Astana Struggles to Regain Grip on Oil Sector
Farkhad Sharip

Kazakh Prime Minister Karim Masimov, addressing the Eurasian energy forum in Astana on September 6, signaled to the West that the government will no longer tolerate even the slightest breach of contract and environmental regulations on the part of foreign oil companies operating in the country. The prolonged row between the Kazakh government and the Italian ENI oil consortium over the Kashagan oilfield illustrates the seriousness of Kazakhstan’s intentions to put an end to what officials call “uncontrolled activities of foreign investors”.

Prospects for the largest oil reserves in Kazakhstan, the Kashagan oilfield estimated to hold  2 billion tons of oil, looked bright in 1997 when Kazakhstan signed a production sharing agreement with an international consortium including Royal Dutch Shell, Exxon Mobil Corp., Total, Conoco Phillips, Inpex Holding Inc. and the KazMunayGaz national oil company. In February 2001 Italian Agip KCO, a subsidiary of ENI consortium, was selected as the Kashagan Project operator. President Nursultan Nazarbayev put forward five conditions on which the oilfield could be effectively developed. These included first oil delivery in 2005, the use of local workforce, equipment and services, the utilization of gas by-products, the observance of environmental safety regulations, and the acquisition of a greater share by KazMunayGaz national company in the consortium.

Seven years on, it turns out, none of these obligations were fulfilled. More than that, oil production was repeatedly delayed. Last June the government voiced concerns over the Kashagan project and expressed doubts over ENI’s technical capabilities to meet production targets. Agip KCO got under fire from the Environmental Protection Ministry for alleged pollution of the Caspian basin. 

It appears, however, that what the Kazakh government is really aiming at is not environmental problems, the utilization of released gas at the oilfield or purchase of Kazakh equipment and services. The basic purport of the government’s unrelenting pressure on ENI-Agip is to tighten its control over the Italian oil company in particular and over foreign oil companies in general, by way of gradually returning foreign-operated oilfields under government control. Karim Masimov stressed this point at the Eurasian energy forum, sending a clear message to western companies that Kazakhstan will adopt harsher tactics in dealing with foreign oil companies, and punish them for non-fulfillment of their investment and production obligations. He told journalists that Kazakhstan will no longer be satisfied with an 8.33 percent share in the Kashagan project, and KazMunayGaz, the leading national gas and oil company, should become co-operator of the project. But he evaded the question about the exact amount of share KazMunayGaz would obtain in Kashagan. Government officials believe ENI has a slim chance to retain its position as operator, but everything hinges on the outcome of ongoing talks between the Kazakh government and the Italian company, which is likely to drag on until the end of the year.

The Italian company was repeatedly inspected by authorities on suspicion of tax evasion. Kazakh finance minister Daulet Yergozhin announced that the final results of inspections will be made public in October, but the estimated environmental damage caused by ENI in Kazakhstan stands at $40 billion. Apparently, the already chilly relations between Kazakh authorities and the Italian company were further aggravated after ENI responded negatively to Kazakh demands to increase the planned output of profit-oil from 10% to 40%. The cause of production delays at Kashagan cannot be explained by harsh climatic conditions or technical problems alone. It seems that Agip was taken hostage by its own ambitious plans to increase oil production from the initially projected 100,000 barrels a day the end of 2005 to 450,000 barrels a day. This revised plan proved to be beyond the capacities of the company, and accelerated the collision with the government.

Whatever may be the root cause of the row around Kashagan, the prolonged tension between the Kazakh government and Agip looks like the beginning of the end of the Italian company’s activities in Kazakhstan. Even if Agip remains as a co-operator, KazMunayGaz will likely control all financial aspects of the project, leaving for its Italian partner responsibilities for oil production and technical problems. Prime Minister Karim Masimov unambiguously declared the intention of Kazakhstan to change the project operator if ENI balks at Kazakhstan’s demands. “We have a plan B for Agip KCO if it refuses to accept our conditions”, said Masimov, transparently alluding to that possibility. Independent sources name Total and ExxonMobil as possible substitutions for Agip KCO.

Government members are divided as to how reconcile tough penalties for ENI with the need for western investment and technical assistance in oil sector. More than half of the $50 billion western investment accumulated since 1993 in Kazakhstan comes from the oil and gas sector. Presumably, Kazakhstan will not go so far as to strip the Italian company of its license for developing the Kashagan oil field.  Masimov stressed that despite the complicated nature of the confrontation around Kashagan, the Kazakh government leaves the door open for further cooperation with foreign oil companies, including ENI. Astana closely follows the European reaction to government pressures on the Italian company.  The unsettled dispute will probably urge Italian Prime Minister Romano Prodi to reschedule his visit to Kazakhstan, planned for October. But repercussions of the row between the Kazakh government and ENI roll far beyond European borders. Practically, given the continuing trend for diversification of oil exports in Kazakhstan and globally growing demand for energy sources, no foreign oil company operating in Kazakhstan – European or American – is immune from government pressure.

In many ways, the scandalous saga of Kashagan follows the Russian pattern, when Royal Dutch Shell, operating at the Sakhalin-2 oilfield, had to cede its controlling package to Russia’s Gazprom. It is hard to expect that Kazakhstan will soften its tough position on Kashagan. The snowballing conflict with ENI, paradoxically as it may seem, raises Kazakhstan’s profile internationally and domestically. It warns foreign countries that Kazakhstan is no longer economically weak country to be treated like a beggar. Within the country, putting the squeeze on foreign oil companies takes the steam out of the brewing anti-government sentiments among the population over selling out the nation’s resources to foreigners.

Published in the September 19 issue of the CACI Analyst.