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Kashagan oil field begins production after decade of delays

By Dina Khrennikova in Moscow

September 16, 2013 - After a decade of delays, huge cost overruns and fraught negotiations with the Kazakh government, the partners in the giant Kashagan oil field project in the Caspian Sea have finally welcomed first oil.

Kashagan, fondly described in recent years as the world's biggest undeveloped oil field, is set to ramp up quickly to produce around 180,000 b/d.

Over the course of this year and next, output is expected to reach phase one design capacity of 370,000 b/d.

This would represent almost a quarter of Kazakhstan's current crude output of some 1.6 million b/d.

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After that, output is designed to rise to 450,000 b/d, but the Kashagan partners have failed to agree with the government on allowing the injection of associated gas back into the reservoir to raise oil output to that level.

A second -- and much more ambitious stage -- was meant to see production peak at 1.5 million b/d after 2018, but those plans have stalled mainly due to the spiraling costs.

Kashagan, discovered in 2000, holds around 38 billion barrels of oil in place, including 13 billion barrels of proven recoverable reserves.

But development of the giant reserves, some 4,200 meters below the seabed, has proven to be more technically challenging -- and therefore more expensive -- than first thought.

The technological challenges -- and the related solutions -- have pushed Kashagan's budget to record highs.

The total cost estimates of Kashagan over the life of the whole project have ballooned in recent years and most recently were pegged at $136 billion from an initially targeted $57 billion.

In 2012, the Kashagan partners and the Kazakh state agreed to raise the budget of the first phase alone to $46 billion from an earlier agreed $38 billion.

The cost overruns have repeatedly delayed the field startup. Initially scheduled for 2005, the launch was subsequently pushed back to 2008, then 2010, 2012, and finally to 2013.

The Kazakh government also used these cost overruns as a reason to chastise the partners, and to push through the entry of state-owned KazMunaiGaz into the ownership structure.

Between 2005 and 2007, in a series of sweeping actions, KazMunaiGaz entered the consortium and gradually raised its stake to the current 16.81%.

Currently, KazMunaiGaz is also in the process of buying another 8.4% stake in Kashagan from ConocoPhillips, which is selling its stake as part of its asset disposal program.

Once the deal is complete, the state-run company will sell an 8.33% stake to China's state-owned CNPC.

The back-to-back deals will see KazMunaiGaz' stake rise slightly to 16.88%.

Assuming the CNPC deal is finalized, the shareholder structure will be: KazMunaiGaz (16.88%); Eni, ExxonMobil, Shell and Total (16.81% each); CNPC (8.33%) and Inpex (7.56%).

Future challenges

While the startup of production will be a welcome boost for the partners, there remain concerns that the challenging operating conditions may not allow the project to continue beyond phase one anytime soon.

Due to severe winters, when temperatures can drop to minus 30 degrees Celsius (minus 22 Fahrenheit), the shallow North Caspian waters freeze for four to six months every year.

The resulting ice drifts, and ice scouring makes the use of traditional offshore rigs risky.

Another key challenge is a high -- 15%-20% -- content of poisonous hydrogen sulfide.

Combined with high pressure at the Kashagan reservoirs, it significantly raises the risk of potential spills.

To prevent ice from damaging the rigs, the partners decided to locate the drilling facilities on artificial islands. An impermeable plastic membrane was laid on the surface of the islands to protect the sea from potential oil spills.

"Kashagan is a very challenging field," Lyazzat Kiinov, then-CEO of Kazakhstan's state-run KazMunaiGaz, said in late April.

"[The partners] have invested a lot into it. Now they are doing their best to launch the field," he said.

But Kiinov hinted that the project may not progress beyond its first phase. "It has been decided to launch production at one section of the field to estimate well capacities, to see how the equipment operates. We will not hurry [with further development] until we get all the answers," Kiinov said.

The consortium is just in time though -- according to an agreement on the project from June 2008, production must begin by October 1 this year or else the expenses incurred by the consortium in the development of the field will not be compensated.

There are also issues with Kashagan's quality. Because both the crude and associated gas at the field are very sour, the consortium has built an onshore facility to "sweeten" the production. Only then will it be of export quality.

The initial output is expected to be shipped via the CPC route to Russia's Black Sea port of Novorossiisk and via the Atyrau-Samara line to Russia. Experts believe that some volumes may also be sent to China. (See related map: Export options for Kashagan crude).

The gas production, which is set to average some 3 billion cubic meters/year, will be purchased in its entirety by Kazakhstan's state-run KazTransGaz.

Some 70%-80% of the gas will be used domestically, with the rest exported, KazTransGaz said in August.

The partners also plan to sell the sulfur produced during the "sweetening" of Kashagan's oil and gas, which is expected to amount to some 1 million mt/year.

With its crude oil, associated gas and sulfur set to start selling any time now, it seems the wait has been worthwhile.

Over the past three years, Kazakhstan's oil production has stagnated at around 1.6 million b/d.

Further discoveries in the traditional onshore provinces are unlikely, according to analysts at UBS and Kazakhstan's state-run Halyk Finance bank, while exploration at new offshore blocks has produced no significant results to date.

So Kashagan's future development will be closely watched: will it stay only a 370,000 b/d producer, or will it expand into a giant 1.5 million b/d field, with the potential to double the country's overall oil output?

Next article: Kashagan partners mull oil export options

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