Publication: Eurasia Daily Monitor Volume: 4 Issue: 166

Paolo Scaroni, head of Italy’s ENI-Agip, which operates Kazakhstan’s super giant Kashagan oil field, is arriving in Astana to discuss compensation for repeated failures to start production on time and within budget. Italian Prime Minister Romano Prodi has also announced that he would go to Kazakhstan in this context.

Kazakhstan is responding forcefully — and in some ways audaciously — to the Agip-led Western consortium that recently admitted to setbacks in developing Kashagan. The consortium notified the Kazakh government in July about massive cost overruns, technical difficulties, environmental challenges, and a continually growing delay to the start of production. The government then warned of possible retaliatory steps (see EDM, August 9), which are now materializing in a systematic manner.

On August 27, Kazakhstan’s Environmental Protection Ministry ordered a suspension of the consortium’s operations at Kashagan for a three-month period, which could be extended and lead to revoking the operating permit, “in order to avoid irreparable damage.” The ministry also notified the Prosecutor General’s Office about “flagrant violations” of environmental legislation by the consortium.

That same day, the Ministry of Emergency Situations filed suit in a local court against the consortium’s operating company, the Italian ENI-Agip, for breaching fire-safety regulations at one of its installations. And also on August 27, Kazakhstan’s Customs Committee (a department of the Finance Ministry) announced the filing of a criminal case against certain senior staff of Agip, which it charged with evading customs tariffs and levies.

The government had given little advance notice of those steps during its August 21 meeting, with ample media coverage. Ministers took the floor one after another to hold the consortium responsible for damages to Kazakhstan. Economics Minister Bakhyt Sultanov expressed serious concern about revenue shortfalls to next year’s budget and National Fund (a social and infrastructure development program) as a result of problems at Kashagan. Environmental Protection Minister Nurlan Iskhakov cited critical findings of ecological inspections and handed over a list of the alleged breaches to the press. Prime Minister Karim Masimov instructed Energy and Mineral Resources Minister Baktykozha Izmukhambetov to take “effective” measures that same day. Apparently, Izmukhambetov fell short of doing so and was replaced on August 27, on which date the government announced the series of legal steps against the consortium.

Conciliation talks between the consortium and the government broke down on September 5. The parties can go to an arbitration court if the talks remain deadlocked.

Addressing the Second Eurasian Energy Forum, KazEnergy, in Astana on September 6, Prime Minister Masimov accused the consortium of having “in recent years systematically violated Kazakhstan’s legislation, ignored Kazakhstan’s national interests, [and] mismanaged the project,” all of which “raised doubt about their ability to operate the project and implement the PSA.” He listed a number of grievances that may be read as conditions for allowing the consortium to proceed with field development at Kashagan. These include:

1) compensation for revenue lost to Kazakhstan through the three-year postponement of commercial oil production;

2) a commitment by the consortium to capture and deliver the associated gas at the field;

3) Kazakhstan’s state company KazMunayGaz to receive a higher equity stake (it currently has 8.33%) in the consortium and the role of joint operator; and

4) greater use of locally purchased goods and services by the consortium for its operations.

Kashagan, deemed the largest oil discovery worldwide in the last 35 years, holds an estimated 2 billion tons of recoverable oil. The consortium, Agip KCO, includes Italy’s ENI-Agip as project operator with an 18.52% stake; Total of France, ExxonMobil of the United States, and the Anglo-Dutch company Shell, also with 18.52% stakes each; ConocoPhillips of the United States with 9.26%; and Japan’s Inpex and Kazakhstan’s KazMunayGaz with 8.33% each.

The consortium signed a production-sharing agreement (PSA) with Kazakhstan in 1997 for a 40-year period. Commercial production was due to start in 2005, but was delayed several times. In July of this year Agip, on the consortium’s behalf, postponed yet again the start for commercial production — this time for the end of 2010 — and raised the investment costs from $57 billion to $136 billion. Such a cost overrun would force Kazakhstan to wait for years before obtaining its share of the commercial revenue in accordance with the PSA.

ENI-Agip takes the position that the differences can be resolved amicably through “constructive open dialogue” within a 60-day period, before going to arbitration court. However, the company — and apparently the consortium as a whole — insists that the discussions be conducted in accordance with the existing PSA. For its part, Kazakhstan deems the PSA to have been breached and demands compensation not only in monetary form, but also through revising the PSA’s terms in Kazakhstan’s favor.

(Interfax, August 21, 27, 28, September 5, 6, 8)