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Low oil prices ruin Kazakhstan’s energy hopes

The country has come a long way, materially, since the Soviet days, thanks to its long-established president. But like many other oil-dependent states, its immediate future is looking less certain

The sharp decrease in the global price of oil over the past year and sustained period of low prices have forced the Kazakh government to cut back projections for oil output in the near future as hopes pinned on oil from the giant but embattled offshore Kashagan field have yet to materialise.

The country’s oil sector has been stagnant in recent years because of falling production in the country’s ageing fields and uncertainty around expansion of the flagship Tengiz and Karachaganak fields and about production at Kashagan. The low price of oil makes production at some Kazakh field economically unfeasible because of high production costs.

The country’s oil and gas condensate output increased to 81.8m mt in 2013 from 79.2m mt in 2012 but fell to 80.8m mt in 2014. The government expects the figure to fall further to 80.5m mt this year and has made next year’s output dependent on the average annual price of Brent crude: 79-80m mt at $50/b; 77m mt at $40/barrel (/b) and 73m mt at $30/b. However, the energy ministry has ruled out the last option, believing the price will settle above $40/b in 2016.

Despite the declared date for the re-launch of production at Kashagan by the end of 2016, in the medium term projections for oil output in 2020 has been reduced to 92m mt, 12m mt lower than in previous forecasts. “The main reason for lower oil output is the decrease in global price of oil”, the energy ministry says, adding that the lifting of Western sanctions against Iran may flood the global markets with 1m extra barrels of oil/day. “The forecasts for output take into account the re-launch of oil production at Kashagan,” he said.

At the same time, Timur Kulibayev, the son-in-law of Kazakhstan’s autocratic president Nursultan Nazarbaev and the chairman of the Kazenergy association, believes that Kazakhstan would be producing 2m b/d by 2020, joining a club of the world’s top 10 producers.

At the same time, the cuts Kazakh state-owned oil companies run by the KazMunaiGas Group have made to their capital spending to the tune of $435m this year and nearly $500m in 2016, equating to deep cuts of between 30% and 50% at individual companies, will jeopardise these plans, local oil executives fear, as local producers may not be able to appropriately respond to the situation when the oil price picks up over the next few years.

Kashagan dreams

Kazakhstan has for a long time anticipated the launch of production at Kashagan, the world’s largest oil find since the discovery of Prudhoe Bay in Alaska in 1968. Production at the field, which is estimated to contain between 9bn and13bn barrels of recoverable oil, was initially expected in 2008 but technical difficulties of extracting oil in environmentally sensitive shallow waters in the Northern Caspian Sea postponed the launch of production by five years. Production, which started in September 2013, was halted two weeks later after the crew of a helicopter flying over the sea saw bubbles surfacing. The acidid gas had eaten through the 80-kmpipelines that link the field with offshore facilities. North Caspian Operating Company, a consortium including European and US majors, is now replacing the pipelines, at a rate that is ahead of schedule, according to Karabalin.

“The date for the start of production at Kashagan is known and it is the end of 2016,” the first deputy energy minister Karabalin told a news conference during the 10th KazEnergy Eurasian Forum in Astana between 29 September and 1 October. “No changes have taken place in the schedule of all the work planned for completion as of today.”

The replacement of the pipelines has added around $2bn to the project’s total bill, adding to the cost overruns, which the project developers will not be able to recover. In June the NCOC consortium’s managing director, Stephane de Mahieu, said that as of August 2014 total investment in Kashagan stood at $44.5bn, and that in 2014 NCOC and the Kazakh government agreed that the estimated $3bn spent on laying the initial pipelines and replacing them would not be reimbursed. “From this point of view it is fair to say that the financial burden caused by defects of the initially built pipelines will be borne by the shareholders of the project, not the Republic of Kazakhstan,” he told an interview with the government-run Kazinform news agency.

De Mahieu suggested that the members of the consortium – Kazakhstan’s state-owned KazMunayGas with 16.88%, European majors Eni, Shell, Total and US ExxonMobil (16.81% each), Japan's Inpex (7.56%) and China’s CNPC (8.33%) – had decided to chip in the additional money given the costs the project had incurred so far; but with hindsight the investors would have found it hard to embark on the project.

The consortium’s managing director claimed that Kashagan would be pumping 90,000 b/d in the first months of operations and that this would rapidly be taken up to 180,000 b/d, a level that will be maintained for six months. During this time the consortium is expected to work on injecting sour gas back into the field to bring the output to 370,000 b/d by the end of 2017.

Kashagan may start pumping oil over the next year or so and quickly achieve a sustained output over the following year, the cost of producing oil in the field continues to agitate market watchers. Kazakh authorities are reluctant to specify the production costs of oil at specific fields, but Karabalin said in October 2014 that the average production costs of Kazakh oil was $50/b. And according to energy minister Vladimir Shkolnik speaking in February, the cost of oil from the giant Tengiz and Karachaganak fields is the lowest in the country and that the cost of Kashagan oil will be on a par with these fields.

But these claims were refuted by the head of KazMunaiGas, Sauat Mynbaev, who said a few days later that the breakeven price of Kashagan oil would be “in the region of $100/b”. Karabalin believes the production costs of Kashagan oil depends on market conditions and total expenditure on the project and return investors want on their investment. “The estimates depend on what the conditions will be at that time and they depend on expenditure and on return on investment placed. And they also depend on for how long the project will produce,” he told the forum.

He also thinks it is incorrect to link Kashagan’s viability to the currency oil prices because such long-term projects witness periods of both high and low prices. “Another matter is how quickly investors will be able to recover investment they have placed and how quickly the project pays off, and this does depend on price falls and increases,” he said.

The postponement of production from 2008 until 2013 enabled the Kazakh government to negotiate the increase of KazMunaiGas’s stake in the project from 8.33% to 16.81%. However, in the latest delay (from 2013 until the end of 2016), the government did not seek to increase the country’s interest in the project but agreed to a compensation payment of $30m/quarter, specified in an agreement concluded between the government and members of the consortium in 2012.

Tengiz and Karachaganak

The expansion of Kazakhstan’s other flagship fields – Tengiz with estimated recoverable reserves between 6bn and 9bn barrels and Karachaganak with 9bn barrels of liquid hydrocarbons and 1.3 trillion m³ of gas – have also been delayed, either by the low oil price or the lack of capacity to export output. A final investment decision on Tengiz is now expected to be made in January 2016. The expansion project’s cost has also been reduced from the earlier estimates of $38bn to $34bn. When completed in 2021, the project will increase output at the field from the current 27m mt to 38mn mt. The low oil price forced the joint venture – comprising Chevron (50%), ExxonMobil (25%), KazMunaiGas (20%) and Lukarco (5%) – to go slow on the project.

Karachaganak, developed by BG Group (29.25%), Eni (29.25), Chevron (18%), Lukoil (13.5%) and KazMunaiGas (10%), is now expected to start an expansion project in 2017 and complete it in 2021. The expansion was suspended by the global financial crisis in 2008 and it has been hampered by the lack of export pipeline capacities. Its current output of 136m barrels of oil equivalent (boe) a year is shipped via the CPC and Atyrau-Samara pipelines. The expansion of the CPC pipeline from 45m mt/y to a design capacity of 67m mt is expected to start in 2016, according to Shkolnik.

The announcement of Anglo-Dutch major Shell’s acquisition of BG Group in April 2015 has raised the issue of BG’s stake in Karachaganak. According to Kazakh law, the deal triggers the Kazakh government’s priority right to purchase the stake, but the financial difficulties the government and KazMunaiGas are experiencing now may force Astana to resell the stake to CNPC, which has shown interest in buying the BG stake. According to Karabalin, government lawyers are now looking into how Kazakh legislation works in the case of the Shell-BG merger.

Potential to increase output

One of the ways of increasing oil output in the existing field is to employ advanced oil recovery technologies to increase oil recovery rate which stands at 30-35% against 50-55% in China or Norway, deputy energy minister Magzum Mirzagaliev believes. Most Kazakh oil fields, except for Tengiz, Karachaganak and Kashagan, have reached the later stages of development and their reserves are classified as difficult. The deputy energy minister told the forum that one percentage point increase in recovery rate would make available 150-160 mn mt of oil in Kazakhstan, “which is equivalent to the discovery of a very large field.” Nazarbayev has tasked the country’s oilmen to increase the recovery rate by 5-7 percentage points, according to Karabalin. Kazakh oil executives believe the Chinese technology of polymer flooding adopted at the 55-year-old Daqing oil field could be transferred to almost all the former Soviet republic’s ageing fields.

Karabalin also believes that the development of the Eurasia project, symbolically launched by Nazarbaev and his Russian counterpart Vladimir Putin in September 2014, will help Kazakhstan tap into 20 new ultradeep oil fields, each holding over 2.2bn barrels. The two countries agreed to invest $500m in the project over the next five years. Now, the Kazakh government wants to attract Chinese oil majors to the project and, according to Karabalin, CNPC has shown interest in taking part.

The third option is to develop shale oil and, potentially jointly with the Chinese, Karabalin believes. However, this issue is only being studied as, in the deputy minister’s opinion, Kazakhstan has still got enough “traditional” oil reserves.

Chinese oil companies have long been present in the Kazakh oil and gas market, accounting for a quarter of the country’s total production, and the new push for cooperation in a wide range of spheres, namely in the energy sector, is seen by China as part of its Silk Road Economic Belt strategy announced in 2013.

The adoption of the strategy coincided with Chinese oil majors’ aggressive expansion in the Kazakh oil and gas sector. In 2013, CNPC paid $5bn for ConocoPhillips’ 8.33% stake in the Kashagan project, outbidding India’s Oil and Natural Gas Company (ONGC). Then Kazakhstan exercised its pre-emption right to purchase stakes in oil and gas companies, preventing ConocoPhillips from selling its 8.4% stake to ONGC.

In April 2014, another Chinese oil giant Sinopec agreed to pay $1.2bn for LUKoil’s 50% stake in their joint venture Caspian Investment Resources which, in turn, owns smaller oil assets in Kazakhstan – a 50% stake in Alibekmola and Kozhasay fields, 50% in North Buzachi, 50% in Arman and 100% in Karakuduk, the combined output of which stood at over 20m boe in 2013 – but the deal was still to be closed owing to approvals missing, when the oil price started diving. In February 2015 LUKoil filed a case with a London arbitration court to force Sinopec to pay the agreed price and the companies agreed on a new price of $1.067 bn in June. The deal is now expected to close by the end of 2015.

China’s appetite

Kazakhstan is benefiting from its proximity to China, which has direct access to the huge market. It is turning itself into a transit hub between central Asia and the Middle East and China. Along with railway and road links, Kazakhstan has been involved in building oil and gas pipelines to China in the past decade. In 2006 the country started oil shipments via a direct Kazakhstan-China pipeline with a capacity of 10m mt/year to China. The pipeline pumps around 12m mt/y at the moment, but its expansion to nameplate capacity of 20mn mt/y has been put on hold. There is not enough surplus output in Kazakhstan and there is also falling demand for oil in China.

In 2009, Kazakhstan started transiting Turkmen and Uzbek gas through the central Asia-China gas pipeline running from Turkmenistan to China via Uzbekistan and Kazakhstan. Lines A and B, completed in 2009 and 2010, respectively, have a combined capacity of 30bn m³/y, while Line C, completed in June 2014, brought the total capacity of the pipeline to 55bn m³/y.

This has made it feasible to supply Kazakh gas, mostly produced in the country’s west over 2,000 km away from China, to southern regions of Kazakhstan, which now rely on Uzbek gas imports, as well as further to China. As a result, in 2010 Kazakhstan started building the Beineu-Bozoi-Shymkent gas pipeline to link up to the central Asia-China pipeline. The first phase of that was completed in 2013 and it reached a design capacity of 2.5bn m³/y in 2014. Astana hopes that following the completion of the second phase of the project Kazakhstan will export 5bn m³/y to China and transit 40bn m³/y of Turkmen gas and 10bn m³/y of Uzbek gas in 2016-2017. According to BP’s Statistical Review, Kazakhstan exported 0.4bn m³ to China in 2014, which almost entirely came from the small Sarybulak gas field in eastern Kazakhstan near the border with China.

Oil price hits KazMunaiGas

Repeated delays in production at Kashagan and low global oil prices are straining the finances of the national oil and gas company KazMunaiGas and its parent, the sovereign wealth fund Samruk-Kazyna, as well as the government. This has pressured the former two to seek support from the state to reduce their debts, while retaining the control of potentially profitable assets.

In June KazMunaiGas said that it would sell half of its 16.81% stake in the Kashagan field to Samruk-Kazyna for $4.7bn in cash in order to pay off its debts and asked holders of its Eurobonds to agree to the sale and to amend the method of calculating its net debt to Ebitda ratio by deducting from its debts any cash and temporary cash investments provided by other members of the KazMunaiGas Group. According to the terms of its Eurobonds, the maximum rate of its net debt to Ebitda is capped at 3.5x. This ratio reached 3.2x at the end of 2014.

According to KazMunayGas, these measures – deconsolidating $2.2bn of debt relating to Kashagan, including $4.7bn in cash raised from the sale of the stake and about $5.4bn in cash held by its subsidiaries – will bring down its net debt from $17.9bn at the end of 2014 to $5.7bn, the level of its Ebitda at the end of 2014. As a result, the national company will be able to maintain the ratio at 1x.

The logic behind the move is to sell an asset that will not contribute to its earnings until it starts production. The move also saved the company the problem of finding a generous buyer for the stake, given the uncertainty around production at Kashagan. Under the deal, Samruk-Kazyna granted KazMunayGas a call option to buy back all or part of the Kashagan shares at market price any time between 1 January 2018 and 31 December 2020.

This option was supposed to persuade its bond holders that it would still hold the stake while trying to solve problems associated with low oil prices: the company’s Ebitda is expected to fall from $5.6bn in 2014 to $2.8bn in 2015.

After the announcement of the deal, in July Samruk-Kazyna, a 100% owner of KazMunaiGas, said it would swap 10%-plus-one shares in the national oil and gas company for its bonds worth tenge 750bn ($4bn) held by the National Bank of Kazakhstan, the central bank. Again, Samruk-Kazyna must be hoping to get the stake in KazMunaiGas back when its financial positions improve.

Refinery sale mooted

Kazakh oil executives deny that the possible privatisation of the country’s three major oil refineries is linked to the financial troubles caused by the oil price. The government’s massive programme to privatise non-core assets of state-owned companies, run by the sovereign wealth fund, in 2014-2016, did not initially include state’s 100% stakes in the Atyrau and Pavlodar refineries or its 50% stake in Shymkent. They are undergoing reconstruction that is expected to be completed by the end of 2016. “Privatisation is possible but not to raise money for reconstruction,” KazMunaiGas’s CEO Sauat Mynbaev says. “Reconstruction has so far been financed by already allocated funds,” he says.

Following the work, the refineries will see their combined capacity increase from 14.3m mt in 2013 to 18.5m mt in 2017. As a result, high-octane petrol production will increase by 115.3% to 5.73m mt; diesel output by 38.3% to 5.63m mt and jetfuel production by 138% to 957,000 mt.

At the moment, Kazakhstan imports around 30% of petrol it takes from Russia. Since the government regulates the prices of octane 80 petrol (and octane 92 until recently) and diesel fuel, higher petrol prices or currency fluctuations in Russia often make wholesale prices of Russian fuel imports higher than Kazakhstan’s domestic retail prices.

The situation like this make fuel imports unprofitable, leading to severe fuel shortages. Although the government claims that expanding the refineries will satisfy domestic demand until 2030, these shortages are prompting demands that the government build a fourth refinery in the country. As of October 2015 the ministry says the issue is being studied and the final decision has not yet been adopted.

The government

The low price of oil has also damaged the finances of the Kazakh government which has embarked on a massive belt-tightening exercises, as the economy took the hit. A more than 50% fall in global oil prices since summer 2014 has resulted in a 33% decrease in oil revenues and a 22% slump in overall budget revenues, according to finance minister Bakhyt Sultanov. Generally, oil accounts for up to 30% of the country’s GDP, 50% of revenues and 60% of exports.

The downward streak of the oil price and a slowdown in its powerful neighbour Russia led to the country’s economic growth falling from 6% in 2013 to 4.3% in 2014. This, combined with lower growth rates in China and the EU, forced the government to cut GDP growth projections to 1.5% in 2015.

The slowdown in the economy and low oil export earnings also forced the government to amend its budget for 2014 in November and cut expected budget revenue by $2.3bn to $21.8bn, increasing budget deficit by $900m to $6bn, or 2.6% of forecast GDP in 2014 against an earlier target of 2.3% GDP.

In February the continuing deterioration in the global commodity markets prompted Nazarbaev to order a 10% cut in 2015 budget spending, or $3.78bn. The falling oil prices and the volatility of the Russian ruble also put massive pressure on Kazakhstan’s national currency, the tenge, to devalue, but the government resisted the measure in order to maintain the exchange rate following a 19% drop in the tenge’s value in February 2014. Following the devaluation, the authorities had repeatedly denied that there would be another devaluation, giving the reassurance there could not be two devaluation in one year.

As a result of the mounting economic difficulties and pressure on the tenge to devalue, in February 2015 Kazakhstan announced a snap presidential election on April 24 as authorities feared that the worsening economic conditions and possible social discontent would hinder Nazarbaev’s re-election in 2016. At the same time, the election authorities were forced to deliver a bigger landslide and higher turnout figures for Nazarbaev because figures lower than the ones shown in the previous election in 2011 – 95.6% of the vote on a 90% turnout would have been seen as diminishing popular support in the president, who has been ruling the country with an iron fist since 1989, before it obtained independence in 1991. As a result, the incumbent received nearly 98% of the vote on a 95% turnout. In his acceptance speech Nazarbaev reiterated the government pledge that there would not be devaluation, but the price of oil did not pick up and Russia did not manage to reverse the slowdown. As a result, having spent $28bn on propping up the tenge since February 2014, in August 2015 the government announced a free-floating exchange regime, allowing the tenge to depreciate by 29% in a day.

Despite the declared policy of free-floating exchange regime for the tenge, in September the National Bank resumed interventions in the exchange market and has since spent about $1.8bn on maintaining the exchange rate. Like the fate of the oil industry, the whole Kazakh economy, which experienced oil-fuelled boom in a decade before the 2008 global financial crisis, seem heavily dependent on the price of oil, and there is little that could be done before the price starts to pick up again.

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