US embassy cable - 05ALMATY4106

C O N F I D E N T I A L  ALMATY 004106 
 
SIPDIS 
 
 
DEPT FOR EB/ESC; EUR/SNEC (MANN); EUR/CACEN (MUDGE) 
 
E.O. 12958: DECL: 11/17/2015 
TAGS: ENRG, EPET, KZ, Energy 
SUBJECT: KAZAKHSTAN: KMG LOOKING TO BUY INTO KARACHAGANAK 
 
Classified By: POEC CHIEF DEBORAH MENNUTI, REASONS 1.4(B) and (D) 
 
1. (C) Summary. Two expatriate oil executives told Econoff 
(in confidence) on November 14 that state-owned oil and gas 
company KMG has opened discussions with KPO (Karachaganak 
Petroleum Operating Company) members about buying a share of 
the consortium.  British Gas (BG) Business Planning Manager 
Robert Flippin told Econoff that BG, unhappy with its 
joint-operatorship (with Italy's Eni) of the field, was 
considering selling part of its stake in return for KMG's 
support for its bid to become KPO's sole operator.  On 
November 11, Gazprom's CEO Alexei Miller and President 
Nazarbayev reportedly discussed plans to renovate the 
Orenburg gas processing plant in order to receive increased 
volumes of Karachaganak associated gas -- a proposal which, 
if given on terms economical to KPO, would pave the way for 
expanded Karachaganak oil production. End Summary. 
 
KMG TO BUY INTO KARACHAGANAK? 
----------------------------- 
 
2. (C) Both Flippin and Karachaganak Representative Office 
Manager (and Eni secondee) Claudio Cogliati told Econoff that 
KMG had recently opened discussions with consortium members 
aimed at buying into KPO.  Both men explained KMG's motives 
in fiscal terms.  Karachaganak's 1997 Production Sharing 
Agreement (PSA), Flippin explained, limited the GOK's "take" 
to 8% during the field's "cost-recovery" phase.  (Flippin 
added that these terms were among the most favorable to 
investors in all of Kazakhstan, likely equaled or exceeded 
only at Tengiz.)  The GOK's share of revenues would improve 
dramatically after cost-recovery had been achieved.  While 
the high price of oil had advanced that projected date to 
2008-2010, Flippin said, KMG was still impatient to secure 
higher revenues, and saw buying into the consortium as the 
way to do so. 
 
3. (C) Flippin told Econoff that BG would consider selling a 
minority KPO share to KMG in return for securing the GOK's 
support in its bid to become sole KPO operator.  The current 
arrangement -- in which BG and Eni are "joint operators" and 
split project staffing, with each office rotating every two 
years --  was, in Flippin's view, "unwieldy," and, in 
Cogliati's, "inefficient."  Flippin speculated that Eni would 
ultimately have to go along with a KMG decision to strip it 
of Karachaganak operatorship because Eni needed KMG support 
to maintain its increasingly-unpopular operatorship of the 
Kashagan field.  (Note: Conoco-Phillips' Hakim Janah recently 
made a similar point, telling Econoff that while Eni's 
management of Kashagan was "terrible," Kashagan consortium 
members were powerless to vote Eni out as long as the Italian 
company had KMG's support.  End Note.) 
 
SEEKING A GAS DEAL...AS A WAY TO PRODUCE MORE OIL 
--------------------------------------------- ---- 
 
4. (C) Following a November 11 meeting with President 
Nazarbayev, Gazprom CEO Alexei Miller told the press that a 
long-term agreement on gas deliveries from Karachaganak to 
the Orenburg gas processing plant "was in the works." 
Cogliati told Econoff that successful completion of the 
project depended on three things:  the estimated $300 million 
 upgrade of the Orenburg facility, an expansion of the gas 
pipeline to meet the projected 15 billion cubic meters (bcm) 
per year delivery (up from the current 7 bcm), and "an 
acceptable price" for the Karachaganak gas.  Flippin 
explained that Orenburg, as Karachaganak's monopsonistic 
buyer, currently paid only 30 cents per thousand cubic feet 
for KPO's gas, a price Gazprom had shrewdly calculated as 
being just above Karachaganak's break-even point.  While KPO 
would be seeking a better price before agreeing to expand gas 
sales to Orenburg, Flippin noted, KPO's real objective was to 
increase production of oil.  In that context, any 
cost-effective means of getting rid of Karachaganak's 
associated gas would be considered. 
 
5. (C) Comment: Neither Flippin nor Cogliati identified any 
particular reason to reject KMG's advance, giving the 
impression that the keys to the deal will be price and the 
size of KMG's share.  Presumably, given the GOK's December 
2004 "preemption" legislation, either BG or Eni (or both) 
could sell part of their 32.5% KPO shares without the 
approval of consortium members Chevron (20%) or Lukoil (15%). 
 End Comment. 
 
ORDWAY 
 
 
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