VZCZCXRO6773
PP RUEHDBU
DE RUEHTA #0116/01 0121204
ZNY CCCCC ZZH
P 121204Z JAN 07
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC PRIORITY 8166
INFO RUCNCIS/CIS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEAIIA/CIA WASHDC
RUEBAAA/DEPT OF ENERGY WASHDC

C O N F I D E N T I A L SECTION 01 OF 04 ASTANA 000116 
 
SIPDIS 
 
NOFORN 
SIPDIS 
 
DEPT FOR EB/ESC; SCA/CEN (O'MARA) 
 
E.O. 12958: DECL: 01/11/2016 
TAGS: ENRG EPET KZ PGOV PREL
SUBJECT: KAZAKHSTAN'S PETROCHEMICAL AMBITIONS: 
FORWARD-THINKING OR FOLLY? 
 
REF: A. 06 ASTANA 737 
 
     ¶B. 06 ASTANA 738 
 
Classified By: Charge d'Affaires Kevin Milas; reasons 1.4 (b) and (d). 
 
¶1. (C) Summary:  The Government of Kazakhstan (GOK) is 
aggressively encouraging foreign investment in a domestic 
petrochemical industry as part of its strategy to diversify 
the economy and to "climb the value chain" of hydrocarbon 
production.  The GOK has authorized a predictable set of tax 
benefits for petrochemical investors, but the largest 
incentive to invest may be the 2005 law governing offshore 
oil contracts, which makes explicit the GOK's intent to favor 
exploration and production bids from companies which commit 
to investing in the petrochemical industry.  Western oil 
company executives are uniformly skeptical of the economics 
of petrochemicals in Kazakhstan, pointing out that the 
country is disadvantaged, especially in comparison with the 
Middle East, in terms of feedstock availability, distance to 
market, and supporting infrastructure.  Numerous potential 
petrochemical projects have been discussed in the media over 
the last year, but the one which appears to be furthest along 
-- a plan to build a $4 billion complex in Atyrau using 
ethane from the Tengiz field -- does, indeed, appear to be 
"uneconomic" and dependent on high-level political will to 
remain on-track.  The 2005 law, along with the growing 
perception that building a petrochemical plant would "please 
the President," creates an interesting dilemma for Western 
oil companies which would prefer to focus on producing and 
transporting crude oil.  End summary. 
 
Outlining the GOK's Vision 
-------------------------- 
 
¶2. (C) The development of a petrochemistry industry is, upon 
first analysis, a logical extension of Kazakhstan's oil 
extraction-based economy, and evidence suggests that the GOK 
has entertained the thought for years.  ConocoPhillips (CP) 
Vice President Bill Berry recently told the Ambassador that 
the GOK had pressured CP to invest in a petrochemical 
facility in 1997, during discussions surrounding CP's entry 
into the super-giant Kashagan project.  The petrochemical 
initiative appears to have first gained official status in 
2003, with the publication of the Republic's "Industrial and 
Innovation Development Strategy for 2003-2015." This document 
singles out petrochemicals as a sector in which Kazakhstan 
has a likely competitive advantage.  (Note: This document, 
which focuses on the development of competitive, 
export-oriented non-raw materials production, is often seen 
as the starting point for Kazakhstan's subsequent "cluster 
theory" approach to economic diversification.  End note.) 
The initiative gained further footing with the 2004 
publication of a six-year plan for developing a Kazakhstani 
petrochemical sector.  The clearest sign that this has become 
a GOK priority, however, are 2005 revisions to the offshore 
oil production law (see para. 7) which made explicit the 
GOK's intent to favor companies in the bidding process which 
pledged to invest in petrochemicals.  President Nazarbayev 
touted the petrochemical industry in his 2004 and 2006 annual 
addresses, but has been relatively low-key in his public 
approach to the issue.  This contrasts, we are told, to his 
private approach in talking to international oil companies -- 
on November 19 CP Country Manager Nick Olds told the 
Ambassador that Nazarbayev had talked to "all the oil 
companies" about investing in petrochemicals. 
 
¶3. (C) While Nazarbayev has not made the connection explicit, 
many observers believe the petrochemical initiative has also 
gained momentum from the President's drive to make Kazakhstan 
one of the fifty "most competitive" nations, and the 
concurrent emphasis on diversifying the economy.  (Comment: 
While petrochemical production would clearly add value to 
Kazakhstan's gas resources, it would, as a 
technology-intensive industry, add relatively few jobs.  End 
comment.)  Shell's Country Chairman, Martin Ferstl (whose 
company advised the GOK on a petrochemical strategy in 2005) 
told Energy Officer recently that he believed Nazarbayev's 
motivations for promoting the industry were driven in part by 
fears that, once Kazakhstan joined the WTO, the country would 
be flooded with Chinese products.  Kazakhstan hoped to export 
petrochemicals to China, Ferstl concluded, in order to help 
balance trade flows. 
 
¶4. (C) In 2005 the state-owned Center for Marketing and 
Analytical Research (CMAR) undertook a feasibility study of 
the industry, contracting with Nexant to produce a detailed 
 
ASTANA 00000116  002 OF 004 
 
 
"Petrochemical Masterplan," the fundamental conclusions of 
which -- that an ethane-based petrochemical complex based in 
Atyrau would have an expected internal rate of return (IRR) 
of 13-16% -- were presented during a November 2005 
petrochemical conference in Astana.  (Note: There was 
widespread skepticism of this IRR figure. Two oil company 
executives whispered to Energy Officer on the margins of the 
conference that Nexant had originally returned a much lower 
IRR -- in the single digits -- only to be told to go back and 
change the study's assumptions.  End note.) 
 
Existing Facilities / Planned Future Facilities 
--------------------------------------------- -- 
 
¶5. (U) In the Soviet era, Kazakhstan's petrochemical 
industries (a polyethylene plant in Aktau, a polypropylene 
plant in Atyrau, a tire-manufacturing plant in Shymkent, and 
a complex of rubber plants in Karaganda) functioned as part 
of a larger Soviet production chain, importing raw materials 
from Russia and distributing the resulting value-added 
products throughout the USSR.  While several of the rubber 
plants have survived since independence by exploiting the 
same interconnections with the Russian market, the Aktau and 
Atyrau plants have struggled.  Both had shut down prior to 
being purchased, in 2004, by "Atoll" -- a Kazakhstani 
joint-venture which, in 2006, joined with Dutch-based Basell 
to become "Kazakhstan Petrochemical Industries" (KPI).  Atoll 
re-tooled the Aktau plant to begin polystyrene production in 
September 2005, using feedstock from Russia and selling the 
resulting plastics inside Kazakhstan (12%), to Russia and the 
CIS (30-40%), and to China (48-58%). 
 
¶6. (C) KPI has not restored polypropylene production at the 
Atyrau facility; this site is now one of several being 
considered as the location for KPI's planned ethane complex 
in Atyrau (par. 10).  The KPI project is merely one of 
numerous new potential projects which have been discussed 
publicly in the past year.  At the November 2005 
petrochemical conference, then-Energy minister Vladimir 
Shkolnik singled out a $3.6 billion KMG / Lukoil gas chemical 
complex planned in Kazakhstan, near the North Caspian border 
with Russia. (Note: This project now seems less likely, with 
Russia reportedly favoring a Russian landing for the offshore 
gas.  End note.)  KMG and Marubeni, a Japanese company, are 
reportedly developing a feasibility study to explore the 
possibility of producing benzene at the Atyrau refinery, for 
use as a feedstock for polystyrene production at the Aktau 
plant. "GS Caltex," a South Korean company, has reportedly 
launched a feasibility study (with KMG) for construction of a 
$1.5 - $3 billion plastics plant.  On December 15, Iranian 
Foreign Minister Mottaki was quoted in the press as 
indicating Iran's interest in building a petrochemical 
complex in Atyrau.  These announced deals and discussions may 
only scratch the surface of active interest: Michael 
Sturdivant, an Almaty-based Deloitte tax advisor, told Energy 
Officer on November 28 that "four or five" companies had 
recently sought Deloitte's advice on possible petrochemical 
investments in Kazakhstan. 
 
Legal and Financial Promotions 
------------------------------ 
 
¶7. (C) Kazakhstan's 2005 law governing offshore oil 
operations (informally, the "Production Sharing Agreement" 
law) formalized the GOK's intent to favor international oil 
companies which invest in petrochemical facilities in 
Kazakhstan.  The law states that, in assigning offshore 
production and exploration rights, the State will favor 
proposals which further the development of "high technology" 
-- of which "petrochemistry" is listed as the highest 
priority.  Prime Minister Akhmetov articulated this 
connection clearly in his keynote speech at the 2005 
petrochemical conference, stating "we will prioritize 
companies who invest in petrochemicals when signing 
exploration and production contracts." 
 
¶8. (C)  ConocoPhillips' (CP) bid to secure Kazakhstan's 
offshore "N" block (Ref A) provides one example of how the 
GOK is implementing this law.  CP related to Post that, 
during CP CEO Jim Mulva's meetings in Astana in May 2006, 
Prime Minister Akhmetov and other officials told Mulva that 
the surest way to win a share of the "N" block was to commit 
to partner with KMG in building a petrochemical facility 
which would utilize "N" block gas.  Akhmetov answered Mulva's 
skepticism about the commercial feasibility of such a project 
by referring to Nexant's finding that an ethane cracker 
 
ASTANA 00000116  003 OF 004 
 
 
complex had an expected IRR of 13-16%. 
 
¶9. (SBU) The GOK has also created tax and other financial 
incentives for petrochemical investment. The 2006 Tax Code 
(Article 119-1) provides a five-year exemption on corporate 
income tax for petrochemical projects established from 
2004-2007 and meeting minimal investment thresholds. (Note: A 
local accountant -- and skeptic of the petrochemical sector 
initiative -- minimized the significance of this article as 
an incentive to investment, pointing out that an exemption on 
corporate income tax has value only if the company has 
taxable profits in the first place.  End note.) 
 
¶10. (SBU) Finally, the GOK has launched a feasibility study 
for the creation of a "National Industrial Petrochemical 
Technopark" in Atyrau, where investors will enjoy the 
benefits of operating in a "special economic zone," including 
exemptions from land and property tax, VAT exemptions on 
service turnover, and exemptions from customs duties on 
imported goods.  (Note: The "technopark" is a key element in 
Kazakhstan's "industrial innovation" strategy -- the 2003 
initiative at diversifying the economy which gave rise to 
Kazakhstan's "cluster" approach to diversification.)  While 
the technopark plans feature prominently in the Atyrau 
oblast's short-term economic development vision, no 
institutions have yet been built. 
 
Atyrau Petrochemical Facility 
----------------------------- 
 
¶11. (C)  The petrochemical project which has received the 
most press, and appears to be furthest along in development, 
is KPI's planned $4 billion ethane-based cracker, an 
associated LPG-based Propane Dehydrogenation Plant, and 
downstream polyethylene and polypropylene facilities, based 
in Atyrau. The project's first stage envisions building a 
cracker utilizing 3 billion cubic meters (bcm) of gas 
annually from the nearby Tengiz oil field, and a second 
complex, further in the future (2013-18), based on gas 
volumes from the Kashagan field. 
 
¶12. (C) The project still appears to face considerable 
hurdles despite much forward-leaning press and clear 
government support. The First Deputy Akim of Atyrau told the 
DCM on November 28 that the oblast based "many hopes on 
petrochemicals," and listed development of a petrochemical 
industry as the oblast's second economic priority, trailing 
only further development of oil and gas production. 
Nevertheless, TengizChevrOil (TCO) General Manager Todd Levy 
recently told DCM (Ref B) that negotiations between KPI and 
TCO for Tengiz gas supplies were proceeding only because 
Nazarbayev had asked Chevron Chairman David O'Reilly to 
support the project.  TCO had agreed to supply KPI with 
below-market gas, Levy said, but even so the project appeared 
to be "uneconomic," and the deal would likely fail without 
additional political intervention. Access Industries (parent 
company of KPI participant Basell) Vice President Paul 
Rodzianko seemed to have reached the same conclusion when, on 
December 7, he asked Energy Officer how the Embassy might 
react to a request from Access to "put some pressure" on TCO 
to conclude a gas deal.  "The project has to happen," 
Rodzianko explained, "because it's important to Nazarbayev." 
 
¶13. (C) Although KPI recently announced signature of an MOU 
concerning "mutual intent to proceed with negotiations over 
gas supplies," with Kashagan operator AGIP KCO, the 
consortium is not factoring gas supplies for a petrochemical 
plant into their project development plans.  Ferstl told 
Energy Officer on December 8 that the GOK had recently 
"seemed to drop" the idea that AGIP KCO should allocate gas 
for a petrochemical plant; for this and other reasons the 
consortium had recently adopted a "full re-injection plan" 
for Kashagan gas.  AGIP KCO's Astana Office Manager, Luka 
Rogoz, confirmed this on December 6, telling Energy Officer 
that "all" of Kashagan's gas would be re-injected, beginning 
six months after first commercial oil production.  As a 
consequence, he continued, Kashagan engineering and 
construction was proceeding on the basis of 100% 
re-injection.  If the GOK came back to the consortium with a 
request to support the petrochemical industry, he concluded, 
"I don't have the faintest idea how we would accommodate the 
request." 
 
Private Sector Skepticism 
------------------------- 
 
 
ASTANA 00000116  004 OF 004 
 
 
¶14. (C) Among local oil company executives, skepticism of the 
GOK's petrochemical ambitions run high. The skeptics 
articulate three primary disadvantages faced by Kazakhstan: 
lack of available feedstock, distance from market, and 
inadequate supporting infrastructure.  To outline the 
argument concerning feedstock: seventy percent of 
Kazakhstan's known gas resides in three fields: Karachaganak, 
Kashagan, and Tengiz.  Karachaganak is reportedly near to 
signing a long-term deal to supply gas to the Orenburg gas 
refinery in Russia which would commit the field's gas 
supplies well into the next decade.  Kashagan partners are 
pursuing full re-injection.  While TCO has lower re-injection 
goals for Tengiz, and the field's high ethane content makes 
it attractive for use in petrochemical production, two 
independent industry studies (by Shell and ExxonMobil) have 
concluded that Tengiz does not have sufficient gas to drive a 
cost-competitive cracker.  Intertwined with the idea of gas 
"availability," of course, is the issue of gas economics: how 
can Kazakhstan's gas -- often highly-sulfurous, and thus 
expensive to process; and associated with oil, and thus 
valuable for raising reservoir pressure for high-value oil -- 
compete with gas from the Middle East which (a) is often 
found separate from oil; (b) is often "stranded" (or isolated 
from market), and thus cannot be monetized on its own; and 
(c) often receives governmental support which lowers the 
price below export parity? 
 
¶15. (C) In terms of infrastructure, the ExxonMobil study 
suggests that the "green field" costs for petrochemical 
development in Kazakhstan are approximately twice that of 
"brown field" costs on the U.S. Gulf Coast -- a difference 
which reflects both significantly higher constructions costs 
in cold and isolated Kazakhstan, and the relative lack of 
surrounding road, port, rail, and electrical infrastructure. 
This lack of infrastructure exacerbates Kazakhstan's third 
major disadvantage, that of geography: thousands of miles 
from either the European or Chinese markets, the country 
suffers a logistical disadvantage in relation to existing or 
potential competitors, especially in the Middle East.  These 
disadvantages add up, in ExxonMobil's detailed study, at 
least, to single-digit returns on investment in 
petrochemical facilities in Kazakhstan.  While the study 
suggests that the GOK can do much to reduce Kazakhstan's 
disadvantages -- primarily by investing in infrastructure -- 
the necessary changes are years, if not decades, away. 
 
¶16. (C) Comment:  There is a clear contradiction between the 
oil companies' calculations that a petrochemical plant in 
Kazakhstan is not economic, and the GOK's evident will that 
one (or more) be built.  The GOK can, to some extent, improve 
project economics even further with tax cuts and, in the long 
term, infrastructure improvements. The 2005 PSA law, of 
course, broadens the relevant economic calculation, 
essentially inviting companies to "write off" a low- (or no-) 
profit petrochemical plant in return for access to a 
potentially lucrative offshore oil field.  And finally, 
pleasing President Nazarbayev carries benefits that cannot be 
captured by purely economic models.  These reasons appear to 
explain the private sector interest expressed so far, and 
will likely, sooner or later, lead to a company taking the 
petrochemical plunge, if adequate supplies of gas can be 
secured.  These investments will likely occur in partnership 
with KMG -- which, as a state-owned company, may have the 
mandate and leeway to undertake "strategic" projects with low 
expected rates of return. End comment. 
MILAS