Kazhakhs Play Hardball with Operators, Terms

Companies such as Royal Dutch/Shell, Spanish Repsol YPF and French Total that are eyeing large blocks in Kazakhstan's sector of the Caspian Sea are becoming frustrated. Their beef is with tax regulations introduced in early 2002 that make it all but impossible to sign any long-term production-sharing agreements (PSAs). Despite slight improvements passed last year, the current tax code effectively limits internal rates of return (IRR) to single figures. Companies complain the current terms lack flexibility, give too many privileges to the host government and fail to take full account of the exploration risks and high costs of transportation in a landlocked region. To add to the burden, state oil company Kazmunaigas (KMG) is guaranteed a 50% share in each Caspian block, with other partners expected to carry its costs, at least during the exploration phase. "At the moment, I can't envisage an internal rate of return of more than 5%," says a western oil executive.

Despite the stalemate, oil executives are hopeful Kazakhstan will gradually sweeten its terms, enabling companies to achieve the minimum internal rate of return of 15% that most are seeking. And negotiations on various projects continue, regardless. That said, Shell's bid for two operatorships still faces hurdles, Repsol's negotiations for the Dukhan Block in the central Caspian are moving very slowly, while Total's quest for part of the Kurmangazy structure, which the Kazakhs share with Russia, appears to be going nowhere. Shell is discussing operatorship of the high-potential Nursultan Block in the south Caspian and is also earmarked to operate the Zhemchuzina Block further north, for which Oman Oil Co. (OOC) has exclusive rights under an early 1990s agreement. Earlier this year, a PSA seemed imminent after agreement on a smaller signature bonus to be paid by the Omanis and a narrowing of differences on the allocation of shares in the project. But talks have stumbled again, with the government reluctant to allow the Omanis to operate under previous legislation that would ensure an IRR of around 16%.

Despite having some of the world's richest oil companies knocking at their door, the Kazakhs appear in no great hurry to award new PSAs and are more intent on boosting their own presence in projects like the giant Kashagan development. The authorities are also playing hardball with operators, imposing penalties for any contract violations -- as Chevron and Canadian-owned PetroKazakhstan have recently learned to their detriment. This is a far cry from the 1990s, when Kazakhstan rolled out the red carpet to western oil companies, offering terms that would be unthinkable today (PIW May2,p6). KMG has recently become an 8.33% shareholder in Kashagan after finally securing half of BG's 16.67% share for over $900 million. In the latest blow to operators, the Energy Ministry recently directed over 30 producers to stop flaring gas immediately or cut back oil production. PetroKazakhstan has had to cut its 150,000 barrel per day Kumkol field production by 30% to comply. Still, with revenues boosted by high oil prices and current output of 1.2 million b/d likely to double in a few years, the government can afford to be demanding.