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Kashagan – Back to the drawing board?


Kashagan oil field image via BBC

It should have turned Kazakhstan into a global oil and geopolitical champion. Instead, it turned out to be a cul-de-sac, swallowing over $50 billion since its discovery almost two decades ago. Kashagan, a mammoth-sized offshore oil field with recoverable reserves of some 13 billion barrels that stretches over more than 3000 square kilometers, was recently shut down indefinitely due to technical problems. With Kazakh ambitions scuttled and the reputation of the project-managing consortium in tatters, will it go down in history as the Titanic of oil fields?

From euphoria to despair, Kashagan has been through it all. Major cost overruns, intense squabbles between major stakeholders, and insurmountable technical problems prevented the project from seeing daylight in 2005, as contractually required. Instead, it only began pumping the first barrels in September last year, but this lasted just a few days before the appearance of micro cracks in the pipelines connecting the offshore field to the onshore refinery, leading to a halt in extraction. Several days later, the leaks were patched and production resumed.

A mere two weeks passed before the pipeline started spilling again. This time around, the consortium shut down the whole operation pending further inspections. On April 7th, officials announced that the field would not restart production, at least not for the next two years. After a decade in the making, the field pumped a total of only 320,000 barrels.

 

The little oil field that couldn’t.

Was it mere hubris that forced such a disappointing outcome on Eni, Shell, Exxon, Total and KazMunaiGaz - the major firms involved in the development of Kashagan? Located in the northern part of the Caspian, at 4200 meters below the seabed and mixed with high-pressured metal-eating hydrogen sulphide (H2S), the oil seemed a hard prize to win from the outset. To tap into the reservoir new technologies had to be developed and 10 artificial islets had to be built in freezing temperatures of -40°. Given its high development costs, the field would have been feasible only in a high oil price environment. And for a brief moment it seemed that it had succeeded.

Unfortunately, in the end the machinery proved to be less resilient than expected. A representative of the consortium explained that, “sulphur stress cracking was identified as the root cause of the pipeline issue [and] the process occurs if steel of high hardness is exposed to high concentrations of H2S under high pressure in the presence of water”.

Initial analyses point out that rather than repairing the 55-mile long pipelines, it would be more cost effective to build a new parallel line out of nickel alloy, which carries a higher price tag. These upgrade works will increase the project’s already soaring costs, adding to the $4-$12 billion in lost revenue, as estimated by Reuters.

Even more worrisome is the fact that contractual terms give the government the right to refuse to reimburse the costs behind Kashagan’s development, potentially even refusing to foot the entire $50 billion bill if the consortium misses its target by the given deadline. The  project had to reach a minimum rate of 75,000 bpd by October 2013 before attaining its final target of 1.5 million bpd in 2015. Kazakhstan’s capital, Astana, has proven to be increasingly impatient with an endless series of mishaps, and even threatening outright nationalization.

 

Dashed ambitions

More than half of the expenditures included in the latest Kazakh budget have been based on oil revenues. Understandably, the Kashagan debacle now forces the government to reassess its economic outlook, as the field will not be able to produce the 450,000 bpd projected for 2014. Growth rates for this year have already been cut and analysts continue to hint at possible downgrades for the Kazakh economy, no longer seen as experiencing sturdy growth.

Geopolitically, the consequences are far more dire. Occupying a surface equal to two thirds of the continental US, Kazakhstan sits at the crossroads between Asia and Europe. Kazakhstan wanted to wager its rising status of world-class energy producer and wean itself off Moscow’s influence in the hope of becoming a regional powerbroker. From 1 million bpd in 2007, Astana had wanted to increase production to 3 million bpd by 2015, riding high on Kashagan’s expected output of 1.5 billion bpd. At that point, the only question in need of an answer was where the oil would ultimately flow.

Beijing emerged as the most attractive partner for Astana. With deep pockets and clever worded statements, China had been making substantial inroads into Central Asia, outplaying and even supplanting Moscow, as the former USSR republics sought to distance themselves from their former imperial master.

Kazakhstan seized this opportunity. A new pipeline was built, stretching from Atyrau, a major hub close to the main Kazakh oil fields, to Alashankou in China. After ConocoPhilips withdrew from the consortium in 2013, the government awarded the stake to China’s giant CNPC, strengthening the bilateral partnership with promises of increased oil flows once the Kashgan field had come online.

Kazakhstan seems to have failed to live up to its production targets, at least in the expected timeframe. All the careful calculations made by Astana had largely depended on the success of its prize crown jewel, the Kashagan oil field. Without it, Astana’s leveraging power has been dramatically diminished, along with its chances of drifting away from Moscow’s orbit.

Named after a 19th century local lyrical poet, the Kashagan oil field would have been the fountainhead of Kazakhstan’s political emancipation. Instead, it turned out to be one of the most scathing riches-to-rags stories in modern oil history.

Editorial Notes:
Related articles
December 2012, Rayhan Demytrie, BBC - Development challenge of Kazakhstan's giant oilfield
April 2014, Steve Levine, Quartz - Kazakhstan’s largest oilfield will be shut down for at least two years

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