After the fall of the Soviet Union, at the Kazakh government’s invitation approximately 30 Western firms set up shop in Kazakhstan’s Caspian shelf to explore for oil and natural gas. Kashagan — one of the largest conventional oil finds in the past 40 years, with an estimated 35 billion barrels of oil reserves — was discovered in 2000. Development began in 2001, with an initial plan to begin oil production by 2005. Kashagan’s consortium members at the time were Italy’s Eni, France’s Total, Dutch-British Royal Dutch/Shell, U.S. firms Exxon-Mobil (then just Mobil) and Conoco-Phillips (then Phillips Petroleum Company), and Japan’s Inpex.

However, the consortium continually pushed back the project’s production date for a variety of reasons. First, Kashagan is an extremely difficult project. It is located in the northern Caspian Sea, which is frozen for three to six months out of the year. Large sheets of ice move across the waters and form on the rigs. Second, over the past decade there have been constant disagreements between the consortium members. Because of these spats, onetime consortium partner BG Group abandoned the project in 2004, Kazakh state energy firm KazMunaiGaz became part of the consortium in 2008, ConocoPhillips withdrew in 2013 and the China National Petroleum Corp. joined the consortium that same year.

Disagreements have stemmed from Eni’s role as operator. Other consortium members and the Kazakh government have accused the Italian firm of falling behind on its responsibilities. The disagreements have also stemmed from the Kazakh government’s pressure on the consortium to stop delaying production and — prior to 2008 — to give KazMunaiGaz access to the consortium. The government has levied a series of fines against the consortium for “environmental reasons” in order to pressure the group to comply. The Kazakh government has also changed its energy policies multiple times in the past decade to squeeze more investment out of foreign firms in the country and to bolster its own energy firms’ stakes in projects across Kazakhstan.

The unforeseen difficulties and constant delays in the project have pushed the price tag for Kashagan’s development from an earlier projection of $10 billion to the current $46 billion — and many estimates indicate that further delays could push costs past $60 billion.

In recent years, despite the rising costs, Kashagan appeared to be on track at last. Oil production finally began on Sept. 11, 2013, and the government hoped that production would quickly hit 175,000 barrels per day by the end of 2013 before increasing to 1.66 million by 2016. These hopes were quickly dashed on Sept. 25, 2013, when the pipeline was shut down after a gas leak was found. Pilot production began again in October, but once again another gas leak was found soon afterward and the project was shut down indefinitely.

Kazakh Oil Minister Uzakbai Karabalin said April 7 that production at Kashagan may not be restarted this year if tests to be reviewed in the second quarter show evidence of more cracks in the pipelines due to extraordinarily high amounts of sulfur. There is quite a bit of speculation that all of the pipelines in the project may need to replaced, which could delay the project for as long as two years.

Impact on Kazakhstan

The delays in Kashagan’s ability to produce in the near future are lowering the Kazakh government’s overall forecasts for oil production and, consequently, government revenue. Last year, the Kazakh government revised its oil production forecasts through 2015 to 1.84 million barrels per day in 2013 (down 2 percent from the 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 greater than the current 1.72 million barrels per day Kazakhstan produces.

 

However, with Kashagan delayed, the government will revise its projections once again. The announcement of the potential delays comes shortly after difficulties developed at Kazakhstan’s other major energy projects — Karachaganak and Tengiz. Both of the projects are revising their production schedules as well, with possible postponements of expansions.

Revisions in energy production mean that the government will have to also revise its state budget, which depends greatly on energy revenues. This does not mean the budget will decrease, but any expansion of spending will be halted. The Kazakh government’s budget revenues for 2014 are projected to be $31 billion and expenditures to be $36 billion. According to Stratfor sources in Kazakhstan, the government was expecting to receive $28 billion over three years (between 2014 and 2016) from Kashagan. According to media reports, the government was to receive $4-8 billion a year from the project. Either way, the government will be losing a large amount of revenue from Kashagan’s delays.

The Kazakh government is already in a tough financial situation. The availability of global credit is shrinking as the United States tapers its monetary policy, and Russia is experiencing its own financial tightening and a decline of its currency. Kazakhstan sharply devalued its currency in February, most of the country’s banks and companies are dealing with heavy debt burdens, and the Kazakh banks’ portfolios of non-performing loans (mostly from Kazakh companies) have skyrocketed. As a result of these circumstances, Astana is restructuring the country’s banking system and providing more subsidies to the population in order to maintain social stability. Now, the government is facing a decline in energy revenues.

The Kazakh government does have a financial cushion in the form of its National Fund, which currently holds $58 billion. The National Fund will transfer $8 billion to the government’s budget in 2014. However, between the currency devaluation, the banking problems and delays in energy projects, this amount could be spent fast.

The Kazakh government is starting to discuss other sources of financing, according to a Stratfor source in Kazakhstan. The government could sell state-owned assets in various sectors worth $10 billion, raise export customs duties on crude oil or increase taxes on automobiles and housing. Another idea is to order the consortium members of the Karachaganak and Tengiz energy projects to expand ahead of schedule. However, this would require pressure tactics against the consortiums, as seen in the past, and it is not clear whether the projects can expand.

Russia’s Opportunity

Though the delays in Kashagan are another burden for the Kazakh government, the situation presents a good opportunity for Russia, as it opens up more pipeline capacity for Russian oil exports going east. Moscow is increasingly concerned about its ability to continue sending large energy exports westward due to increased tensions between Europe and Russia. Over the past few years, Russia has increased its oil exports to Asia; Asia took 4 percent of Russia’s oil exports in 2004 but now is the destination of nearly 20 percent of Russia’s oil exports.

Russia currently uses multiple routes — pipelines, rail and sea — to export oil to Asia. The Kazakhstan-China pipeline is another potential route. Russia already has multiple pipelines in western Siberia that connect to the Kazakhstan-China pipeline, though it is mostly used for swapping oil. Russia has not exported oil to China via the Kazakhstan-China pipeline since 2010, when Russia’s own pipelines to China began coming online.

 

However, in 2013, Russian oil giant Rosneft signed an agreement with the Kazakh government for use of the pipeline — primarily the Atasu-Alashankou leg that has a connection to the Omsk oil basin in Russia. The deal, which comprises transiting an initial 55,000 barrels per day, caused political tensions within Russia. Russia’s pipeline operator, Transneft, said the deal would cause it to lose transit revenue, as it would not make money off Kazakhstan’s transit. The Atasu-Alashankou pipeline already has low transit fees, but with the Customs Union entering its next stage, Russian oil shipments will be tax exempt — another incentive for Rosneft to use the pipeline.

Atasu-Alashankou has been operating at 300,000 barrels per day and was supposed to increase production to 450,000 barrels per day in 2014 due to Kashagan’s oil production. However, with Kashagan delayed, there is more room for Rosneft to use the Atasu-Alashankou pipeline. Thus, while the delays at Kashagan are a blow to Astana, Rosneft will benefit for now by having an inexpensive means of sending additional capacity to China.