In last six months attention of many observers was focused on the events in Kazakhstan connected to the activities of the Chinese companies from the energy sector. In November last year one of the shareholders of the consortium, that manages development and extraction of oil in one of the richest oil deposits in the world – Kashagan, ConocoPhilips took a decision to sell its stake to the Indian company ONGC Videsh. Transaction has not been finalized yet as it is subject to the obligatory approval from the government of The Republic of Kazakhstan. The approval is still pending. The Kazakhstan government is entitled to the preemptive purchase of the shares and considers to use its right to purchase the ConocoPhilips stake, however not for Kazakhstan but for a third party – one of the Chinese state owned oil companies. Kazakhstan’s government plans have led to the new wave of discussion concerning share of Chinese companies in the Kazakh energy sector and increasing Kazakhstan’s dependency on the mighty neighbor.
Located in the northern part of the Caspian Sea and discovered in July 2000 Kashagan oil field is the largest oil deposit that has been discovered in the last 40 years, since the discovery of the Ghawar oil field in Saudi Arabia. According to estimates the oil field, stretched on the area of 75km length and 35 km width, has total reserves of 38 billion barrels. As the Kshagan oil is light, with the API around 45°, 38 billion barrels equals to around 4.8 billion tons. From the geological point of view the structure is considered as very complicated and even with application of the latest state of the art technology only 1.2 billion tons (10 billion barrels) can be extracted. The quantity of 1.475 billion barrels, as reported on the National Company KazMunayGas JSC (KMG) website, is considered as overestimated. More conservative estimates lower the amount of oil that can be extracted to less than 800 million tons. However even the last number is very significant in the eyes of the Kazakh government, because GDP growth rate and the treasury revenues strongly rely on the raw materials export, including energy resources. Income, that comes from taxes imposed on oil companies, both foreign and domestic ones, as well as dividend from shares in oil companies play important role in the state’s budget. Kzakhstan has around 3% of the world oil reserves. In 2012 79.2 million tons of oil were produced. Planned production in 2013 is estimated to reach 82 million tons. Kazakh authorities plan to raise the output to 120 – 130 million tons in 2020. This plan is partially based on the estimated oil production in Kashagan. Rating agency Fitch estimates the Kazakhstan’s GDP growth in 2013 for 5% but under the condition that the Kashagan’s facilities will be finally operational.
Shares and shareholders
Many connect their plans and hopes to the flow of the black gold from Kashagan but first and foremost this is crucial for the shareholders of the consortium – North Caspian Operating Company B.V. (NCOC), which basing on the agreement – North Caspian Production Sharing Agreement (NCPSA), includes not only Kashagan but also other deposits: Kalamkas, Kashagan Southwest, Aktote and Kairan. Total contractual area covers around 5500 quare kilometers of the Caspian Sean waters.
Current list of the NCOC shareholders:
1. Eni S.p.A trough its subsidiary Agip Caspian Sea B.V. (16.81 percent, registered in Netherlands)
2. Kazakh state owned National Company KazMunayGas JSC (KMG) trough its subsidiary KMG Kashagan B.V. (16.81 percent, registered in Netherlands). In 2010 shareholders rights were transferred to PSA LLP. According to another rust agreement shares in PSA LLP were transferred from KMG to the Ministry of Oil and Gas of the Republic of Kazakhstan.
3. ConocoPhilips trough its subsidiary ConocoPhilips North Caspian Ltd. (8.4 percent, registered in Liberia)
4. ExxonMobile trough its subsidiary ExxonMobile Kazakhstan Inc. (16.81 percent, registered in Kazakhstan)
5. Japanese Inpex Corporation trough its subsidiary Inpex North Caspian Sea Ltd. (7.56 percent, registered in UK as a branch of the Japanese corporation)
6. Royal Dutch Shell trough its subsidiary Shell Kazakhstan Development B.V. (16.81 percent, registered in Netherlands)
7. French Total trough its subsidiary Total EP Kazakhstan (16.81 percent, registered in France)
Technical Difficulties and planned output
Not all of the consortium members consider further participation in the project as a lucrative business. In November last year ConocoPhilips announced intention to sell all its shares to Indian company ONGC Videsh (OVL), which as a subsidiary of the state owned Oil and Natural Gas Corporation Limited (ONGC) and is involved in holding’s international operations. OVL agreed to pay 5 billion USD. Official explanation for this decision, as provided by ConocoPhilips, was, that company sells shares in Kashagan as a part of wider scheme to wind up its international operations and focus on shale gas exploration in the USA. Selling for 5 billion USD shares in one of the biggest oil deposits in the world, as the actual value of the shares is probably much higher, is rather caused by fears that further involvement in this project will bring more short term losses short term and that the whole project will not bring expected gains. Except from already mentioned complicated geological structure there are many other factors that made Kashagan one of the most difficult and the most expensive oil extraction projects in the world. Very high content of hydrogen sulfide (according to experts around 19 percent, according to consortium reports 15 percent), forces consortium to build additional facilities for its removal, processing and storage. It’s possible that part of the processed hydrogen sulfide will be sold, but the eventual income from these operations is hard to estimate. In the area where the oil deposits are located Caspian Sea is shallow. Water in the location of oil deposits is only several meters deep, in the shallowest place only 3.7 meter, so the consortium is forced to built facilities on the expensive artificial islands. Very low water salinity causes the ice cover in winter thicker and lasting longer than the ice in an open sea. Ice cover is several meters thick so the consortium had to order in Norway special icebreakers, tow ships and firefighting vessels that would be able to operate at the shallow waters of Caspian Sea. Moreover very high temperatures in summer, high initial pressure in the deposit (770 bars) and high requirements towards natural environment protection forced the consortium to use the most advanced and most expensive technologies for the oil extraction and transportation.
The over mentioned difficulties caused changes in the project operations schedule. First experimental phase launch was delayed several times. According to the information given by Claudio Descalzi, Chief Operating Officer of Eni – Exploration & Production Division, first drills are finally scheduled for October 2013, while the Kazakh Minister of Economy and Budget Planning Yerbolat Dossayev informed not that much earlier about September as the borderline date. In the first experimental phase the daily output is planned to reach 75 000 barrels in the first month of operations, 150 000 barrels daily in the next three months and then to be increased systematically up to 350 000 – 450 000 barrels in the third quarter of 2014. Currently estimated cost of the whole project significantly exceeds the originally planned amount of 57 billion USD. Till August 2012 investment consumed 116 billion USD. This number blights hopes for closing the total budget with the number of 136 billion USD, that was set in 2007 and 2008. 136 billion USD budget already included increased cost of facilities construction and other additional expenses. Finally the total cost of the investment will probably reach the amount of 187 billion USD. Considering the amount of money that has to be pumped into this project, cost of oil extraction and transportation as well as other operational costs, as per calculations presented by Sauat Mynbayev – Minister of Oil and Gas, oil sale from Kashagan field will be profitable only at the price not lower than 90 – 100 USD per barrel. It must be also considered, that while the advantage of the Kashagan’s oil is its low density, the high content of hydrogen sulfide (0.8 percent in the already processed product) is the strong disadvantage.
India enters the game
Why then, in such a situation, Indian company decided to buy shares at the value not much lower than the book value (5.5 billion USD)? Stagnation in the Indian oil industry led to the raising share of the imported oil in the total oil consumption. In the last 5 years the share of imported oil has raised from little over 70 percent to 82 percent. India’s dependency on the oil import prompts worries about the country’s energy security. The government pushes state owned companies to increase their stakes in overseas projects. Currently OVL’s share in different projects worldwide gives the company only 9 million tons of oil annually. Company’s managing director D.K. Sarraf wants this amount to be increased to 20 million tons till 2017 – 2018 and to 60 million till 2030. Purchase of the shares in Kashagan project would give OVL 20 000 barrels daily in the very first phase of the project and numbers will be increasing in the course of time. OVL’s participation in Kashagan’s project can have considerable influence on the India’s energy security, of course under condition that OVL will deliver oil to India instead of selling it in the spot market. Other consortium participants did not decide to use their right to the preemptive purchase within the 60 day period stipulated in the agreement. Considering the project status their silence was not surprising. According to the law transaction also requires Kazakh government’s approval. As none of the CNOC shareholders, including 100 percent state owned KMG, raised objections it could have been assumed that the government’s approval would be a pure formality. And possibly would have been just a formality, if not the fact, that the Chinese showed intention to gain the access to the project.
China needs oil
Similar to India, but in the smaller degree, China is also dependent on the import. In 2012 imported oil’s share was 58 percent of the total China’s consumption. According to International Energy Agency (IEA) in 2020 import is expected to reach 77 percent share in total oil consumption. According to the estimates made by the American Energy Information Administration (EIA) this trend will last and in 2035 imported oil will cover 75 percent of the total Chinese oil consumption. Currently up to 80% of the Chinese oil imports is shipped with tankers trough the Malacca Strait and South China Sea, where due to increasing tensions and conflicts the threat to the stability and safety of the Sea Lines of Communication is on the rise. Chinese authorities are trying to secure the oil supplies with the participation in construction and management of the sea ports in the Indian Ocean like Kyaukhphyu in Myanmar and Gwadar in Pakistan and to transport oil from these ports with pipelines directly to China. Trough Kyaukhphyu will be transported oil from the local oil fields and trough Gwadar oil from the Persian Gulf region.
However these solutions are expensive and their long term political stability is hardly predictable. Pekin also does not want to be too dependent on Russian oil and turns to Central Asia with growing appetite for the Kazakh oil. As the experts stress, price of the oil extraction in Kashagan is not the most important factor in Chinese calculations. If the production cost is higher than market price oil from Kashagan will flow not to the Chinese refineries and further to the market but will be stored as a strategic reserve, which can wait either for the emergency situation or for the significant rise of the oil market prices . Strategic reserves could be used for keeping the domestic prices of gasoline and other petroleum- derived products at the reasonable level at the time of the sharp market prices and to keep at bay the threat of the rising inflation. Sharp inflation rise is one of the Chinese government’s greatest fears.
Chinese resourcefulness vs Indian ineptitude
Kashagan oil field has been tidbit for Chinese for many years. For the first time Chinese companies tried to obtain shares in this project in 2003 when Sinopec and CNOOC tried to purchase in equal shares form the BG Group its 16.67% share for the total amount 1.23 billion USD. At that time transaction was blocked by other shareholders, mainly Eni. However Eni and other members of the consortium were not given a chance to find another partner as a replacement for BG Group or to purchase all shares by themselves. In 2004 Kazakhstan’s parliament passed the bill, that the Kazakhstan government had the right to preemptive purchase of the half of the shares offered for sale in any strategic project in the country, including already existing and operating ones. Government eagerly used its new right and in 2005 purchased trough KMG 50 percent of shares from BG Group. Another 50 percent was obtained by Eni. After years of disputes concerning taxes, costs and environmental impact of the Kashagan project in 2008 government and consortium members signed the agreement, that was actually dictated by the government and very beneficial for Astana. KMG obtained, on the extremely preferential terms, another 8.33 percent of shares in the consortium. Eni’s shares and shares of other participants were respectively decreased to the quantity that has been preserved till now and they were also obliged to bear proportionally the cost of KMG’s further participation in the project. In 2005 Kazakhstan authorities decided to take over shares in the project from the exiting shareholder for the treasury as the actual beneficiary, however current situation seems to be completely different.
The deadline for Kazakhstan’s decision either to execute its right to preemptive purchase of shares from ConocoPhilips at the price agreed between ConocoPhilips and OVL or to approve the transaction passed on May 25th. On May 22nd without giving any explanation, by the arbitrary decision announced by Sauat Mynbayev Kazakh government extended the time for the final decision till the beginning of July. According to information provided by government officials, authorities consider purchase of the shares from ConocoPhilips and then reselling them to one of the Chinese companies. The names of the potential buyers have not been revealed, however taking into account that all possible buyers are Chinese state owned companies, the issue which one will be authorized to buy shares is not crucial. If Nazarbayev chooses China, the decision which company will participate in the consortium will be made after consultations between Beijing and Astana.
Majority of media, including Indian, announced, that ConocoPhilips shares will be obtained by the Chinese company. Many arguments support this thesis, however according to the Kazakh political scientist Daniyar Ashimbayev Kazakh authorities are involved in behind-the-curtain negotiations with the prospect buyers and evaluate which offer brings most benefits. However it should be stressed, that what is beneficial from the point of view of the Kazakh government is not necessarily beneficial for the state and society. Apparently OVL is not in a strong bargaining position. Commentators accuse the government in New Delhi of inaction and lack of any lobbying. India’s Minister of Foreig Affairs Salman Khurshid raised this issue during his meeting with Nazarbayev not until the end of April, much later than the Nazarbayev’s visit in Beijing took place. On April 6th President of Kazakhstan met Xi Jinping and Zhou Jiping, chairman of China National Petroleum Corporation (CNPC). According to media information during the meeting with Khurshid Nazarbayev pointed out that India already obtained, without any tender, 25 percent of share in the Satpayev block, but he missed the fact, that oil reserves of this block are estimated at merely 1.75 billion barrels. It is said that From Nazarbayev Khurshid also heard, that India should consider other possibilities of cooperation, not connected to Kashagan field. According to observers the lukewarm attitude of the Kazakh authorities towards Indian company could also be caused by the fact, that OVL did not meet its other obligations and did not build advanced biotechnological facility in Kazakhstan.
Significant factors that can weigh on the Astana’s decision are financial issues. According to rating agency Moody’s OVL’s purchase of shares in NCOC from ConocoPhilips would have negative impact on company’s credit rating. Indian company would have to take credit to finance this transaction and that would increase its consolidated debt burden by at least $5 billion. OVL does not have the financial fire power as Chinese companies have, due to fact that they can rely on the financial support from the Chinese state’s foreign currency reserves. A financially strong partner is warmly welcomed by the Kazakh authorities, which cherish hope, that participation of the Chinese company in Kashagan would pave the way to cheap Chinese credits for the Kazakh companies from the energy sector. According to RusEnergy expert Igor Ivanenko relatively low prices of oil in the recent years could cause the growing need of Kazakh companies to obtain cheap foreign credits. KMG has already announced on several occasions that is not interested in purchase of shares from ConocoPhilips and in taking the lead in the consortium, mainly due to insufficient technological capabilities.
However what is not mentioned by KMG’s spokesmen its financial capabilities are also quite limited. In April 2013 KMG obtained 3 billion USD from the bond issue. It’s a part of a wider program. KMG plans to issue bonds of the total value 10.5 billion USD. The first issue of the dollar-denominated bonds, with a nominal value of 1 billion USD, have maturity of 10 years with the interest rate of 4.45 percent annual and the second issue of bonds have a nominal value of 2 billion USD and maturity of 30 years with the interest rate of 5.8 percent annual. KMG announced plan to invest almost 10 billion USD for doubling its reserves of oil and natural gas. Maxim Edelson from Fitch Ratings estimates that KMG on the company’s accounts and on the accounts of its London-listed subsidiary KazMunaiGas Exploration (KMG EP) has around 6.6 billion USD. KMG EP is involved in KMG’s operations of oil and gas extraction. At the first sight it looks like the financial situation of KMG is very good but this picture is gloomed by the fact, that KMG is going to use money from the bond issue to pay old debts connected to the Kashagan project instead of investing them in new projects. In the first quarter of 2012 KMG EP reported a net loss of 4 million USD. In 2012 KMG EP reported falling net income (1.079 billion USD, down 23 percent yoy) in spite of the higher revenues (up 23 percent yoy).This situation was caused by the higher production costs. If raise in domestic sales (up 39 percent yoy) had not been much higher than expected, financial results would have been much worse.
Chinese companies that have abundant financial resources and support of the Chinese state fit perfectly into this picture. Due to fact, that ConocoPhilips was not interested in negotiations with Chinese companies like China National Petroleum Company (CNPC) the only way for Chinese companies to obtain shares in Kashagan is to purchase them from the Kazakh government or from the Kazakh state owned company like KMG. This solution gives also the opportunity for the Kazakh government to get, at minimal risk, some additional revenues for the treasury as the transaction could be financed with the loan either from the Chinese buyer who would like to purchase shares or with the loan from one of Chinese banks (like China Development Bank). Loan could be returned after the finalization of the transfer of shares in NCOC to the Chinese company.
Kazahstan – China oil pipeline expansion
Presumption that Kazakh government is seriously considering Chinese participation in the Kashagan project is also supported by the fact that works aimed at increasing capacity of the Kazakhstan – China oil pipeline have been intensified. One section of this pipeline that is already fully completed stretches connects Atasu in south-east Kazakhstan with Alashankou on the border with China. Shareholders (in equal shares) in the Kazakhstan – China Pipeline LLP (KCP LLP) , joint venture managing the project, are Kazakh state owned KazTransoil JSC (KTO) and Chinese National Oil and Gaz Exploration and Development Corporation (CNODC). In 2005 annual capacity of the Atasu – Alashankou section was 10 million ton. In 2012 the capacity was increased to 14 million ton. Financed by the Chinese partner further expansion is currently in progress. After it is completed the annual capacity will be up to 20 million ton.
Originally the expansion of the Atasu – Alashankou section was to help not only to increase the volume of Kazakh oil transported to China but also to serve as a transit route for Russian oil trough Kazakhstan. The pipeline worked as an extension of the already existing pipeline that runs trough Omsk and Pavlodar to Atasu. In 2012 Chinese companies proposed, that 10 million tons annually to be delivered from Russia to China trough the Kazakhstan – China Pipeline. Kazakhstan agreed to reduce rates for oil transit to the requested by the Chinese buyers. Chinese demand for oil exceeds the quantity that Russia can deliver trough Eastern Siberia – Pacific Ocean pipeline (ESPO). After the second phase of ESPO pipeline is completed total annual capacity should reach 80 million ton and 28 percent of the pipeline output is reserved for the Chinese buyers. But is still not enough. In January 2013 Rosneft invited CNPC for negotiations that aimed to reach the final agreement on the Russian oil transit trough Kazakhstan. However there have been no tangible results of this initiative yet. Possibility of the take over of the ConocoPhilips shares by a Russian company with the help of the Kazakh government is not considered by any of experts, except from Ashymbaev. Majority of the Kazakh society looks at Russia, regarded as successor of the Soviet Union and Kazakhstan’s Big Brother, with distrust and fear. Russian companies also have not been very active in competing for the access to the Kzakhstan’s natural resources.
Instead of waiting for the results of negotiations between Russian and Chinese companies KCP LLP can exploit the unused capacity of the already existing oil pipeline for transportation of the Kazakh oil from the Caspian region, including Kashagan, to China. There is already an operational section of the oil pipeline from Atasu do Kumkol. What is to be done and is to increase capacity and expand the already exisitng 777.5 kilemeter long pipeline section between Kenkiyak and Kumkol. Pipeline expansion is already included in the KCP PLL plans as the second phase of the projects. If the expansion is successfully completed the oil pipeline of the annual capacity 20 million tons will run across the Kazakhstan from Atyrau to Alashankou. During Nazarbaev’s visit to China in the beginning of April KMG and CNPC signed agreement on the basic principles of cooperation. This agreement lies foundation for the pipeline expansion and increasing its capacity. Chinese side needs only obtain shares in NCOC and Kashagan project with the help of Kazakh government, complete the planned pipeline expansion and oil from the Caspian Sea will flow to the Middle Kingdom.
However many arguments are against this scheme. Although Nazarbaev governs Kazakhstan as an autocratic ruler he cannot completely ignore public opinion and media, which significant part is very skeptic towards new Chinese investments in Kazakhstan’s oil mining sector. In last years many articles concerning Chinese investment appeared in Kazakh press. Journalists raised concerns over Chinese share in Kazakh oil mining sector, lamenting that Chinese companies already control 40 percent of the total oil output in the country and that soon they will gain a dominant position in this industry. According to data presented by Konstantin Syroezhkin, expert of Kazakhstan Institute for Strategic Studies, companies in which Chinese entities have any shares have 36.46 percent share in total Kazakhstan’s oil output. However as Chinese have control stake only in part of these companies the actual share of the Chinese companies in Kazakhstan’s oil production effected trough the controlled companies is only as high as 23.75 percent. According to Syroezhkin writing about Chinese expansion in the Kazakh energy resources sector is creating myths and is unfounded attack on Chinese investors.
According to opponents of the wider access of the Chinese companies to new deposits this share is already very high and transfer of the shares in Kashagan project would significantly worsen situation, because, basing on the calculations made by KMG, in the coming years three oil fields Tengiz, Karachaganak and Kashagan will produce around 70 percent of the total country’s oil output. As the state owned KMG trough KMG EP and other companies in the holding has currently 26 percent share of the total oil and natural gas production in Kazakhstan Chinese companies’ share should be considered as very significant and concerns raised by public opinion and media are at least partially justified. According to data from 2011 Petro China’s share in oil and natural gas production was 6.9 percent, CNPC also had 6.9 percent. Petro China is CNPC’s subsidiary. According to the data sheet prepared by Wood Mackenzie in the group named as “other” are included other companies, and should be also included some Chinese companies as CITIC, owner of shares in Karadzanbas oil field or Chinese sovereign fund China Investment Corporation, shareholder in KMG EP (11% of shares). For comparison, shares of Western and Russian companies in the oil and natural gas production are: Eni 6.1 percent, Lukoil 7.4 percent, BG 6.1 percent, ExxonMobil 8.6 percent. From the foreign companies only Chevron has really outstanding share with 20.6%, mainly due to fact that as participant in Tengiz project has 50 percent share in this rich deposit.
Asymmetric relations and alternative solutions
Giving to Chinese the access to new deposits can have negative impact on the market diversification. It should not be neglected that Western corporations in Kazakhstan are the weaker party to a deal and often have to agree on the unilateral and arbitrary actions or decisions of the Kazakh authorities as it happened in the Kashagan project. Behind Chinese companies stands mighty neighbor and it could not be that easy for Kazakh government to handle projects where Chinese companies are involved. From this point of view increased Indian presence in Kazakhstan is much less dangerous, all the more that current Indian presence in the Kazakh energy resources sector is a mere shadow of the Chinese activities. China is very important buyer of the Kazakh oil. In 2012 Kazakhstan exported to China 10.6 million tons of oil which makes Middle Kingdom second biggest importer of Kazakh oil. On the other hand Kazakhstan takes just 9th place on the already strongly diversified list of the Chinese oil suppliers with less than 5 percent share of the total Chinese oil imports. Even taking into account the indisputable appetite of Chinese companies for Kazakh oil it seems that Beijing has more trumps in hand than Astana. In this situation it should be seriously considered if widening this asymmetry lies in Kazakhstan’s interest.
Kazakh opposition also voices its opinion in this matter much strongly than before. On May 19th at the meeting of the lower House of Kazakh parliament – Mazhilisa deputy from the National Communist Party of Kazakhstan, party generally considered as loyal to Nazarabaev, Tursunbek Omurzakov submitted the formal question to Prime Minister Ahmetov concerning the matter of the purchase of the shares from ConocoPhilips by Kazakhstan. Omurzakov, who is the member of the Committee on Finances and Budget, pointed out that the purchase of the shares could be financed by the Kazakh sovereign fond Samruk-Kazyna, which resources he estimates for 60 billion usd. As an alternative source of financing he also considers financial resources that would be allocated in the planned national pension fund. Murzakov estimates that total amount allocated in this fund could reach 21.5 billion USD. In his view purchase of the shares in NCOC, which means buying assets in Kazakhstan, would be much better investment that buying foreign financial instruments. It can be added that if Kazakhstan would decide to buy shares form ConocoPhilips and transfer them to the one of the state owned companies like KMG then the scheme of interconnected transactions as proposed by Rosneft in March will become a viable option. Rosneft would deliver 7 million tons of oil annually to the Kazakh refinery in Plovdar and Kazakhstan would deliver same quantity of oil via Kazakhstan – China Pipeline to China. Chinese buyers would pay for oil to Rosneft.
Unfortunately Kazakhstan’s authorities have proved on several occasions, that when it comes to transactions in oil mining sector often more important are benefits of Nazarbayev’s family and families of other oligarchs than the country’s interest. In the past it happened that shares in Kazakh companies were transferred to Chinese buyers trough the chain of murky transactions made by obscure companies controlled by the members of the ruling elite. However in the recent times government has been sending more positive signals indicating that more attention will be paid to the wider participation of the Kazakh society in the country’s economic boom. Among positive examples are expanding recently launched “People’s IPO” programme or more strict control over operations of state owned companies, which led to a criminal proceeding into evasion of tax and other mandatory corporate payments to budget in relation to the accountant of KMG Kashagan BV. Kazakhstan’s authorities have the difficult choice to make and the decision the make will not only concern the future of the shares in NCOC and Kashagan oil fields but also the future overall direction of the Kazakh oil mining sector.