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Chinese in Kashagan

Chinese in Kashagan published on

Several weeks ago we wrote (here) about the complex situation resulting from ConocoPhillips’ decision to exit the North Caspian Operating Company B.V. (NCOC) and its intent to sell stake in the consortium to the Indian company ONGC Videsh Limited (OVL). In the previous article we also mentioned the possible reactions of the Kazakh government, which was considering blocking the deal and purchasing ConocoPhillips shares only to resell them to a Chinese state-owned enterprise. On July 2 the Ministry of Oil and Gas announced on its official website that state-owned KazMunayGas JSC (KMG) would purchase ConocoPhillips shares in the consortium on behalf of the Republic of Kazakhstan. On the same day on the sidelines of energy summit in Moscow, Lyazzat Kiinov, KMG’s head at that time, was reported saying that China National Petroleum Corporation (CNPC) would pay more than US$5 billion for the shares (US$5 billion was the amount agreed between ConocoPhillips and OVL). Replacements and demotions in the Ministry of Oil and Gas and state-owned companies followed the government’s decision and Kazakh media were flooded with speculation about the possible terms under which the government had agreed to resell shares to a Chinese company.

In the previous article we also noted the importance of the upcoming launch of oil production in Kashagan. In its latest July report BNP Paribas emphasizes that oil export from Kashagan will be the key factor driving the economic growth rate (4.6 percent in the first quarter and 3.9 percent in the first five months of this year while projected growth for 2013 was 5 percent) and export rate (7 percent decline in the first quarter yoy while imports rose 7 percent) in Kazakhstan.

Personnel Reshuffle

The announcement of the government’s purchase of shares coincided with a major reshuffle of top positions within the ministry and firms held by KMG. On July 3 Lyazzat Kiinov was removed from his position as Chairman of the KMG Management Board, and on July 10, from his position as Chairman of the Board of Directors of KMG EP too. Moreover, on July 3 Sauat Mynbayev was also removed from the post of Minister of Oil and Gas. These dismissals may not necessarily be punishment for mismanagement of the Kashagan project, as suggested by Kazakh political scientist Dosym Satpayev quoted by Reuters, but could result from the necessity to adjust to the new situation arising if the Chinese company did indeed join the consortium.

Such reading of the reshuffling was expressed by another Kazakh political scientist, Daniyar Ashimbayev, in an interview published on the Vremya website in which he draws conclusions that differ significantly from Satpayev’s thesis. The nomination of Uzakbai Karabalin, who is 65, to serve as the new Minister of Oil and Gas, is connected to his vast experience and knowledge of the Kazakh oil industry, which could prove useful in the ministry’s work on the discovery and exploration development of new deposits. Oil from fields like Tengiz and Ozen, where KMG EP significantly increased production, will gradually peter out. If Kazakhstan wishes to preserve its position as a leading producer, it cannot rely solely on unpredictable Kashagan production and should actively engage in the exploration for new fields. Karabalin, whose career has been connected with oil industry and has been General Director of Kazakh Institute of Oil and Gas JSC (KIG) since 2010, appears the better candidate to execute these tasks than manager and technocrat Mynbayev.

It is also hard to consider Mynbeayev’s nomination as a state representative and new head of KMG as a demotion. According to Ashymbayev, Mynbayev is a perfect fit for the situation that will require the new KMG chairman to improve the giant corporation’s management efficiency, keep a tight grip on the subsidiaries that are mainly either offshore companies or are controlled through them, and significantly increase control over their activities. As for Kiinov, Ashymbayev remains somewhat vague, referring to his age and pointing out that his job in KMG and KMG EP was temporary and that he would probably be moved to a less demanding post.

The reshuffle is perhaps mainly technical, but moving Mynbayev to head up KMG just after the decision on the purchase of ConocoPhillips stakes is intriguing. In April Mynbayev voiced his skepticism on this issue and underlined that KMG was not prepared organizationally, technically or financially to act as project leader. He also stressed that he did not want to see major investors leaving Kazakhstan. Earlier Mynbayev expressed the opinion that Chinese participation in the project was conceivable only under specific terms. Apparently Nazarbayev and the Kazakh government have reasons to consider current Chinese proposal attractive and consider Mynbayev the right man to lead the negotiations, agree on transaction terms and, what might be the most challenging aspect of all, actually cooperate with the Chinese.

Transaction Scenarios

Some Kazakh and Western media, including Bloomberg, reported that KMG may first sell some part of its own stake in NCOC to CNPC, only to buy ConocoPhillips shares with the money received from the Chinese later. Those two simple transactions could be a very convenient combination for the Chinese and Kazakh parties, since this would resolve the issue of how KMG could evade the right of other stakeholders to exercise their rights to preemptive purchase. In this scenario KMG would not resell to CNPC shares purchased from ConocoPhillips that had already undergone procedures in which other participants expressed their disinterest, but instead would sell their own shares that are theoretically subject to preemptive purchase by other NCOC shareholders. It is still an open question whether KMG and CNPC will try to create a mechanism to evade other shareholders’ preemptive purchase rights, or first buy Conoco Phillips shares in order to resell them to CNPC with the possible financial backing from the Chinese side in the form of credit as described in the previous article.

The transaction amount was reported to fluctuate between US$5 billion and UD$5.5 billion, but the higher figure is more likely. Kazakh authorities will expect from the Chinese buyer the reimbursement of a couple hundred million US dollars, which would be paid by ConocoPhillips as a tax if the transaction with OVL were not blocked. Various versions of the contract terms between KMG and CNPC have appeared in Kazakh media since the end of June.

According to a Kazakh portal Respublika, in exchange for the shares in the project, Chinese buyer would pay half of KMG Kashagan B.V’s dues as a consortium member until all costs of the project were covered from oil revenue. This means additional several billion US dollars paid within several tens of years. According to other sources, the Chinese were said to pay for the Kashagan shares the total amount of US$15 billion. It was also published that they were to lend Kazakhstan US$5 billion on preferential terms and wipe out US$10 billion of existing Kazakh debts. To the surprise of many, some other media announced that in return for the shares the Chinese would offer Kazakhstan an access to a Chinese port located … on the Pacific shore.

These assumed transaction terms have been neither officially confirmed, nor indirectly supported by any events. However, some facts do support a thesis of Kazak companies’ debts being partially written-off in Chinese banks as a part of a deal. On July 3, KMG informed on its website that Mangistau Investments B.V. (MI BV), a 50/50 joint venture of KMG and CNPC, paid off a loan worth US$2.8 billion to the China Exim Bank ahead of time. The loan was drawn by MI BV in 2009 to purchase Mangistaumunaigaz (MMG) shares (currently MI BV owns 99% shares of MMG) and was to be repaid by 2019. As China Exim Bank and CNPC are both Chinese state-owned companies it can be concluded that US$1.4 billion has just been presented to KMG by the Chinese state. Officially, the loan repayment was possible due to very effective and profitable operations of KMG and MMG.

Rejected alternatives

In short-term perspective, each scenario presented above is financially more attractive to the Kazakh government than several hundred million US dollars that would have been collected as tax from the transaction between ConocoPhillips and OVL. The Kashagan project is another in a series of deals that Indian ONGC has lost to Chinese companies, with CNPC’s takeover of Petro Kazakhstan, Encana’s Ecuador’s assets obtained by a Chinese consortium and Ugandan oil fields acquired by CNOOC being just a few examples. The higher Chinese offer was behind the failure of the Indian company’s bid for ExxonMobil’s block 31 located close to the Angola’s coast. Apparently, the Indian company fails to beat the offers of its Chinese competitors. As mentioned in our previous article, reselling ConocoPhillips shares in the consortium to a Russian enterprise or keeping them as Kazakhstan’s assets and financing the transaction from the funds provided either by Samruk-Kazyna or the Kazakh pension fund seem to be possible, too. An analysis of the reasons of Chinese generosity and effects that increased Chinese control over oil production could bring to Kazakhstan can also be found in our previous article. Some Kazakh analysts and journalists, like Rasul Rysambetov, reckon that Chinese access to the Kashagan project is only a beginning of the process of the consortium takeover. For gaining control over the whole project is the safest way for the Chinese to secure oil export from Kashagan to China regardless of changes in other shareholders’ policies.

Consortium takeover

Rysambetov reasons that Chinese shareholder at first would try to acquire the shares from French Total, or exchange its shares in another project (for example Halfaya – an oil field in Iraq) for Total’s stake in NCOC. Total has already cooperated with the Chinese in a series of projects, for example with CNPC and independent company Tethys Petroleum in gas and oil exploration in Tajikistan. It also sold 20 percent of its shares in a Nigerian project to another Chinese company, Sinopec. To be precise, another consortium member – Eni sold its shares in a Mozambique project in March to CNPC, too. Also Shell has conducted many projects in cooperation with Chinese companies (especially CNOOC), such as Nanhai Refinery Project or blocks 62/02 and 62/17 in Yinggehai. Shell sold to CNOOC a part of its shares in a Gabon project, too. For one of such projections to come true though, a consortium member would have to act opposite to its 2003 decision when all NCOC members blocked Chinese access to the Kashagan project and unlike ConocoPhillips when it chose to negotiate with an Indian company over its Chinese competitor.

Regardless of which Chinese company takes over ConocoPhillips shares, and regardless of the new Chinese shareholder is satisfied with 8.33 percent share in the project or undertakes efforts to increase its stake, the Chinese will be pushing for the increase of Kashagan oil export to China. Trend agency reported a few days ago that CNPC allegedly signed contracts with Shell and Eni in order to secure oil shipments to Sichuan. There is only one issue remaining unsettled – oil transport. Currently the only way that could be considered for Kazakh oil shipments from Kashagan to China is via Kazakhstan-China Pipeline (KCP). After last year’s pipeline expansion, some sections achieved the annual capacity of 14 mln tones, and the target capacity of the whole pipeline from Atyrau to Alashankou is 20 mln tones. The current status of the pipeline development is presented in our previous article. Considering that KCP is to transport oil not only from Kashagan, but also other regions of Kazakhstan (last year oil export to China reached over 10 million tones) and that maximum production of the Kashagan field should be around 56 mln tones (originally this capacity was scheduled for the period 2015-2041) it could be assumed that the share of Kashagan oil exported to China will constitute only a small part of total oil quantity produced by the consortium.

Technical drawbacks and difficulties which caused sharp cost increase and project delays are other factors that should be taken into consideration. In the first phase of the project the annual production is set at 18-22 million tones. And only in the second phase, not earlier than by 2018 – 2019, the production will be increased by additional 18 mln tones annually. In the coming years NCOC shareholders will have maximum 22 million tones to share and the Chinese shareholder cannot count on more than 2 mln tones per year accordingly. The exact oil amount that will fall into CNPC and other consortium shareholders’ hands depends on the size of the Kazakh government’s share and it is subject to provisions of the North Caspian Production Sharing Agreement. Compared to the KCP’s capacity, 2 mln tones is not a significant quantity and the Chinese may push for higher share in the Kashagan project, therefore the increase of oil quantity exported to China seems to be a viable option.