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16 December 2016

Kashagan: Islands of misfortune

Who will be profiting from the world’s potentially most lucrative oilfield?

Until recently, launching production at Kazakhstan’s largest oilfield, Kashagan, resembled a classic soap opera: just as the plot seemed to be coming to an end, the scriptwriters would keep finding new twists for the already tiresome story. Nevertheless, the story did come to a logical end – in October, Kashagan finally produced its first oil, which started flowing into pipelines for export. It was previously forecasted that Kashagan’s maximum daily oil output at full capacity would reach 1.5 million barrels per day (i.e. the same as is produced at the Great Burgan field in Kuwait, or twice as much as at Russia’s largest field, Samotlor), which would automatically place Kazakhstan among the top five oil producers in the world (it is currently in the top twenty of “black gold” producers).

The Kashagan field was discovered by Soviet geologists back at the start of the 1990s, and became one of the largest oilfields found during the last forty years. Kashagan is located 80 km from the Kazakh city of Atyrau (formerly Guryev), and the oil extraction company estimated its oil reserves at 35 billion barrels, of which 11 billion are considered recoverable, with accompanying gas reserves of around 1 trillion cubic metres.

Kashagan is currently run by the international consortium North Caspian Operating Company (NCOC), whose shareholders include the Kazakh national company KazMunaiGas and the leading players on the oil market: ENI (the main operator), Total, ExxonMobil, Royal Dutch Shell, CNPC and Inpex. From the very beginning, ConocoPhillips was also involved in the project, but later sold its share to KazMunaiGas, which resold it to the Chinese CNPC for 5 billion dollars.

Four artificial islands for oil extraction were constructed in Kashagan, which required the installation of 55,000 piles in the Caspian seabed. To process the extracted crude oil, the Bolashak refinery was built 30 kilometres from Atyrau, and an oil-sludge processing plant was opened in the port of Bautino.

After a series of delays due, amongst other things, to re-building the accommodation facilities for the oilfield’s permanent staff, the consortium members agreed in 2008 that oil extraction would begin in 2013 (previously, the first oil had been expected in 2005, 2008 and 2011). Kashagan, indeed, produced its first barrels as planned. A few days after the extraction operations began, Moody’s agency updated Kazakhstan’s outlook from “stable” to “positive”, and the Fitch Ratings stated that Kashagan’s development would facilitate renewed economic growth in Kazakhstan.

The euphoria in Astana did not last for long, however. Two weeks later, it became apparent that the oilmen had failed to take into the account all of the oilfield’s complexities – regular gas leaks from the pipelines started to occur, caused, it was later reported, by poor-quality welding and high levels of hydrogen sulphide in the crude oil. As a result, a couple of hundred kilometres of pipes needed to be replaced, oil production was suspended for another three years, and the Kazakh government imposed a multi-million fine on the NCOC consortium for damaging the region’s environment.

Kashagan has now been brought online again, but in a completely different reality. While after the 2013 fiasco many Western media were wondering whether the oilfield was capable of recovering its investment costs, today, when oil prices have fallen almost three times and OPEC is considering cutting oil production, the profitability of the largest oilfield on post-Soviet territory has become even more dubious. What is more, Kashagan’s initial development costs have grown from 57 to almost 180 billion dollars over the past 20 years, making it pretty much the most expensive oil project in the world.

Nevertheless, Kazakhstan itself does not intend to give up on its projected oil-production volumes. “Limiting oil production at Kashagan is completely out of the question. Since there are commitments and significant investments, nobody will be limiting it”, the Kazakh Minister of Energy, Kanat Bozumbaev, clarified. At the same time, KazMunaiGas representatives claimed last year that the oilfield could only be profitable if oil prices were in the region of 100 dollars per barrel – but the price today is at least half of that.

No matter what dividends Kashagan brings its investors, launching production at such a large oilfield will inevitably affect the entire crude market and all its participants. After Kashagan was brought online, OPEC (of which Kazakhstan is not a member) had to review its September forecast that world oil production would fall by 150,000 barrels a day. Now it believes that oil production in non-OPEC countries will increase by 200,000 barrels a day in 2017.

Simultaneously, Merrill Lynch’s analysts have named Kashagan as one of three factors (together with increasing oil production in Libya and Nigeria) which could hamper price growth for this type of fuel next year. The bank’s experts assessed the ENI’s plans to achieve a daily oil output of 230,000 barrels at Kashagan by the end of 2016 as “challenging”.

As to the destination for Kashagan’s oil, when the Chinese CNPC replaced ConocoPhillips as a shareholder, it was thought that production would be redirected towards the Chinese market, especially since Kazakhstan has been actively building pipelines in that direction lately. But the position of the European stakeholders is currently stronger and, as expected, the first oil from Kashagan went to Europe – what is more, via Russian territory. This situation is unlikely to please Azerbaijan, which counted on using the Baku–Tbilisi–Ceyhan pipeline. It was with Kashagan in mind that the so-called Kazakhstan Caspian Transportation System was created, which included the Eskene–Kuryk pipeline, terminals on both sides of the Caspian Sea, and a whole fleet of tankers. Before Kashagan began operating, Baku and Astana’s energy ministries had managed to discuss future oil routes in the context of setting up “a diversified exports system and new China-oriented energy projects” in Kazakhstan.

At the end of October, Russia also launched production at a new Northern Caspian oilfield (named after Vladimir Filanovsky) operated by Lukoil. Apparently, until Kashagan reaches its full capacity (according to the former NCOC managing director Stephane de Mahieu’s forecast, daily oil output from Kashagan could reach 370,000 barrels by the end of 2017), its crude oil together with Russian oil will be pumped into the Tengiz–Novorossiysk pipeline, which is managed by the Caspian Pipeline Consortium. Part of the oil will most likely go via the Atyrau–Samara pipeline and, from there, to the port of Ust-Luga in the Baltic Sea.

For the time being, the Trans-Caspian Oil Transport System and Kashagan will be developing in parallel. But when oil production starts to increase, their paths will cross, and part of the Karshagan oil is expected to go to China, as it is the most promising market for neighbouring Kazakhstan. Hence, the current main oil suppliers to China (among which Saudi Arabia and Russia are the leaders) will have to make room for a new one. They have already been experiencing increased competition from African countries, especially Angola, which in July this year overtook both leaders by the volume of its supplies to China, but Kazakhstan’s advantage over Africa is obvious in logistical terms. It is possible that, in the best-case scenario for Kazakhstan, in the near future, Kashagan oil could well interfere with Igor Sechin and his Rosneft’s Napoleonic plans for China. It is no coincidence that Kashagan’s opening was welcomed by Washington’s statement that, even with low oil prices, Kazakhstan should be developing such oilfields in order to support the world’s energy security.

Kashagan is seen as directly beneficial not only by Northern Caspian oil producers and consumers, but also by those who are interested in preventing the growth of prices for such commodities. But for Russia – which is unwilling (and unable) to break its “hydrocarbon addiction” – further successes by Kazakh oilmen only threaten future losses. As long as Nursultan Nazarbaev remains in power in Kazakhstan, Astana’s independent energy policy is unlikely to provoke the Russian Federation into making any sudden moves against its southern neighbour. However, there is no guarantee that experts will not be forced to return to discussing the “Ukrainian scenario” once he is gone.

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