Why is Kashagan a problematic project?

Scandals around the largest offshore oil and gas field in Kazakhstan have been growing. The Government of Kazakhstan has increased the size of its claims against international companies developing Kashagan to more than $150 billion.

In 2023, the Kazakh government filed a lawsuit against shareholders of the North Caspian Operation Company (NCOC), challenging the $13 billion in reimbursable costs invested in the development of Kashagan. The claim was submitted to the International Commercial Arbitration Court in Geneva (Switzerland) according to UNCITRAL rules. This amount subsequently increased to $15 billion.

According to Bloomberg, an additional claim has been filed for $138 billion which concerns lost profits and reflects the calculation of the cost of oil promised to the government, but this promise was not fulfilled by the contractors of the field.

In addition, another claim for compensation is related to contracts for the development of Kashagan which are allegedly connected with corruption. What kind of corruption schemes is not specified.

The field operator, NCOC, commented to the media that it has several disputes regarding the application of certain provisions of the Kashagan Production Sharing Agreement (PSA), which are subject to arbitration. The investors believe that they acted in accordance with the contract but did not disclose any details of the litigation.

The Ministry of Energy of Kazakhstan stated that under the terms of the PSA, details of arbitration disputes and claims are not subject to disclosure.

Thus, neither the authorities nor Kashagan investors have yet confirmed the increase in the total amount of claims to more than $150 billion but they have not refuted it either.

In addition to these claims, the Ministry of Ecology and Natural Resources of Kazakhstan is demanding $5.1 billion in fines from NCOC for violating environmental legislation, including for illegal storage of sulfur. The trial on this claim is also ongoing.

Petrocouncil.kz found out the opinion of oil and gas experts on this case and tried to find out what the consortium promised Kazakhstan when they signed the Kashagan contract.

Where does this amount come from?

Olzhas Baidildinov, a member of the Public Council of the Ministry of Energy of Kazakhstan: ‘I believe that the second, larger claim relates to certain revenues, payments, taxes, and investments lost by Kazakhstan because the consortium repeatedly postponed the start of the production. Currently, Kashagan is at the first stage of development and production is about 400-450 thousand barrels per day (b/d). The second stage provided for production of 800-850 thousand bpd. Then, the field should have reached a production plateau of 1-1.2 million bpd.’

According to him, Kazakhstan currently produces about 1.7 million bpd of oil. That is, Kashagan, in fact, if fully developed, could increase this figure by one and a half to two times, considering the growth in production at Tengiz.

‘As we see, the consortium cannot cope with this. Either the economics of the project are really that bad or something else. As a result, we are still at the first stage. All those promises about the construction of a gas processing plant (GPP), new gas supplies and something else are related to the implementation of the second phase. If a decision has not been made and nothing has been done, then, accordingly, the second phase may not be implemented at all. We will remain with the production indicator that we have now – about 19-20 million tons per year.’

It is also possible that $138 billion is the sum of Kazakhstan’s lost revenues in the past, present and future. In addition, the government is interested in reducing reimbursable costs, so it does not want to recognize $15 billion in expenses.

According to Abzal Narymbetov, the oil and gas analyst: ‘I think that this amount was formed due to costs. The more costs, the state receives the less profit. At this moment, the total costs of the project are estimated at $60 billion. It seems to me that the Kazakh country considers lost profits. The second point is the delay in the start of production. Initially, it was planned to start in 2005, but in fact they started 11 years later. How much oil could have been produced at the field over a given period is also lost profit’.

Revenues worth hundreds of billions

To understand why the oilfield never became extremely profitable when the exploration became a sensation (such gigantic field was discovered for the first time in the last 40 years), it is necessary to analyze how the field was developed all these years.

The exploration began in June 1993 when the Kazakh government approved the Concept of the state program for the first stage of development of the Kazakh sector of the Caspian Sea. In December 1993, an international consortium was created to carry out geological exploration work in this area. It included local Kazakhstan CaspiShelf and seven foreign oil companies: Mobil, Shell, British Petroleum (BG), British Gas, Agip, Total and Statoil.

From 1994 to 1997, the consortium conducted seismic surveys over an area of ​​100 thousand square meters and estimated the potential of the site from 26 billion to 60 billion barrels of oil where investors spent over $200 million.

The PSA for the Northern Caspian Sea between the above-mentioned companies and the government of Kazakhstan was signed in November 1997 and came into force in April 1998. At the same time, it was announced that the exploration period for the field would be 6 years and the development period would be 20 years from the date of commercial exploration with the possibility of two extensions of 10 years each. The total volume of capital investments in development would be $28 billion, the planned total income would be $800 billion including the so-called divisible income – $690 billion, (more than 80% would belong to Kazakhstan).

In September 1998, the “Kazakhstan International Shelf Operating Company” – Offshore Kazakhstan International Operating Company (OKIOC) was created as the project operator to conduct exploration on an area of ​​5.6 thousand square kilometers. It included all investors from the previously created consortium.

In October of the same year, the Kazakh national company Kazakhoil sold its 14.3% stake to two new investors- the Japanese INPEX and the American Phillips for $450 million.

In August 1999, OKIOC began drilling the first exploratory well, East Kashagan-1. At the end of June 2000, an oil was obtained from the well with a daily flow rate of 600 cubic meters of oil and 200 thousand cubic meters of gas. A few days later, the operator announced the exploration of the field.

Kashagan has size of approximately 75×45 km. Its recoverable reserves are estimated at 7-9 billion barrels of oil and total geological reserves are 38 billion barrels. Natural gas reserves are over 1 trillion cubic meters. The reservoir of the field lies at a depth of about 4200 meters below the seabed and is under high pressure (770 bar). Oil is characterized by a significant content of high-sulfur gas (up to 19% hydrogen sulfide). The climatic conditions are harsh due to extreme temperatures: from +40 degrees in summer to -40 degrees in winter. The Northern Caspian is covered with ice for approximately five months of the year due to the low level of salinity from the influx of fresh water from the Volga and Urals as well as the shallow waters.

It was also noted that the location in a closed sea area creates difficulties for logistics, production safety and solving engineering and logistics problems. It was the starting conditions. In 2001, Agip KCO was chosen as the single operator of the pilot development phase. In 2002, the consortium promised that first oil would be produced at the end of 2005, commercial production would begin in 2006 and the field would reach its maximum production level in 2015. However, as early as 2003, investors seemed to know that they would not keep their promise. In the spring of the same year, BG announced its decision to leave the project. Negotiations lasted two years where the British company wanted to sell share to the other participants in the project, but the Kazakh government also claimed to it.

In March 2005, BG sold a 16.67% stake in Kashagan for $1.79 billion to Agip, ExxonMobil, Shell, Total and ConocoPhillips. The buyers immediately signed an agreement with the government to transfer half of this share to the Kazakh side for just over $913 million.

As a result, Eni, Total, ExxonMobil and Shell each had an 18.52% stake in the project and ConocoPhillips had 9.26%, INPEX and KMG had 8.33% each.

In May 2005, KMG and Agip KCO signed an agreement on amendments and additions to the PSA for the Northern Caspian Sea. The consortium first paid a fine of $150 million to the budget for delaying the start of production.

After the amendments, it was stated that over the entire period of the project, investors plan to generate income in the amount of more than $85 billion, about $50 billion should be used to reimburse capital and operating costs and the government would receive $65 billion in revenue, KMG would receive $10.6 billion.

During 1998-2004, all planned exploration wells were drilled in Kashagan, Kalamkas, Aktoty, Kayran and South-Western Kashagan and they gave positive results. Total preliminary geological oil reserves were estimated at 5.7 billion tons, recoverable reserves at 1.9 billion tons.

FieldGeological, millions of tonsRecoverable, millions of tons
Kashagan4 8621647
South-Western Kashagan64 (condensate)20
Aktoty305 (condensate)100
Total5 7051 917

In June 2007, investors turned to the authorities with a request to amend the plan and budget for the development of Kashagan. They asked to begin commercial production in the second half of 2010 and to increase project costs from $57 billion to $136 billion. The government stated that changing the production schedule was equal to changing the contract itself.

The parties negotiated and in October 2008 they signed additional agreements to the existing PSA. It was announced that ‘the agreements have improved economic conditions’ for Kazakhstan and ‘strong control mechanisms have been established over the timing and costs of the project’. KMG acquired shares of 1.7% from each participant and as a result Kazakhstan’s participation in the project increased from 8.33% to 16.81%. The total price for the acquired share was $1.78 billion. The payment was planned to be made after the start of oil production.

In addition, Kazakhstan would receive (including the profit from the increased share in the project) will $7.2 billion compensation in NPV value ​​(at a discount rate of 10%) which is equivalent to $71 billion in undiscounted cash flows at an oil price of $85 per barrel. The compensation amount would increase to $13.7 billion in NPV with an oil price of $125 per barrel, which is equal to the undiscounted $87 billion, respectively. It was also stipulated that if commercial oil production does not begin before October 1, 2013, the consortium’s costs will not be reimbursed. The number of penalties for delaying (after 2008) the start of oil production increased from $50 million to $120 million per year in 2012. Interest rates on capital investments (uplift) were reduced from LIBOR +3% to LIBOR +2, 5%.

In 2009, the functions of the field operator were transferred to NCOC. In 2013, the new operator announced to operate the field. On June 30, Kashagan production facilities were launched. However, already on September 24, a leak of raw gas was detected during a routine inspection of the gas pipeline running from sea island D to the Bolashak oil and gas treatment plant. A few days later the problem was fixed, production resumed but then another leak was detected. Thus, an investigation has begun and in May 2014, it was announced that both the oil and gas pipelines required complete replacement.

In December of the same year, the Kazakh government and Kashagan shareholders signed a Settlement Agreement which established the responsibility of the parties for the incident. In particular, the parties agreed that all costs of eliminating the consequences of the accident (replacement of pipelines were estimated at $3 billion) would be transferred to the investors and Kazakhstan would not suffer any losses. However, it later turned out that the field operator included this amount in the reimbursable costs.

Commercial production at the field resumed only in the fall of 2016. Another significant event is the entry of the Chinese CNPC into the Kashagan project. In 2013, the US ConocoPhillips left the project where 8.33% shared was planned to be bought by the remaining participants The government exercised its pre-emptive right and CNPC paid $5 billion for the share. In addition, it committed to invest up to $3 billion, which KMG should invest as part of financing the second stage of the Kashagan development.

In 2010 the Kazakh government created PSA LLP with the functions of the Authority on behalf of the government to strengthen the position of Kazakhstan and to participate in the management of the Kashagan project. It is the PSA that represents the interests of Kazakhstan in the arbitration proceedings with the shareholders of Kashagan.

Since 2010, PSA LLP has been able to resolve several arbitration disputes in favor of Kazakhstan. It achieved compensation in the amount of $1.305 billion from participants in the Karachaganak project as Shell, Eni, Chevron and Lukoil. The parties agreed on the final methodology for sharing production and as a result, Kazakhstan will receive an additional $600 million by 2037 at an oil price of $40-50 per barrel. The Kazakh government and Karachaganak Petroleum Operating (KPO) have approved the Karachaganak expansion project to further maintain production plateau at the field. The dispute began because in 2015 Kazakhstan expressed disagreement with the methodology for distributing profits from the sale of Karachaganak oil.

In 2023, commenting on arbitration with NCOC and KPO, General Director of PSA LLP Beket Izbastin noted that arbitration is a generally accepted mechanism for resolving disputes between parties to a PSA. Filing a claim in commercial arbitration will show the international community that Kazakhstan is defending its interests in a civilized manner and as is generally accepted in Western countries, through an independent forum. He also noted that Kazakhstan is open to dialogue to resolve controversial issues through negotiations. At the same time, building a constructive dialogue requires two sides as mutual respect, consideration of interests and cooperation are the key to success.

Corruption allegations

As already mentioned, one of Kazakhstan’s claims against the field’s operators is related to contracts that may have a corruption component.

In October 2019, the US Department of Justice reported that former executives of the Monaco-based intermediary company Unaoil – Cyrus and Saman Asani – admitted that from approximately 1999 to 2016 they participated in a corruption scheme to secure contracts for foreign companies by bribing local officials in several countries, including in Kazakhstan. Perhaps, this is what this investigation is all about.

Earlier, in March 2016, The Huffington Post wrote that the American engineering and construction company KBR hired Unaoil to help win oil and gas contracts in Kazakhstan. KBR was part of Halliburton until 2007 and according to thousands of internal documents obtained by reporters Halliburton paid Unaoil millions of dollars from 2004 to at least 2009.

In 2004, Unaoil tried to conclude a joint contract for KBR and the British Petrofac to work on the Kashagan field. Unaoil paid $80 thousand a month to a certain Leonid Bortolazzo, a former Eni manager, who was then working as a consultant at the Kazakh Institute of Oil and Gas (KING), owned by KMG. Unaoil even bought high-end furniture worth tens of thousands of dollars for Bortolazzo. The contract also included a signing bonus of $165,000.

Journalists note that Halliburton has unsuccessfully tried to conclude contracts in Kazakhstan since 1998 where repeatedly encountered obstacles. KBR’s partnership with Unaoil was intended to give the company an advantage in the Kashagan contracting process just as the international oil companies that operated the field began to implement their final plans for its development.

In 2010, the Kazakh financial police accused Agip KCO of fraud because the company recorded the same expenses twice during the construction of the Bolashak integrated oil and gas treatment facility in the amount of $110 million (planned to be reimbursed from Kashagan oil and gas). Based on this fact, a criminal case was initiated under the article ‘Fraud’.

As the Corriere Della Sera newspaper wrote, Eni was once accused by Italian prosecutors of giving a bribe of $20 million to Kazakh officials in 2007.

These are not isolated cases of corruption, economic and other violations that were recorded during the pilot industrial development of Kashagan. There were facts of overestimation of the cost of goods imported from abroad. Since investors are exempt from import duties, they procure almost all the necessary goods abroad. That is why the share of Kazakhstani goods in procurement of Tengiz, Kashagan and Karachaganak operators does not exceed 10%. In addition, there were also cases of work permits of foreign workers with high salaries, etc.

Perhaps, the cost of developing the field has increased not because of harsh climate conditions and logistical difficulties, but because of the poor management and corruption the project faced from the beginning? It seems that foreign investors and Kazakh officials have decided that Kashagan’s huge reserves will be enough for everyone for the next 30 years. But when the rules of the game are constantly changing, players already forget what they were like originally. That is why they begin to accuse each other of violations. Hence, the billion-dollar claims.