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Kazakhstan tries to revive its flagging upstream

Slower economic growth and an array of problems in the oil sector are prompting the government to make changes

An economic slowdown – caused by the stagnant energy sector and falling demand for Kazakh exports in Russia and China – has prompted Kazakhstan’s government to overhaul its regulatory approach and improve the investment climate in the country’s energy sector.

While the country’s considerable untapped reserves are a draw and Kazakhstan remains a reasonable place to do business for large oil operators, the situation on the ground is tough for smaller operators. Costs can be prohibitive and getting projects moving can take too long.

The failure to start commercial production at the giant Kashagan field, in the Caspian Sea, has led to a shortfall in the country’s overall oil output and budget revenue. Production from the field isn’t expected to restart until the second half of 2016, meaning that commercial production – defined as sustained output at 75,000 barrels a day (b/d) – is unlikely before 2017.

The government had hoped Kashagan would produce 60,000 b/d of oil on average by the end of 2014. But when the latest delay was announced in April, Astana tried to make up for the shortfall by increasing output from existing oilfields. In October, having failed to reach agreement with operators on how to compensate for the Kashagan shortfall, the government admitted it now expects no increase in oil output this year, which will stand at last year’s 1.63 million b/d. Partly as a result of this, Astana has now lowered its GDP growth target from the initial 6% to 4.3% for 2014.

Post-peak production

Leaving aside the giant Tengiz oilfield and the Karachaganak gas-condensate field, which in 2013 accounted for almost half of the country’s total oil and gas condensate output, Kazakhstan’s major fields have already passed peak production and are pumping oil at or near capacity. They are depleting rapidly. Mostly owned by the national oil and gas company KazManaiGas and Chinese operators, other established producers – Mangistaumunaygas, CNPC-Aktobemunaygas, Uzenmunaygas, Kazgermunaygas, Embamunaygas, PetroKazakhstan Kumkol Resources, Karazhanbasmunaygas, Buzachi Operating, Turgai Petroleum and Kazakhoil Aktobe – accounted for 39.5% of last year’s output. According to KazManaiGas, more than 90% of the country’s proven recoverable reserves are contained in fields developed by these companies and in Kashagan. According to KazManaiGas Exploration & Production, the upstream arm of the state firm, combined proven and probable reserves (2P) at Uzenmunaygas and Embamunaygas decreased from 1.5 billion barrels in 2006 to 1.1bn barrels in 2012; and its share of 2P in Kazgermunaygas (50%), Karazhanbasmunaygas (50%) and PetroKazakhstan (33%) decreased from 490m barrels in 2009 to 410m barrels in 2012.

Overly optimistic assessments of reserves at existing oilfields and an obsession with offshore oil blocks in the Caspian Sea in the late 1990s and early 2000s saw Kazakhstan lose focus on onshore exploration. This has seen government spending on exploration fall to slightly over $20m a year in 2010-12, 300 times less than spending by subsoil users and less than 0.2% of tax receipts from the extractive sector.

This lack of a systematic approach risks a further reduction in reserves, the KazEnergy association of oil and gas and energy companies said in a September report.

As of 1 January 2013, there were 146 exploration contracts signed, including 12 production-sharing agreements (PSAs), 73 for exploration and extraction and 61 for exploration. Most of these contracts were signed before 2008 when the government imposed a moratorium on new licences while it drafted new tax and subsoil legislation. KazEnergy said: “Starting from 2015, a significant reduction should be expected in the replenishment of hydrocarbons reserves which will be possible largely through the reassessment of existing fields or discoveries made in the near future.”

In the 14 years since the discovery of Kashagan, which has proven recoverable reserves of 7bn-9bn barrels, in 2000, there have been just five major discoveries.
KazEnergy criticised the 2010 subsoil use law, which abolished combined licences for exploration and extraction. As a result, following the exploration stage, the explorer has only three months to obtain a licence for extraction or lose the deposit.

To remedy the situation, in May 2014 the government launched its own exploration programme for 2015-19, and will allocate around $900m to it – though it is not yet clear who will be spending this money.
Energy minister Vladimir Shkolnik announced in October that KazManaiGas would spend a further $5bn on exploration over the next three years, aiming to increase its proven reserves from 6bn barrels to 10.3bn barrels in 2022.

The steady stream of operators going sour on the country points to the Kazakh upstream’s other problem – its generally poor investment climate. In January 2013, Norway’s Statoil quit a project to develop the 2.8bn barrel Abai Block in the Caspian Sea. In 2012, Total handed over an official notice that it would not develop the Zhenis field (recoverable reserves of 1.3bn barrels), while Italy’s Eni withdrew from the Shagala project. Last year, ConocoPhillips pulled out of the N Block and Kashagan project.

For all its potential, Kazakhstan just doesn’t look attractive to foreign investors, said Kate Mallinson, Central Asia analyst at London-based GPW Consultancy. “Onerous fiscal terms, a lack of transparency, as well as significant regulatory burden, continue to hinder much needed development of the country’s energy resources,” Mallinson said. “Furthermore, an unwieldy bureaucratic system means that investors have to have significant patience and financial resources particularly when institutional paralysis sets in in the prelude to a forthcoming presidential succession expected later this decade.”

Mallinson believes the impact of Western sanctions on Russia’s economy, lower oil prices and the delay in commercial production at Kashagan have dampened Kazakhstan’s hitherto healthy economic growth and served as “a wake-up call” to the government that more investment is urgently required.

To attract foreign investors to the upstream, the government announced plans last spring to cut the time needed to obtain exploration licences and slash 60% of expert examinations required for mining contracts. Nonetheless, investors will still be left waiting up to two years to gain a contract.

Astana is now overhauling the laws regulating the business environment in general and the extractive sector in particular to reduce government involvement in business. Deputy investment and development minister Yerlan Sagadiyev told Petroleum Economist that the government had already submitted a bill offering “radical improvements” in conditions for entrepreneurship to the Kazakh parliament. He says it will be passed in 2014.

Kazakhstan watchers are more cautious, saying the country’s problem is not the law but its implementation. “I think at a senior level the government is serious about reform, although investors are likely to hold back to see how deep and effective that reform will be. We have some positive signs, which have been widely welcomed, but as yet most people will adopt a wait-and-see attitude,” said Dominic Lewenz, director of oil and gas research at Almaty-based Visor Capital, an investment bank. “I also think it’s not necessarily all about new laws – rather the better implementation of existing laws and cutting the administrative burden, which obviously takes time. Despite the inertia, I think the direction is positive and widely welcomed,” he added.

Kazakhstan’s tax laws are optimised to work with larger mature producers, but less effective for exploration projects and more difficult, higher-cost fields. Unlike Russia, Kazakhstan doesn’t offer exemptions for trickier projects. It is also much harder for a smaller upstream player to complete the relevant paperwork, which means the system has tended to discourage independent exploration and redevelopment groups, Lewenz said. “I would hope this would therefore be one particular focus of reforms.”

That suggests the government is still too focused on bringing in large international operators rather than luring the smaller, fleet-of-foot firms that could spearhead exploration. Astana also wants to develop the domestic oil services industry but, Lewenz said, in doing so it has made it more difficult to bring in outside labour. This has slowed down developments and hampered technology transfer.

Eurasia dreams

The policy muddle, combined with the disappointment at Kashagan, has left the Kazakh upstream facing declining reserves. The Eurasia project, hopes the government, will correct this. According to project’s designers, the pre-Caspian basin may hold up to 20 new oil deposits, each holding more than 2.2bn barrels. On 30 September 2014, president Nursultan Nazarbayev and his Russian counterpart Vladimir Putin symbolically launched the joint project. The two countries will invest $500m in it over the next five years.

The first stage, expected to start in 2015, will analyse and interpret geological and geophysical data collected in Soviet times. Second-stage studies will focus on the structure of sediments at depths of up to 25,000 metres and the third stage will involve drilling a reference well to a depth of 14,000-15,000 metres, Almaty-based independent oil expert Sergey Smirnov told Petroleum Economist.
It looks like a long shot. The sheer depth of the wells makes some doubt the project’s viability. Soviet experimental drilling in the area in the late 1960s and early 1970s showed little sign of oil, if any, noted Smirnov. “Russia’s got experience of drilling holes to such depths, but no-one in the world has extracted oil from such depths,” he said, referring to the drilling of the Bertha Rogers hole to a depth of nearly 10,000 metres in Oklahoma in 1974 and the Kola Superdeep Borehole to a depth of 12,262 metres in 1990.

Smirnov also questioned the economic feasibility of the plan. “As far as I know, no-one has studied the feasibility of projects to extract oil from super-deep wells in Kazakhstan,” he said. The average production cost of Kazakh oil extracted from conventional depths is already as high as $50 per barrel, according to deputy energy minister Uzakbai Karabalin. Drilling the world’s deepest wells will be even more expensive. It seems a costly way to revive Kazakhstan’s flagging upstream. 

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