Newsletter No. 878
News-Analysis
January 17, 2008

 

The following newsletter has been contributed by Elena N. Shadrina (Shingetsu Member No. 102). Shadrina is a Russian doctoral candidate at Niigata University.

JAPAN-KAZAKHSTAN ENERGY COOPERATION: FALLING BACK AND MOVING FORWARD

Similar to previous newsletters on developments in Japan-Kazakhstan relations, the current one also covers spheres of particular mutual interest such as cooperation in the energy sector and the politico-diplomatic realm. Additionally, one field -- promotion of ties in education -- is addressed here for the first time.

Energy Affairs

Japan’s aspirations to compensate for its own lack of resources and curtail its energy overdependence on the Persian Gulf are well-known. Kazakhstan, for its part, also regards the energy sector as pivotal to national economic development. At the outset, Kazakhstan relied heavily on international cooperation in this area. However, with domestic market reforms and shifts in the global marketplace, the nation has now started to amend some of its energy policy tools to better suit the changed realities.

Given that the geographical distance between Japan and Kazakhstan significantly affects the feasibility of joint initiatives on conventional carbons -- such as oil and gas -- nuclear cooperation is, perhaps, the most useful avenue for bilateral energy ties. Moreover, it corresponds well to both countries’ targets in terms of energy exports and energy diversification.

But before we look once again at Japan-Kazakhstan nuclear ties, it is in fact the field of oil development that has produced the most dramatic story, and so that is where we will begin.

The Troubled Kashagan Oilfield Project

Our previous account (Shingetsu Newsletter No. 803) shed some light on the problems of the Kashagan project. As we earlier observed, the Kazakh authorities have been irked by cost overruns and delays in the Kashagan project and have pushed for cash compensation and a bigger stake for state energy company KazMunaiGas. Such a stake would equal those of four largest foreign participants -- ENI, Royal Dutch Shell, ExxonMobil and Total, after a pro-rata cut in favor of Kazakh state company KazMunaiGas by all other consortium members. Before the settlement, each of the four had a 18.52% stake, and two other participants in the project, ConocoPhillips and Japan’s Inpex, had 9.26% and 8.33% stakes, respectively.

The six-month long conflict has just been resolved in talks that ended on January 14. But let us first view the situation from the point where we stopped in our last newsletter.

Kazakhstan demanded a greater share of the profits from Kashagan as compensation for delays, which allegedly extended as long as eleven years the time it would take for the country to see returns from the field. Costs for developing and running the project have more than doubled, hitting US$136 billion, according to state information. In October, Deputy Finance Minister Daulet Ergozhin said that the delays cut Kazakhstan's returns from the project by more than US$10 billion over the forty-year life of the field.

In 2004, ENI and its partners already paid a US$150 million fine after delaying the start of oil production at the field from 2005 to 2008. Talks to revise Kashagan's 1997 contract took place after engineering costs and safety considerations forced the group to delay output a second time to the third quarter of 2010.

Kazakhstan had pressured the companies by amending its subsoil law to allow it to cancel oil projects such as Kashagan if developers “significantly” violated production contracts.

Understandably, events surrounding the development of the Kashagan field have raised concern among foreign investors about the fate of their investments in Kazakhstan. ExxonMobil, which had been the only member of the consortium that had been holding out on agreement to lower its interest in favor of KazMunaiGas, saying it had a different view on the valuation, was finally satisfied with the agreement. Company spokesman Gantt Walton said, “Kashagan is an extremely complex project and ExxonMobil and the other consortium members have reached an agreement on a strengthened operating model.”

Kazakhstan is often, and not groundlessly, compared to Russia. Back in the 1990s, both countries were struggling with the economic aftermath of the collapse of communism and wooed investment and technology by signing production-sharing agreements with foreign companies. When costs began to soar on higher metals prices, and crude oil set fresh records, deals signed in leaner times came under review.

The notion that Kazakhstan is following in the footsteps of Russia, which a year and half ago under a similar scenario revised its agreement with Royal Dutch Shell, Mitsui, and Mitsubishi, and took control over the Sakhalin-2 project, is rather strong. As Christopher Weafer, chief strategist at Moscow-based UralSib Financial Corporation, put it: “This is likely to be only Phase One of the ownership question… As Kazakhstan appears to be following the path set by its neighbor and mentor Russia, we should expect to see them to eventually build their position at least to a blocking stake and perhaps higher.” (A blocking stake would be about 25%, he said).

To some experts, Kazakhstan's tougher stance also mirrors that of other oil producers, such as Venezuela or Nigeria, which have tightened their grip on national resources as prices have surged. At the same time, Canada, which by no means can be reckoned a particularly rebellious state, has also changed the terms of previously-agreed contracts or renationalized assets. The latter exemplifies that an unbiased approach to examining cases akin to Kashagan is perhaps more appropriate than labeling them as simply another example of “resource nationalism,” or acting as part of a global “resource war.”

Meanwhile, Kazakh Energy Minister Sauat Mynbayev denies that the government is now planning to review contracts held by other foreign-led groups, such as Chevron’s Tengizchevroil Project and the BG Group's Karachaganak development. “We don't have such plans,” Mynbayev said. “They are different from Kashagan: There was no way we could accept an unjustified cost increase and delays.”

What are the terms of the new January 14 agreement?

The agreement provides that state-run KazMunaiGaz will pay US$1.78 billion to double its Kashagan stake to more than 16%, on par with the top shareholders. This was announced by Energy Minister Mynbayev at a January 14 press conference in the Kazakh capital, Astana. The ENI-led group will also pay the government US$5 billion to compensate for lost revenue and share profits with the state earlier than planned, he said.

ENI and its partners will make the US$5 billion (it was rumored to be about US$7.5 billion in October) payment to the government over the life of the Kashagan contract, which will not be extended beyond 2041, Mynbayev said. This amount has been calculated based on oil prices at US$65 a barrel, and may fluctuate with crude prices, he said. Kazakhstan will earn an additional US$7 billion in revenue between 2010 and 2015 by doubling its stake in Kashagan, says Rinat Gainoulline, an equity strategist at Moscow's Alfa Bank.

“Although none of the foreign oil companies will be happy to give up equity, it's a small price to pay to resolve the impasse,” commented Christopher Weafer. “It's better to have reduced equity in a project that has full state support rather than a bigger position in a project that faced an increasing number of problems.”

ENI will lose its role as sole operator of the field after production starts at the end of 2011. KazMunaiGaz, ExxonMobil, Total SA, and Shell will join ENI in a new operating company, with Kazakhstan holding a “controlling function” in the field's future development. Energy Minister Mynbayev commented: “The new company will coordinate and approve work. The actual development work will be split up among the partners, for example with one doing the drilling and another building coastal infrastructure.”

The companies, which will transfer some of their Kashagan stakes to KazMunaiGaz, as well as the government, are set to complete the changes to the development contract resolving the dispute by the end of May.

ENI spokesmen noted that the agreement also includes a “value transfer package from the consortium to the Kazakhstan authorities” and “provides for an increased role of KazMunaiGaz in operations and for a new operating and governance model.”

Kazakhstan will take as much as 5% of the profit even before the foreign partners recoup their costs, Mynbayev said. Under the original contract, the state would have received nothing until the companies had recovered their initial investment. Kazakhstan will keep its 10% share of so-called “profit oil,” the crude that will be sold once the project's costs have been paid. Tax breaks for the foreign investors, known as uplift, will also be trimmed, according to Mynbayev.

The Kashagan issue was a major focus of attention in Kazakhstan. Kazakh Prime Minister Karim Masimov himself attended the final round of negotiations. The final talks lasted more than nine hours. Even President Nazarbayev has put his hand into the dispute settlement by meeting representatives of ENI's partners, including Shell Chief Executive Officer Jeroen van der Veer, at his Astana residence on January 14.

This giant oilfield (no less than 1.5% of world’s estimated reserves) in the Caspian Sea is crucial for Kazakhstan to achieve its stated goal of reaching 2% of the global crude output by 2018. It is no wonder that the Kazakh elite put on as much pressure as they could to get a good deal.

Earlier, the Wall Street Journal quoted Mynbayev as saying: “We know what price we are offering and what price they (foreign companies) would agree to,” and his assertion turned out to be accurate. The Russian media unanimously evaluate the Kashagan settlement as an absolute triumph for Kazakhstan.

As for how the results immediately affected Japan's largest oil and gas explorer Inpex Holdings, its stock dropped 4.24% on the Tokyo Stock Exchange and became the biggest decliner for one day on the MSCI AC Asia Pacific Energy Index. However, Hidetoshi Shioda, a senior energy analyst at Mizuho Securities Company, stated: “The stock is reacting to the news, but I don't think the drop will extend further.”

The precise stake that Inpex will hold in Kashagan after the January 14 agreement has not been announced.

Advancing Cooperation in Nuclear Fuel Processing

On the other hand, Kazakhstan-Japan bilateral cooperation in the field of nuclear energy is progressing quite smoothly.

As is known, Kazakhstan is home to a fifth of global uranium reserves with aspirations to become the world's top producer by 2010, surpassing Australia and China. On the flip side, Japan is widening efforts to forge closer ties with uranium-rich Kazakhstan so as to reduce its dependence on increasingly-expensive Persian Gulf crude oil.

In Shingetsu Newsletter No. 659 we reported about the representatives of Kansai Electric Power Company visiting Kazakhstan in April 2007 as members of mission led by METI Minister Akira Amari. During that visit, they confirmed an agreement with Kazatomprom regarding cooperation on nuclear fuel procurement. Currently, Kansai Electric is also collaborating with Kazatomprom on uranium mine development.

On December 26, 2007, it was announced that Kansai Electric, Japan's Nuclear Fuel Industries, and trading house Sumitomo Corporation were tying up with Kazakhstan's state-run energy company in uranium processing for nuclear power generation. According to Mitsuji Mori, a spokesman for Kansai Electric, the three Japanese firms signed an agreement with Kazatomprom with the aim of securing a stable supply of nuclear fuel for Kansai Electric, Japan's second-biggest utility, which currently procures such fuel from Japan's Mitsubishi Nuclear Fuel Company and from abroad.

Mori also said that under the tie-up state-owned Kazatomprom will handle the reconversion stage of the nuclear fuel cycle at a facility in Kazakhstan to turn enriched uranium gas into powder for use in nuclear power plants. Kansai Electric and Sumitomo, meanwhile, will provide expertise and funding for necessary modifications to the plant, which will be capable of producing roughly twice the nuclear fuel needed by Japan.

No financial details were disclosed, but according to the Nikkei, the cost of upgrading the Kazakh facility alone is expected to be somewhere in the US$614 million to US$702 million range.

Celebrating Kazakhstan's Independence Day

Kazakhstan has celebrated the 16th anniversary of Kazakh Independence on December 16. Japanese politicians, journalists, and diplomats received invitations to a state reception, and figures from Tokyo and other regions were in attendance.

In his speech on the occasion, Akylbek Kamaldinov, ambassador of Kazakhstan to Japan, dwelled on the history of the bilateral relationship, recollecting the opening of the diplomatic mission in 1996. He also stressed that the countries are becoming important partners.

According to Professor Tetsuji Tanaka, executive director of Central Asia and Caucasus Research Institute, who also attended the reception, Kazakhstan’s bright future and its political stability constituted the grounds for the nation elected to the Organization for Security and Cooperation in Europe (OSCE) chairmanship in 2010. Professor Tanaka also said that Japan pays great attention to Kazakhstan’s development, and expressed the hope that the Kazakh presence in the OSCE will harmonize the situation of the entire Central Asian region. He congratulated Kazakhstan on its achievement.

Controversy on Kazakhstan’s Chairmanship of the OSCE

Overall, the late November news that Kazakhstan will serve as the 2010 chair of the OSCE generated a mixed reaction among international experts and human rights activists. Some believe that the decision undermines the OSCE's ability to act as a vehicle for democratization, but others hope that Kazakhstan can serve as a bridge that helps close existing gaps in the organization.

Kazakh Foreign Minister Marat Tazhin was quoted as saying that the decision would stimulate “the comprehensive modernization of our country, and the region in its entirety” with the introduction of domestic reforms and the continuation of election monitoring activities carried out by the OSCE's Office for Democratic Institutions and Human Rights (ODIHR).

Representatives of a leading human rights organization, Human Rights Watch (HRW), expressed skepticism that the OSCE's action would promote liberalization in Central Asia. The decision does “damage to the organization's credibility,” said Rachel Denber, the deputy director of HRW's Europe and Central Asia Division.

Although this development clearly generated much debate in Europe, there have been no reported comments from the Japanese government or human rights organizations.

Joint Symposium on Chemical Engineering

In accordance with opinions expressed during the second “Central Asia Plus Japan Intellectual Dialogue” held in Tokyo on January 30, 2007, concrete efforts at cooperation in the educational sphere between Kazakhstan and Japan seem to be starting to progress.

The Japan-Kazakhstan Joint Symposium on Education and Research in Chemical Engineering is to be held on January 21 to 22 in Tokyo. This symposium aims at facilitating collaborative research and educational development between chemical engineers in Japan and Kazakhstan. It is supported by the Tokyo Institute of Technology and the Kazakh embassy in Tokyo.

The symposium has been organized based on a “Memorandum of Agreement on Academic Exchange” between the Tokyo Institute of Technology Al-Farabi Kazakh National University, in Almaty; as well as the “Memorandum of Agreement on Academic Exchange” between the Tokyo Institute of Technology and the Kazakh-British Technical University, also in Almaty. Both of these agreements were originally signed in November 2006.

Among the issues that will be covered by the symposium are the fundamentals and applications of ongoing research topics that involve advanced unit operations; natural resource development and utilization; chemical and biological technologies for sustainable development; use of separation technologies and reactions for processing; plasma and high temperature processing, surface chemistry, fine-particle engineering, and nanotechnologies; engineering micron-size process systems, process intensification, computer applications and process systems engineering, environmental risk abatement technologies, and medical technological processes.

In this way, we can observe that Kazakhstan-Japan relations, despite the setback for Inpex, are indeed deepening in several crucial economic, political, and educational spheres.