Financial Times: Caspian oil: Tightening rules of the game: “Kazakhstan is one of the few places in the world open for business to international oil producers seeking to replenish their reserves. For governments increasingly concerned about the security of energy supplies, the republic offers a plentiful source of oil outside the Middle East.”: “Kashagan wells yield poisonous sulphurous gas as well as oil.”: “Kashagan will have two lives spanning 70 years, one for oil and another for gas,” says Martin Ferstl, Shell’s chairman in Kazakhstan. (ShellNews.net) 15 Dec 04

By Isabel Gorst

Published: December 15 2004

Kazakhstan is one of the few places in the world open for business to international oil producers seeking to replenish their reserves. For governments increasingly concerned about the security of energy supplies, the republic offers a plentiful source of oil outside the Middle East.

Thanks to high oil prices and keen foreign investment, Kazakhstan’s oil industry is thriving and soaring output is powering an economic boom.

For now, all Kazakhstan’s oil is produced onshore. However, since 2000, when a group of six foreign companies led by Italy’s Agip, discovered the Kashagan field in the north-east Caspian Sea, the big players’ interest has focused offshore.

Kashagan is regarded by oil companies as a fluke. In a world running out of truly huge fields, it was the biggest find in 30 years. Kazakhstan’s offshore is far more promising than other areas of the Caspian Sea. Reserves will support production of at least 3m barrels per day.

Agip and its partners have struck lucky at all five structures drilled on their acreage so far, making Caspian exploration look easy. But tapping Kashagan oil is daunting.

High pressure reservoirs are dangerous to tackle especially in ecologically fragile, shallow waters round the field.

The former Soviet Union - of which Kazakhstan was a part until 1991 - was not renowned for its care of the environment, but had banned drilling in much of the area altogether.

Kashagan wells yield poisonous sulphurous gas as well as oil.

There is no profitable gas market in or around Kazakhstan and the government has outlawed flaring. So huge state-of-the-art compressors are being imported to re-inject gas into the field for recovery later.

“Kashagan will have two lives spanning 70 years, one for oil and another for gas,” says Martin Ferstl, Shell’s chairman in Kazakhstan.

Kazakhstan’s master plan for development of the Caspian envisages investment of more than $30bn by 2015, much of which will come from foreign companies. Kashagan, the trailblazer, will alone absorb $20bn, $8bn of which will be spent before first oil is produced in 2008.

“Annual expenditure required to implement Kashagan is higher than anything I have ever seen before,” says Mr Ferstl.

In the early stages most Caspian spending will go on infrastructure projects in the remote region, including processing plants, ports and a fleet of tankers that KazMunaiGaz (KMG) has ordered from a Russian yard to shuttle exports across the Caspian.

Kazakh oil regulations oblige developers to maximise purchase of locally manufactured equipment. Italy’s Saipem has teamed up with a Kazakh partner to establish an offshore fabrication yard near the coast.

Kazakhstan believes it was too soft when negotiating early foreign oil contracts in the years immediately after independence, when the government was struggling to steady an economy reeling from divorce from the (former) USSR.

Oil prices were much lower in the 1990s but Kazakhstan offered rare access to big, already discovered oilfields that investors could not resist.

If a tough production-sharing law drafted for the Caspian is passed, investors will have to submit to operation by KMG and pay all the state company’s costs during exploration.

Foreign companies favour production-sharing agreements (PSAs) because they provide a stable tax regime for the life of a project.

But Kazakhstan, taking a leaf out of Russia’s book, is having second thoughts about handing out PSAs everywhere in the Caspian.

“Nothing is ever final in Kazakhstan,” says Julia Nanay, senior director of Petroleum Finance in Washington DC.

Oil produced under shifting tax and royalty deals will be subject to an export duty introduced this year which rises to 33 per cent when oil prices are above $40 a barrel.

“Kazakhstan is now firmly on the oil map of the world and it is quite natural that it will tighten the rules of the game. The main concern is that the tightening does not drive away investors,” says Boris Zilbermints, head of Lukoil Overseas’ Kazakhstan division.

Lukoil was fortunate to secure four Caspian contracts before Kazakhstan began rethinking the rules.

“Unless terms are improved Caspian fields will yield rates of return well below the 15-20 per cent generally targeted by oil majors,” says Mr Ferstl.

The Caspian master plan says more than 100 blocks will be let out via competitive tenders.

But companies are busy bargaining individual offshore contracts with Kazakhstan behind the scenes.

“A drop in price to just $25 a barrel could pose a high risk for investors. The danger is that companies will do all kinds of deals in the Caspian that may turn out to be marginal down the road,” says Ms Nanay.

For now onshore fields are providing all Kazakhstan’s booming oil output. The giant Tengiz field on the east shore of the Caspian has been operated by the ChevronTexaco-led Tengizchevroil (TCO) venture since 1993 and is the republic’s biggest producer.

TCO is investing $4bn in a project to boost output to 500,000 barrels per day in late 2006.

At Karachaganak field, Karachaganak Petroleum Operating (KPO), working with BG Group, Agip, ChevronTexaco and Lukoil, in 2003 completed a $4.4bn investment to double liquids production. To circumvent export constraints, KPO also laid a 675km pipeline west to the Caspian Pipeline Consortium’s export system near Atyrau.

Now 140,000 barrels a day of Karachaganak oil moves on to world markets via that route.

Karachaganak is also one of the world’s biggest gas fields. But until a viable market can be found, most gas is being re-injected into the reservoir.

Russia’s Gazprom imports some Karachaganak gas at miserly prices, and is not keen to share pipeline access to better paying export markets.