CPC has created a favorable investment environment for the oil industry
After Kazakhstan gained independence, the first president of the country, Nursultan Nazarbayev, relied on the oil industry as the engine of the economy, which became a catalyst for attracting foreign investment. And then, it became clear that Kazakhstan needed a reliable export route to get oil to world markets. Such a route was Tengiz-Novorossiysk of the Caspian Pipeline Consortium, through which more than two-thirds of Kazakhstan's oil is pumped today. Kairgeldy Kabyldin, a direct participant in all negotiations and construction of the oil pipeline, now Deputy General Director of CPC–K JSC, talks about the idea, the history of construction, and the future of the CPC.
How did it go
– I came to work at the Ministry of Oil and Gas Industry of the Republic of Kazakhstan in the spring of 1993. From that moment on, I was lucky enough to be involved in this project. At that time, an agreement was signed with Chevron Corporation on the creation of the Tengizchevroil joint venture.
Naturally, like any investor, Chevron, first of all, considered ways to export the produced oil. It certainly knew about the value of Tengiz oil because its quality was different from any Russian export mixture. It was lighter and therefore more valuable on international markets. The premium on each barrel of Tengiz oil was about $3.25. When Chevron arrived, Tengiz was already producing 3 million tons. If we assume that they were exported through the Atyrau-Samara oil pipeline and then to Eastern Europe through Brest, Novorossiysk, and southern Europe, mixed with oil from other Russian fields, we can calculate that about $75 million a year of foreign exchange earnings was lost. And that was a lot of money at that time.
After realizing this and planning investments in Tengiz, Chevron sought to build a specialized export route to export Tengiz oil, considering its quality. Tengiz needed direct access to the Black Sea because the oil will mix with West Siberian, Tatar, Bashkir oil if you go through Samara. If it went through Grozny to Novorossiysk, it would blend with Azerbaijani, Chechen oil there. Therefore, Chevron chose a separate CPC route, although different options were assumed before, including to Baku and further through Ceyhan, to Turkey, through the Black Sea. But the Turkish side talked about the problems of passage through the Bosphorus.
There was a route to Iran. But, of course, Chevron could not go there because Iran was under UN sanctions. Hypothetically there even was a route via Turkmenistan-Pakistan to India. Before the CPC route was determined as the main and priority, the Kazakhstani side considered many routes.
- Was it considered by the Kazakhstani side or by Chevron?
- By the Kazakhstani side, only by the Kazakhstani side. Because by that time, everyone understood that Kazakhstan had potential in the form of Tengiz and Karachaganak, that investors would come to Kazakhstan sooner or later. Before that, the World Bank and Ernst&Young consulting company (currently – EY) analyzed all the risks of transit countries, environmental, geopolitical risks associated with the safe transportation of oil, risks associated with investments.
– What year was this done?
– It was just at the cusp of 1991 and 1992. Thus, the Caspian pipeline route, called Tengiz - Black Sea, was identified as a priority. Further, the feasibility study of this route has already begun. The first feasibility study was prepared, funded by Oman, and a consortium was created to finance it and the development of pre-investment documentation.
Oman volunteered to finance this consortium, which was established in June 1992, registered in Bermuda. It was called CPC LTD Bermuda. Initially, the participants were Oman Oil Company and the Republic of Kazakhstan. In July, Russia joined it as the route went through its territory. And to implement this project, state support from Russia was needed. It was necessary to obtain the right of passage, the required approvals, and permits for laying the pipeline route.
– Was Oman involved in choosing the pipeline route?
– No, it was completely the decision of the Kazakhstani side. When Kazakhstan said that it prioritized the Tengiz-Black Sea route, now an investor was needed. The project required huge investments, and then Oman Oil Company, which acted as a consultant to our government in the Tengiz deal, offered to arrange financing, but according to the scheme: "I will find financing if the Republic of Kazakhstan guarantees the pumping of oil through this pipeline," in which case any international bank will give money under such a guarantee.
The project was estimated at more than $2 billion at that time. Naturally, the state treasury could not afford such huge investments. The scheme is straightforward. While guarantees should be on the principle of "pump or pay", you guarantee, for example, to pump a certain amount of oil, even if you pumped less, for example, nine mln tons, you pay a tariff for ten guaranteed. This guarantee was requested by Oman Oil Company, as the operator of the future Tengiz-Novorossiysk project, from Kazakhstan.
But then another story begins. In 1993, Chevron came to the Tengiz field, and it has its vision for the development of the field and transportation of the produced oil. And when they were offered: "Give guarantees, and we will find financing," they replied: "Guarantees are also worth something. Give us a share in the project." There were proposals to give Chevron a quarter, and then there would already be four participants in the consortium. But Chevron did not agree to this because it could not cooperate with Mr. John Deuss, the Head of Oman Oil, who at that time was under UN sanctions. Secondly, they said, "What does Oman have to do with it?". It is clear about Russia and Kazakhstan, they provide the territory, give all the necessary permits, approvals for laying the pipeline, and in the end, they are the owners of the territory. And Chevron is a shipper.
And so, until 1995-96, negotiations were going on, each side hogging the covers. And, in the end, there was no result. It was not possible to organize the financing. Then another principle was proposed, which our President Nursultan Nazarbayev initiated: "an apple in half". That is, we said: "We give 50% to production companies." Then, in addition to Chevron's interest, such companies operating in Kazakhstan as Shell, Oryx company, BP, BG were consolidated. A group of companies expressed a desire to become an investor in this project, if they were given a share in the project, they would be provided with guaranteed capacity. That is, they would distribute the pipeline capacity among the participants. And hence the principle of "apple in half" was born, which our president announced, 50/50.
Fifty percent went to international oil companies that wanted to become investors in the project, and 50 percent remained with Russia, Kazakhstan, and Oman. And in the spring of 1996, a protocol was signed on the reorganization of the consortium. And initially, these principles were sent to the Russian side. Mr. Nazarbayev wrote a letter to Mr. Yeltsin that we propose to involve international oil companies in the project. Yeltsin approved, after that, the protocol on reorganization was signed.
It was beneficial for all participants. International oil companies guarantee the pumping of oil on the principles of "pump or pay". For this, they get the right of access to the pipeline and divide the capacity among themselves, setting a tariff. It is beneficial for them because access to the pipe and the tariff would be regulated if the state owned the oil pipeline. And there were risks for them that tomorrow it could restrict access to the pipeline or change the tariff, which would be economically unprofitable. In return, they committed themselves to 100% financing of the initial construction project.
– When was the final agreement signed?
– It was April 1996 when the protocol was signed. Literally, a month later, negotiations began at the Metropol Hotel in Moscow. They lasted from May to December, and all these principles, which I have listed, should have been included in a legally binding document called the shareholders' agreement, that is, in fact, the founding document of the project. Two legal entities have been created in Russia and Kazakhstan for transparency and tax purposes – CPC-R and CPC-K.
The CPC oil pipeline passed through 450 kilometers of the territory of Kazakhstan and 1100 kilometers of the territory of Russia. These two legal entities were created for the relevant taxes to be paid from oil transportation in the relevant territory.
– More than six months of negotiations. What were the main issues resolved at them?
- Look, eight companies at that time and three states became participants in the project. And this, figuratively speaking, "friendly family" had to be seated at one round table to concertize their plans and goals into a single document that would guide them in the future, which is the shareholders' agreement. As a participant in this process, I can say that there was a desire to achieve mutually beneficial or mutually acceptable conditions for each participant. Firstly, naturally, everyone came with their own, as they say, "charter": Russia, Kazakhstan regulated such projects under GOST standards, international companies handled the design, construction, and operation of the pipeline following international standards, bearing in mind the API standard, European standards – it was necessary to harmonize all these standards.
Secondly, both Russia and Kazakhstan did not have laws that would protect foreign investment. Accordingly, it was necessary to prescribe in this agreement the obligations of Russia and Kazakhstan to investors. Thirdly, it is essential to fix taxes. For this purpose, a financial and economic model was developed. Then the right to a tariff, it was necessary to sign a corresponding regulatory act that transportation through the oil pipeline system of the Caspian Pipeline Consortium will not be regulated by the anti-monopoly legislation of the two countries.
Then the so-called "quality bank" appeared, which operates when oil is delivered to the system. A calculation is already made at the output, who has lost in quality, receives compensation from others, and who has spoiled the quality pays. This is a system that has proven its viability today.
Add to this that it was necessary to obtain all the required permits along the pipeline route, this is already at the regional level, in the Astrakhan region, Kalmykia, Stavropol region, Krasnodar territory, where the pipe crosses protected areas, somewhere protected natural territories, there were territories on the route where there were some military graves that had to be bypassed or passed in compliance with all necessary norms and rules and to preserve them as much as possible. The same is valid on the territory of Kazakhstan.
Kazakhstan and Russia transferred the existing assets of the Tengiz-Grozny oil pipeline, their assessment and technical audit were carried out according to international standards. There were public protests in the Abrau-Durso Nature Reserve on the Black Sea coast during the highway passage in the Krasnodar territory. Russian colleagues had to conduct explanatory work, break through the bureaucracy of the local administration, and so on.
I think it was only the consolidation of mutual concessions and compromises that allowed us to reach a general agreement, called the CPC Shareholders' Agreement. And this is a unique experience, and some provisions of our shareholders' agreement have been transformed into international standards, into the Energy Charter Agreement. So, the CPC experience is now actively used in many documents and contracts.
All coordination with ministries and departments was carried out by the Ministry of Oil and Gas team headed by Minister Balgimbayev, and I think he made a considerable contribution. On behalf of the ministry, Mr. Shatalov, the First Deputy Minister, handled all the coordination from the Russian side. And, of course, our President, Nursultan Nazarbayev, was constantly monitoring this whole process, keeping his finger on the pulse and helping. He was always in contact with the Russian President, Mr. Yeltsin, with the Russian Prime Minister, Mr. Chernomyrdin. He was one of the locomotives of the project's development, without exaggeration.
– Was the final point set on December 6, 1996?
- Yes, the signing took place in Moscow, at the President Hotel, at a round table. Immediately after that, Minister Balgimbayev called Mr. Nazarbayev on mobile phone and congratulated him on signing the contract. Indeed, it was a success because the establishment of this consortium created a favorable investment environment for the country's oil industry. After that, Karachaganak began to develop, Tengiz began to develop (the second stage started, the third stage on the way). After that, investors came to Kashagan. CPC has become such a bridge for investment by international investors in Kazakhstan's oil projects.
In 1999, as Deputy Prime Minister, Mr. Tokayev participated in the ceremony of the beginning of the pipeline construction in Yuzhnaya Ozereevka. In two years, all the necessary facilities for the start of transportation were built, and in 2001 oil hit the pipe. Basically, it was filled with oil from the Tengiz field. Almost half a million tons of oil were pumped there, filled it up to Novorossiysk. And in October 2001, the first tanker was already shipped – the oil pipeline began commercial activity.
– When did it become clear that the pipeline needed expansion?
– The expansion was initially included in the project. And as soon as all the necessary decisions of shareholders on investments of the first stage project were signed, which is about $2.2 billion for a capacity of 28 million tons, and after that negotiations on the expansion project immediately began. It envisaged reaching a design capacity of 67 million tons. The negotiations lasted almost ten years. The initial construction project was implemented exclusively with the money of foreign investors. The project was managed entirely by them. There were no governing bodies, not even a board of directors. There was a committee of production companies. They carried out all the approvals, necessary tenders, and so on.
As for the expansion project, several options were also considered. It was possible to borrow money from banks for financing, but this model did not pass. We decided to finance it because the production companies agreed to postpone the initial debt payment to them at the end of the expansion project and decided to finance it with money from the current cash flow. That is, with the CPC's own money. And this required making specific changes to the original provisions of the shareholders' agreement regarding loan servicing, the interest rate on shareholders' deposits, power distribution, and the tariff. All this again took considerable time.
In 2009, we agreed on the principles, signed them, and in 2010 the construction of the second stage, or to put it another way, the expansion project began, which in 2018 ended with the commissioning of the project at full capacity. The cost of the second stage was estimated at 5.5 billion dollars. The project was completed for 5.2 billion, if I remember correctly.
– What was built?
– Ten additional pumping stations were built as part of the expansion project. In addition, to increase the pipeline's capacity, it was necessary to replace the pipeline section in Kazakhstan, build an additional tank farm, and replace the main technological equipment.
– The next large-scale project to increase the oil pipeline capacity, which is being implemented now, is the Bottleneck Elimination Program (BEP)…
– I would call it modernization. Design studies were carried out within the framework of the current operation, and the possibility was identified to increase pumping volumes by using additives that change the speed of pumping liquids through the pipeline. Thus, we expect to increase the capacity to almost 82 million tons at the Tengiz terminal.
After completing the Tengiz future expansion project, its production will increase by 12 million tons, and the BEP project aims to create these 12 million tons of added capacity. And this project will also be implemented at the expense of the current cash flow, that is, shareholders' funds. This proves once again that CPC is a time-tested project. I will add that the CPC is an excellent example of cooperation between the state and a private investor, a collaboration between states, Russia and Kazakhstan. CPC is a model for the construction of cross-border oil pipelines. We used his practice in the Kazakhstan-China oil pipeline construction project.
CPC has already reached a stage where we can say that the project has succeeded. Today, CPC is already paying dividends to all participants. CPC is an excellent example of safety standards. We have been working without safety violations and, therefore, without injuries and accidents for two years.
– Mr. Kabyldin, we sincerely congratulate you on the 25th anniversary of the CPC project, which is celebrated almost simultaneously with the anniversary of Kazakhstan's independence. And, in turn, we would like to ask you to congratulate your colleagues on the anniversary.
– CPC is almost the same age as our independence, considering that work on it began in 1992. To all colleagues, shareholders, I would like to wish further success, prosperity, reliability, well-being, and, of course, strong health to all of you, my dear colleagues, and friends!