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The saga of Kashagan

Yaroslav Razumov


Let me start with two notes from different sources and countries; at first sight it seems that the notes are not connected with each other, although they are close in subject matter.


Firstly, the Financial Times, a very trustworthy newspaper, referring to the international companies that are preparing for the development of Kashagan oil field, stated that the peak of oil extraction will be reached “by the end of the next decade”(cited from “Exclusive” N1, 2007). In general, this term is logical, taking into account the proposed start-date of industrial exploitation of the field in 2009. However, this date might be delayed again. Secondly, just before the Nauryz holiday, 21st of March, an expanded meeting among the officials of the Ministry of Finance of the Russian Federation was held in Moscow. Aleksey Kudrin, the head of the ministry, said at the conference that the ministry forecasts a reduction in the average annual price of Urals brand oil down to 30 USD per barrel after 2010. According to his opinion, this price is the most likely one within the period, and the current price is, apparently, the limit.

Market fortune telling
We don’t know who prepared the forecasts announced by the minister; however, such opinions are widely held in the Russian analytical sphere. For example, last autumn the problem was raised by Sergey Karaganov, the Chairman of the Presidium of the Council on Foreign and Defense Policy of Russia and a famous political scientist, at the conference “Strategic partnership of Kazakhstan and Russia: current condition and perspectives for development” in Almaty. After describing a broad picture of the world energy market’s future, the expert forecast a serious and long-term reduction in oil prices. The reason is the large investment into the expansion of production capacities occurring in different parts of the world, which in turn, increases the supply. The serious attention given to energy saving technologies and alternative sources of energy in the major oil consuming countries should also be taken into account. These two factors actually can turn the market by 180 degrees, with prices probably changing gradually. However, it would not matter to a country with high dependency on resource exports whether the change takes place over one year or three years. If they couldn’t diversify the economy in 15 years, what could they change in such a short time! It might sound cynical, but maybe it would hurt less if it happens quickly… Besides, why can’t prices fall sharply? It has happened before. Let’s remember the crises of the world oil market in the early 1970s, mid 1980s and late 1990s. The first of the crises scared the West very much, the second became the main reason for the collapse of the USSR (this country, with all its systematic weaknesses, had a larger safety margin than its successor countries). And if the third lasted a bit longer, it might have destroyed these successor countries. Anyhow, let’s return to the forecasts of the oil price. Of course, they often contain a lot of politics and attempts to manipulate something (however, if the Russian officials and experts were motivated by the manipulation interests, it would be more practical for them not to announce the pessimistic forecasts in order not to decrease the stability of the situation). However, we should note that also a large number of experts share the opposite opinion, predicting further increases in the price. Let’s consider a politically neutral opinion, not Russian and not American. Pier-Rene Boki, professor of the French Institution and a famous specialist, expressed an opinion in our recent interview that the oil prices would only rise: - Even if they decrease, it would be only temporarily. The price may decrease to 50 USD per barrel, or even 40, but only for 2 to 3 years. Later, when the world industry reaches another peak, prices would start rising again, possibly approaching 100 USD per barrel. Other experts who share this opinion relate the further growth of prices of energy resources to their possible deficit in the future, because of the exhaustion of reserve stocks. Whatever reasons are given, there is no balance between the totally different forecasts. Anything could happen, including the wild case of the price of 100 USD per barrel, if there is a war between the USA and Iran, but let’s hope that will not happen!

“There is a smell of oil everywhere in the universe”
Now, let’s revert back to Kashagan. Let’s hope that the forecasts of the optimists about the price come true (but not the 100 USD!), then there will be nothing to worry about. However, let’s start from the worst possibility – imagine that Kudrin and Karaganov are right. What will happen then? Obviously, the planned (or the announced) peak of development of the field will take place at the time of low oil prices. Here we should refer to local, rather than Russian or European experts. Where, if not in our country, should the problem be very closely studied? After all, there aren’t many countries with as high a dependency on oil exports as Kazakhstan has. Many people say that the prices may fall sooner or later; but where are the arguments supported with calculations? We only know of the report of Bulat Khusainov, a well-known economist. There are several more publications in some of Kazakhstan’s institutes, but they are more of a compilation, rather than original research. This is evidence for the fact that our society of experts is, in general, still far behind the international analytical centers (only in general, with the presence of some outstanding specialists). I remember the same situation in 1998 – the prices for the resource have already decreased all over the world, but nobody, except for political PR personnel, commented on the situation. Comparing the level, depth and range of coverage of oil related problems in the world and our country, I remember the following part from the famous novel of Viktor Pelevin “Generation π”, as an image describing “our point of view”: “The deepest revelation that has ever visited a person intoxicated with drugs was caused by a critically high dose of ether. The person managed to write it down. The note is as follows: “There is a smell of oil everywhere in the universe.” Now, let’s look at some works of local experts. For example, one of the works, based on the international conference, considers the Caspian region as “a potential source of (pay attention here!) the largest reserves of un-extracted energy resources in the world”! (“Cooperation of the Central Asian countries and the USA on ensuring the security in the region”, Almaty, 2005). Sometimes one can find direct contradictions in a single work of an expert. For example, in the book “Oil and gas resources of Kazakhstan in the system of world and regional relations”, published in 2002, the introduction states that “by the reserves of oil and gas, Kazakhstan is in the top ten of oil producing countries” and within the next two pages, there is a list of the top ten countries by reserve stocks, with Kazakhstan nowhere to be seen! The work “Kazakhstan in the years of independence”, published in Almaty in 2005, says that “according to the latest assessments (however, the source is not stated), the total reserves of oil and gas in Kazakhstan are 23 billion tons, including 13 tons that are allocated in the Caspian shore”. Interestingly, in the work “Strategy of economic reforms of the Republic of Kazakhstan”, which was published around the same time, totally different figures are given – 4.6 billion tons of oil! If there are such discrepancies in the assessment of the most important issue for the country, we shouldn’t be surprised by other assessments, such as the opinion, expressed in “Sayasat” journal, that the “voluntary” resignation of Boris Yeltsin was caused by the fact that “he couldn’t defend the interests of his country in the Caspian region”. Thinking logically, the author of the article meant that Russia lost so much on dividing the fantastic riches of the Caspian Sea with other countries bordering the sea, and the loss was so fatal for Russia, that Yeltsin had to commit a political hara-kiri By the way, when the “Sayasat” journal published the expert’s opinion, the majority of people thought that oil extraction from Kashagan would start really soon and it would be significantly large. The opposite opinion was discouraged; for example, the author of these lines) became, unofficially, unwelcome in some of businesses in the oil industry for expressing such doubts. To be fair, we should note that it was not only the experts who were influenced by the mirage of the “oil Klondike” on the shore of the Caspian Sea. Government officials were dictating the mood. In 1996 during the official visit of Kazakhstan’s delegation to the USA, when the conditions for involvement of American companies in the development of the resources on the Caspian shore were discussed, some of our officials easily stated gigantic oil reserves and similarly outstanding profits from the extraction. This happened even before the oil exploration works had started! Maybe that’s when the tradition of expecting quick profits from the “Caspian oil Eldorado” comes from. Here is an example supporting the tradition: in 1997 Nurlan Balgimbaev, the President of “Kazakhoil” at that time, said that “by 2003 the transportation capacities of the existing export oil pipelines will not be enough… Annual extraction by that time may reach 100 million tons… In another 5 – 10 years, we expect to reach the peak of extraction in our Republic – more than 170 million tons of oil per year” (“Panorama”, N24, 1997). After several years he assessed the possible annual oil extraction in the country during 2010 – 2015 at the level of 200 million tons. Similar forecasts were made by many people at that time. That incautious optimism didn’t materialize.

“Kashagan is our everything!”
With a degree of exaggeration, we can say that “Kashagan is our everything!” The exaggeration wouldn’t be very big. The significant role of the oil sector in the economy of our country is known even to schoolchildren; it is also known that during recent decades, there hasn’t been any discoveries of large new oil or gas fields, and the majority of the fields exploited now are old and used up very much. Thus, the resource base of the most important industry of our economy is not in its best form. New technologies that increase the share of oil extracted from a field, more precise exploration of old fields, and the development of such projects as Tengiz and Karachaganak help, but they don’t change the situation fundamentally. Moreover, their peak extraction periods are expected at different times. As reflected in the main development programs of our country, the oil industry is the locomotive of our economy. The resources of the shore look like a salvation, like a chance for a better future. Kashagan is the biggest pearl among the resources. This has become especially true in recent years, as the shine of others, such as Tyub-Karagan, significantly reduced after unsuccessful oil exploration works. That’s why the endless delays in the commencement of development of Kashagan and full-scale oil extraction on the field are serious problems. Under some unfavourable conditions, it could influence the overall economy of the country. Let’s imagine that oil prices decreased. It will decrease the profitability of many of Kazakhstan’s old oil fields and the revenues from exports are also decreasing. Then it would be possible to compensate the price reduction with an increase in sales of oil, even at lower prices (not the best way, but it may be the only way to do under some circumstances). And the increased production could come from the shore; but then we’d have to finally start the extraction.

“Keep on drilling!”
Let’s consider the reasons for delays in the commencement of industrial scale development of Kashagan. There are some explanations given, but they are not very original. The involved parties speak about the unique complexity of the field: water is very deep and the oil is deeper; an abundance of sulfur exists; very high pressure prevails; ice freezing in winter; a broad range of ecological issues… And on top of all this – a poorly developed infrastructure around the field. All of the factors are objective, and Kashagan developers deserve respect for the attention given to the factors. However… There is nothing new among these factors, which are always stated in response to questions about delays in the development. I remember that several years ago an oil company, which was involved in the Kashagan consortium, arranged a trip for a large group of Kazakh journalists to the USA, to the region where the company had been working successfully for many years in conditions similar to those in the north of Caspian Sea. That was the objective of the trip; to show that the modern oil extraction industry can successfully resolve very difficult problems. However, the journalists were also told that there were no two completely similar oil fields in the world, each one has own specifications; but the industry has accumulated an extensive experience. This experience can be used in Kashagan. Now let’s consider an opinion of a Russian expert. While the Americans were optimistic, as they tend to be in general, about the terms and possibilities of developing on shore resources; the Russians are in a mood of reserved pessimism. However, the gist of the opinions is the same. Six years ago Yuri Byaliy, a well-known Russian political scientist, said the following in the interview to the author of these lines: - I expect a whole range of purely technical problems with the oil from Eastern Kazakhstan, even if it is abundant there. Firstly, the conditions of the stormy Caspian shallow waters, which require large amount of investments into the infrastructure and expenses to prevent ecological problems. Secondly, the specifications of the fields, such as high temperature and pressure; they will require additional efforts and costs in building and using the wells… And finally, the oil composition, which includes a high content of sulfur and, possibly, high levels of mercaptan. Such oil cannot be transported in oil pipelines without special treatment at the point of extraction. Thus, there is an issue of de-mercaptation before transit (it implies large costs for huge amounts of equipment, as if the extraction volume is large, it will require equipment plants). Hence, the complicated features of the Kashagan oil field were known to the specialists from the beginning. And it didn’t stop the companies, involved in the consortium, from being interested in working on the field and compete for the rights to operate the project. Maybe that’s the reason for the excessive expectations with respect to the term of commencing the production, which were made public by our officials and experts. However, in the second half of 2002 the consortium asked the government of the Republic to postpone industrial extraction on the field for two years. Continuous delays have taken place since then. It seems that the works on developing Kashagan never stop, but we don’t see any oil yet. Do you remember how Panikovsky and Balaganov were sawing dumb-bells in their search for hidden gold? The situation is somewhat similar. “Keep on drilling!” What is the reason for these enormous delays? In our opinion, the only logical explanation is that the difficulties appeared to be too big. Actually, the comments of the parties involved can be summarized in this way. However, under the risk of being called a dilettante, I would like to ask the following question: is it possible that the combined expertise of the largest oil producing companies in the world wasn’t enough to calculate and foresee the risks and problems earlier? The commencement of the production has been delayed for five years! Let me emphasize once again – the major international oil producing companies are working on Kashagan! Does the oil field appear to be so complicated for the development, that the whole experience gained is not enough? In this case the following question arises: can the field be developed in general with the current level of technology, and what would be the cost of the oil extracted? Maybe the problem is in the disagreement among the consortium members with respect to the required investments, which appeared to be larger than expected? If that is the case, then this is the issue of the degree of interest in developing Kashagan. Now it is time to return back to the notes, which started this article – the forecast of the Russian Ministry of Finance regarding oil prices falling after 2010. That’s when the full scale production from Kashagan is now expected. What if the Russian forecast appears to be true? Will we have any of the high cost oil from Kashagan then, if even the period of very high oil prices didn’t result in anything except new delays? Let me justify the question above with the following. In October 1999 at the KIOGE-99 conference David Varney, Executive Director of British Gas, said the following about the works on the shore: - Because of the costs of transportation to the world market, the total cost of the oil from Central Asia will always be very high. With low oil prices, which may happen again, investments in this region will be unattractive… Note that the expert only mentions one aspect of the cost – transportation. This one factor is already a big problem under unfavorable prices. Yet, there are other costs of oil production. It is most likely that the companies involved in the consortium take into account these factors. Then why does the situation develop so slowly? It seems that there is only a choice of two: intensify the realization of the project or abandon it. The comment of the parties involved on this question is as follows: projects such as Kashagan are long-term projects, and the current price changes can be ignored. Maybe that is true. However, even large companies cannot invest into the project that doesn’t produce the benefits today and will not do it tomorrow. Maybe the day after tomorrow… Or is it producing something? Let me cite again the six year old interview with Mr. Byalov, the Russian political scientist: Discovering oil in Eastern Kazakhstan, of course, is an important event. However, I’d like to warn the government and the people against a premature and groundless euphoria… One shouldn’t forget, first of all, about the risk of a “commercial bluff”, when very optimistic forecasts regarding the newly opened oil fields sharply increase the stock prices of the companies involved in the consortium, hence bringing large profits to the shareholders. Let’s remember that this happened with respect to many oil structures in the shallow waters of Azerbaijan (For example, Karabakh). But all of it finished sadly.

Geography and politics
Suppose that the world energy market will follow the dynamics of recent years within the nearest decade, then there will be no price risk of Kashagan project. There are also political risks. For example, if the dynamic American president decides to use force against Iran. In this case, Tehran is capable of responding by creating problems for American interests in the Caspian Sea. Although there are not only American companies working in Kashsgan, Iran might ignore it in case of a full scale conflict. The issue remains open. Here is another more serious issue. As far as we see today, the oil from Kashagan will be delivered to the world market through the system of oil pipelines Baku – Ceyhan. At least, that what was said to the author by the European company staff member, who was responsible for transportation strategy. Let’s consider the oil pipeline Baku-Ceyhan: Iran, with its well-known attitude towards the pipeline and its main supporter – the USA, is very close. But more importantly, Turkish Kurdistan is also close. In several years, the Americans will leave Iraq and the Kurdish problem will become more topical in the region. This problem is not a peaceful one, and its terms are close to the expected commencement of industrial production from Kashagan.

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