VZCZCXRO7845
PP RUEHAST RUEHBI RUEHCI RUEHLH RUEHLN RUEHPW RUEHVK RUEHYG
DE RUEHTA #1271/01 1980437
ZNR UUUUU ZZH
P 160437Z JUL 08
FM AMEMBASSY ASTANA
TO RUEHBS/USEU BRUSSELS PRIORITY
INFO RUEHC/SECSTATE WASHDC PRIORITY 2751
RUCNCIS/CIS COLLECTIVE 0559
RUCNCLS/SOUTH AND CENTRAL ASIA COLLECTIVE

UNCLAS SECTION 01 OF 03 ASTANA 001271 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EPET ECON PGOV PREL KZ
 
SUBJECT: SCENESETTER FOR SPECIAL ENVOY BOYDEN GRAY'S JULY 22-23 
VISIT TO KAZAKHSTAN 
 
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Summary 
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¶1. (SBU) Your visit to Astana will acquaint you more intimately with 
the dynamic developments in Kazakhstan's energy sector.  U.S. and 
Kazakhstani strategic interests are essentially aligned regarding 
Kazakhstan's vast energy resources.  The Kazakhstanis agree with us 
that U.S. and Western companies must continue to play a leading role 
in Kazakhstan's energy exploration and development.  The 
Kazakhstanis also recognize that expanding and diversifying 
transport routes will best enable them to capture the maximum 
benefits of their energy wealth.  Kazakhstan's importance as an 
energy supplier is poised to grow dramatically in the coming years 
as new projects, notably the Kashagan field, commence production and 
existing ones expand.  Crude is the focus for now, with much of the 
available natural gas reinjected to maximize crude output.  With the 
January signing of an MOU on revised terms for the Kashagan 
contract, Kazakhstan and the international oil companies are seeking 
to further enhance their cooperation.  Kazakhstan's growing success 
on the upstream side is leading to greater attention to keeping the 
mid-stream on track, i.e., to ensuring adequate transport routes for 
bringing increased volumes to market.  Near-term crude production 
increases are likely to flow by rail through Russia, by tanker 
across the Caspian to Baku, and through the CPC pipeline, should it 
be expanded.  A trans-Caspian oil pipeline would appear to be the 
most attractive option to handle later production increases. 
Privately, the Kazakhstanis agree and have quietly begun planning. 
However, the public line continues to call for an agreement on 
delimiting the Caspian before constructing such a pipeline.  End 
Summary. 
 
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An Emerging Energy Power 
------------------------ 
 
¶2. (SBU) Kazakhstan exported just over 60 million tons of crude oil 
in 2007 and is expected to be one of the world's top ten oil 
producers soon after 2015.  The country also has significant natural 
gas reserves -- 1.8 trillion cubic meters is a low-end estimate -- 
but for now, natural gas exports are relatively small, just 10.2 
billion cubic meters in 2007, in large part because gas is being 
reinjected to maximize crude output.  U.S. companies have 
significant ownership stakes in Kazakhstan's three largest oil and 
gas projects:  Kashagan, Tengiz, and Karachaganak. 
 
¶3. (SBU) Kashagan was the largest oil field discovery since Alaska's 
North Slope and is perhaps the world's most technically complex oil 
development project.  In January, the Kazakhstani government and the 
Kashagan consortium's international partners signed an MOU on 
revised terms for the Kashagan contract, which include a new 
operatorship model, up to $5 billion in financial compensation to 
Kazakhstan for several years of production delays and significant 
cost overruns, and an increased ownership stake and management role 
for Kazakhstan's state oil and gas company, KazMunaiGas (KMG). 
Under the new terms, ExxonMobil, Shell, and Total are expected to be 
co-operators, each with a specific area of responsibility.  The role 
of Eni, the original sole operator, is being dramatically reduced; 
it will complete phase one development and perhaps manage phase two 
onshore activity.   Efforts to turn the January MOU into a detailed, 
formal agreement have not yet succeeded, though in June additional 
MOUs were signed postponing first crude production from 2011 to 
2013, and reconfirming a fixed tax regime for the project.  In any 
event, the January deal appears to have paved the way for further 
cooperation between Kazakhstan and the international oil companies 
on new projects, with ExxonMobil, ConocoPhillips, and Chevron all 
bullish about their prospects.   Kashagan's current equity 
stakeholders are as follows:  KMG (16.81%), ExxonMobil (16.66%), 
Shell (16.66%), Total (16.66%), Eni (16.66%), ConocoPhillips 
(8.28%), and Inpex (Japan) (8.28%). 
 
¶4. (SBU) Tengiz -- with a 50% Chevron stake, 25% ExxonMobil, 20% 
KMG, and 5% LukArco - is the world's deepest operating "super-giant" 
oil field, with the top of the reservoir at about 12,000 feet deep. 
  With the project's second generation expansion coming on line, 
crude production at Tengiz is increasing this year from 400,000 
barrels per day to 540,000.  A "future growth option" could increase 
production by an additional 60 percent by 2015.  The Tengiz project 
is reportedly Chevron's most valuable asset worldwide -- worth $24 
billion to the company and yielding $2.7 billion in profit for 
Chevron in 2007.   The Tengiz consortium is currently fighting a 
$300 million environmental fine levied for on-site storage of 
several million tons of sulfur.  The consortium maintains that it 
received all the proper permits for sulfur production, and that no 
permits are necessary -- or available -- for continued sulfur 
storage.  A meeting between Chevron CEO Dave O'Reilly and President 
Nazarbayev in June apparently produced an acceptable compromise on 
the fines.  With sulfur prices at record levels, Tengiz is storing 
 
ASTANA 00001271  002 OF 003 
 
 
$4-6 billions worth of sulfur.  Sulfur sales in the first quarter of 
2008 netted $120 million, and the stockpile is now being reduced. 
The major bottleneck is rail transportation capacity. 
 
¶5. (SBU) Karachaganak (with a 32.5% BP Group stake, 32.5% Eni, 20% 
Chevron, and 15% Lukoil) is one of the world's largest oil and gas 
condensate fields.  Karachaganak produced 10.4 million tons of oil 
and 12 bcm of gas in 2007. 
 
------------------------- 
Bringing Energy to Market 
------------------------- 
 
¶6. (SBU) With major production increases on the horizon, Kazakhstan 
must develop additional transport routes to bring its crude to 
market.  Currently, the bulk of Kazakhstan's oil is exported via 
Russia, including through the Transneft system and the 
independently-owned Caspian Pipeline Consortium (CPC) pipeline, in 
which Chevron holds a 15% interest.  Near-term crude production 
increases are likely to flow by rail through Russia, by tanker 
across the Caspian Sea to Baku, and through the CPC pipeline, should 
an agreement be reached with Russia on CPC expansion.  The 
Kazakhstani government is focusing its efforts on the 
Kazakhstan-Caspian Transportation System (KCTS), which envisions a 
pipeline (Eskene-Kuryk) moving crude to Kazakhstan's Caspian coast, 
from where it will be transported by a "virtual pipeline" of tankers 
to Baku.  Using large tankers, it might be possible for KCTS to move 
up to 1.8 million barrels per day.  Kazakhstan and Azerbaijan signed 
a general Inter-Governmental Agreement on KCTS in August 2007, but 
the two sides have not yet reached agreement on a more detailed 
document, with the Kazakhstanis claiming that Azerbaijan is 
slow-rolling the process. 
 
¶7. (SBU) A trans-Caspian oil pipeline would appear to be the most 
attractive option to handle production increases expected in the 
longer-term.  Kazakhstani officials agree in private, but in public 
maintain that an agreement on delimitation of the Caspian Sea among 
the five Caspian littoral states is a prerequisite - at least 
politically, if not legally -- for moving forward on such a 
pipeline.  That said, KMG has set up a division to develop 
trans-Caspian pipeline options, purportedly providing $20 million in 
funding for its work. 
 
¶8. (SBU) Moving increased volumes of Kazakhstani oil from Baku 
onward will also be a challenge.  It will require expansion of 
existing pipelines or construction of new ones that run through 
Georgia, such as Baku-Tbilisi-Ceyhan (BTC) and pipelines to the 
Batumi and Supsa on the Black Sea coast. 
 
--- 
Gas 
--- 
 
¶9. (SBU) All indications are that Kazakhstani will only have limited 
gas for export over the short- and mid-run.  Over 90 percent of 
Kazakhstan's current gas exports flow through Russia, though the 
country hopes to export 5 bcm annually to China beginning next year. 
 While the Kazakhstani government appears to favor increased gas 
production, the economics -- together with the geological realities 
-- argue for reinjecting most gas for now in order to maximize crude 
production.  Tengiz last year produced just 4 bcm of gas, with 2.3 
bcm used for domestic consumption and the rest sold to Russia; its 
second generation expansion this year will result in a production 
increase, but to just 7 bcm.  Kashagan will also principally 
reinject once it comes on line.  These low volumes raise doubts 
about the economic viability of, for example, building even a small 
gas pipeline to Turkmenistan that would link up with a trans-Caspian 
gas pipeline.  (One alternative might be swap arrangements that used 
Kazakhstani gas to satisfy Turkmen commitments to Russia, thus 
freeing up additional Turkmen volumes to move across the Caspian.) 
 
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Welcoming to Investment, But More Assertive 
------------------------------------------- 
 
¶10. (SBU) Both the Kazakhstani government and the international 
companies are committed to an enduring relationship, and Kazakhstan 
continues to welcome foreign investment in energy exploration and 
production.  Nonetheless, the country has grown increasingly 
assertive in its energy sector in recent years. Kazakhstan pushed 
hard to renegotiate the existing Kashagan contract (alleging 
contract violations by the consortium), seeking much more onerous 
terms with prospective investors, and aggressively pursuing 
environmental and tax claims against international oil companies. 
(See para 5 above for details on the Tengiz consortium's 
environmental fine.)  In October 2007, President Nazarbayev signed 
legislation which gives the government the right to terminate a 
subsoil use contact if it determines that a company's actions 
 
ASTANA 00001271  003 OF 003 
 
 
violate Kazakhstan's national economic security interests. 
Nazarbayev has stressed publicly that the legislation would be not 
be applied retroactively, against contracts that already existed 
when the legislation went into effect.  The Kazakhstani government 
this May introduced an export duty on crude oil and oil products; 
however, Kashagan, Tengiz, and Karachaganak are exempt from the 
duty, as their contracts specify a fixed tax regime.  The Prime 
Minister has told the Ambassador repeatedly in private that these 
three contracts will have to be ratified by the Parliament in order 
to retain their stabilized tax regimes. 
 
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KazMunaiGas 
----------- 
 
¶11. (SBU) KazMunaiGas (KMG), Kazakhstan's state oil and gas company, 
is a vertically-integrated concern with over 30,000 employees and 25 
subsidiaries responsible for exploration, extraction, processing, 
transportation, and sales.  KMG is responsible for 16% of 
Kazakhstan's crude production and 65% of the country's oil 
transport.  It also controls 30% of Kazakhstan's crude refining 
capacity and 100% of its gas trunk pipelines.  In 2007, KMG became 
the sole owner of Georgia's Batumi oil terminal and purchased a 
controlling stake in Rompetrol, which owns two refineries in Romania 
and several hundred gas stations throughout Europe.  These 
acquisitions are important elements in Kazakhstan's efforts to 
diversify transport routes and should facilitate movement of 
Kazakhstani oil from the Black Sea onward.  KMG First Vice President 
Maksat Idenov has ambitious plans for restructuring KMG and 
implementing administrative reforms that would make the company more 
manageable, streamlined, and transparent.  In May, KMG President 
Uzakbai Karabalin, who had apparently tried to oust Idenov, was 
dismissed from his post.  Karabalin was replaced by Serik 
Burkitbayev -- a surprise candidate who during 2003-07 headed 
Kazakhstan's Oil and Gas Institute, an engineering, research, and 
design organization. 
 
ORDWAY