08ASTANA2449, KARACHAGANAK: KAZAKHSTAN’S UNSUNG SUPERGIANT OIL AND GAS

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Reference ID Created Released Classification Origin
08ASTANA2449 2008-12-11 03:51 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Astana

VZCZCXRO3338
OO RUEHAG RUEHAST RUEHBI RUEHCI RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW
RUEHLA RUEHLH RUEHLN RUEHLZ RUEHNEH RUEHNP RUEHPOD RUEHPW RUEHROV
RUEHSK RUEHSR RUEHVK RUEHYG
DE RUEHTA #2449/01 3460351
ZNR UUUUU ZZH
O 110351Z DEC 08
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 4087
INFO RUCNCIS/CIS COLLECTIVE 0916
RUCNCLS/SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEHBJ/AMEMBASSY BEIJING 0318
RUEHKO/AMEMBASSY TOKYO 1023
RHEBAAA/DEPT OF ENERGY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEAIIA/CIA WASHDC
RHEFAAA/DIA WASHDC
RHEHNSC/NSC WASHDC 0483
RUEKJCS/SECDEF WASHDC 0392
RUEKJCS/JOINT STAFF WASHDC
RHMFIUU/CDR USCENTCOM MACDILL AFB FL

UNCLAS SECTION 01 OF 03 ASTANA 002449 
 
SENSITIVE 
SIPDIS 
 
STATE FOR SCA/CEN, EEB/ESC, EUR/RUS 
STATE PLEASE PASS TO USTDA FOR DAN STEIN 
 
E.O. 12958: N/A 
TAGS: PGOV EPET EINV RS KZ
SUBJECT:  KARACHAGANAK:  KAZAKHSTAN'S UNSUNG SUPERGIANT OIL AND GAS 
FIELD 
 
REF: (A) ASTANA 2176 (B) ASTANA 1646 
 
1.  (U) Sensitive but unclassified.  Not for public Internet. 
 
2.  (SBU) SUMMARY:  On December 2-4, Energy Officer toured the vast 
Karachaganak oil and gas field near the small town of Aksai (pop. 
35,000), 40 kilometers from the Russian border in northwestern 
Kazakhstan.  Although less well-known than its supergiant neighbors 
Tengiz and Kashagan, Karachaganak is one of the world's largest oil 
and gas condensate fields and produces 49% of Kazakhstan's natural 
gas and 18% of its oil.  The Karachaganak Petroleum Operating BV 
(KPO), co-operated by Britain's BG Group and Italy's Eni under a 
40-year production sharing agreement (PSA), manages the field, which 
contains 1.2 billion tons of oil and condensate and 1.35 trillion 
cubic meters of natural gas.  KPO's Business Governance Controller 
Chris Circuit expressed concern to Energy Officer that Kazakhstan's 
national oil company KazMunaiGas (KMG) would make a push in 2009 for 
an equity stake in the project, which is the largest, most 
profitable PSA in Kazakhstan in which KMG does not have ownership. 
Field manager Tom Hanson said KPO has a "very cooperative" 
relationship with Gazprom, the precursor of which initially 
discovered the field in 1979 and established a symbiotic 
relationship with the field that continues to this day.  Constraints 
on oil transportation capacity worry the consortium, particularly 
with the slow pace of negotiations over the expansion of the CPC 
pipeline, KPO's preferred export route.  Managing Director Roger Fox 
said relations with the regional government and the local population 
are generally strong, although the oblast continues to levy heavy 
environmental fines and at least one local newspaper regularly 
accuses the company of violating environmental laws and standards. 
To the residents of Aksai and Uralsk, however, KPO is an employer of 
choice and a model corporate citizen known for investing in schools, 
roads, and hospitals.  END SUMMARY. 
 
WILL KMG DEMAND AN EQUITY STAKE? 
 
3.  (SBU) KPO, which comprises Italy's Eni (32.5%), the United 
Kingdom's BG Group (32.5%), Chevron (20%), and Russia's Lukoil 
(15%), manages the Karachaganak field under a 40-year production 
sharing agreement that began in 1997; BG Group and ENI alternate as 
lead operators of the project.  BG Group's Roger Fox is the current 
managing director and will be replaced in October by a senior 
manager from Eni.  There is widespread concern among KPO partners 
that KMG will pressure the consortium to grant it an equity stake, 
particularly now that negotiations over Kashagan have concluded. 
(NOTE:  KMG insisted that the Kashagan partners increase KMG's 
equity stake from 8.33% to 16.81% as compensation for cost overruns 
and production delays.  See reftel A.  END NOTE).  KPO's Business 
Governance Controller Chris Circuit seemed resigned to the 
inevitability of government ownership, telling Energy Officer, 
"after Kashagan, we're next."  According to Circuit, there are only 
a few people in the government who can take on an issue of this 
magnitude, such as KMG Vice President Maksat Idenov and Minister of 
Energy and Mineral Resources Sauat Mynbayev, both of whom were 
directly involved for several months in the Kashagan negotiations. 
"Now that they have finished Kashagan," he said, "they will 
undoubtedly continue to press us for a share.  We need to stay 
focused on our jobs, keep things running smoothly, and not give them 
an excuse to make demands."  Karachaganak is the largest, most 
visible producing asset in which the government of Kazakhstan does 
not have an equity stake. 
 
OIL AND GAS PRODUCTION FIGURES 
 
4.  (SBU) Circuit was quick to emphasize that although KPO produces 
49% of all natural gas in Kazakhstan, it not a gas project.  "The 
sole driver is to maximize liquids," he said, noting that half of 
the gas produced at Karachaganak (6.6 billion cubic meters, or bcm) 
is reinjected into wells to maintain pressure for pumping oil and 
another 6.6 bcm is sold to Gazprom at rates as low as one-tenth the 
European price.  Less than 0.5% of all gas produced is flared, which 
is well below the industry standard.  The sprawling field covers 280 
square kilometers and contains 300 wells, including 100 active wells 
and 200 Soviet-era wells that KPO must plug and abandon.  BG Group 
alone has invested approximately $5.5 billion in the project since 
 
ASTANA 00002449  002 OF 003 
 
 
1997.  There are three main operating fa
cilities at Karachaganak: 
Unit 3, the original production site established by the precursor to 
Gazprom, remains the main production site, generating up to 470,000 
barrels of oil equivalent per day (bpd), including condensate.  Unit 
2 uses groundbreaking technology -- including three powerful 
compressors built by General Electric/Nuovo Pignone -- to separate 
the oil from the gas and reinject the hydrogen-sulfur gas back into 
producing wells.  A third major facility, the Karachaganak 
Processing Complex (KPC), stabilizes the oil and ships it by 
pipeline 635 kilometers to Atyrau where it joins the CPC pipeline. 
In November, BG Group and Eni announced they would delay Phase III 
expansion, citing the capital-intensive nature of the project and 
the high cost of inputs.  Privately, KPO's Circuit confided that the 
government of Kazakhstan was eager for KPO to continue current tax 
and royalty payments, particularly in the current financial 
environment, rather than allowing the consortium to make major new 
capital investments that would defer royalty payments until the 
costs were recovered, per the terms of the PSA. 
 
SYMBIOTIC RELATIONSHIP WITH GAZPROM 
 
5.  (SBU) Karachaganak has a long-standing, mutually-beneficial 
relationship with Gazprom.  In fact, the field was originally 
designed and developed by Soviet engineers in the 1980s as a single, 
fully integrated facility with the Orenburg Gas Processing plant, 
more than 150 kilometers to the north.  To this day, according to 
field manager Tom Hanson, KPO has a strong, cooperative relationship 
with Gazprom, which owns the Orenburg Gas Processing Plant.  (NOTE: 
Former Gazprom CEO Viktor Chernomyrdin and current CEO Alexei Miller 
are both former directors of the Orenburg facility.  END NOTE). 
Hanson said he or his staff are "on the phone every day - sometimes 
several times a day" with Gazprom technicians in Orenburg and added, 
"operationally, they are very easy to deal with."  Hanson also noted 
that all expatriate staff working at KPO have Russian visas and 
senior managers travel to Orenburg and/or Moscow at least quarterly. 
 Hanson said he is aware of the government of Kazakhstan's desire to 
build a new gas processing plant in Kazakhstan, but he is not aware 
of any tangible progress. 
 
TRANSPORTATION DILEMMA 
 
6.  (SBU) KPO exports more than seven million metric tons of oil per 
year (up to 470,000 bpd) via the CPC pipeline.  Company executives 
are anxious for an expansion in CPC capacity, particularly once 
additional production comes online under Phase III.  KPO ships minor 
volumes of crude via the Atyrau-Samara pipeline but prefers to use 
CPC because it offers a quality guarantee  and access to global 
markets.  Unlike Tengiz and Kashagan, KPO does not transport crude 
by rail and does not own rail cars or loading facilities.  KPO's 
high-sulfur sour gas is transported to Orenburg, where it is 
processed and sold, including to Kazakhstan.  To avoid importation 
of its own natural resource, the governor of the West Kazakhstan 
region has pushed KPO to invest in a domestic gas processing plant 
and domestic gas pipelines.  KPO has resisted the former, but did 
begin construction of a gas pipeline to Uralsk, which KPO's Circuit 
called an "absolute nightmare" because there is no domestic network 
for it to connect to. 
 
GOOD RELATIONS WITH THE OBLAST AND LOCAL POPULATION 
 
7.  (SBU) Managing Director Roger Fox surprisingly said that, unlike 
investors in Atyrau oblast, KPO has had no problem obtaining work 
permits from West Kazakhstan oblast officials.  He also proudly 
noted that -- notwithstanding the highly-publicized environmental 
fines KPO has paid -- it is the only subsoil user in Kazakhstan to 
request and receive a three-year environmental permit and said that 
the company recently received ISO 14001 certification for its 
environmental management system, which will lead to a tax rebate in 
2009.  Fox praised the government's use of the "polluter pays" 
principle, saying Kazakhstan is ahead of most European countries in 
enforcing environmental standards.  According to Fox, despite KPO's 
strong environmental record, the company continues to pay fines, 
particularly since the local government keeps all revenue collected 
for environmental violations.  In 2007, according to Fox, KPO paid 
approximately $8 million in fines, while it expects to pay as much 
 
ASTANA 00002449  003 OF 003 
 
 
as $60 million in 2008, even though total emissions declined, 
because the local government increased fines by a factor of 15.  Fox 
said that there is one "trashy newspaper" in Uralsk that regularly 
criticizes KPO for alleged harm to the environment, but he noted 
that it has toned down its rhetoric lately.  Fox said relations with 
the local population are excellent, citing KPO's multi-million 
dollar investment in social projects in the region, including a 
kindergarten, museum, hospital, and highway.  Fox lamented that 
since the oblast governor controls the allocation of KPO's social 
investment funds, very little is invested in Aksai itself. 
 
TAX AND LEGAL ISSUES AT THE NATIONAL LEVEL 
 
8.  (SBU) Commenting on the national regulatory environment, Fox 
said that KPO has already paid $650 million in crude export duties 
and continues to make quarterly payments -- "under duress," he 
emphasized (see reftel B).  As for the new Tax Code, which will 
become effective January 1, 2009, Fox said that the new rent tax may 
not be applicable to KPO because it has a tax stability clause, 
although he wryly noted that this did not prevent the authorities 
from imposing the crude export duty on KPO.  Finally, Fox said that 
the new requirement for parliament to ratify KPO's production 
sharing agreement in order to guarantee its tax stability would 
amount to "a unilateral renegotiation of the contract," which the 
consortium would strongly protest. 
 
HOAGLAND

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