Projects
Kazakhstan Yet Again Pushes its Main Upstream. Foreign Investors for Changes in Terms Is this effectively killing the proverbial golden goose?
Paulina Mirenkova, Associate Director, Eurasian Energy Research, S&P Global, paulina.mirenkova@spglobal.com
Matthew J. Sagers, Vice President, Eurasian Energy Research, S&P Global, matt.sagers@spglobal.com
Key implications
Host country disputes with foreign investors are hardly new for the international oil and gas industry; these seem to simply be a regular feature of the business. Kazakhstan once again is applying pressure on its most important upstream foreign investors, apparently attempting to extract an even larger share of revenue and other concessions from the projects they operate.
But the challenge for the international consortia running the so-called “Big Three” projects in Kazakhstan — Kashagan, Karachaganak and Tengiz — seems to be somewhat different this time simply because of the astronomical claims being put forward. New claims against the consortium developing Kashagan currently exceed $150 billion, and new claims against Karachaganak reportedly stand at $3.5 billion. Although no claims have been presented against Tengiz yet, the government has expressed strong dissatisfaction with the overall cost and significant delays in the start-up of its latest expansion phase and may yet seek to extract concessions.
Tengiz’s current expansion project, referred to as the future growth project (FGP), has two stages. The first stage — the wellhead pressure management project (MPMP) — was finally launched in April after considerable delays; delays that were broadly attributed to various pandemic-related issues that slowed the early going. This aspect of the project involves drilling new injection wells and installing pressure-boosting facilities to maintain production levels from existing development.
The second part involves additional production wells and new sour gas injection, which will increase aggregate Tengiz production capacity by 12 MMt/y (260,000 b/d). This expansion is now expected to come on stream in the second half of 2025 instead of 2022 as originally scheduled, increasing oil production for the consortium to about 40 MMt/y (870,000 b/d) in the late 2020s. The expansion was sanctioned by the shareholders in 2016 with a budget of $36.8 billion, but increased costs have raised the estimated expenditure to $46.7 billion.
Even with long-standing concerns about the Kazakh government's actions toward foreign investors over the years, many international oil companies remained generally optimistic about continuing their activities in Kazakhstan. But this view may be changing materially now. With significant capital investments already in place and significant oil flowing, the IOC-investors are naturally keen to maintain their existing positions and expand their investment to boost output. Consequently, Kazakhstan appeared well positioned to negotiate extensions of their operating licenses and probably leverage additional investments in that process. Just across the Caspian Sea, Azerbaijan successfully did just that with its oil megaproject, Azeri-Chirag-Gunashli, in 2017, after it had previously done so with the Shah Deniz gas project in 2013.
However, Kazakhstan instead seems to be challenging existing PSAs in an attempt to raise more of the revenue into the state treasury, essentially risking the very partnerships that have fueled the country’s extraordinary upstream growth and general economic prosperity that has been in evidence since independence. While international oil companies (IOCs) grow increasingly frustrated with such tactics, based on past experience, Kazakhstan seems to view them as a useful strategy to secure a larger share of profits.
In doing so, Kazakhstan’s government conveniently overlooks the fact that the country's oil patch was a largely unknown frontier to international companies in the early 1990s. At that time, Kazakhstan needed to be especially appealing. Despite agreeing to stable financial terms for investors in the 1990s, Kazakhstan now expresses broad dissatisfaction with the previously negotiated PSA terms, somehow believing the consortia simply are not paying enough. But given the current phase of operation for Karachaganak and TCO, for example, the government’s share of profits is actually quite high, at well over 80%. This will change somewhat in the medium term, given recent sizable capital expenditures incurred by both projects.
Also, in current circumstances, Kazakhstan falls far short of offering new advantaged (low-cost, low-carbon) barrels now desired by IOCs. It appears that Kazakhstan’s primary source of advantaged barrels are largely concentrated in the existing major upstream projects that are now reaching maturity. Furthermore, these expansion projects are covered by existing license terms.
Noting a lack of inflow of fresh foreign investments into the oil and gas industry for new projects (dating since about 2009 when new PSAs were abolished), the government made changes to the Tax Code in 2018 in an attempt to improve the situation. But showing only limited success, the government has since moved forward with other measures to enhance investment terms, such as introducing the IMC in 2023. Although claiming some success by signing a few new projects, doubts persist about the overall effectiveness of the IMC, especially since stable contract terms for long-term complex projects remain elusive.
Various critics, amplified on social media, seem to compound the pressure on the international investors, downplaying the obvious and substantial benefits these projects bring, such as billions in investments, government revenues, export earnings and social projects. One idea put forward involves an unrealistic expectation that there are more benevolent investors from non-Western countries (e.g., Russia or China) that would be willing to take on the risks inherent in these projects and invest more while accepting a lower return, and that the stakes currently held by Western investors could be swapped out for frozen Russian assets in Western banks to accomplish this. Also ignored is the question of whether such alternative operators even have the necessary expertise to run such complex projects.
It appears that the government is again seeking a larger share of revenues and profits moving forward, coupled with additional investment guarantees. This approach was often effective in the past, with the government successfully extracting additional financial benefits. These actions essentially seem to dash the current desire to revitalize exploration and foreign investment in the upstream by attracting new investors, and therefore seem to put at risk Kazakhstan's own prosperity.
Old grievances resurface
The government of Kazakhstan signed agreements over two decades ago (in 1993 for Tengiz and 1997 for Karachaganak and Kashagan) that allowed international companies to invest billions of dollars into these projects as well as more broadly in the oil and gas industry. Investors have basic requirements, which are to recoup their investments and achieve a reasonable rate of return.
However, the government has a lengthy history of exerting pressure on international companies, including those developing Kazakhstan’s three strategically important oil and gas fields — Kashagan, Karachaganak and even Tengiz. This pressure is manifested through a range of regulatory measures aimed at disputing certain provisions in the contracts or extracting additional concessions from the companies involved.
For example, a long-standing dispute between KPO and the government of Kazakhstan achieved what was thought to be a final settlement in December 2020, and there appeared to be a general hope that the previous wave of disputes between the government and major investors would be in the rearview mirror. However, a new pressure campaign against Kazakhstan’s top oil investors is back on. This includes the initiation of new arbitration cases by the government that reportedly claim about $155 billion from two of the three big project consortia, NCOC and KPO.
Over the past year or so, there has been a noticeable resurgence of certain viewpoints within Kazakhstan, critical of the Big Three and PSAs in general. These narratives are increasingly gaining momentum within the country, particularly in social and mass media, and seem to align with the government's general position, although this is far from certain. While the lawsuits are ongoing, the emergence of a wave of voices calling for major changes to the three major projects is quite remarkable, seemingly aimed at placing additional pressure on the investors.
Broad criticism of these long-term contracts has become more prevalent again, with many commentators asserting that Kazakhstan, being in a vulnerable state during the 1990s, was exploited when entering into these agreements. The benefits the country gained from these developments seem to be just simply taken for granted. Calls to not extend the current PSAs are becoming more widespread, and even demands to terminate them altogether have become in vogue. The critics of PSAs argue that they disproportionately favor foreign companies at the expense of the host country's interests, imposing an imbalanced relationship. Thus, it appears that the government is once again seeking additional compensation from the investors and may even be pushing for a new arrangement that would grant them more control over the assets.
Recently, some local “experts” suggest that the oil reserves in the Big Three projects will be largely depleted within the next decade (i.e., before the expiration of the existing contracts). Therefore, they argue that instead of waiting for their expiration, Kazakhstan could even replace (“buy out”) the current investors with new investors willing to assume responsibility for the projects under entirely new terms more favorable for Kazakhstan. One such commentator pointed out that in 2023 Kazakhstan was losing close to $500,000 per month from these projects due to their exemption from export duties. Another perennial complaint is that these projects are not sourcing an adequate amount of local content, even though this is a major stipulation built into the projects’ procurement. These grievances largely ignore the challenges of developing such complex fields in Kazakhstan and the resultant need for high levels of technology and expertise that reside largely outside Kazakhstan. The government more recently, in an effort to sweeten its bid to attract more investment, already waived the imposition of export duties on crude from new offshore projects.
Another important consideration some domestic experts put forward is the uncertainty surrounding the future demand for oil due to the ongoing energy transition. Therefore, they argue it is imperative for Kazakhstan to act now while oil remains a valuable commodity. Waiting until the PSAs expire is simply not feasible given the urgency of the situation, according to these experts.
The government has been relatively quiet amid the extensive public criticism of the Big Three projects. The Ministry of Energy emphasized that Kazakhstan’s government has assured foreign investors of the stability of the rules outlined in their agreements and is committed to their enforcement. The ministry highlighted the positive impact of stable subsoil terms in attracting significant foreign investment into the oil and gas industry. It also emphasized that each participant in the project has exclusive rights to manage and use their share, along with associated rights and obligations. Furthermore, the ministry stated that Kazakhstan respects this arrangement and refrains from interfering with the internal commercial decisions of other parties, including share exchanges. But the ministry noted that all share exchange activities must comply with national legislation and the stipulations of the agreement.
Government's current actions
Actual actions taken so far by Kazakhstan's government is the launch of litigation with NCOC and Karachaganak over several issues. Many of the media commentaries posit that these actions are designed to strengthen Kazakhstan’s overall negotiating position, implying that they are part of a deliberate pressure campaign. The first of these involves environmental charges against NCOC, following by the filing of international arbitration claims against NCOC and KPO.
An unprecedented environmental fine for NCOC
On March 29, 2023, Kazakhstan’s Ministry of Ecology and Natural Resources filed a case with the Atyrau administrative court against the Kashagan consortium. The complaint reportedly estimated a fine and penalties totaling 2.3 trillion tenge ($5.14 billion) due to alleged violations of environmental regulations. These alleged violations encompassed a litany of issues, including the storage of sulfur in excess of permitted quantities at the Bolashak processing plant, discharge of wastewater into an evaporation pond without adequate treatment and flaring of raw gas without an environmental permit. These alleged infractions were uncovered during a 2022 inspection conducted by the Environmental Department of Atyrau Oblast at the NCOC’s onshore and offshore facilities. NCOC denied the allegations, asserting that the company adheres to the most stringent environmental requirements throughout its operations.
The magnitude of the proposed fine is staggering. The bulk of the penalty is assessed for sulfur storage violations. The Ministry of Ecology and Natural Resources subsequently clarified that the amount of the fine was determined using established methodology but emphasized that the court would be responsible for setting the final fine. The $5.3 billion environmental fine that could be imposed on NCOC for storing excess sulfur seems unreasonable for an event for which there is no discernable negative impact or actual damage. For example, when compared with the penalties associated with a real environmental disaster, such as the 2010 Macondo blowout in the Gulf of Mexico, it seems excessive. That catastrophe involved the explosion and sinking of BP PLC's Deepwater Horizon oil drilling rig, leading to the tragic loss of lives of 11 workers and causing the largest oil spill in the history of marine oil drilling operations. Consequently, BP incurred a then-unprecedented $5.5 billion penalty under the US Clean Water Act, in addition to numerous billions spent on compensation to victims, cleanup and restoration efforts. The total value of the global settlement between BP and the US government and five US Gulf states was over $20 billion in 2017.
The Kazakh government appears to be sending a mixed message to the consortium. On the one hand, it threatens to impose substantial fines on NCOC for sulfur storage. On the other hand, it is pushing NCOC to construct a 4 (2+2) Bcm/y gas processing plant to utilize more sour gas instead of reinjecting it, an activity that significantly increases byproduct sulfur production and storage. This situation creates a paradox for NCOC.
In April 2023, NCOC challenged both the fine and the validity of charges stemming from the inspections. Following extensive legal battles and appeals, an Astana court of appeals sustained the earlier fine by rejecting NCOC’s appeal in February 2024. In April 2024, local media reported that NCOC had taken its case to Kazakhstan's Supreme Court.
Another blow: New arbitration claims against NCOC and KPO
NCOC also finds itself embroiled in another major legal battle, this time in an arbitration case over PSA terms. On April 11, 2023, PSA LLC, a government body responsible for overseeing PSA projects in Kazakhstan, initiated international arbitration proceedings in Geneva against NCOC, seeking $13 billion in claims. The dispute stemmed from the government's contention that the operator improperly deducted expenses during the period spanning from 2010 to 2018. Subsequently, these claims were said to have risen to $15 billion. The claims also allege that NCOC breached tender procedures for the project and failed to fully fulfill contractors' work obligations. Then by April 2024, PSA LLC had reportedly revised its claims against the consortium to a staggering $150 billion. The bulk of this is for a claim of an astounding $138 billion for “lost profits” and reflects the calculation of the cost of oil production that was promised to the Kazakh government but was not delivered by field developers’ revenue.
Details of the arbitration cases remain relatively sparse due to the confidentiality of the proceedings. However, in another cryptic report, news outlets disclosed an additional compensation claim related to contracts in the Kashagan development that were allegedly affected by corruption.