With reserves estimated at 35 billion barrels of oil, Kashagan is one of the largest conventional oil finds in the past 40 years and has been the Kazakh government's hope for major oil export expansion in the future. Production at the project was initially planned to begin in 2005 and cost $10 billion to develop. In the eight years since, the project has not yet begun producing oil and has cost more than $46 billion to develop.
The project has been delayed for many reasons. First, it is extremely difficult technically, since Kashagan is located in the northern Caspian Sea, which is frozen most of the year and sees large sheets of ice move across the surface of the sea and form on the rigs.
In addition to the technical issues, there have been disagreements between the consortium members — Italy's ENI, Dutch-British Royal Dutch/Shell, France's Total, the United States' ExxonMobil and ConocoPhillips and Japan's Inapex. In 2004, the United Kingdom's BG Group left the consortium. The Kazakh government forced state firm KazMunaiGaz into the consortium in 2008 at a time of nationalist moves against foreign-run businesses in the country. In 2009, Kashagan's operator, ENI, was accused of falling behind in its responsibilities, and the composition of responsibilities between consortium members was reallocated. In 2012, ENI was in further trouble when an Italian court began proceedings over accusations of bribes to Kazakh officials, leading to delays in ENI's operations as it considered leaving the project.
Now, ConocoPhillips has decided to leave the project, selling its 8.4 percent stake. Initially, ConocoPhillips planned to sell the $5 billion stake to India's ONGC, but on July 2 the Kazakh government exercised its right under Kazakh law to acquire the stake itself. However, the Kazakh government is not looking to hold onto the shares, knowing that Kashagan needs much more investment if it is to eventually start producing oil at its potential level. Astana also does not believe New Delhi could or would offer as much financial support for the project as Beijing. Because KazMunaiGaz does not have the financial capability to purchase the ConocoPhillips shares, the Chinese have reportedly offered to provide the money needed for the Kazakh government to acquire the shares without an outright nationalization.
Several options for acquiring the stake appear to be under negotiation between China and Kazakhstan. The first option comprises China's offer to pay $5.4 billion for the stake and give Kazakhstan free access to the Chinese port of Haylugan on the Pacific Ocean, meaning land-locked Kazakhstan could start exporting on the greater international market in the future. As part of this deal, the Chinese are also offering favorable lines of credit to the Kazakh government. Kazakhstan countered that offer with one in which China would pay $5 billion and then write off Kazakhstan's $10 billion debt to China, which China has not indicated it would favor. A third option reportedly under consideration by the Chinese would provide the $5 billion in financing to KazMunaiGaz to purchase the ConocoPhillips shares that would not be repaid. China National Petroleum Corp. would then offer another $5 billion to purchase the shares from KazMunaiGaz. It is not clear which option is most likely at this point, but negotiations will most likely be finished some time in the next few weeks.
With China soon to be on board to keep Kashagan afloat, the Kazakh government has also turned to the United Kingdom to help the struggling project. On July 1, British Prime Minister David Cameron visited Kazakhstan, a first for a sitting British premier. Financial assistance for Kashagan's oil production facilities was included in $1 billion-worth of deals signed between the two countries. Cameron also reiterated the United Kingdom's commitment to pursuing Kashagan's potential at a time when Anglo-Dutch Shell's continued role in the project was being questioned.
Kazakhstan's Production Woes
In order to coincide with Cameron's visit, the imminent deal with China and Kazakh President Nursultan Nazarbayev's birthday, Kashagan began initial production June 30. This production, however, was mostly symbolic and did not actually produce much oil. ENI and other consortium members have asked for production not to begin for several months until the facilities are ready, and the best-case scenario for production in 2013 would be 75,000 barrels per day.
The initial production target — which the government is still pushing to reach — is for Kashagan to produce 180,000 barrels per day in 2013; 370,000 barrels per day in 2014; and 1.5 million barrels per day by 2016, but the government's ability to meet these goals is doubtful. In addition to ENI's concerns over meeting production targets, the International Energy Agency's deputy executive director, Richard Jones, said June 24 that he believed the first real oil production from Kashagan would be postponed until late 2014.
The uncertainty over Kashagan's ability to produce in the near future is lowering the Kazakh government's overall forecasts for oil production and, consequently, government revenue. Already in June, the Kazakh government revised down its oil production forecasts through 2015. The Kazakh government has now said it will produce 1.84 million barrels per day in 2013 (down 2 percent from previous forecast), 1.88 million barrels per day in 2014 (down 3 percent) and 2.02 million barrels per day in 2015 (down 6 percent). These new forecast production targets are still an increase from the current 1.72 million barrels per day Kazakhstan produces. However, if Kashagan is delayed again or does not meet its targets, these oil production targets will have to be revised down once more — most likely more drastically.
There are signs that the country's energy sector is facing other difficulties as well. Kazakhstan's natural gas projects, Karachaganak and Tengiz, have both decided not to expand to the next phase of production due to the cost of operation being too high. Currently, Kazakhstan produces 19.7 billion cubic meters of natural gas — half of which is exported, mostly to Russia. Kazakhstan had planned to more than double production to 50 billion cubic meters in 2013 and 60 billion cubic meters by 2015. Now, however, the Kazakh government has revised down its estimated production to 40 billion cubic meters in 2013, with rumors that there could be another revision this fall. At current production levels, Kazakhstan just about breaks even on the natural gas it exports versus what it imports due to regional transport disconnections across the country. Astana had counted on a major expansion in production to become a regional natural gas exporter — something it will not achieve any time soon.
Effects of Stagnant Production
There are two key consequences from Kazakhstan's struggles to boost its oil and natural gas production. The first is that the country is starting to be overshadowed by its other energy-rich neighbors, something that could hurt Kazakhstan's competitiveness. Turkmenistan's massive Galkynysh (also called South Iolotan) natural gas field has officially come online — though it will not be formally inaugurated until this fall when Chinese President Xi Jinping visits. Galkynysh is arguably the second-largest natural gas field in the world, with between 4 trillion and 14 trillion cubic meters of natural gas, and is helping Turkmenistan raise its natural gas exports to China to at least 50 billion cubic meters in 2013 — up from 20 billion cubic meters in 2012. Turkmenistan's exports to China will most likely reach 65 billion cubic meters by 2015. In addition, Russia recently signed a series of major oil and natural gas deals with China. Previously, China was heavily focused on Kazakhstan for future oil and natural gas supplies, and now it appears to be branching out to other partners, even if Beijing has not simply dropped Astana, as is seen in the Kashagan deal.
The more immediate consequence of failing to meet production targets will be the effect on Kazakhstan's government revenue. The Kazakh budget is heavily dependent on oil and natural gas, which make up 52.2 percent of budget revenue. Oil makes up nearly 98 percent of these revenues, though future budgets had planned for natural gas to make up a larger role — something that now is being revised. Already, the Kazakh government revised the budget down 4 percent to coincide with the energy forecast revisions, and even this new budget forecast is dependent on Kashagan meeting the lowered but still perhaps out of reach production targets. The Kazakh government has also revised its gross domestic product growth forecast from 7.5 percent to 5 percent on changes due to a slowdown in the Kazakh economy and stagnant energy production.
In addition to the Kazakh government's budget relying on Kashagan production, the budget is also vulnerable to fluctuations in the price of oil. Currently, the government has estimated its budget on the assumption that Brent crude costs $117 per barrel, though Brent crude is currently trading at $103 per barrel. The Kazakh government has started to revise its budget to take the lower price per barrel into account, and this could leave the government with barely enough revenue to break even for 2013.
The Kazakh government has long known it is vulnerable to energy shifts, and so it has stashed away approximately $61.8 billion in its sovereign wealth fund. For a government budget of just $34.5 billion in 2013, Astana has somewhat of a cushion should either Kashagan not meet its target or oil prices fluctuate more severely. Still, the Kazakh government is in a vulnerable position, even if it is not at immediate risk of destabilization. The Kazakh government has shown that it is deeply interested in getting Kashagan running, by turning to both the British and the Chinese — though to what degree their help can fix the project remains to be seen.