The Kashagan oil field in the Caspian Sea is a largely known oil field outside the Middle East and the fifth largest oil field in the world regarding the reserves. Discovered in 2000, it is the largest new oil deposit found in the last 30 years. Kashagan has potential reserves as high as 70 billion barrels with recoverable reserves estimated at 7-13 billion barrels of crude oil. The Caspian offshore oil field would have become the pillar of Kazakhstan’s energy industry joining the pair of onshore hydrocarbon producing giants, namely, the Tengiz oil field and the Karachaganak gas field. It was planned that the initial production from the super-giant field commenced startup at 26,000 barrels per day (bpd) and in two-year period hit 370,000 bpd with a further increase to about 1.5 million bpd in future years. The average oil production in Kazakhstan in the first half of 2015 was 1.63 million bpd, indicating a growth of 20,000 bpd over the same period in 2014. According to the OPEC’s forecasts, oil production in Kazakhstan will decline to average 1.57 million barrels per day in 2016.
However, the project is becoming a burden rather than a benefit for its participants. The Kashagan project has rather unusual adverse operating environment and complexity, namely, both the high levels of highly toxic and corrosive hydrogen sulfide in the Kashagan reservoir, which is under very high pressure over 770 pounds per square inch. Dealing with mentioned issues caused significant cost overruns and delays in the oil commercial production, which discouraged project member-companies, particularly, the ConocoPhillips, which opted out in 2013.
At the same time, mentioned problems gave an opportunity to KazMunaiGas to renegotiate the Production Sharing Agreement (PSA), which was signed in 2001. Citing environmental concerns and cost overruns the KazMunaiGas managed to get a compensation for lost profits as high as $5 billion and increased its share in the Kashagan project from 8.33% to 16.81% because of its foreign partners surrendering 2% of their stake. As a result, Kazakhstan could finally have the fair distribution of revenues over the Kashagan project.
However, redistributing shares resulted in additional financial risks for the Kazakhstani authorities. For instance, the financial responsibilities of KazMunaiGas for the implementation of the Kashagan project have significantly increased. The financial burden that fell on KazMunaiGas’s budget could become unbearable in the middle term, especially, in case if the company would not find the possibility to reduce the net consolidated debt totaled $19.7 billion in 2014, $2.2 billion of which should be provided for consolidated financial statements related to the Kashagan project.
Despite these facts, the international experts strongly believe that KazMunaiGas could deal with aforementioned issues because it is the state giant oil and gas producer in the country. Currently, the Fitch Ratings affirmed both the company’s long-term foreign currency Issuer Default rating and Finance Sub B.V.’s foreign currency senior unsecured rating at “BBB” with a stable outlook. According to the forecast, the Kazakhstani Government will continue to support the National Company KazMunaiGas providing the company with the debt reduction plan. For instance, there is a possibility that in order to cut the current debt service fees thereby improving total liquidity KazMunaiGas will sell a 50% stake in KMG Kashagan B.V. to State Fund Samruk-Kazyna for $4.7 billion. Actually, this transaction could support financially company’s current liabilities under the planned capital expenditure program. KazMunaiGas announced about its intention to sell half of KMG Kashagan B.V. to Samruk-Kazyna at the beginning of July 2015. According to the information of the Kazakhstan Stock Exchange, the deal is planned to be over by the end of 2015. It was also announced that Samruk-Kazyna would be able to buy the whole stock or same stake of shares in KMG Kashagan B.V between January 1, 2018, and December 31, 2020.
It is obvious that even if the transaction is made, this will not change the situation over the distribution of the shares in the Kashagan project, particularly, Kazakhstani side will still hold 16.8% stake of shares. However, the deal will result in the equal sharing of financial responsibilities of KazMunaiGas and Samruk-Kazyna over the Kashagan project. Therefore, the mentioned deal could be considered in different perspectives. On the one hand, it could really establish the background for KazMunaiGas’s debt relief. Thus, it seems logical to find an additional source of financing of investments in order to improve its financial profile in the middle term. On another hand, due to the fact that Kazakhstan’s economic growth slowed sharply in 2015, KazMunaiGas could search for the investment opportunities outside the country.
For instance, there is at least one investor betting that the Kashagan project will fulfill its potential, namely, state-owned China National Petroleum Corporation (CNCP). Moreover, in 2013 KazMunaiGas resold ConocoPhillips’ 8.33% stake in the project to CNCP for $5.5 billion. The deal was just one of 22 agreements, amounting to $30 billion, made between Kazakhstan and China during Chinese President Xi Jinping’s state visit on September 7, 2013. Currently, the Kashagan field is being developed by a group of partners including Shell (16.81%), Exxon Mobil (16.81%), Total (16.81%), CNPC (8.33%), KazMunaiGas (16.81%), INPEX (7.56%) and AgipKCO (Eni) (16.81%), which is responsible for phase I of the field’s development, while Shell is responsible for production operations.
As it was already mentioned earlier, the partners are suffering from the constant increasing of the project’s costs. The cost estimate for phase I was increased to $46 billion in January 2012, from the original estimate of $ 24 billion. Therefore, despite the fact that the world’s largest oil companies together with KazMunaiGas have been spent over $50 billion in investment the Caspian Sea-based project is still not working. Under these circumstances, the most important question to ask is: Will the Kashagan project be profitable at the low oil prices so the development costs of the companies could be recovered?
Since the Kashagan oil is very sulfurous and requires additional cleaning, the cost of its production would be much higher than the average cost of oil production in Kazakhstan, which stood at around $50 per barrel. Therefore, it is already clear that the production will be unprofitable at the level of $50-$60 per barrel. However, over last few weeks, the price for Brent crude oil was below $50 per barrel and there are no signs of supply cuts among the OPEC members, which could help to stabilize the international oil market. Of course it hard to predict the oil price even in the middle term. So experts have a different point of view about the oil prices for 2017 when the Kashagan field will be put into operation. Actually, it is even more problematic to forecast the oil prices for the period when the Kashagan field will enter into phase II of its development.
It was planned that the full-scale production phase at the Kashagan field would have been started in 2020. However, because of the constant delays the mentioned date should be reconsidered. Since the latest delay was the result of the leaks found in the gas pipeline, the oil extraction at the Kashagan field could be restarted only after replacement of two 95-kilometer gas pipelines. Actually, the whole Kashagan operation was shut down on September 11, 2013. The leaks that shut down the production were caused by stress fractures, in turn, caused by high concentrations of toxic, metal-eating hydrogen sulphide in the oil. The replacement works which were estimated at $1.8 billion are planned to be completed in December 2016.
The profitability of Kashagan oil field could be correctly assessed not earlier than in 2017. According to the previous prognoses made by the Ministry of Energy of Kazakhstan, the country should have been increased oil production to 742 million barrel (104 million tons) by 2020. However, due to the low oil prices, oil production is decreasing in Kazakhstan. Namely, Kazakh oil production was set to total around 568 million barrels (79.5 million tons) in 2015 compared to 577 million barrels (80.8 million tons) in 2014. The First Deputy Minister of Energy, Uzakbay Karabalin, has already warned that production could drop to 550 million barrels (77 million tons) in 2016 if price drops continue. Therefore, the decrease in oil prices has a dramatic influence over Kazakhstan’s energy industry in general, and over the Kashagan project in particular.
Unfortunately, there is still a high possibility of emerging unexpected problems, which could cause the further delays or even closing down the project temporarily. Moreover, it may become an “unreachable” dream for its members. Therefore, it should be highlighted that the moment of truth for the Kashagan project will come in 2017 when the project operator will launch commercial oil production at the field.