ASTANA91 2008-01-18 08:44 2011-08-30 01:44 CONFIDENTIAL Embassy Astana

VZCZCXYZ0002
OO RUEHWEB

DE RUEHTA #0091/01 0180844
ZNY CCCCC ZZH
O 180844Z JAN 08
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 1510
INFO RUCNCIS/CIS COLLECTIVE PRIORITY 0369
RUEHAK/AMEMBASSY ANKARA PRIORITY 2121
RUEHLO/AMEMBASSY LONDON PRIORITY 0507
RUEHRO/AMEMBASSY ROME PRIORITY 0375
RUEHVEN/USMISSION USOSCE PRIORITY 1861

C O N F I D E N T I A L ASTANA 000091 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: DECL: 01/18/2018 
TAGS: EPET EINV ECON KZ
SUBJECT: KAZAKHSTAN: ALL SIDES SMILING WITH KASHAGAN DEAL 
 
Classified By: Ambassador John Ordway, Reasons 1.4 (b) and (d) 
 
------- 
SUMMARY 
------- 
 
1. (C) In a marathon negotiating session on January 13, the 
Kashagan consortium partners reached agreement in principle 
with the Government of Kazakhstan (GOK) on restructuring the 
ownership and operatorship of the project, overcoming two 
main stumbling blocks.   ENI had objected to a new operating 
model; ExxonMobil had rejected the price for the equity stake 
transferred to KazMunayGaz (KMG), Kazakstan's national oil 
and gas company.  With the CEOs of all six foreign partners 
and Kazakhstani Prime Minister Masimov in the same room, ENI 
and ExxonMobil found themselves isolated and eventually 
joined the consensus.  The parties agreed to an equity 
transfer to KMG that will result in KMG -- and thus the GOK 
-- having a Kashagan ownership share equal to that of the 
four largest consortium partners.  They also agreed to a new 
operating model which will bring ExxonMobil, Shell and Total 
in as co-operators, each with a specific area of 
responsibility.  KMG will share in overall management, and 
intends to ensure smooth and effective relations among the 
operating companies.  End Summary. 
 
2. (C) This cable is based on separate, extensive 
conversations after the agreement was reached with senior 
in-country management for ExxonMobil and ConocoPhillips, and 
with Maksat Idenov, KMG's first vice president. 
 
------------ 
OPERATORSHIP 
------------ 
 
3. (C) ENI has been the operator during the initial phase of 
Kashagan -- the world's largest oil discovery since Alaska's 
North Slope.  By all accounts from companies within and 
outside the consortium, ENI does not have the capacity to 
operate a project of this complexity, which will entail 
extraction of sour oil under extremely high pressures using a 
complex and potentially dangerous gas reinjection scheme. 
The result has been repeated delays and massive cost 
overruns.  The consortium partners we have been in regular 
contact with (ExxonMobil, ConocoPhillips and Shell) have been 
telling us privately since at least 2004 that ENI was in over 
its head.  All the parties except ENI had long come to the 
conclusion that a new operating model was required. 
 
4. (C) All of our interlocutors described ENI as being in 
denial until the very last moment of the negotiations about 
their inability to continue as Kashagan operator.  KMG First 
Vice President Maksat Idenov told us that he had worked with 
ExxonMobil, ConocoPhillips and Shell to devise an approach 
that would have the GOK, rather than the international 
companies, demand a change in the consortium's operating 
structure.  In the course of the final nine-hour negotiating 
session, ENI CEO Paolo Scaroni, completely isolated and under 
attack particularly from ExxonMobil and Shell, finally gave 
in.  The new arrangements, which will be worked out among the 
four majors involved within the next 4-6 weeks, envision 
dividing the operatorship into different aspects, including 
offshore, onshore, and drilling.  The companies will reach 
the decision on who does what based on capabilities and 
availability of the appropriate expertise. 
 
--------------------- 
COMPENSATION/FINANCES 
--------------------- 
 
5. (C) In addition to the value transfer as a result of KMG's 
acquiring additional equity (para 6), the January 13 Kashagan 
deal also includes cash compensation to KMG.  The most 
significant component is a $250,000,000 bonus payment to be 
made upon the commencement of production.  ExxonMobil had 
tried to mitigate the value transfer by seeking a 10 year 
extension of the PSA, later reducing their demand to 5 years 
and then 3 years.  The GOK stood firm, but did agree to give 
the current partners a right of first refusal on any 
extension or new PSA at its expiry.  (Note:  The size of the 
field and the delays in beginning production make it very 
likely that there will be substantial oil still in the ground 
when the current PSA expires.  Given the reinjection of sour 
gas and high pressure in the fields, it is likely that even 
at that point the project will continue to be technically 
demanding and require the involvement of international 
majors. End Note.) 
 
6. (C) Our intelocutors report that at no point during the 
negotiations did the GOK request the international partners 
to assume any responsibility for financing KMG's very large 
cash calls for capital expenditures and operating expenses 
over the next several years.  Idenov told us that KMG plans 
to finance part of these cash calls through its own 
resources, and part by debt financing.  He is planning a 
series of meetings with selected major European and Japanese 
banks over the next month or so to begin to line up 
commitments. 
 
--------- 
OWNERSHIP 
--------- 
 
7. (C) The GOK had signaled early on that it was seeking &#x00
0A;additional equity ownership to bring KMG's share in Kashagan 
up to the same level as the four large stakeholders -- ENI, 
Shell, Total and ExxonMobil -- and that it expected part of 
the compensation it felt it was due for delays and cost 
overruns to be reflected in the purchase price for KMG's 
additional stake.  In the initial stages of the negotiation, 
it appeared that the GOK was preparing an all-out assault to 
get the consortium partners to agree to dilution of their 
shares.  The GOK's arsenal included environmental charges, 
tax charges, labor violations, operating permits, the 
requirement for GOK approval of the operating budget and, 
most ominously, a new subsoil law that provided a potential 
legal basis to revoke the PSA.  As serious negotiations got 
underway, however, all of these threats receded.  (Note: The 
one exception was a threat by President Nazarbayev in a 
December  meeting with Tillerson's deputy to use the subsoil 
legislation.  Nazarbayev, however, reverted to his previous 
public line when he reassured the Ambassador privately the 
next day that the legislation would not/not be used against 
any existing contract.  End Note.)  In the end, both 
ExxonMobil and ConocoPhilips confirmed that the GOK used 
tough, but legitimate business pressures to pursue their case. 
 
8. (C) ExxonMobil was the last holdout in agreeing to an 
increased ownership share for KMG.  After Exxon signaled its 
willingness late last year to reduce its stake, the 
negotiations focused on the price for KMG's share. 
ExxonMobil, however, took a position of principle:  it would 
accept no less than "market price."  ExxonMobil told us that 
CEO Rex Tillerson had decided that Exxon was going to hold 
the line on this issue.  However, all our sources indidated 
that Tillerson was subjected to very strong pressure in the 
final negotiations, both by the other CEOs and by the 
Kazakhstani side.  According to our in-country ExxonMobil 
contact (who was not in the meetings but who was extensively 
debriefed about them), it was the lure of future business in 
Kazakhstan that eventually led Tillerson to reverse course, 
and to agree to a "below market price" figure of $1.8 billion 
as the valuation of KMG's increased share. (Note: 
Determining the "market price" for this share is essentially 
impossible, as different financial models will yield wildly 
varying results depending on the assumptions used.  That 
said, all parties involved agree that $1.8 billion is a 
"below market price," even if they can not tell you how much 
below market.  End Note.) 
 
9.  (C)  ExxonMobil has been pursuing a major and innovative 
on-shore proposal with the GOK for the past 18 months that 
would build on the company's acknowledged industry-leading 
skills and, if successful, produce major additional revenues 
for Kazakhstan.  It was made explicit to ExxonMobil that 
failure to agree to the restructuring proposal would result 
in their losing any chance of additional business in 
Kazakhstan -- permanently.  It apparently was the lure of 
this opportunity that persuaded ExxonMobil to accept what all 
the other majors had already agreed to.  ExxonMobil told us 
that no promises were made about any future business, and the 
GOK is on the record publicly as saying that there were no 
side deals made.  However, Idenov strongly hinted to us that 
an agreement with ExxonMobil was imminent -- and went out of 
his way to praise Exxon's professionalism, high standards, 
and critical role in the new operatorship arrangements for 
Kashagan.  He claimed he had told Tillerson that ExxonMobil 
could have first pick on the aspect of the operatorship they 
wanted.  The ExxonMobil office in Astana is scouring the town 
for new office space, and is anticipating the imminent 
arrival of more business development cadres. 
 
------- 
COMMENT 
------- 
 
10. (C) While KMG will benefit from some relatively modest 
guaranteed cash transfers, the real financial gain from the 
Kashagan deal for Kazakhstan is a greater share of upside 
potential if oil prices remain high -- though coupled with 
greater downside risk if prices drop or production does not 
materialize as projected.   ExxonMobil evidently decided that 
the risk of being permanently shut out of development 
prospects in Kazakhstan was not worth the further argument on 
the market value of its existing Kashagan stake.  For its 
part, ConocoPhillips is also bullish on its prospects in 
Kazakhstan over the next few years.  They have offered to 
second technical experts to KMG, at no cost, to help them 
evaluate the N Block that Shell and ConocoPhillips had fought 
so hard over, and that KMG is now going to explore on its 
own.  Idenov apparently has high regard for ConocoPhilips CEO 
Jim Mulva -- a fact that may further work to the benefit of 
the company.  End Comment. 
ORDWAY

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