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TO RUEHC/SECSTATE WASHDC IMMEDIATE 4735
INFO RUCNCIS/CIS COLLECTIVE 1253
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RUEHAST/USOFFICE ALMATY 1251

UNCLAS SECTION 01 OF 04 ASTANA 000352 
 
SENSITIVE 
SIPDIS 
 
STATE FOR SCA/CEN, EUR/CARC, EEB/ESC 
STATE PLEASE PASS TO USTDA FOR DAN STEIN 
 
E.O. 12958: N/A 
TAGS: PGOV ECON EPET EINV KZ
SUBJECT:  KAZAKHSTAN:  KMG's IDENOV ENTERTAINS, REVEALS 
 
REF:  (A) 08 ASTANA 2465 (B) ASTANA 0317 (C) 08 ASTANA 2276 
 
ASTANA 00000352  001.3 OF 004 
 
 
¶1.  (U) Sensitive but unclassified.  Not for public Internet. 
 
¶2.  (SBU) SUMMARY:  On February 25, the Ambassador met Maksat 
Idenov, First Vice President of KazMunaiGas (KMG), and the 
government's lead negotiator for all new oil exploration and 
production deals.  Idenov was candid and animated throughout the 
meeting, which was conducted in English and lasted well beyond the 
scheduled time.  He clearly enjoyed the opportunity to confide in 
the Ambassador and shared previously undisclosed details of 
negotiations to explore the N Block, an offshore hydrocarbon-rich 
reservoir in the North Caspian estimated to contain 2 billion 
barrels of recoverable oil.  Idenov said negotiations to expand the 
capacity of the CPC pipeline were moving "very slowly" and said the 
development of KCTS would spur Russia to action and help "jump 
start" CPC expansion.  Idenov was noncommittal on Nabucco and very 
cautious when discussing the possibility of a trans-Caspian 
pipeline.  Idenov also said the government had "already solved" work 
permit issues raised by international oil companies and offered his 
opinion that sulfur is not a "waste product" and thus Tengizchevroil 
should not be fined for producing and storing it.  Idenov was 
critical of former Kashagan operator Agip throughout the meeting and 
asked for the Ambassador's assistance to spread the message to 
companies and government officials alike that "adherence to sound 
business principles is essential to the future development of 
Kazakhstan as a civilized society."  END SUMMARY. 
 
N BLOCK NEGOTIATIONS IN PROGRESS 
 
¶3.  (SBU) Before the meeting began, the Ambassador was escorted to a 
private room in the back of Idenov's spacious office suite on the 
15th floor overlooking construction of the ambitious, and very 
expensive, Khan Shatyr entertainment center.  On the way, he passed 
a crowded table of senior Western advisors preparing KMG for 
negotiations to explore the promising offshore N Block.  Idenov left 
the negotiating table to meet the Ambassador and immediately briefed 
him in candid and colorful terms on the status of the talks. 
 
NATIONAL PRIDE AT STAKE 
 
¶4.  (SBU) Idenov started by saying that ConocoPhillips (Conoco) CEO 
Jim Mulva, Mubadala chairman Sheikh Mohammed Bin Zayed, and 
President Nazarbayev agreed on a 40-year tax and royalty contract 
through 2057, without a tax stabilization clause.  Conoco and 
KazMunaiGas (KMG) would be "joint operators" of the project, with 
Conoco and Mubadala owning 49 percent of the operating company and 
KMG owning a majority stake of 51 percent.  Idenov then immediately 
confided to the Ambassador, "Of course, when we say we'll be joint 
operators, we are only kidding ourselves because we don't have the 
capability to carry that out yet.  But we must say it for matters of 
national pride."  Conoco, Idenov said, will be the "main driver" of 
the project and will supply the necessary exploration technology, 
organizational expertise, business processes, and project 
management. 
 
A PRIVATE LOOK INSIDE THE N BLOCK DEAL 
 
¶5.  (SBU) Idenov then abruptly stood up and left the room, returning 
in a flourish with his personal laptop, which he opened to show the 
Ambassador an internal presentation on the N Block transaction.  As 
he scrolled through the presentation, Idenov paused to underscore 
certain points and answer questions.  He sounded somewhat like a 
real estate agent as he pointed out the size of the N Block (more 
than 8,000 square kilometers, or roughly the size of Japan), and its 
convenient location near both the Central Asia Center gas pipeline 
and the Baku-Tbilisi-Ceyhan oil pipeline.  He also noted that the 
water depth of the Block ranges from 30 to 375 meters and its 
distance from shore ranges from 15 to 90 kilometers.  Idenov said 
KMG has retained an expensive team of world-class business advisors 
including accountants Ernst and Young, financial advisors Barclays 
Capital, energy consultants Gaffney Cline, and the law firm of 
 
ASTANA 00000352  002.3 OF 004 
 
 
Curtis, Mallet-Prevost "not to protect me, but to give me an open, 
sustainable, honest deal." 
 
PREVIOUSLY UNDISCLOSED DETAILS 
 
¶6.  (SBU) As Idenov walked the Ambassador through the presentation, 
he disclosed several details of the N Block deal that were not 
previously known (reftel A).  For example, he said that Conoco will 
pay 50 percent of the $100 million signing bonus when the contract 
is signed and 50 percent in 2010.  He also disclosed that the N 
Block consortium will pay the government a commercial discovery 
bonus based on the quantity of N Block's proven reserves.  If the 
consortium discovers less than 1 billion barrels of oil, the bonus 
will be $1.50 per barrel; if they discover greater than 1 billion 
barrels, the bonus will be $2.50 per barrel.  Idenov showed a bar 
chart showing expected cash flow for the project indicating that 
Conoco and KMG will incur net losses for the first 10 years of the 
project.  The company is not expected to be in the black until 2017 
and will not reach full cost recovery until 2023.  Idenov told the 
Ambassador that the project assumes a price of oil of $70 per 
barrel, with $60 as a break-even point.  "At $40 per barrel," he 
said, "we're not surviving." 
 
REMAINING ISSUES TO RESOLVE 
 
¶7.  (SBU) Idenov was optimistic that the parties would come to 
agreement on the N Block, but he said they are still working to 
resolve three remaining issues: 
 
-- Internal rate of return.  According to the heads of agreement 
signed in Astana by KMG, Conoco, and Mubadala on December 5 (reftel 
A), the project will deliver an internal rate of return (IRR) of 
11.75 percent.  Since that time, however, the government suspended 
its crude export duty, which Conoco calculated would raise the IRR 
to 13 percent.  When Conoco CEO Mulva asked the government to raise 
the IRR for the project to 13 percent, however, Idenov chided Mulva, 
saying, "Jim, I know the HOA is not a binding agreement, but come 
on!  You can't be serious!  You need to negotiate in good faith and 
honor your previous agreement." 
 
-- Environmental safety.  In 1968, according to Idenov, a Soviet 
drilling rig exploring the area around the N Block "fell apart and 
sank."  All agree that the wreck might complicate drilling 
operations, but they have not agreed who will be responsible for 
removing it and who would be liable for any environmental damage it 
may cause.  Conoco wants the government to remove the rig (or at 
least pay for its removal and indemnify them against any future 
liability).  Idenov said he offered to carve out the territory on 
which the rig rests from the N Block acreage, but Conoco balked at 
the suggestion, because, according to Idenov, they "want creamy 
butter on their crunchy bread" (i.e., they want to have their cake 
and eat it too).  Idenov said he offered to compensate Conoco for 
the cost of removing the Soviet rig, if the N Block yields no 
producing wells. 
 
-- Natural gas sales.  Conoco told Idenov that it would like to 
negotiate the price for any associated natural gas sales up front. 
Idenov said the government has offered to sell the project's natural 
gas at the Russia-Kazakhstan border, according to the price 
determined by confidential agreement between KMG and Gazprom, which 
he did not disclose to the Ambassador or, for that matter, to 
ConocoPhillips.  Idenov noted in passing that KMG president 
Kairgeldy Kabyldin will travel to Moscow on February 27 to meet with 
Gazprom CEO Alexei Miller to discuss this, among other issues. 
 
NABUCCO AND THE TRANS-CASPIAN PIPELINE 
 
¶8.  (SBU) When the Ambassador asked about Kazakhstan's interest in 
the Nabucco gas pipeline to Europe, Idenov said he is personally 
very familiar with the project, having studied the possibility of 
exporting Iraqi gas to Europe via Nabucco when he worked as a vice 
president for Shell in the Middle East in 2004-06.  Without 
 
ASTANA 00000352  003.3 OF 004 
 
 
commenting specifically on Kazakhstan's interest in participating in 
Nabucco, Idenov said Kashagan alone contains 140 trillion cubic feet 
of natural gas, implying that Kazakhstan could become a major gas 
exporter in the future.  When asked about the possibility of a 
trans-Caspian gas pipeline, Idenov leaned back in his chair, pointed 
at the ceiling, and said, "That is a question for Zero One," meaning 
President Nazarbayev.  "Only he can answer that question."  Idenov 
added that no work has been done in Kazakhstan on the proposed 
Caspian littoral ("pri-kaspiskii") gas pipeline, saying, "there's no 
feasibility study, no funding, no construction." 
 
A DIRECT LINK BETWEEN CPC AND KCTS 
 
¶9.  (SBU) Idenov told the Ambassador that work on the expansion of 
the Caspian Pipeline Consortium (CPC) pipeline is "slowly moving 
forward."  He said the consortium agreed in December 2008 on the 
basic principles of expansion, but "there is still no agreement on 
money."  (COMMENT:  It was not clear if Idenov was referring to 
funding for the feasibility study, which we understand has been 
approved, or BP's sale of its 6.6 percent stake in the consortium, 
which we understand is still under discussion.  END COMMENT). 
Echoing the comments of Chevron's Jay Johnson (reftel B), Idenov 
drew a direct link between CPC and the Kazakhstan Caspian 
Transportation System (KCTS):  "Until the Russians see a strong move 
on KCTS, CPC will struggle."  Idenov sounded concerned that KCTS was 
"not moving" and said Minister of Energy Sauat Mynbayev had asked 
him to "jump into KCTS" to get things going.  Idenov said that as 
soon as he concludes the N Block negotiations, he will turn his 
attention to KCTS.  "I will start with ExxonMobil," he said, "and 
push them first.  But do you know the real problem with KCTS?  It is 
Chevron, saying, 'We will participate, but if CPC is expanded, we 
will ship our oil through CPC first.'"  Idenov complained that 
Chevron's attitude threatened to jeopardize the entire project, 
since no one will begin construction or modernization of pipeline, 
port, and shipping infrastructure without a firm commitment of 
supply from the major oil producers. 
 
WORK PERMITS "ALREADY SOLVED" 
 
¶10.  (SBU) When asked why Kazakhstan reduced the number of work 
permits issued to foreign workers by half in 2009, Idenov told the 
Ambassador hastily, "That problem has already been solved."  When 
asked to elaborate, he said Pierre Offant, who has been seconded 
from France's Total to be the new managing director of the Kashagan 
consortium, complained that he could not obtain work permits for 
Kashagan employees, so he took Offant to see Minister of Labor 
Berdybek Saparbayev.  According to Idenov, Saparbayev immediately 
agreed to grant work permits to Kashagan employees in the first two 
(skilled labor) categories, but asked that the company show a 
preference for Kazakhstani candidates in the third category, which 
Idenov said comprises mainly truck drivers, crane operators, and 
laborers.  Idenov said other large foreign investors should 
similarly have no difficulty obtaining the necessary work permits. 
"If Jay Johnson has a problem, tell him to come see me and we'll go 
to the Ministry of Labor together and work it out," he said. 
(COMMENT:  Idenov did not seem to appreciate the costs, delays, and 
difficulties associated with resolving work permit issues only on a 
case-by-case basis with the direct intervention of himself and the 
Minister of Labor.  END COMMENT). 
 
SULFUR NOT A WASTE PRODUCT 
 
¶11.  (SBU) Idenov mentioned in passing that in his opinion, sulfur 
is not a "waste product," but a legitimate, marketable commodity 
associated with processing Tengiz crude.  As a result, Idenov said, 
Tengizchevroil should not be fined for storing the sulfur produced 
from the sour gas associated with Tengiz crude.  However, Idenov 
said, "I cannot say this publicly.  I cannot openly contradict my 
government's position.  I must be more discreet.  But I have made 
the point privately in conversations with Energy Minister Mynbayev 
and Deputy Prime Minister Shukevich." 
 
 
ASTANA 00000352  004.3 OF 004 
 
 
A PASSIONATE PLEA FOR GOOD BUSINESS PRACTICES 
 
¶12.  (SBU) As the meeting came to a close, the conversation turned 
to standards of good corporate behavior.  This is obviously an issue 
of deep personal concern to Idenov, who began to rail against 
Western companies operating in Kazakhstan in a way that he said 
violates international business practices.  In particular, Idenov 
singled out Italy's Agip, saying, "I'm very disappointed in them. 
Whatever Agip touches either falls apart or violates basic business 
principles."  At Karachaganak, co-operated by Agip and BG Group, 
Idenov said KMG has already sent one formal notice of dispute and 
plans to send another soon.  In the first case, Idenov said a 
KMG-sponsored audit by KPMG called into question the operator's 
claim to recover $250 million in costs incurred in 2003-2004.  In 
the second instance, KMG plans to ask for an objective, third-party 
assessment of the operator's decision to spend $350 million to 
replace the type of pipelines and metal structures used at the 
field.  "I must send these letters as a matter of principle," he 
said.  "Until we restore good business practices in Kazakhstan, we 
will not be able to develop as a civilized society."  He then added 
ominously, "When companies continually violate good business 
practices, they issue an open invitation to the Dark Side of the 
Force to come in and replace them." 
 
¶13.  (SBU) COMMENT:  Meeting with Maksat Idenov is always both 
entertaining and informative.  During this latest encounter, his 
characteristic candor and dramatic flair were on open display, to 
our pleasure and benefit.  Although he may be a prima donna, Maksat 
is also an astute businessman who has the confidence of President 
Nazarbayev and the authority to make or break billion-dollar deals 
for U.S. companies.  He has high demands and high expectations for 
foreign investors operating in Kazakhstan's oil and gas industry, 
and woe to those who disappoint him.  He also has a keen 
appreciation of Russia's role in Eurasian energy security and is 
willing to poke and prod Russia when it serves Kazakhstan's 
interests, for example, on CPC expansion.  While we do not agree 
with Idenov on everything, we understand and support his insistence 
that international investors conduct business with the highest 
standards of accountability and integrity and will reinforce this 
point in private meetings and public speeches to the diplomatic and 
business communities.  END COMMENT. 
 
HOAGLAND