Prospects of export routes for Kashagan oil

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

50%  with a  pipeline expansion project started  in  late  2003 (Lelyveld, 2002). However, problems beneath the surface, which endured for the last 4 years, seem to be driving Kazakhstan to look elsewhere for its future, including the projects like BTC.

 Many experts suspect that modifications of existing routes, like the established Druzhba system, may  satisfy investors and importers, not only in Russia, but also in Kazakhstan. The Russian pipeline  monopoly,  Transneft,  has  announced plans to  begin merging the Druzhba system, which runs from Russia to Slovakia, with a pipeline called Adria that terminates in Croatia. Connecting the Adria pipeline to Russia’s  Southern Druzhba system would require the cooperation of six countries (Russia, Belarus, Ukraine, Slovakia, Hungary,  and  Croatia). In  December 2002,   these countries signed a preliminary agreement on the project. Since then, however, progress has been slow moving, while the transit states wrangle over  the project’s details (including tariffs and environmental issues). Of the six partners, to-date, only three countries,  Slovakia, Hungary,  and Ukraine are  fully  ready  to implement the reversal (OGJ, 2002a, b).¹³ The most recent to ratify the necessary legislation, Ukraine, approved in February 2004. In the meantime, Kazakhstani oil may only access the Druzhba system to facilities on the Baltic  Sea, if those terminals do not handle Siberian oil.