08ASTANA225, KAZAKHSTAN: GOK AND KMG DISCUSS KASHAGAN, OIL AND

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Reference ID Created Released Classification Origin
08ASTANA225 2008-02-04 13:35 2011-08-30 01:44 CONFIDENTIAL Embassy Astana

VZCZCXYZ0001
OO RUEHWEB

DE RUEHTA #0225/01 0351335
ZNY CCCCC ZZH
O 041335Z FEB 08
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 1671
INFO RUCNCIS/CIS COLLECTIVE PRIORITY 0383
RUEHAK/AMEMBASSY ANKARA PRIORITY 2131
RUEHTH/AMEMBASSY ATHENS PRIORITY 0148
RUEHSF/AMEMBASSY SOFIA PRIORITY 0185

C O N F I D E N T I A L ASTANA 000225 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: DECL: 02/04/2018 
TAGS: EPET EINV ECON PREL KZ
SUBJECT: KAZAKHSTAN: GOK AND KMG DISCUSS KASHAGAN, OIL AND 
GAS TRANSPORT ROUTES WITH ENERGY COORDINATOR AMBASSADOR MANN 
 
 
Classified By: Ambassador John Ordway, Reasons 1.4 (b) and (d) 
 
------- 
SUMMARY 
------- 
 
1. (C) Senior Kazakhstani officials and KazMunaiGaz (KMG) 
executives told visiting Eurasian Energy Diplomacy 
Coordinator Ambassador Mann on January 25 that they welcomed 
the Administration's decision to reestablish the energy 
coordinator's office.  They explained that the GOK pressed to 
renegotiate Kashagan's terms because rapidly rising project 
costs were turning the economic balance of the deal against 
Kazakhstan's interests.  They said that all the details of 
the new Kashagan agreement -- including which companies would 
be responsible for which operator functions -- would be 
finalized within four or five months.  Mann's Kazakhstani 
interlocutors recognized the financial benefits of a 
trans-Caspian oil pipeline, but claimed it would be 
politically difficult to build one without a five-party 
agreement on the Caspian's delimitation.  Kazakhstan is 
pressing ahead on plans &9)# 
cluding its demand to raise tariffs.  The 
Kazakhstanis explained that building a 
Bourgas-Alexandroupolis pipeline will not be easy, but 
reaffirmed that Kazakhstan will provide volume if the project 
comes to fruition.  They were pessimistic about the prospects 
for a trans-Caspian gas pipeline, citing not only political 
issues, but a lack of Kazakhstani volume, which raises 
questions about its economic viability.  End Summary. 
 
--------------------------------------------- ------ 
GOK WELCOMES REVIVAL OF ENERGY COORDINATOR'S OFFICE 
--------------------------------------------- ------ 
 
2. (C) Eurasian Energy Diplomacy Coordinator Ambassador 
Steven Mann held separate meetings in Astana on January 25 
with State Secretary Kanat Saudubayev, Foreign Minister Marat 
Tazhin, Energy Minister Sauat Mynbayev, KazMunaiGaz (KMG) 
President Uzakbai Karabalin, and KMG First Vice President 
Maksat Idenov to discuss developments in Kazakhstan's oil and 
gas sector.  The U.S. Administration, Mann told his 
interlocutors, had recently decided to revive the 
coordinator's office.  We achieved important successes in the 
first stage of Caspian oil and gas development -- notably, 
the Baku-Tbilisi-Ceyhan (BTC) pipeline -- and now sought to 
enhance cooperation on the second stage, including on 
trans-Caspian pipelines, Mann explained.  Saudabayev reminded 
Mann that he had personally pressed Washington to recreate 
the coordinator's office, adding that he hoped the job would 
not end in 2009 with the new administration.  Saudubayev also 
stressed that Kazakhstan's policy supporting diversification 
of oil and gas transport routes remained unchanged.  Mynbayev 
similarly welcomed the renewed USG attention, noting that "we 
are far from having the market resolve all issues" and thus 
need diplomatic efforts too.  He agreed with Mann on the 
importance of incorporating more cooperation on energy in the 
U.S.-Kazakhstan strategic partnership. 
 
-------- 
KASHAGAN 
-------- 
 
3. (C) Mann told his interlocutors that the USG welcomed the 
Kashagan deal and appreciated the Kazakhstani side's 
professionalism in its handling of the negotiations. 
Mynbayev explained that while the new joint operating 
structure may not be ideal, the key was that all sides 
managed to agree to it, and it also provides for more 
accountability, allowing for better control of expenses. 
Kazakhstan's position in the negotiations, he stressed, was 
that it could not consent to a continuation of Eni's role as 
sole operator and of lesser rights for KMG than for the other 
partners, especially regarding access to information.  KMG is 
now in a more equal position, though the GOK recognizes that 
KMG's engineering and technical capabilities are not 
sufficient for it to play the top role.  The issue to be 
resolved going forward, Mynbayev explained, is how to divide 
responsibilities in the joint operating company, including 
which companies will have the operating lead on on-shore, 
off-shore, pipeline, and drilling activities.  The GOK wants 
the most qualified company selected for each, but will 
approve whatever ExxonMobil, Shell, and Total decide, 
 
Mynbayev explained.  He added that with Kashagan resolved, 
the GOK expects to increase cooperation with ExxonMobil on 
other projects.  (Note: This is consistent with what we have 
heard from ExxonMobil representatives.  End Note.) 
 
4. (C) Echoing Mynbayev's comments, KMG President Karabalin 
explained that the GOK's original intent was not to change 
the Kashagan agreement to gain at the expense of the other 
parties.  However, once the GOK learned about the enormous 
cost increases, it realized it had to do something.  With the 
cost increases, the economic balance of the project had 
shifted against Kazakhstan's interests, which is why the GOK 
insisted on restoring that balance.  The negotiations, 
Karabalin contended, were difficult because the companies &#x00
0A;resisted.  At the same time, the GOK recognized that there 
would be additional costs if the project was delayed further. 
 With a signed MOU, and a budget approved for sixth months, 
the parties have four or five months to finalize all the 
details.  KMG has gained a lot from the deal, including a 
better, stronger image.  The other parties also gained from 
having KMG as an equal partner; where issues arise, KMG can 
take them immediately and directly to the Prime Minister's 
cabinet. 
 
5. (C) KMG First VP Idenov provided additional details on the 
GOK's impetus to renegotiate Kashagan's terms.  He explained 
that he had reviewed five key aspects of the project -- 
decisionmaking; internal controls; health, safety, and 
environmental standards; technical integrity; and project 
management -- and determined that Kashagan had failed to meet 
international standards in each.  The consortium tried to 
blame the Kazakhstanis for everything, but of over 300 
consortium staffers, only nine were from KMG, Idenov said. 
The Kashagan management committee was composed of local 
representatives of the companies, who did not have proper 
accountability.  The consortium spent $4 billion on a 
production island, but the work was not done right.  The net 
present value of the project had dropped by 24.5 percent -- 
which was fine for Kashagan's well-paid managers, but 
disastrous for corporate shareholders.  Most importantly for 
Kazakhstan, the cost increases for the overall project (which 
came at the expense of Kazakhstan's royalties) were 
staggering, rising from $8.7 billion to $57 billion over four 
years.  Nevertheless, the GOK approved all of them -- until 
the final increase to $136 billion.  Idenov himself proposed 
the new operating model, compensation for Kazakhstan, and 
bringing the project in line with international standards. 
His principles were to negotiate in good faith, keep the 
project running during the negotiations, and not use 
Kazakhstan's new subsoil law amendments. 
 
6. (C) Idenov said he expects to be chairman of the 
management committee of Kashagan's new joint operating 
company, where the leading roles will be played by KMG, 
ExxonMobil, Shell, and Total.  He will insist that the rest 
of the company's board be made up of the other partners' 
executive vice presidents, not their local representatives. 
Eni will continue as the operator for Kashagan's experimental 
phase only.  Idenov would like to find specific tasks for the 
minority partners, ConocoPhilips and Inpex.  Idenov praised 
KMG's lawyers -- Curtis, Mallet-Prevost -- and its financial 
advisors -- ABN Amro - for the "superb job" they did in 
assisting KMG in striking a good deal.  He estimated that 
KMG's compensation, not including KMG's additional equity 
stake, is worth $5 billion up front, and $20 billion over the 
life of the project. 
 
------------------------ 
TRANS-CASPIAN OIL ROUTES 
------------------------ 
 
7. (C) Mann told his Kazakhstani interlocutors that with 
additional oil from the second phase of TengizChevrOil (TCO) 
and from Kashagan, Kazakhstan would need to focus more 
attention on a prospective trans-Caspian oil pipeline. 
Tankers will be necessary, but probably not sufficient for 
such volumes.  He explained the USG legal position that a 
five-party agreement on delimitation of the Caspian is not 
necessary to build a pipeline, and Karabalin added that 6000 
kilometers of pipeline have already been laid there. 
Mynbayev said that the issue is not just a legal one, but 
rather both legal and political, and that it would difficult 
to build a pipeline without a five-party agreement.  FM 
Tazhin and KMG President Karabalin separately stressed the 
same point.  Tazhin contended that the 2007 Tehran summit of 
Caspian littoral states had resulted in a very positive 
political declaration on delimitation, and there appear to be 
positive changes in the Russian and Turkmen positions, and 
maybe even that of Iran.  Delimitation would be a key issue 
 
at the 2008 Baku summit, though Tazhin was not optimistic 
about reaching a final solution for the event.  Karabalin 
added that of course, if a pipeline could be built, it would 
be very much in Kazakhstan's interests, as it would lower 
transport costs. Idenov told Mann that he had set up a unit 
within KMG to develop trans-Caspian pipeline options and had 
provided $20 million in funding for its work.  Tazhin 
contended that if the companies put together a "real 
document" -- something more than a feasibility study -- on a 
trans-Caspian oil pipeline, it would make discussion of the 
whole issue "more concrete and productive." 
 
--------------------------- 
VIRTUAL PIPELINE OF TANKERS 
--------------------------- 
 
8. (C) Mynbayev explained that in the absence of a 
trans-Caspian oil pipeline, Kazakhstan and Azerbaijan would 
move forward with their own plans for a Kazakhstan Caspian 
Transportation System (KCTS), including building the 
appropriate terminal infrastructure in Kuryk and Baku, and 
developing a "virtual pipeline" of tankers -- Kazakhstan 
prefers large ones of 60,000 DWT -- to ferry oil from the 
former to the latter.  Mynbayev reminded Mann that when 
Azerbaijani President Aliyev visited Kazakhstan in August 
2007, the two sides had reached an inter-governmental 
agreement on KCTS, which is currently awaiting ratification. 
The GOK expects to play a large role in KCTS, but issues that 
remain to be resolved include dividing functions, getting 
guarantees from companies to provide supply, and making 
guarantees to companies on access.  Karabalin said that the 
participation of private companies -- which Azerbaijan wants 
and Kazakhstan does not -- is another outstanding question. 
Mynbayev also noted that the Kazakhstanis themselves are 
constructing the Eskene-Kuryk pipeline.  It is not a long 
pipeline, he stressed, and will be ready in time to handle 
the supply. 
 
--------------------------- 
MOVING OIL FROM BAKU ONWARD 
--------------------------- 
 
9. (C) Mann asked his interlocutors about Kazakhstan's plans 
to move oil from Baku onward.  Mynbayev noted that the quota 
for companies in BTC that are shippers of Kazakhstani oil is 
small, and the long-term plans for the pipeline remain 
unclear.  Karabalin said that BTC will be the number one 
route for Kashagan oil, but its capacity will likely not be 
large enough.  However, if Azerbaijani oil volumes decline, 
it may not be feasible to build a second BTC pipeline.  This 
is why Kazakhstan is also looking at the Baku-Supsa pipeline 
route, and at moving oil through Kulevi and Batumi. 
Kazakhstan purchased one-third of the Batumi oil terminal 
already, and has reached agreement on acquiring 100 percent. 
Karabalin argued that Azerbaijan wants to charge high prices 
for Kazakhstani access to BTC.  The Kazakhstanis have 
proposed their being offered the same prices as BTC 
consortium members.  He asked Mann to press the Azerbaijanis 
to respond to the GOK on this issue.  In terms of moving oil 
from the Blac
k Sea coast onward, Karabalin stressed the 
importance of KMG's acquisition of Rompetrol, which will 
enable it to move oil through Constanta and thus avoid the 
Bosphorous.  Rompetrol also has a refinery located just 30 
kilometers from Constanta.  Both the Batumi and Rompetrol 
acquisitions allow Kazakhstan to bypass Russia, he noted. 
 
--------------------------------- 
CASPIAN PIPELINE CONSORTIUM (CPC) 
--------------------------------- 
 
10. (C) Karabalin told Mann that Kazakhstan had agreed to all 
10 terms the Russians had placed on CPC expansion.  This 
included the requirement to raise tariffs, even though the 
Kazakhstanis are not interested in doing this, since the less 
they pay for transport, the better.  (Karabalin noted that 
just a $1 per ton tariff increase will raise the costs of 
exports from Kashagan by $840 million over the life of the 
project.)  That said, the Kazakhstanis understood the desire 
of the Russians to make the CPC self-sustaining.   Mann 
advised that he was not optimistic on CPC expansion, noting 
that whenever problems are resolved, new ones seem to arise. 
 
-------------------------------- 
BOURGAS-ALEXANDROUPOLIS PIPELINE 
-------------------------------- 
 
11. (C) Mynbayev told Mann that the Bourgas-Alexandroupolis 
pipeline is "not a simple issue," even for the Greeks.  There 
are major issues to be resolved regarding land acquisition, 
 
financing the pipeline, and providing guarantees of access to 
companies.  Diplomatic efforts are needed, not just a 
reliance on market forces.   The pipeline is more important 
for Russia than Kazakhstan.  That all said, the GOK's 
position is that if the pipeline is built, Kazakhstan will 
participate, Mynbayev explained.  Karabalin said that he 
expected Bourgas-Alexandroupolis will, in fact, be built.  It 
helps solve the Bosphorous problem, where tankers can bear 
huge losses --- sometimes up to $400,000 -- while waiting to 
go through the straits.   KMG and Chevron have committed to 
provide 10 million tons of crude annually to the pipeline, so 
long as they get the same terms for access as Russian 
companies.  The Russians, Karabalin explained, are setting up 
a holding company to build it.  Once that is done, the 
Kazakhstanis will sign a formal agreement on participation. 
 
---------- 
GAS ISSUES 
---------- 
 
12. (C) Ambassador Mann also raised the issue of a 
trans-Caspian natural gas pipeline, stressing U.S. support 
for gas westward to Europe.  Mynbayev told Mann that this 
would be an even more difficult project than an oil pipeline. 
 On top of the political issues, the economics are doubtful. 
Without Turkmenistan, the volumes would be very small, and 
thus such a project would make little sense.  Karabalin noted 
that TengizChevrOil (TCO) could provide significant amounts 
of gas -- each ton of oil there results in approximately 1 
million cm of gas -- but for the foreseeable future, most of 
that gas will be reinjected.  Down the road, gas from TCO 
could be brought by pipeline to Turkmenistan, to link up with 
a trans-Caspian gas pipeline.  He added that Kazakhstan plans 
to ultimately provide 15 bcm of gas from Karachaganak to the 
Orenburg gas reprocessing plant, of which 23 percent would be 
returned for domestic Kazakhstani needs, and 77 percent sold 
to Gazprom.  The Orenburg expansion project, he said, is 
moving along fine, though Kazakhstan is not in a rush, as 
Karachaganak needs to first reach its next output stage. 
 
--------------------------------------- 
TENGIZCHEVROIL (TCO) ENVIRONMENTAL FINE 
--------------------------------------- 
 
13. (C) Mynbayev told Mann that the environmental fine 
against TengizChevrOil (TCO) was principally an issue for the 
Ministry of Environmental Protection, as well as for the 
Ministry of Finance, given TCO's interest in charging the 
fine against royalties to be paid to the GOK.  That said, his 
Ministry of Energy expected to become more active on the 
issue. 
 
----------------------- 
CHANGES IN TURKMENISTAN 
----------------------- 
 
14. (C) Tazhin agreed with Mann that there have been positive 
changes in Turkmenistan, noting, for example, that President 
Berdimuhammedov had visited the EU in Brussels in November -- 
something Niyazov would never have done.  That said, Tazhin 
contended that the Turkmen remain unreliable on natural gas, 
despite the fact that it is their only resource for their 
country's development.  Just several days prior, they had cut 
off gas exports to Iran, he noted. 
 
--------------- 
KMG RESTRUCTING 
--------------- 
 
15. (C) Idenov gave Ambassador Mann a lengthy, impressive 
briefing on his ongoing efforts to restructure KMG.  Among 
other things, he aimed to create more individual 
accountability within the company.  Idenov was also working 
on a detailed code of professional conduct that was 
consistent with the world's best practices. 
ORDWAY

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