Middle East Economic Survey
VOL. XLVII
No 32
The North Caspian PSA: Kashagan’s Development
By Julia Nanay
The following is a paper presented by Julia Nanay, Senior Director of Washington-based PFC Energy, at the Kazakhstan Oil and Gas Conference in London on 29 June 2004.
Speaking as an industry analyst about the development of the North Caspian Production-Sharing Agreement’s (PSA’s) Kashagan field has clear drawbacks. It doesn’t give you the insider’s perspective. Often it is left to analysts to interpret difficult subjects that insiders would rather not discuss in public. Progress on the Kashagan field is one of these difficult subjects. This is a massive undertaking, fraught with many technical, political, and geopolitical challenges, as well as internal disagreements and always some new problem. I’ve come to the conclusion after considerable reflection about Kashagan that this is the proverbial elephant that has been cornered but refuses to be caught. It’s a huge project that will show itself to be full of surprises. And while it is likely to yield big rewards, these will be diminished by having to manage a never ending stream of below ground technical risks and above ground political and geopolitical risks. Add to this mix, a project where you have five of the world’s largest oil companies as equal partners, with only one of them as the operator and you have a recipe for constant second-guessing. Confuse this picture with the possibility of taking out one of the private oil company partners and bringing in its place Kazakhstan’s National Oil Company, KMG, and it will stir the pot some more.
Over the last two years at this same conference, the subject of North Caspian Shelf developments was addressed. But this is the first time that we can actually point to significant progress in the Kazakh offshore, with the approval of the initial development plan for the Kashagan area fields. Submitted in December 2002, the development plan was finally given the go-ahead on 25 February 2004. This is indeed the dawning of an exciting era for the North Caspian, where the North Caspian PSA will play out over the next 37 years. Some of us won’t be in the business anymore when this agreement reaches its end so we won’t see the whole saga unfold.
But if the last few years are any indication, it is going to be an interesting three decades ahead.
· Since the PSA was signed in 1997, three companies have dropped out and a fourth is now about to leave.
· Two companies have joined the consortium and two others that wanted to join could not.
· From the first sale of shares in this PSA, when they were valued at $35mn for each 1% by the buyers, today the same shares are valued at $74mn for each 1%. The price has more than doubled in six years.
· Over $2bn has been invested in the PSA through 2003.
· By 2008, $10bn will have been invested.
· First production which was once foreseen to materialize in 2005 has been pushed back to 2008, and the initial volume estimates are a conservative 75,000 b/d.
The delay in first production:
· Provides the time to create the necessary infrastructure in the Caspian Sea for more efficient and environmentally sound drilling to be carried out at a more measured and well planned pace than if production had been forced to begin earlier.
· Allows the $8bn in spending which is required to achieve early production to be spread out over more years, facilitating more efficient development.
· Provides time so that the periods of exploration and appraisal drilling don’t have to overlap.
· Could provide extra time – beyond 24 April 2004 as stipulated in the PSA – for wrapping up the exploration phase. Six years of exploration have been completed now, and a report has been sent to KMG detailing which exploration blocks will be considered for further development. So far the size of reserves in only one field, Kashagan, has been decided and the reserves in Aktote, Kairan and Kalamkas are still to be revealed. If the end to the exploration phase is delayed, it would put off the immediate need to finance new appraisal wells. The drilling of each well in the North Caspian PSA costs over $100mn, making these among the most expensive in the industry. So long as production is not further delayed, trimming immediate expenses and spreading costs over a longer period makes the project economics look better. The PSA repeats the phrase “the consortium must exercise all reasonable efforts to achieve their goals” dozens of times, and the partners seem to have successfully argued their case in order to achieve delays.
The development plan irons out many of the differences between the government and the consortium partners over costly gas utilization and sulfur disposal schemes. When the final development plan was adopted on 25 February 2004:
· The government annulled the 23 April 2003 order which imposed a 16% VAT on the consortium and its contractors for imported services and goods. The VAT is now back down to 0%.
· Imposed a $50mn annual fine for every year that production is delayed beyond 2005 ($150mn if production begins in 2008).
· Nixed the immediate need to build a $4bn gas processing plant by approving plans to re-inject most of the gas – though this plant will eventually be built.
Let me then discuss what I see as some of the important elements and challenges of Kashagan’s development plan.
Addressing Environmental Concerns
· Constructing artificial islands:
ü Given the fragile ecosystem, introducing artificial islands must be done with care.
ü At the same time, drilling from artificial islands that are now in place has improved performance. Drilling the first well at Kashagan from the Sunkar floating rig led to the delays in the project which pushed back first production.
ü Artificial islands are being used to conduct drilling, and will also be used to collect and store oil and for the initial separation of oil and gas.
· Shallow Waters of North Caspian – oil is under a thick salt dome which requires the drilling of deep subsalt wells:
ü While the wells are drilled in waters of 1.5-10ms (average depth of the North Caspian is 3.3ms), the drilling can reach up to 6,000ms below the seabed (average drilling depth is 4,300ms) and through a salt layer.
ü No water depth to disperse oil spills.
· Fluctuating Sea Levels:
ü Seasonal changes impact drilling and supply operations while changes in the sea level can be more permanent and unpredictable – also affecting operations.
ü One day in June 2001, the water level around the Sunkar rig dropped by 1ms making it difficult for supply boats not to run aground.
ü Given the shallow sloping gradient of the seabed, water levels can change by 1ms every 10km.
ü Water levels change the coastline temporarily moving it up to 30km inland or 10km offshore.
ü High winds also contribute to the changing sea levels.
· Ice hazard four-to-five months of the year:
ü Drifting ice chunks/water freezes over, means slowdown in work late November until late March.
· Poisonous hydrogen sulfide gases:
ü Must regulate oil discharge and the discharge of poisonous sulfide gas – sulfur (H2S) content of the gas is 16-18%.
· Sulfur disposal (separation, storage and marketing):
ü Needs to be disposed of in costly enclosed or underground onshore storage areas, or industrial uses must be found (road gravel, fertilizer industry, chemical industry, other).
Addressing Technological And Technical Challenges
· Large proportion of poisonous hydrogen sulfide gas to be reinjected into high pressure reservoirs offshore (this process is being used onshore in Karachaganak and Tengiz).
ü Each compressor unit will be designed to handle 2.2 BCM/year, with 800 bars of pressure, 16-18% of H2S content but this will be offshore in a fragile ecosystem – technical challenges will be more difficult than onshore.
Development will be by Phases
· 2008 – Production reaches 75,000 b/d.
· 2010 – Production reaches 450,000 b/d.
· 2013 – Production reaches 900,000 b/d.
· 2016 – Production reaches 1.2mn b/d.
And will need to be matched by export route choices
· 2008-13, will rely mainly on Atyrau-Samara and an expanded CPC:
ü Due to AIOC’s needs in Azerbaijan, BTC will be able to accept little Kashagan oil until after 2012.
· By 2013, another major export pipeline will be required but the CPC and BTC experience shows that such a pipeline will take at least 10 years to develop:
ü China?
ü Russia?
ü Iran?
ü BTC or expanded BTC?
Social Investments
· Investments by members of the consortium will be made in schools, hospitals, sports facilities, water supply, electrical systems, and gas distribution and in training of Kazakh staff.
Local Content
· Over 50% of contracts will be to Kazakh contractors.
· Over 80% of workers and employees will be Kazakh.
Current Uncertainty
While the government has reportedly agreed, as part of the negotiations leading up to the final development plan, not to burden the North Caspian PSA partners with any more direct financial demands, the introduction of state company KMG as the potential buyer of BG’s already pre-empted 16.67% stake in the North Caspian PSA, creates new uncertainties for the project’s immediate progress. For starters, BG announced that it had two Chinese companies as buyers for its share in March 2003. The consortium partners exercised their pre-emption rights in May 2003, nullifying the Chinese entry. More than a year later, BG’s share distribution to the other consortium partners has not been approved by the government. BG has still not been paid and now state company KMG has decided that it wants to pre-empt the pre-empters and buy the stake for itself. Negotiations will occur this week on this issue – ironing out the details of how much to pay, in what form to pay it, in what timeframe to pay it and not to mention, the question of KMG’s funding of its share of the development costs. Just when the North Caspian PSA partners had thought they could move forward with no more “administrative and political” problems, a new stumbling block emerges. This may portend the future of the North Caspian PSA, where the partners have to be prepared for constant surprises, unexpected delays and new costs.