08ASTANA779, GOK INCREASES PRESSURE ON TENGHIZCHEVROIL OVER

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Reference ID Created Released Classification Origin
08ASTANA779 2008-04-21 11:52 2011-08-30 01:44 CONFIDENTIAL Embassy Astana

VZCZCXYZ0000
RR RUEHWEB

DE RUEHTA #0779/01 1121152
ZNY CCCCC ZZH
R 211152Z APR 08
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC 2267
INFO RUCNCIS/CIS COLLECTIVE 0490
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEBAAA/DEPT OF ENERGY WASHDC

C O N F I D E N T I A L ASTANA 000779 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR SCA/CEN, EEB 
COMMERCE FOR HUEPER 
ENERGY FOR EKIMOFF 
 
E.O. 12958: DECL: 04/17/2018 
TAGS: PGOV PREL EPET KZ
SUBJECT: GOK INCREASES PRESSURE ON TENGHIZCHEVROIL OVER 
SULFUR 
 
REF: ASTANA 206 
 
Classified By: AMBASSADOR ORDWAY FOR REASONS 1.4 (B) AND (D) 
 
1. (C) Summary: Kazakhstani authorities continue to closely 
scrutinize TenghizChevroil (TCO), which has already paid 
hundreds of millions of dollars in fines in recent years. 
Consortium representatives describe a working environment 
made difficult by government harassment and constant requests 
for information. TCO's most serious problem concerns sulfur 
production and storage.  It has already paid a $300 million 
environmental fine for storing sulfur without official 
permission, and now faces an additional $300 million 
administrative penalty connected to the original fine. 
Chevron CEO David O'Reilly met with President Nazarbayev on 
April 15, with the sulfur issue a primary topic of 
conversation.  End Summary 
 
TCO Under Scrutiny 
------------------ 
 
2. (C) TCO, which is owned by Chevron (50%), KMG (20%), 
ExxonMobil (25%), and LukArco (5%), has been fined by both 
national and regional authorities on numerous occasions in 
the last year. Most significantly, TCO  was fined over $600 
million dollars for storing 2.5 million tons of sulfur 
without official permission.  The fine was later reduced to 
$300 million by an Atyrau regional court.  TCO now faces an 
additional $300 million administrative penalty connected with 
the alleged environmental violations.  On April 15, Chevron 
CEO David O'Reilly met with President Nazarbayev in Astana 
and urged the Kazakhstanis to work towards an equitable 
solution on the sulfur issue.  TCO has also paid a series of 
smaller fines.  For example, the environmental prosecution 
department of the Atyrau Oblast brought environmental charges 
against TCO for excessive gas flaring in 2007, for which TCO 
paid a $12 million fine.  Kazakhstan's Ministry of 
Environment charged TCO with 22 environmental violations 
subject to civil penalties of $1.1 million dollars. 
 
3. (C) In a meeting with Poloff on April 12, Linsi Crain, TCO 
Deputy Manager for Government and Public Affairs, and Mark 
Maurer, TCO Finance Manager, said that interference and 
harassment from Kazakhstani authorities is unrelenting. 
The Kazakhstanis, they said, are looking for every 
opportunity to "find a hole." Maurer stated that TCO receives 
fifteen threatening letters a week. Crain described TCO as 
constantly in reactive mode because of the intense scrutiny. 
Pete Clark, Chevron Eurasian Business Unit Manager for 
Strategic Planning, told Poloff in a separate meeting on 
April 5 that Chevron is in a defensive position at Tenghiz, 
trying to preserve contract sanctity.  Realistically, said 
Clark, Chevron will suffer reduced earnings at Tenghiz, but 
"we are trying to hold off as much as possible." "Every time 
we fix one problem, another arises," he added. 
 
4. (C) Crain, Maurer, and Clark were extremely critical of 
the latest sulfur fines. Clark noted that when O'Reilly met 
with President Nazarbayev last year, Nazarbayev promised to 
instruct Prime Minister Masimov to solve the sulfur conflict. 
 Despite Nazarbayev's promises, the Kazakhstanis have not 
relented on sulfur.  TCO cannot go to the Ministry of Energy 
and Natural Resources for permits on storage, because such 
permits do not even exist. Maurer said that TCO believes that 
it can take a royalty offset for the $300 million 
environmental fine.  The Ministry of Finance, however, 
disagrees.  According to Maurer, TCO may at some point decide 
to challenge the government by taking the offset, or file a 
notice of arbitration. 
 
5. (C) Crain said that TCO sold 2.05 million tons of sulfur 
in 2007, with sales equaling 126% of production and an 
increase of 24% from 2006.  Total sulfur on pads was reduced 
by nearly half a million tons in 2007, and new projects are 
underway to increase sales capacity to three million tons per 
year.  TCO prepares a biweekly report for the Kazakhstanis on 
sulfur, but still has faced accusations that it is not doing 
everything possible to sell its sulfur.  Crain said that TCO 
has enough clients for its sulfur, but faces issues of 
transportation capacity. 
 
6. (C) When asked why TCO is facing such intense oversight, 
Maurer replied that "it is strictly about the money."  Patty 
Graham, ExxonMobil Kazakhstan Government and Public Affairs 
Representative, told Poloff that she has heard the fines are 
linked to the budget concerns of regional governments. Clark 
 
echoed Graham, saying that Tenghiz fines have become an 
essential part of the Atyrau Oblast budget.  Courtney Fowler, 
a partner at PriceWaterhouseCooper (PWC) in Almaty, told 
Poloff on April 6 that once after a large fine against TCO 
was upheld by the Kazakhstani courts she overheard the Atyrau 
Akim saying "Why so much? I only needed $7 million." (Note: 
In the end, all of the $300 million sulfur penalty went to 
the central authorities). 
 
7. (C) Although acknowledging that Chevron's partnership with &#x000
A;Kazakhstan at Tenghiz has been extremely profitable for all 
parties, Clark admitted that the relationship is not without 
cause for occasional concern.  Chevron would like to think 
that it is irreplaceable, he said, because of the value and 
reliability it provides to the project.  Nevertheless, "there 
are ways we could replaced," he said, particularly with the 
project personnel increasingly Kazakhstani.  Chevron will be 
most vulnerable, believes Clark, after completion of second 
stage expansion.  (Comment: We think this is exaggerated. 
KMG does not have the ability to manage this project for the 
foreseeable future.) 
 
8. (C) The story is slightly different from the GOK 
perspective.  Energy Minister Mynbayev has told visiting USG 
delegations and the Ambassador that his ministry will "have 
to get more involved" to resolve the sulfur problem.  Senior 
management at KMG is also reasonably aligned with KMG on this 
issue.  Prime Minister Masimov confirmed to the Ambassador on 
April 17 that President Nazarbayev had promised Dave O'Reilly 
(again) that the sulfur issue will be solved.  Masimov said 
that the President has turned this problem over to him and 
that he has not yet figured out how to resolve it. 
 
The Bigger Picture 
------------------ 
 
9. (C) Westerners with links to Kazakhstan's energy sector 
told Poloff that problems at Tenghiz are part of a broader 
pattern of behavior by the GOK.  PWC's Fowler believes that 
the GOK is "layering one tax after another" on the IOCs and 
using tax and environmental laws as "extortionary tools." She 
assessed the energy investment climate as worsening.  Marla 
Valdez, a partner at the law firm of DentonWildeSapte in 
Almaty, believes that there is "no doubt that the government 
is tightening up."  Patty Graham of ExxonMobil believes that 
the recently announced oil export duties will also place 
additional pressures on western companies, even though it 
will not directly affect companies operating under 
tax-stabilizing contracts.  Attention is sure to shift to the 
IOCs, believes Graham, when local companies begin to bear the 
brunt of the export tax. 
 
10. (C) Nevertheless, no one is yet proclaiming that the sky 
is falling.  Graham sees clear distinctions between 
Kazakhstan and countries such as Venezuela and Russia and 
does not believe Kazakhstan will follow their path.  Valdez 
reported that companies are still coming in to Kazakhstan to 
make acquisitions, describing DentonWildeSapte's acquisitions 
services as "booming."  Fowler noted that Kazakhstan has some 
promising leaders who have the right vision for Kazakhstan's 
energy sector, praising Presidential Administration Head 
Kairat Kelimbetov in particular. 
 
11. (C) The biggest issue is contract sanctity. Despite the 
large numbers involved in the long-running sulfur dispute, 
most of the GOK's actions against the IOCs are based on 
contract provisions that the government construes in their 
favor and the IOCS argue strenuously are clearly in their 
favor.  While the companies are quick to say they will go to 
arbitration, it is in the interest of neither side to let the 
situation get so far out of hand - and an acceptable 
compromise is inevitably found.  More broadly, Masimov has 
told the Ambassador on several occasions that existing 
contracts will be honored as long as Nazarbayev has anything 
to say about it - a view that the companies largely echo. 
However, the contracts are vulnerable to attack in the longer 
run if they are in conflict with subsequent tax and other 
legislation.  Masimov told the Ambassador that his idea is 
that the contracts be "ratified" by the Parliament, thus 
giving them a status superior to contravening legislation and 
a much better chance of surviving post-Nazarbayev scrutiny. 
It is not clear that the companies will eagerly agree to have 
their confidential contracts exposed to parliamentary (and 
public) scrutiny, but the threat of imposing the new tax code 
due to be adopted by the end of the year regardless of 
stabilization clauses could be a very significant bit of 
 
leverage.  Masimov broached this idea with O'Reilly during 
his recent visit. O'Reilly apparently was not expecting this 
approach, and said that he would consult with the company's 
lawyers and provide a response later.  TCO has resisted 
joining EITI because of concerns about publicly revealing 
certain portions of their contract. 
 
------- 
Comment 
------- 
Sulfur at Tenghiz is hardly Kazakhstan's most pressing 
environmental problem, particularly when TCO is making a 
good-faith effort to accelerate pad removal.  With a series 
of extravagant fines and unrelenting pressure, however, the 
GOK risks creating a serious rift with TCO.  While there are 
many factors at play - the populist appeal of taking on the 
IOCs, the budget pressures created by an economic downturn, 
simple greed - a primary cause for conflict the appears to be 
that bureaucratic elements, including the Environmental 
Ministry and Tax Committee, are pursuing their own agendas 
aided by tough interpretations of ambiguous legislation.  The 
GOK leadership must sort out this situation by reducing the 
pain to the oil companies to a manageable level. 
Simultaneously, they have to avoid providing the opposing 
bureaucrats (and the procuracy and financial police lurking 
in the background) with ammunition to accuse them of selling 
out the country or violating the law. 
ORDWAY

Wikileaks

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