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Prospects of export routes for Kashagan oil

  1. Introduction

Kazakhstan has emerged as the main focus of upstream oil and gas investment in the Caspian region, especially since the discovery of a world-class super giant at the offshore Kashagan field. The field known as Kashagan lies in the north–west Caspian off the coast of Kazakhstan and is reported to cover an area 47 miles (75 km) long by 22 miles (35 km) wide. The discovery well, Kashagan East, was a single vertical well, drilled to a total depth of 4500 m.2 The contracting companies continued to explore other structures in the North Caspian Sea contract area and they found considerable reserves in 2002 at the Kalamkas field (Oil and Gas Journal—OGJ, 2002a, b). The Aktote, Kashagan South West and Kairan areas explored by the end of 2004. These offshore fields are large by international standards, but still considerably smaller than the giant Kashagan field. Appraisal programs for these fields are still underway.

Kashagan oil field, believed to be the fifth largest ever found in the world, has estimated total reserves of as high as 50 billion barrels of oil (up to 15–20 billion of which are thought to be recoverable)3 and 25 tcf of natural gas (EIA, 2008a–c; OGJ, 2001). Kashagan alone represents almost 50% of the proved oil reserves of Kazakhstan4 and it is by far the largest offshore field in the Caspian basin. The 480-square mile deposit is reportedly so large that it is believed to even surpass the size of the North Sea oil reserves (Krastev, 2002).

Drilling began in 2000 under the auspices of its concessionaire, the Offshore Kazakhstan International Operating Company (OKIOC). The OKIOC later changed its name to Agip Kazakhstan North Caspian Operating Company (Agip KCO). The contracting companies involved in the North Caspian Sea Production sharing agreement operated by Agip KCO originally were: ENI–Agip (Italy)

16.67%; BG (formerly subsidiary of BP, UK) 16.67%; ExxonMobil (US) 16.67%; TotalFinaElf (France/Belgium) 16.67%; Royal Dutch/ Shell (UK/Netherlands) 16.67%; Inpex 8.33%; ConocoPhillips (US)

8.33.5 This composition and company shares have changed

overtime which is explained below. The North Caspian production sharing agreement (PSA) covers 5600 sq km.

2. Significance of Kashagan reserves and impact of the discovery

Although the field is still being appraised, in 2007 Agip KCO estimated the field’s recoverable reserves at 13 billion barrels of oil equivalent, with further potential totaling 38 billion barrels using secondary recovery techniques (gas injection, for example). Further exploratory drilling activities are still in progress (in 2003 five wells have been drilled at Kashagan and three more wells drilled in 2006 for exploratory purposes) (EIA, 2008a–c).6

In late 2007, an Eni spokesman estimated that the field would initially produce around 3,00,000 bbl/d from the field as of late 2011. According to KazMunaiGaz, full-scale commercial production is not expected to commence until 2013–2014. The consortium originally estimated peak production at around 1.3 million bbl/d by 2016. The Kashagan project is at the heart of Kazakhstan’s bid to triple its output to 150 million tons by 2015 and become one of the world’s biggest exporters. This figure may be adjusted under a new ownership structure agreed to in early

2008.

The Kashagan field has presented particular challenges for its developers. ENI, the operator of the consortium, has pushed back the projected startup date from 2005, then to 2008, and then to the end of 2011. AGIP-KCO members have set a July 2013 deadline for the start of commercial output at the field and increased its projected expenditures from $57 billion to $136 billion (Socor,

2008a, b; Leonard, 2008). This huge discrepancy over the final cost of the project alone indicates the complexities faced in develop- ment phase. According to the Economist Intelligence Unit, govern- ment receipts from the field’s production are expected to total $20 billion through 2041. Large scale production will require comple- tion of the Kazakh pipeline as well as an oil and gas treatment plant with an initial capacity of 3,00,000 bbl/d (EIA, 2008a–c).

Kashagan also contains a high proportion of natural gas under very high pressure, the oil contains large quantities of sulfur, and the offshore platforms require construction that can withstand the extreme weather fluctuations in the northern Caspian Sea area. A new tax structure was introduced by the government in 2005, so the ownership rights of the field remained unclear for almost

2 years after British Gas (BG) decided to sell its 16.7% share of the field. Only recently after drawn-out negotiations, consortium members decided to redistribute BG’s share, giving half to themselves and half to KazMunaiGaz.7

In September 2007, Kazakhstan requested over $10 billion in compensation from the multinational consortium that was developing the Kashagan field in Kazakhstan, and the government prohibited further work on the field (in part, because of environmental violations) until the parties come to an agreement. After months of negotiations during 2007 and 2008, the share- holders finally agreed to allow Kazakhstan’s KazMunaiGaz to raise its stake from 8.33% to 16.81%, paying $1.78 billion or roughly half their book value. The other shareholders (Eni, Shell, ExxonMobil, and Total) will reduce their respective 18.52% stakes and will compensate the Kazakh government for delays. The companies will pay an additional $2.5–$4.5 billion to the country, depending on the price of oil. Upon completion of the negotiations Eni, Shell, ExxonMobil and Total each own 16.66%. ConocoPhillips and Japan’s Inpex, now both have 8.28% and KazMunaiGaz has managed to increase its share 16.81%. Revised deal was finally signed on October 31, 2008.

According to the details of the deal, the proportion of Kazakh managers in the Consortium is being increased substantially, including a first deputy head of the operating company. Kazakh- stan’s income from the project (which had been fixed at 5% until now) will be tied to world oil price fluctuations of between $45 and $180 per barrel. ENI remains the operator during an ‘‘experimental’’ phase, following which the other four major shareholders would each take charge of an area of responsibility. It is also expected that Total and Shell, along with KazMunaiGaz, will form a new operating company after the field comes online. There are some unconfirmed reports that at that stage Kazakh government might choose ExxonMobil as the new chief operator of the project.

The start of commercial production is rescheduled to 2013, instead of 2010, for this 40-year project. First-phase production is now anticipated to rise from 75,000 barrels per day (bpd) in the first year to 4,50,000 bpd or some 22 million tons annually by the third year. Within 9 years production is expected to peak at 1.5 million bpd or 70 million tons.

The discovery of Kashagan and subsequent discoveries in and around the same Agip KCO operating area (such as Kalamkas) have had a significant impact on the regional reserve estimates. The four Caspian states—Azerbaijan, Kazakhstan, Russia (Caspian reserves only) and Turkmenistan—are projected to have remain- ing proven liquid reserves of 49.7 billion bbl (Fig. 1).

The Caspian is dominated by six key projects (Kazakh–Kasha- gan, Tengiz, Karachaganak, Azeri–Chirag–Guneshli [ACG], Shah- Daniz, and the Severnyi block in Russia), which contain a combined 26.9 billion bbl, or 68% of the region’s total liquids reserves.8 For the purposes of this analysis, even if we estimate immediate producible oil reserves of Kashagan at a conservative

10 billion bbl, it still represents more than 20% of the regional total. The giant discovery has strengthened Kazakhstan’s regional reserve position, and it now controls about 80% of the Caspian’s oil (OGJ, 2001; EIA, 2007; BP, 2008).

Further appraisal work at Kashagan and the surrounding Agip KCO acreage will certainly lead to an upward revision of the reserves in the near future, strengthening Kazakhstan’s position in the region still further.

Despite the addition of 750 million bbl of reserves from the Korchagin and Khvalynskoye oil fields in the Russian sector of the Caspian, Azerbaijan remains firmly in the second spot with 15% (7.5 billion b/d) of the Caspian total (Fig. 1). Exploration drillings in Azerbaijan during 2000–2003 has largely been disappointing, casting serious doubt over the ultimate potential of the southern Caspian. Turkmenistan’s liquid reserves have more or less remained unchanged at 4% (2.2 billion b/d), while Iran has yet to contribute to the regional total with substantial exploration drilling did not started as of 2006.

With estimated associated gas reserves of about 25 tcf, the Kashagan oil discovery has enhanced Kazakhstan’s position as a regional gas player too, bringing it closer with the vast remaining gas reserves held by Turkmenistan. Kazakhstan and Turkmenistan contribute 51% and 33%, respectively, of the Caspian’s 459 tcf total remaining gas reserves (Fig. 2).

Although oil currently remains more important to Azerbaijan, it contributes about 17% of the region’s remaining gas reserves, primarily due to the giant Shah Daniz gas field. Despite its smaller gas volumes, Azerbaijan has a geographical advantage that has enabled it to secure a significant gas sales contract with Turkey at an international market price. Unlike some of the other Caspian states, Azerbaijan remains relatively well positioned to gain additional gas market share and capitalize on its gas assets in the longer term.

Iran, which has yet to commence exploration in its sector of the Caspian, is not expected to contribute to the region’s liquids production considerably before 2010.

Turkmenistan 2.2, 4% Russian (Caspian),0.3, 1%

Iran (Caspian),0.1, 1% Azerbaijan,7.5, 15%

Kazakhstan, 39.6, 80%

Azerbaijan Kazakhstan Turkmenistan Iran (Caspian) Russian (Caspian)

Fig. 1. Caspian region remaining liquids reserves estimates (billion b/d;%) Total: 49.7 billion b/d).

Iran (Caspian), 11, 2%

Russian(Caspian),0, 0% Azerbaijan 65, 14%

Turkmenistan, 230, 51% Kazakhstan, 153, 33%

Azerbaijan Kazakhstan Turkmenistan Iran (Caspian) Russian (Caspian)

3. Possible routes to export Kashagan oil and gas

Successful exploitation of the Kashagan will depend on the construction of new transport pipelines, capable of handling large volumes of oil produced in a landlocked sea. The direction of such a pipeline remains in question, and thus holds the potential for fierce competition among regional and global powers (OGJ, 2002a, b).

Alternative routes that are being considered (Fig. 3) and some concerns associated with each project are as follows:

Fig. 3. Map of the alternative routes for Kashagan hydrocarbon resources.

This 691 km route is part of the interconnected Kazakh–Rus- sian pipeline system. Expansion work that started in 1999 is completed in 2001 at a cost of $37.5 million. Kazakhstan increased oil exports via the Russian route to 3,10,000 b/d in 2002, from a capacity of 2,10,000 b/d in 2000. Before the completion of the CPC pipeline at the end of 2001, Kazakhstan exported almost all of its oil through this system. But, since Kazakhstan desired more independence from the Russian transit systems, it favored the development of transport alternatives. Still, in June 2002, Kazakhstan and Russia signed a 15-year oil transit agree ment under which Kazakhstan will export 3,40,000 b/d of oil annually via the Russian pipeline system. Russia’s trade ministry also pledged to increase the capacity of the line to around

5,00,000 b/d.9 As the CPC project grows with Kazakh production, absolute volumes though Atyrau–Samara are expected to grow, but this pipeline will become relatively less significant.

3.2. Caspian pipeline consortium (CPC) (route 2 on map)

The CPC was formed to build a 980-mile-long pipeline system to transport oil from Tengiz, western Kazakhstan, to the Black Sea at Novorossiysk, Russia, and began to bring oil to world markets in the fall of 2001. The governments of Russia (Through Transneft

24% and Rosneft-Shell 7.5%), Kazakhstan (19%), and Oman (7%) developed the CPC project in conjunction with a consortium of international oil companies.10 However, On November 6, 2008, Russian company Transneft announced that it has bought Oman’s share in the CPC for around $350 million—half the starting price offer from Hungary’s MOL and Kazakhstan (RIA Novosti). Another buyer for Oman’s share was Kazakhstan, which holds 19% in the CPC. Russia’s share is now 31%.

The CPC Project upgraded the existing line from Tengiz via Atyrau and runs along the Caspian coast to join in the north with the Russian end of the line. The system also consists of port facilities and a newly built line from the northwest Caspian coast in Russia to Novorossiysk. The total cost of the project is $2.6 billion. The completion of both the expansion of CPC pipeline and ongoing Tengiz operations should add more than $150 billion in combined GDP to the Russian and Kazakh economies. The CPC pipeline will also be used for transporting natural gas liquids from a production plant to be constructed at Karachaganak by the KIO consortium.

Initial capacity of the CPC pipeline was 5,60,000 b/d. The CPC pipeline exported around 6,90,000 bbl/d of crude oil in 2007, and the consortium has plans for a $1.5 billion expansion project to increase the pipeline’s peak capacity to 1.35 million bbl/d. With the completion of the two pipeline spurs from Kenkiyak and Karachaganak to the CPC at Atyrau and the usage of additives, CPC transport levels have increased from around 6,00,000 bbl/d in

2005 to a monthly peak of 8,00,000 bbl/d in February 2007.

The pipeline is an extension of the existing oil transit infrastructure surrounding the Caspian Sea. Newly constructed components of the line run from the Russian town of Komso- molskaya straight westward to Novorossiysk. The pipeline is supplied with Kazakh oil through the Soviet-era links surrounding the Sea, which the consortium members have refurbished.

In September 2007 consortium members reached a major milestone in agreeing to raise the transport tariff to $38/thousand tons (mt) from $30.24/mt, effective in October 2007. The share- holders also agreed to cut the interest rate on CPC loans to 6%/year from the previous rate of 12.66%. The decisions followed several meetings among the project partners this year as they attempted to resolve financing issues, which have held back expansion of the link. Consortium members are also awaiting the formulation of the Bourgas–Alexandropoulis pipeline route, which would keep incremental CPC volumes from further crowding the Turkish Straits.

Last round of talks was held in Moscow where Russian Industry and Energy Minister Viktor Khristenko and Kazakh Energy and Mineral Resources Minister Sauat Mynbayev were negotiating a common position doubling the CPC’s throughput capacity in two stages by 2012 from 32 million to 67 million tons of oil annually. It is envisaged as part of the expansion of the CPC that an extra 17 million tons of Kazakh oil will be oriented to the Burgas–Alexandroupolis pipeline. However, despite the Russian Ministry’s press statement on the issue,11 neither Kazakh side nor

the other CPC consortium members confirmed that deal was reached.

The above-mentioned two projects represent the Russian route for Kazakhstan.12 Russia controls nearly all of Kazakhstan’s current export routes. Recently, the industry newsletter ‘‘Petro- leum Argus’’ reported friction with Russian energy officials over Kazakhstan’s demands that it should be able to control the volume and destination of its oil shipments through the Russian pipeline system. In other words, the country’s influence has grown to the point where it wants to play the oil market, as Russia does. A Russian official reportedly responded, ‘‘If they want equal treatment, they should start supplying oil to the Russian domestic market as our producers do.’’ (Russian companies must sell to the home market at a cheap subsidized price.) (Interfax, 2008).

On the surface, relations with Russia have been free of such complaints. On December 7, 2002, Nazarbayev met in Astana with Aleksei Miller, chief executive of the Russian gas monopoly Gazprom, about boosting sales of Kazakh gas abroad. The two countries were also worked on plans to raise Kazakh oil transit by



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