Kazakhstan Become Dependent On Oil Projects To Support Economy
Last year proved to be a turning point for Kazakhstan’s oil industry.
In July, the consortium managing the country’s biggest onshore oilfield, Tengiz, signed off on a US$37 billion expansion plan that will raise output at the deposit by 260,000 bpd. Several months later, Kazakhstan relaunched operations at the massive Kashagan field in the Caspian, a project that has suffered perennial problems since its conception.
Kazakhstan is now poised to return to production growth after suffering losses since 2014, just as its economy begins to recover from the malaise caused by the oil price crash. With 30 billion barrels in reserves, the former Soviet state’s output is set to continue rising for at least another decade. However, the problem is that its existing reserves are concentrated heavily on a handful of giant fields in the Pre-Caspian Basin.
Kashagan, Tengiz and Karachaganak, a large onshore gas and condensate field, accounted for over half of Kazakh output last year. As Tengiz and Kashagan prepare to ramp up production, this share will widen, especially as many of Kazakhstan’s older fields continue to see decline. Meanwhile, recent years have experienced a slump in exploration, leaving little potential for alternative sources of growth.
Naturally, this is a concern for Astana, which relies on the oil industry for 60% of its budget revenues. It is worth examining how this situation has arisen, and whether there are any remedies.
The Tengiz field, launched in 1993, is estimated to contain 6-9 billion barrels. Its operator, Chevron, was able to take an existing Soviet-era project, with wells already dug into the ground and oil reserves easily exploited, and capitalise on it. Karachaganak, which is now run by a consortium that includes Royal Dutch Shell and Italy’s Eni, also began pumping oil and gas prior the collapse of the USSR. Kashagan, which is thought to hold 9-13 billion barrels, was discovered much later, in 2000. However, its development has been dogged by delays and cost overruns. Even after it came online for the first time in late 2013, production was halted several weeks later after gas leaks were discovered in its offshore pipeline network.
As such, Kashagan has hardly served as an advertisement for investors interested in greenfield projects in Kazakhstan. Mauro Fiorucci, an energy expert at Opportune who spent some time as a consultant to Kazakhstan’s national oil company (NOC), KazMunaiGaz (KMG), recalls the sentiment among investors when Kashagan was discovered.
“Immediately after the discovery, there was a lot of excitement among majors and independents about Kazakhstan, especially in the pre-Caspian Basin,” he told NewsBase.
During those years, Astana offered international oil companies (IOCs) a favourable deal, known as the 80-20 production-sharing contract (PSC). Under this agreement, the government received 80% of profits from production while foreign companies received 20%, but only after they had fully recovered, tax-free, their initial costs.
However, investors’ appetite for the oil industry in Kazakhstan began to wane after 2010, according to Fiorucci. “Very few were able to acquire interesting assets … and it was not worthwhile investing significantly in exploration,” he said, citing challenging geology and a lack of logistics, particularly with regards to export infrastructure. “The problem was getting your oil out of the country,” he said.
Early exploration disappointments and issues at Kashagan further cemented the belief that Kazakhstan’s potential had been overestimated.
Fiorucci also pointed to difficulties investors experienced when dealing with the government.
Astana dropped the 80-20 PSA, replacing it with a law requiring investors to form joint ventures with KMG. The NOC was also given a pre-emptive right to buy stakes in projects established under the old PSA system when companies involved wanted to divest.
“[Authorities] often leveraged their power to change legislation and inflict penalties to negotiate better terms with their operators,” Fiorucci noted.
One company that fell victim to these changes to law was privately owned Tristan Oil. The government seized the producers’ assets in 2010, leading to a drawn-out court battle. Tristan emerged victorious at court in 2014, having cited its rights under the Energy Charter Treaty, although the damage had already been done, both to the company and Kazakhstan’s investment image.
Majors too have fallen foul of Kazakh authorities.
KPO, the consortium managing the Karachaganak field, has locked horns with Astana over several tax disputes in its history, and is currently fighting off a claim of US$1.6 billion.
Some smaller explorers got around problems with authorities by teaming up with local partners.
“All the smaller players understood that without significant local partners, they wouldn’t manage to develop their fields or acquire interesting blocks,” Fiorucci said. “Roxi Petroleum, for instance, is listed in London but backed by Kazakh investors”
Roxi, which owns blocks in the Pre-Caspian and Turgay basins in western Kazakhstan, is currently gearing up to launch commercial operations. Another example is Nostrum Oil and Gas, which plans to ramp up output to 50,000-60,000 boepd this year at its assets in the west of the country.
The home front
The lack of investment in the upstream sector has been compounded by Kazakhstan’s mismanagement of its resources. Astana set up KMG in 2002 and established its subsidiary, KMG Exploration Production (KMG EP), three years later as a means of attracting extra financing to the country’s oil sector.
“Capital markets were attractive, so they could get a good price for listing the company,” Fiorucci said, noting that many of assets transferred to the subsidiary had little growth potential. As oil prices rose, KMG EP accumulated a lot of cash without having the ability to invest it properly, as many of its fields were already mature. According to Fiorucci, the company’s management lacked the foresight to spend these funds on acquisitions instead.
KMG is projecting its current output to remain stable until 2021, without much growth potential.
“They don’t have an equity story to share with investors. Their production is stable but it won’t go any higher,” Fiorucci noted.
Enter the dragon
China has been the source of the bulk of investment in Kazakhstan’s oil reserves.
Following the country’s independence in 1991, Western companies were the only ones with the means to invest in the country at short notice, and thus were the first to land major contracts. Back then, China had yet to emerge fully as an energy-hungry powerhouse.
Times have changed, though, with Chinese companies now controlling 30-40% of Kazakhstan oil and gas reserves. Many of the joint ventures consisting of Chinese partners in the country are now reporting output declines, however.
This includes PetroKazakhstan (PKI), which reported a slump in extraction of 15% in 2016. The company, which is partly under the control of China’s CNPC, produced around 78,000 bpd of oil during the year from assets spanning Kazakhstan’s South Turgay Basin. Similarly, CNPC-Aktobemunaigaz, which operates in the Pre-Caspian Basin, has reportedly seen a dramatic decline in output over the last three years, from 127,000 bpd to just 83,000 bpd. One exception has been Mangistaumunaigaz, however, which forecasts a continued rise in its production this year.
The fact that many Chinese enterprises have seen more dramatic declines in output levels compared to mostly Kazakh state-owned companies may be tied to Astana’s need to maintain spending and keep workers in employment. The government has been anxious to avoid mass layoffs during the current downturn, as it struggles to contain oil worker strikes.
Astana is pinning its hopes for the future on the so-called Eurasia project, which calls for the exploration of complex sites in the pre-Caspian Basin that are over 10,000 metres deep. The US$500 million scheme will culminate in the drilling of a 14,000-15,000 metre borehole. Recently, Astana was keen to publicise that it had begun holding talks concerning the project with international investors, including Italy’s Eni, Russia’s Rosneft, China’s CNPC and Azerbaijan’s SOCAR.
According to Fiorucci, however, Eurasia is unlikely to garner much interest.
“The majors don’t have the appetite, the exploration is risky and expensive,” he told NewsBase. However, he went on to speculate that some companies might make minor commitments under “strings attached” to previous or upcoming agreements with the government regarding other investments. Other speculative projects, such as the country’s oil sands, have failed to make headway in several years.
While the Central Asian republic’s increased dependency on Tengiz, Kashagan and Karachaganak is assured, there is some potential for the country to establish other, much smaller projects. If Kazakhstan is sincere about wanting to raise investment in exploration, it will need to offer attractive terms in upcoming licensing rounds and adopt a more constructive stance in tax disputes, however.
Notably, the Kazakh Energy Ministry announced last week it would be offering at least 30 subsoil licences in a tender sometime this year, without divulging details.