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Kashagan: A Giant in the (Painfully Slow) Making

Thirteen years in the making and $50 billion later, the supergiant Kashagan oil field in Kazakhstan is finally online after many delays, but its short-term impact on the global oil market will be negligible and return on investment way down the road.

That said, we’re potentially set to see the first commercial output by the end of this month, and eventually we’re looking at a 1.5-million-barrel-a-day production capacity.

On 11 September, initial oil production began at Kashagan after years of delays. But only days into initial production, operations were halted on 25 September when a leak was detected on a pipeline running to a processing plant that receives oil from the field.

Anxieties were running high as this could have meant another delay to the late October goal of achieving the first commercial output. On 6 October, production resumed, though and by 8 October had reached 61,000 bpd.  

This is but one in a long line of headaches that have plagued the supergiant development, but eventually the impact will be supergiant—just like the field itself.  

Kashagan is the largest oil field outside the Middle East, and it has also proved to be the most expensive in the world to develop—so far. By further way of comparison, Kashagan is roughly equivalent to Brazil’s total proved onshore and offshore reserves, plus Kazakhstan also has the onshore Tengiz oil field.   

The Kashagan field was discovered in June 2000 and is the largest oil discovery in the past 35 years. It is believed to hold up to 35 billion barrels of oil in place and 10 billion barrels of recoverable oil, along with around 1 trillion cubic meters of natural gas. Initial production should reach 180,000 barrels per day before shooting up to 350,000 bpd and eventually reaching 1.5 million bpd. In 2014, the estimate is that we will see 8 million tons of crude produced at Kashagan.  

Located some 80 kilometers southeast of Atyrau in Kazakhstan in the Caspian Sea, the supergiant field is the country’s ticket to the big boy’s energy club.

The corporate stakeholders are a consortium of supermajors each with 16.81%, including ExxonMobil, France’s Total, Royal Dutch Shell and Italy’s Eni, along with state-owned KazMunaiGaz. The smaller partner in the consortium is Japan’s Inpex, with a 7.65% stake. But China’s state-run CNPC is also now in on the game with a recently acquired 8.4% stake that it bought out from ConocoPhillips for $5 billion. For commercial output by the end of this month, the target is 75,000 bpd—anything less will have repercussions.

Right before operations were halted on 25 September, production had reached 48,000 bpd—pretty impressive for a week and a half. Now, only a couple of days after resuming production, output is already at 61,000 bpd, so barring any further accidents, we see no reason to assume the consortium won’t reach the 75,000 bpd output target by the end of this month.

What happens if the supermajor consortium fails to reach commercial production by the end of October? This is what’s got shareholders a bit nervous. Under the production-sharing agreement with Kazakhstan, the consortium will face still fines if the deadline is pushed back. The Kazakh authorities have run out of patience over the past 13 years, and the project is already a full eight years behind schedule. The price the consortium will pay for failing to meet the October deadline is the forfeiture of compensation for expenses, which have been astronomical.  

But it’s no picnic working in Kashagan, and the delays have not been frivolous. The area suffers extremely harsh winters and the shallow waters freeze over, while the great depths of the field itself—up to 15,000 feet below the sea bed—and reservoir pressure that exceeds 10,000 pounds per square inch with lethal levels of hydrogen sulfide make it impossible to employ traditional fixed or floating drilling platforms. Simply put, the technical challenges have been enormous, but they have been met.

Getting Kashagan Oil & Gas to Market

Kashagan Oil FieldEarlier in September, the Kazakh government noted that it would likely be piping its Kashagan oil export quota to China through Russia’s Black Sea port of Novorossiysk via the Caspian Pipeline Consortium (CPC) pipeline, or alternatively via the existing Atasu-Alashankou pipeline, which is set to be expanded thanks to a new agreement between Kazakhstan and China.

Without its Kashagan share, China control some 25% of Kazakhstan’s oil output, and infrastructure deals coming online will cement this Chinese presence significantly.
As for the supermajor side of the Kashagan consortium, export quotes will go through the CPC, which they control from their Black Sea terminal. The first shipment—slated for October if the leak is fixed in time—will be the first ever to go through the CPC terminal.

CPC operates the only oil-export link in Russia that enjoys shared foreign ownership, while Chevron is the largest corporate shareholder in the CPC pipeline, with 15%. Russian and Kazakhstan hold 31% and 21%, respectively, in the pipeline. The other shareholders include ExxonMobil, Russia’s Lukoil and a JV between Shell and Russia’s Rosneft. This crude quote could go to European refiners.

So while the Chevron-backed CPC pipeline route is the preferred route, there are alternative routes for companies who don’t have access to this. Those routes include Russia’s Atyrau-Samara link and the route to China from Atyrau in western Kazakhstan to Alashankou in northwest China. This latter route can handle 3 million tons for 2013 and up to 6 million tons beyond that.  And the good news is that China is considering offering a higher price for Kashagan oil, compared to its typically below-market prices at the Chinese border.

The impact on the market will be big, but not in the immediate or short term. But within the next decade, when production is at its maximum, it will give new projects coming on line in the Mediterranean some stiff competition.

What does it mean for the consortium that has put $50 billion into this already (double the initial estimates)? It means it will be a long time before they start seeing any return on investment. Because of the massive expense overrun here, the prospects of generating huge returns quickly have diminished.

Even if the first phase of production shoots up as the consortium—and the Kazakh authorities—hope, it will still take at least five years for the supergiant players in this game to recover development costs—and that would presume steady production. So we’re looking at more than five years minimum before we start to see any profits flowing from this project, and even then profits must be shared with the government.

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