Problems for Kazakhstan at the country's biggest field
Kazakhstan’s biggest field has been an expensive flop. It is a problem for the country. Can Kashagan recover?
The consortium developing Kashagan is being ultra-conservative in its latest predictions in an effort not to add to the disappointments that have blighted the project. But another big disappointment – that the oilfield won’t produce the long-promised output of 1.5 million barrels a day (b/d) – hangs over the project.
The latest news from Kashagan inevitably centred on the billions of dollars needed to get oil flowing from the field again. When it was discovered in 2000, the Caspian Sea field, which has recoverable oil reserves of about 13 billion barrels, was the largest oil find in 30 years.
On 7 November, it emerged that the North Caspian Operating Company – a consortium of KazManaiGas, Eni, ExxonMobil, Shell, Total, China National Petroleum Corporation (CNPC) and Inpex – had chosen German and Japanese companies to carry out a $3bn-plus replacement of the field’s entire 200-km pipeline network. Leaks in Kashagan’s pipes forced the consortium to shut in the field in October 2013. It had been producing for just a few weeks. “The replacement plan is under finalisation and expected to be available by the end of 2014,” Antonio Vella, head of Eni’s upstream operations, said during a conference call on 30 October. “The material of the new pipeline is X60 [a measure of the pipe’s strength] carbon steel cladded with corrosion resistant alloy and 100% of the pipeline material has been ordered.”
Initial results of an investigation into the leaks in the pipeline network that carries the corrosive and poisonous gas, hydrogen sulphide (H2S), known as sour gas, from the field to onshore facilities, identified cracks at the welds of the pipeline spools as well as on some of the pipeline bodies.
The leaking pipes – apparently not designed to carry such corrosive gas and purportedly bought too soon and left out in the sun – were originally supplied by Japanese companies Sumitomo and JFE, and installed by an oil contractor controlled by Eni, which has been the project’s operator during the development’s troubled first phase.
The decision to use sub-standard equipment, most likely to save money, has cost billions, says one source with knowledge of the project, but on a wider level it’s a “damning indictment of project management”.
Poor project management has been the bane of the project since its inception more than a decade ago.
There’s plenty of blame to go around, but much of it has to be shouldered by Eni, the original operator of the project. Costs have soared from the original $10bn to $50bn today, and will reach an estimated $136bn throughout the life of the project. A new operator, the North Caspian Joint Venture (NCJV), to be headed by an ExxonMobil executive, is set to take over shortly, leaving some to wonder how the project would have fared with the US supermajor in charge in the first place.
“The assumption is that companies like ExxonMobil wouldn’t have spent that kind of money – they have a reputation for a greater focus on cost effectiveness and are more ruthless in maintaining cost control,” said Andrew Neff, senior energy analyst at IHS Energy, a consultancy.
In mitigation, the project has been immensely challenging. As well as managing the reservoir’s sour gas, the developers have had to contend with the extreme climate in the north Caspian Sea, where winter temperatures sink as low as -40°C while summer peaks can hit 40°C.
Since the sea is quite shallow in that area, it is covered with ice from November until March, making it impossible to use a conventional offshore drilling rig, which is why a network of expensive artificial drilling islands had to be designed and built.
The oil reservoir is also very deep – it lies more than 4,000 metres subsurface, compared with around 1,500 metres subsurface at other Caspian Sea oilfields. Because of its depth, Kashagan’s reservoir is high-pressure and high-temperature, adding significant technical difficulty to the development.
Carlo Freni, a senior executive at GE Oil & Gas, said the Kashagan gas compression system that his firm was contracted to provide in 2004 is the highest-pressure reinjection train ever built. “At the core of GE’s Kashagan solution were two ultra-high pressure, sour gas re-injection trains. The re-injection trains first had to be designed to reliably handle the extreme pressures and sour-gas concentrations, and then configured to operate safely in the harsh Caspian Sea – transportation to which proved to be an immense challenge in and of itself,” Freni said.
With such obvious obstacles to overcome, the original timetable for first oil by the end of 2005 was hopelessly unrealistic, and delays were inevitable. These, in turn, aggravated internal disagreements within the operating consortium, leading to five changes in the joint venture’s make-up since the Agip Kazakhstan North Caspian Operating Company was formed in mid-2001. Disputes with the Kazakh government have also affected the project.
Government interference has been another problem for the project. On top of 2007 legislation that allowed it to break natural-resource contracts deemed harmful to the nation’s interests, the Kazakh government used the delays as a way to raise its stake in the project to today’s near 17% and impose a succession of fines on the consortium. The government is now holding talks on the penalties for the latest delay in commercial production to the second half of 2016, which could be eye-watering.
Yet even here many believe the government is setting the consortium up for a fall. Magzum Mirzagaliyev, the deputy energy minister, told journalists at the Kioge oil and gas conference in Almaty on 1 October that: “Judging by information we receive and technical forecasts we see, [the resumption of production] should be in the second half of 2016.”
However, reports citing unnamed consortium sources appear to support analysts’ doubts about the timeframe, arguing that installing the pipeline network and testing it before the winter of 2016 sets in will be a stretch. “Given the history of the project I’m a little surprised, because the end of 2016 is too optimistic,” said Dominic Lewenz, head of research at the Kazakh-based investment bank Visor Capital. “I would have thought it’s far more likely it will come on stream in 2017 or later.”
This sudden bout of caution and the attempt to push back the timing to 2017, say analysts, is to break the cycle of delay that is wearing investors down. The latest postponement is expected to cost the companies and their investors dearly. In July, investment bank Morgan Stanley said it had reduced its 2016 earnings estimates for Eni, Total and Shell, which each hold 16.8% stakes in the project, by $500m per company. In percentage terms, that is a 6% fall in 2016 net income for Eni, 3% for Total and 2% fall for Shell – at a time when these firms are already not generating enough cash to cover their capital expenditure and dividends.
For the Kazakh government, the delay means its plans for raising oil production by around 25% to 2.15m in 2017 are in tatters. Now it doesn’t see annual oil output reaching above 2m b/d until after 2020. And that peak production target of more than 1.5m b/d from the third phase of Kashagan also now looks under threat as costs continue to spiral and an oil price above $100 a barrel looks far from certain.
Under present plans, the first phase is for 370,000 b/d, then that will be extended to 450,000 b/d for the end of the first phase and beginning of the second. The third phase was for that magic figure of 1.5m b/d.
However, Lewenz said the government and the consortium need to make a decision probably early next decade on what to do about further stages – given the cost structure of the industry. “My view is there’ll be a complete relook at the design, because the question is the reserves versus the cost for it. Maybe they’ll go for a design that takes them to 1.2m b/d,” he says.
IHS’ Neff agreed. “I think 1.5m b/d is achievable, but this is the optimistic scenario in which everything goes right – and it’s hard to imagine everything going right after so much has gone wrong so far. It’s probably more realistic – and this is still contingent on most things going right – to get to 1.2m b/d,” he said.
In the meantime, Kazakhstan hopes to compensate for the shortfall from Kashagan’s delay by raising production at other fields, such as Tengiz – another supergiant oilfield that suffered its own delays and cost-overruns, but has been producing since 1993, achieving output of 450,000 b/d in 2013.
Mirzagaliyev, the deputy energy minister, said on 1 October the government is looking to boost production at Tengiz by 240,000 b/d to around 760,000 b/d by 2019-20. To achieve this, the government signed off later on a proposed expansion at Tengiz, even though the cost of it had risen from $23bn to about $40bn, due to cost inflation for services and other equipment. The Chevron-led consortium developing Tengiz, however, has yet to commit to the expansion. The fall in the oil price also casts doubt on the expansion, and threatens talks with other producers about raising output at their fields.
For a country in which oil accounts for 25% of GDP and is the glue that keeps the social contract between its autocratic rulers and citizens together, stagnant production and a falling oil price spells trouble. The delays at Kashagan could have much wider repercussions for Kazakhstan.
Problem child: Kashagan by dates
2000: In May, the Offshore Kazakhstan International Operating Company – grouping Eni, BG, BP, Statoil, Mobil, Shell, Total, Inpex, Phillips and the Kazakh government – strikes oil. Reserves estimated at 11 billion barrels. In July, President Nursultan Nazarbayev declares Kashagan, in shallow Caspian waters, the world’s “largest recently discovered oilfield” and says it could hold 50 billion barrels.
2001: After a battle among the partners, Eni takes operatorship of the project – seen by many as the compromise candidate. First production is scheduled for 2005. BP and Statoil withdraw (their stakes are later spread among the other foreign partners). A new operating company, Agip Kazakhstan North Caspian Operating Company is formed.
2002: The appraisal complete, Kashagan’s partners say the field is commercially viable.
2003: BG withdraws. The remaining foreign partners share its stake. First oil is delayed until 2008.
2004: Kazakhstan approves a new development programme. Eni says output will eventually rise to 1.2 million b/d.
2005: After negotiations, the Kazakh government buys half of the BG stake sold to the other partners.
2006: Eni says the project is $5 billion over budget and revises up its estimate to full development to $31 billion. It delays first oil till 2010.
2007: Kashagan’s budget problems deepen, with some estimates putting full development costs above $130 billion. A new law is passed, giving the Kazakh government power to change or cancel contracts with foreign firms if national interests are at stake. Eni is stripped of the operatorship, which is later passed to a new, reorganised consortium, in which state firm KazMunaiGaz takes a larger stake: North Caspian Operating Company (NCOC).
2008: First oil target delayed again, to 2013. If missed, Kazakhstan will not pay cost compensation.
2009: NCOC formally takes over.
2011: The Kazakh government shelves the second phase development.
2012: The government approves a new budget for phase one, which has risen to $46 billion.
2013: ConocoPhillips sells its holding to KazMunaiGaz, which then sells a stake to China National Petroleum Corporation (CNPC). Shareholders in NCOC are: KazMunaiGaz (16.877%), Eni (16.807%), Shell (16.807%), ExxonMobil (16.807%), Total (16.807%), CNPC (8.333%) and Inpex (7.563%). First production begins. Eni says output will reach the phase-1 target of 370,000 b/d in 2014. A natural gas leak later shuts down the field.
2014: Total says Kashagan will resume output in 2016.