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    Investor Dispute at Kazakh Field Rages on [Update]

Summary

Kazakhstan risks undermining its investment appeal, which has improved following reforms in subsoil and tax legislation.

by: Joseph Murphy

Posted in:

Natural Gas & LNG News, Asia/Oceania, Premium, Corporate, Litigation, Exploration & Production, Investments, Political, Tax Legislation, News By Country, Kazakhstan

Investor Dispute at Kazakh Field Rages on [Update]

(Adds analyst comment at end)

The investors in the giant Karachaganak gas and condensate project in northwestern Kazakhstan have had their share of difficulties with the government over the years.

By all accounts, the Soviet-era field continues to reward its developers with handsome returns. Shell notably decided to hang on to its 29.5% stake in the project which it acquired through the takeover of BG Group in 2016, despite divesting billions of dollars of the latter’s others assets.

Yet Karachaganak’s international investors, which also include Italy’s Eni, US Chevron and Russia’s Lukoil, have locked horns on several occasions over the years with Kazakh authorities over contract terms. In 2010, for instance, the Karachaganak Petroleum Operating (KPO) consortium was accused of overstating development costs and violating immigration law. The conflict was resolved when KPO agreed to give up a 10% stake in the field to Kazakhstan’s national oil company KazMunayGas (KMG).

The investors are now fighting off a new claim from the government over how profits from production are shared, totalling $1.6bn according to Lukoil. It appeared that this dispute had been resolved late last year. In October, it emerged that the consortium had offered the government $1.1bn in cash, a $1bn loan for infrastructure developments and a greater share of income which Kazakhstan’s energy ministry estimated would bring it an extra $415mn in budget revenues by 2037.

This deal was never finalised, however, and reports suggest the two sides still have quite some way to go before reaching a compromise.

Final arbitration hearings are due to take place next week, Kazakh energy minister Kanat Bozumbayev told Reuters on September 26. “Arbitrators usually take no more than half a year [to reach a verdict]. But maybe we will settle it before that,” the minister said.

More alarmingly, the government is now seeking a $1.1bn payment from KPO on top of the sum agreed last year, Bloomberg cited sources as saying that day.

On one hand, the dispute does not appear to have held back investments at Karachaganak. In September last year, KPO agreed on a $1.1bn plan to remove bottlenecks, enabling an extra 4bn m3/yr of sour gas to be processed, and the recovery of an extra 10mn mt of liquid hydrocarbons during the field’s remaining operating life. This project is slated for commissioning at the end of 2021. And in May this year, the consortium agreed to build a fourth injection compressor unit at an undisclosed cost.

These investments are necessary to help maintain Karachaganak’s production, which has been flagging in recent years. The field yielded 403,300 b/day of liquids in the first half and 9.72bn m3 of gas, down from 425,500 b/day and 9.77bn m3 respectively. Around 45% of gas is typically re-injected into reservoirs, while the rest is exported to Russia where it is processed.

KPO has also discussed with the government the construction of gas processing facilities, enabling Kazakhstan to lock in more value by processing gas domestically rather than selling it to Russia – at what have been very low prices. These various projects have likely been discussed at length in the same closed meetings between investors and the government as the arbitration proceedings.

Broader implications

On the other hand, the prolonged dispute could tarnish Kazakhstan’s image as a place to invest, at a time when it is looking to bolster offshore exploration. KMG sealed a deal with Lukoil on drilling at the Zhenis block in the Caspian Sea in April, and the pair are working to finalise a similar agreement at the I-P-2 area. The company is in exclusive talks with another Karachaganak investor, Eni, on exploring the Abay block, after attracting the Italian major to the nearby Isatay site in late 2017.

Kazakhstan is also negotiating a second-stage expansion at the offshore Kashagan oilfield, whose developers also include Eni and Shell, as well as development of several of its satellites. Kashagan and the surrounding fields are set to drive Kazakh oil production growth over the next decade.

By taking too hard a line at Karachaganak, Kazakhstan could jeopardise some of these other projects, or at least cause delays. Kazakhstan’s investment profile over the years has already been damaged by high-profile disputes, including the infamous wrangling during Kashagan’s development and an ongoing case between Moldovan businessman Anatolie Stati and the government over the expropriation of oilfields in 2010.

The disagreement could also undermine some of the positive steps Kazakhstan has taken recently. The government last year introduced a new subsoil code and implemented tax reforms, in an effort to bring more investment into its oil and gas industry. These steps appear to have been well received given the flurry of recent deals in the Caspian. Lukoil CEO Vagit Alekperov cited the reforms when first voicing the company’s interest in Zhenis.

But not all projects are the same, so not too much can be read into this, said Prism Political Risk Management's director, Kate Mallinson“The latest dispute over Karachaganak is not a bellwether for further disputes in the energy sector in Kazakhstan. Karachaganak is an extremely complex PSA which centres on a profit sharing process based on targets but changing inputs for each non operator. Kazakhstan is urgently seeking FDI owing to rising social expenditure,” she told NGW.