A $30 Billion Hole In Caspian Sea?

A $30 Billion Hole In Caspian Sea?

For more than a decade, the promised bonanza from Kazakhstan's giant offshore Kashagan oil field has been a costly mirage for its developers. And the wait still isn't over.

The companies backing the project -- which include Exxon Mobil Corp., Eni Spa and Royal Dutch Shell PLC -- in March missed the startup date Eni predicted last year. And now, after a decade of work and more than $30 billion in expenses, it isn't clear when one of the world's biggest untapped fields will produce its first drop of oil.

Eni CEO Paolo Scaroni said last month the operators "are going to begin production in June." A spokesman for the North Caspian Operating Company BV, which represents all of the oil companies in the project, says "we are confident that we will deliver oil in the course of this year," though he said he isn't sure when. A person close to KazMunaiGas, or KMG, the Kazakh state oil company that owns close to 20% of Kashagan, said it may be 2014 before significant amounts of oil flow.

Delays beyond Oct. 1 could subject the companies to new financial penalties on top of tens of millions of dollars worth of concessions they have already given the Kazakh government for missing earlier deadlines and cost overruns, according to energy consultancy IHS CERA. Setbacks could also heighten tensions with a frustrated Kazakh government, say several people close to the project -- and will make it difficult for the firms to make more than a marginal profit from their investments.

Kashagan is an example of the challenges energy companies face in a world where the easy oil has already been pumped. To find big new fossil-fuel deposits, companies must look in places that are remote, technically challenging or politically thorny. In Kashagan, cold weather, difficult supply routes and friction with government officials have contributed to the lag time.

A spokesman for the North Caspian Operating Company said the biggest cause of delays is Kashagan's technical complexity and a cautious approach by the companies to avoid problems like oil or gas leaks.

Kashagan's potential upside is enormous, said Laurent Ruseckas, a consultant with IHS CERA who advises companies in Kashagan. Oil is now trading at close to $90 a barrel, and the 370,000 barrels a day Kashagan is projected to produce in its first phase is supposed to triple as companies make further investments.

But technical challenges and strained relationships among the operating companies and with the Kazakh government have made the project "a nightmare for almost 10 years," said Fadel Gheit, an oil-company analyst with Oppenheimer & Co. When production does start, it will largely be in Shell's hands, since a joint venture between Shell and KMG is operating that phase, according to the companies.

Kashagan's challenges were evident from the time big oil companies -- including Eni, Exxon, Shell, Total SA, Statoil PLC, BP PLC and BG Group PLC -- explored the area after the Soviet Union's breakup. Companies signed a production-sharing agreement with the Kazakh government in 1997 that expires in 2041 and allows companies to recover much of their costs before paying a big portion of oil revenue to the government. Of the initial foreign oil-company players, only Eni, Exxon, Total and Shell remain.

Early exploration revealed more than 10 billion recoverable barrels of oil -- along with great challenges. The reservoir is about 12,000 feet below the northeast Caspian Sea floor and mixed with toxic sulfur gas. The sea freezes for several months a year. The north Caspian harbors endemic seals and rare sturgeon.

The companies debated who would take the project's lead, settling on Eni, though it had less experience with giant oil developments than Shell and Exxon. The companies projected first oil in 2005, though Eni soon began pushing back the startup date due to technical problems.

Missteps, cost overruns and controversies have dogged the project. Eni has disclosed in public filings that Italian authorities are investigating whether it has paid bribes in Kazakhstan. An Eni spokeswoman said the company "has zero tolerance towards illegal acts and bribery" and is fully cooperating with the authorities.

In 2003, Saipem SpA -- a company in which Eni owns about 43% -- formed a joint venture with a company co-owned by a former Kazakh deputy energy minister, Nurlan Kapparov. Last year Mr. Kapparov became Kazakhstan's minster of environmental protection.

Oil companies including the Kashagan operators have since 2003 awarded more than $100 million in contracts to the joint venture for projects like building pipe racks and rigs for Kashagan and other Kazakh oil projects.

In an email, the Kazakh Ministry of Environmental Protection said Mr. Kapparov resigned from his management positions at his companywhen he became environment minister, and that his shares are in a trust that Mr. Kapparov doesn't control.

The joint venture "is regularly checked by the Ministry of Environmental Protection, but Minister Kapparov has never taken any role in the review," the ministry said.

The Eni spokeswoman said Saipem "has always been managed at arm's length" from Eni. She said the joint venture received the Kashagan work after a competitive bid process. Saipem declined to comment.

Meanwhile, some partners such as BP, Statoil and BG sold their stakes in Kashagan, as Eni pushed back its first oil production to 2008, and then to 2010. By 2008, Eni's projected budget for the first phase had risen from less than $10 billion to $25.6 billion, according to IHS CERA.

That year, the companies renegotiated the management structure, taking Eni out of the lead role. The Kazakh government imposed increased penalties on the companies for production delays beyond October.

Since then development has progressed and the companies finished drilling their production wells last year.

Perhaps most significantly, the Kazakh government hasn't agreed to extend the Kashagan companies' production-sharing agreement past its 2041 expiration, according to the person close to KMG and a consultant advising companies in Kashagan. Without the extension, it would be difficult for the companies to make the profits that they expected when the project began.

Copyright (c) 2012 Dow Jones & Company, Inc.


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