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DE RUEHTA #0060/01 0220931
ZNR UUUUU ZZH
O 220931Z JAN 10
FM AMEMBASSY ASTANA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 7241
INFO RUCNCIS/CIS COLLECTIVE 2381
RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEHBJ/AMEMBASSY BEIJING 1743
RUEHKO/AMEMBASSY TOKYO 2449
RUEHUL/AMEMBASSY SEOUL 1359
RHMFISS/DEPT OF ENERGY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEAIIA/CIA WASHDC
RHEFAAA/DIA WASHDC
RHEHNSC/NSC WASHDC 1939
RUEKJCS/SECDEF WASHDC 1789
RUEKJCS/JOINT STAFF WASHDC
RHMFIUU/CDR USCENTCOM MACDILL AFB FL
RUEHAST/AMCONSUL ALMATY 2205

UNCLAS SECTION 01 OF 04 ASTANA 000060 
 
SENSITIVE 
SIPDIS 
 
STATE FOR SCA/CEN, EEB/ESC, S/EEE, S/CIEA 
STATE PLEASE PASS TO USTDA 
 
E.O. 12958: N/A 
TAGS: PGOV PREL ECON EINV EPET SOCI RS KZ
SUBJECT:  KAZAKHSTAN:  BEHIND THE SCENES OF KARACHAGANAK AND 
KASHAGAN 
 
REF: (A) 08 ASTANA 2449 
     (B) 08 ASTANA 1646 
     (C) 09 ASTANA 0041 
     (D) 09 ASTANA 0352 
 
ASTANA 00000060  001.3 OF 004 
 
 
¶1.  (U) Sensitive but unclassified.  Not for public Internet. 
 
¶2.  (SBU) SUMMARY:  For more than 90 minutes on January 20, Maksat 
Idenov, First Vice President of national oil company KazMunaiGas 
(KMG), briefed the Ambassador on the ongoing dispute between 
shareholders in the Karachaganak Petroleum Operating Company (KPO) 
and KMG.  In September 2009, KPO filed a claim at an international 
arbitration court in Stockholm for $1.4 billion for reimbursement of 
crude export duty payments.  Speaking without notes -- but with 
passion and conviction -- Idenov argued the government's case that 
KPO has not provided sufficient justification or supporting 
documentation for major expenditures since 2003.  He said the 
government has filed a counter-claim for $3 billion.  Unable to 
reach agreement at the level of corporate senior executive vice 
president, Idenov stated that the parties have begun talks at the 
level of corporate CEO.  The case is scheduled to go to arbitration 
on March 21.  Idenov also summarized budget negotiations for the 
massive, $150 billion Kashagan oil-exploration project.  In both 
cases, Idenov underlined that he only is asking international 
companies to follow fundamental principles of good business 
management.  END SUMMARY. 
 
BACKGROUND ON KARACHAGANAK 
 
¶3.  (U) KPO comprises Britain's BG Group (32.5%), Italy's ENI 
(32.5%), Chevron (20%), and Russia's Lukoil (15%).  One of the 
largest oil and gas condensate fields in the world, with reserves 
estimated at 1.2 billion tons of oil and 1.34 trillion cubic meters 
of gas, it is the only significant oil exploration project in 
Kazakhstan in which KMG does not have an equity stake (ref A). 
 
¶4.  (U) On September 18, 2009, Bloomberg reported that BG Group, as 
the lead operator, initiated arbitration proceedings to seek 
reimbursement of $1 billion for oil export customs duty payments 
made from June 2008-January 26, 2009, when the government lowered 
the crude export duty to zero (ref B).  On December 29, 2009, Prime 
Minister Karim Masimov told reporters that Kazakhstan wants to join 
the Karachaganak project as an equity partner, reportedly with a 10% 
stake.  (NOTE:  According to Idenov, the consortium claims $1.4 
billion while the government had filed a counter-claim for more than 
$3 billion.  When asked to comment on reports that KMG has requested 
10% of KPO, Idenov confirmed Masimov's statement, but concluded, 
"You never know how an arbitration case will play out."  END NOTE). 
 
 
IDENOV IN THE LEAD 
 
¶5.  (SBU) Contrary to reports from ExxonMobil, which is not a member 
of the KPO consortium, Idenov has retained the Karachangank 
portfolio and is the government's lead negotiator on the dispute 
(ref C).  He told the Ambassador that he met in London on January 11 
with executive vice presidents from the KPO shareholders, but they 
were unable to reach an accord.  As a result, Idenov said he will 
appeal to the companies' CEOs in an attempt to resolve the dispute. 
He implied that both sides are working in good faith to reach a 
negotiated settlement before the case goes to an international 
arbitration court in Stockholm on March 21. 
 
SHOW ME THE RECEIPTS 
 
¶6.  (SBU) Idenov told the Ambassador that KPO has submitted requests 
for reimbursement of hundreds of millions of dollars in expenses 
from 2003-2008, without proper justification or supporting 
documentation.  Launching into his brief, he jumped to a white board 
and began to make his case in graphic detail without the aid of 
notes.  According to Idenov, KMG retained the audit firm KPMG to 
 
ASTANA 00000060  002.3 OF 004 
 
 
review KPO's 2003-2006 statements and discovered that KMG reimbursed 
KPO for $697 million during that period, without proper supporting 
documentation.  He also asserted that the audit firm Ernst and Young 
reviewed KPO's statements from 2007-2008 and could not justify $347 
million in expenses.  Idenov told the Ambassador that when he 
presented this information to KPO executives, they replied, "All 
right, Maksat, we'll write you a check for that amount and just 
recover those costs later."  Idenov said he refused to do business 
that way, and would pursue the matter further. 
 
HIGH STAKES 
 
¶7.  (SBU) Idenov described in detail several situations dating to 
2002, where -- in his opinion -- KPO management made unwise 
decisions that cost KPO's shareholders dearly.  (NOTE:  Although KMG 
does not own equity in KPO, Idenov considers KMG, as the authorized 
agent of the Republic of Kazakhstan, a shareholder in the project. 
END NOTE.) 
 
-- In 2002, he said that President Nazarbayev attended the 
inauguration of a major new gas processing plant.  "There was a red 
ribbon and big scissors, and smiles all around," he described.  One 
week later, according to Idenov, a gas leak due to poor quality 
welding forced the plant to shut down and evacuate employees.  The 
plant remained idle for one year, "and the shareholders suffered," 
Idenov concluded. 
 
-- Also in 2002, the Atyrau-Bolshoi Shagan pipeline became plugged 
by caustic soda, because KPO pumped unprocessed condensate through 
the pipeline.  Idenov asserted that KPO cut off the damaged segments 
and rebuilt the pipeline at a cost of $600 million. 
 
-- In 2006, KPO's "Train 4," a processing unit that separates gas 
from liquids, was estimated to cost $467 million to build.  Idenov 
said he approved the expenditure, and then was told later that the 
project cost had escalated to more than $1 billion.  "I understand 
that the cost of construction can increase with time," he explained 
, "but give me some justification!" 
 
-- Idenov also mentioned KPO's $192 million purchase of new pipe 
racks for the project, which arrived before the cement foundation 
was laid on the platform.  As a result, the piperacks were stored 
outside, where they were punished by the severe climate of northern 
Kazakhstan, deteriorated, and were rendered useless. 
 
-- In 2006, Idenov said he authorized KPO to spend $478 million for 
the front-end engineering design (FEED) of Phase III expansion 
activities.  Once these funds were spent, he claimed, KPO requested 
another $300 million to fund a new design concept. 
 
-- In 2008, Idenov approved a request for $450 million to procure 
high-technology material (called X-60) that would resist corrosion 
by sour gas.  Later that year, KPO discovered that newer technology 
(called F-22) had come on the market, and requested another $480 
million to acquire the new material, abandoning the previous 
material. 
 
-- In 2009, according to Idenov, KPO submitted an annual budget for 
2010 of $2.1 billion.  Once Idenov reviewed the details, however, he 
said he could only find justificatmw)QQvc.yor executives barely escaped a similar fate.  He 
asserted that BG Group's Peter Drunfield circulated an eight-page 
letter to Masimov and Samruk-Kazyna Deputy Chairman Timur Kulibayev, 
disputing Idenov's claims and asking for their support.  However, 
they refused to respond, and the KPO partners declined to support 
Drunfield, who subsequently left BG Group.  Idenov disclosed that 
 
ASTANA 00000060  003.3 OF 004 
 
 
KMG and KPO are now deep in negotiations on these issues, and 
suggested that he would elevate the discussion to the level of 
corporate CEO.  Idenov admitted that KMG also could provided better 
project oversight, and should have demanded the documents supporting 
KPO's expense claims years earlier. 
 
FIGHTING FOR FUNDAMENTAL PRINCIPLES 
 
¶9.  (SBU) Idenov mentioned complaints by KPO member companies -- 
with the notable exception of Chevron -- that he is causing trouble 
and making unreasonable demands.  "When they ask me, 'What are you 
fighting for?,' I tell them, 'Serve the shareholders honestly, and 
follow five simple business principles:  Quality Decisions; Quality 
Health, Safety, Security and Environment; Quality Technical 
Integrity; Quality Project Management; and -- most importantly -- 
Quality Internal Controls.  This is Kazakhstan's demand to KPO!'" 
(NOTE:  Idenov thanked the Ambassador for his September 28, 2009, 
speech on corporate responsibility to the members of the American 
Chamber of Commerce.  He contended that was the first time any 
Western ambassador has stressed publicly the theme in Kazakhstan. 
"It has made a huge difference," he said, "and will help U.S. 
companies, which set a good example for others."  END NOTE). 
 
AKSAI IN WONDERLAND 
 
¶10.  (SBU) Idenov highlighted KMG's demand that KPO's senior 
management staff move to Astana from London in order to provide 
proper oversight and supervision.  He complained about KPO's 
expenditure of $482 million on salaries and overhead expenses in 
2009, but just $320 million on oil and gas production services. 
"It's like Alice in Wonderland," he exclaimed.  "They're making 
their own rules, just like the White Rabbit.  You can start wherever 
you want, finish wherever you want, but there is one rule: 
everybody gets a prize.  Everybody gets paid." 
 
A DISSENTING VOICE 
 
¶11.  (SBU) In a private meeting on January 20, Alex Verba, chairman 
of Astana Law Partners LLP, strongly disputed the government's 
claims that KPO lacks supporting evidence for cost reimbursement. 
An auditor, Verba was a resident advisor on cost reimbursement 
issues to the Karachaganak project in Aksai from 2000-2005.  He 
argued that the government is trying merely to counterbalance the 
legitimate claim of KPO for reimbursement of illegal crude export 
duties.  Verba claimed that KMG has never done a professional audit 
of the cost-reimbursable claims, and that they lack the expertise to 
do a proper audit.  Verba also alleged that KMG has its own reasons 
for not conducting a full audit.  "Their people were benefitting 
from these subcontracts, and other arrangements, for years," he 
claimed.  Verba predicted that the government would lose its 
arbitration case.  "They haven't won one yet," he underlined. 
 
KASHAGAN'S 2010 BUDGET 
 
¶12.  (SBU) Having finished the litany of charges against 
Karachaganak, Idenov turned to Kashagan.  He highlighted the 
government's significant concern about the project to hook up the 
drilling islands to the onshore processing plant, which is 30% 
behind schedule and well over budget.  The initial tender won, he 
continued, with a bid of $196 million, but current costs have 
reached $443 million.  The original 2010 budget for Kashagan of 
$10.5 billion was reduced to $8.2 billion after careful review by 
KMG (ref C), he stated.  To illustrate, he told the Ambassador that 
the general director of the North Caspian Operating Company (NCOC), 
detailed from Total, is paying $22,000 per month for an apartment in 
Astana, and that other senior corporate executives are paying 
similar amounts.  Idenov said he approved these expenses, but warned 
the executives that the amounts were excessive. 
 
PHASE II UNDER REVIEW 
 
 
ASTANA 00000060  004.3 OF 004 
 
 
¶13.  (SBU) Idenov asserted that he agreed to Kashagan's Phase I 
budget of $38 billion, but has asked the consortium for supporting 
documentation and justification of planned expenditures.  In 
addition, he has not approved the request for $15 billion to fund 
Kashagan's Phase II development ($3.2 billion in 2010, $5 billion in 
2011, and $7 billion in 2012), "because they (Agip/ENI) are 
Italians.  Because they messed up (on Phase I).  Because I don't 
trust them.  They scared all of us with their management of Phase 
I," he explained.  Idenov expressed his preference for Phase II to 
first undergo FEED, which would enable the consortium to develop a 
more accurate and realistic project plan, but the partners 
protested.  According to Idenov, they said, "No!  Give us the $15 
billion and let's go!"  Idenov claimed he merely was trying to 
protect them from the Financial Police, who would likely launch an 
investigation into the project if large investments could not be 
justified.  Idenov also invited the Ambassador to send a 
representative to the next Kashagan budget meeting, claiming he had 
nothing to hide.  He even speculated that the private-sector 
partners would protest this unusual display of transparency. 
 
IDENOV'S FUTURE 
 
¶14.  (SBU) As the meeting came to a close, Idenov indicated that he 
had received job offers from Shell (where he used to be a Vice 
President for Strategic Planning), Agip, and Statoil.  Idenov 
dismissed these offers, saying it was just a way for the companies 
to remove an obstacle in their way.  "I'm not going away that 
easily," he asserted.  "But if the gentleman on the wall 
(Nazarbayev) says we shouldn't follow these five fundamental 
principles, then I will know that times have changed, and I will 
start to consider my options." 
 
¶15.  (SBU) COMMENT:  Maksat Idenov possesses a large and lively 
personality.  He clearly has critics in the government -- witness 
his shrinking portfolio -- and among the international oil 
companies.  However, it is hard to argue with his basic business 
principles, and reasonable to expect that projects as complex, 
costly, and critical as Karachaganak and Kashagan could be managed 
more efficiently.  Nevertheless, we hope that in both cases, the 
parties are able to reach accommodation without resort to legal 
action.  END COMMENT. 
 
HOAGLAND