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May 2012 | EPmag.com

SPECIAL REPORT:

CASPIAN REGION

rom the time of Zoroastrian and Hindu pilgrims, whotraveled from India to worship at Ateshgah of Baku where

a vent from a subterranean gas field once fed a continuouslyburning flame; throughout the Second World War, whenalmost 80% of the Soviets oil was produced in Azerbaijan; tothe December 1994 ratification of Heydar Aliyevs first produc-tion-sharing agreement (PSA), the Contract of the Century,which would propel the country toward being the worldsfastest-growing economy in 2006; the history of Azerbaijanis interwoven with the development of its oil and gas industry.

The Caspian region presents lucrative butdifferent visions for oil and gas investment

Aker Solutions, through

its Drilling Technologies

division, supplied, installed

and commissioned a drillingderrick & equipment

package to AIOC

(operated by BP).

Azerbaijan:Land of fire

Near the Georgian border there is a spring from which gushes

a stream of oil, in such abundance that a hundred ships may

load there at once, so says the account of Marco Polo in refer-

ence to Baku oil.

The Caspian Sea, the largest inland body of water on earth,

separates what are undoubtedly the two oil giants of the region,

Azerbaijan and Kazakhstan. The Caspian region has become acentral focal point for untapped oil and natural gas resources

and contains an estimated 10% of the earths potential oil

reserves. The major projects that have contributed to this envi-

able position have been Tengiz and Karachaganak in Kaza-

khstan and Azerbaijans Azeri, Chirag, and Guneshli fields.

Natural gas reserves in the Caspian region are proven at

more than 236 Tcf, and the regions total oil reserves are

reported to constitute more than 60 Bbbl of oil, with some

estimates as high as 200 Bbbl. With the aid of substantial

foreign investment, the region produced 4.5 MMb/d in

2010, compared to just 870,000 b/d in 1995. While no

doubt a remarkable achievement, the bulk of potential

remains largely untapped.Further development faces significant challenges. The two

oil giants, with vastly different economies, legal structures, and

political environments, are addressing very similar issues sur-

rounding the production and transportation of oil and gas in

the region but in very different ways. This report byE&P

andGlobal Business Reports explores the directions

each country is taking. The success of these respective paths

has implications for Azerbaijan and Kazakhstan and will

no doubt hold important lessons for neighboring countries

Uzbekistan and Turkmenistan.

F

Prepared by Global Business Reports

for E&P. More information can be

found at gbreports.com

Eugene Yukin, Joseph Hincks, Katie Bromley, Katya Koryakovtseva, and Saskia Coplans, Global Business Reports

Two sides of the same sea:

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There are 57 oil deposits in Azerbaijan. Eighteen ofthem are in the Azeri sector of the Caspian Sea, and therest are on land. According to the State Oil Company ofAzerbaijan (SOCAR), the Caspian basin has deposits of

30 billion tons of oil and 18 Tcm to 20 Tcm of gas. Oilhas always been part of the life of the people in Azerbai-jan, said Adil Mammadov, president of Azpromo, Azer-baijans national body for the promotion of foreigninvestment.

Azerbaijan is arguably the most experienced oil andgas producing nation in the world. The first industrialproduction of oil in Azerbaijan took place in 1846, adecade before the Americans sank their first oil well inPennsylvania. The worlds first oil pipeline was laid fromBaku to Supsa on the coast of the Black Sea, and theworlds first oil tanker was built in Azerbaijan. In 2012,

the country must draw on its exceptional heritage as itprepares to undertake some of the most ambitioushydrocarbon plays in the world.

The contract of the centuryand the rise of the PSAsDespite Azerbaijans heritage as an oil and gas produc-ing nation, after regaining independence from theSoviet Union the country was desperately in need offoreign investment and technology to reinvigorate itshydrocarbons sector and bolster its nascent economy.

The Azeri, Chirag, and deepwater Guneshli Contract

No. 1, a 2004 agreement signed between then PresidentHeydar Aliyev and the Azerbaijan International Operat-ing Company (AIOC), is commonly referred to in Azer-baijan as the Contract of the Century. Azerbaijans firstPSA laid out special provisions for the shareholders whowould develop the field and was to change the economy,political standing, and standard of living in Azerbaijan

for decades to come. TheAzeri-Chirag-Guneshli (ACG)deal was not only a massivefinancial coup for the govern-ment ACG has estimated oil

reserves in excess of 5.4 Bbbl,and conservative predictionswhen the field came onstreamin 2006 had it that the con-tract would bring in up to US$170 billion in revenues forthe country before 2025 butalso set the framework forfuture extraction of oil andgas in the country. Since 2004,more than 20 PSAs have beensigned in Azerbaijan.

Parties to Azerbaijans PSA agreements are the gov-ernment of Azerbaijan represented by SOCAR andcontractors represented by various foreign oil and gascompanies. The tax system consists of two alternative

regimes: the statutory regime governed by the TaxCode, and the tax regime established by existing PSAs.Contractors under PSAs pay a prenegotiated profit taxbut enjoy various favorable conditions such as exemp-tion from VAT and customs duties on imports.

More broadly, the legal regime for foreign investors isas favorable as the one created for local investors, andAzerbaijani law protects foreign investors interests fromfuture adverse changes in the legislation for the next 10years, although this does not apply to changes in legisla-tion concerning defense, national security and publicorder, environmental protection, credit and finance,

and public morale and health.The success of Azerbaijans PSAs, and their continued

stability, has been key to attracting foreign investmentinto the country. Salans, the largest international law firmoperating in Azerbaijan, played a major role in fosteringagreements for the ACG field in Azerbaijan as well asthe Karachaganak and Kashagan fields in Kazakhstan.The other Caspian states with major oil productionsuccumbed to a great extent to impulses of resourcenationalism, particularly in Kazakhstan, said JamesHogan, managing partner at the Baku office of Salans.

The Kazakhstan approach entailed periodic demands

to renegotiate contract terms, which held up projects,and in some cases such changes rendered the originalcontract somewhat meaningless. Azerbaijan was differ-ent. There has not been a single case of a PSA havingto be renegotiated, said Hogan. It is a system that hasworked well for both the contracting oil companies andthe state, and both parties concentrate on getting thejob done.

The scope of Azerbaijans PSAs goes beyond the basicsof extraction to include provisions for various sector-related subcontractors. Customs regulations in Azerbai-jan, for example, are regarded as problematic, subject

to complex bureaucracy and vulnerable to corruption;however, logistics companies who deal directly with theoil and gas sector have a somewhat easier experiencethanks to the PSAs.

The energy sector for the most part falls under thePSA and as such clients benefit from preferential tax ben-efits to encourage trade in Azerbaijan, said John Quinn,operations director at ACE Forwarding Caspian, whosecompany has a 15-year history of offering freight forward-ing and dangerous goods management services to inter-national oil and gas companies operating in Azerbaijan.If you look at the region Russia, Kazakhstan, Azerbai-

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CASPIAN REGION

George Taggart, regional

manager, Caspian,

Drilling Technologies

at Aker Solutions

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EPmag.com | May 2012

jan, Turkmenistan, Georgia a lot of the legislation fol-lows suit, and all have similar requirements ... (but) thereare differences in the PSA agreements; we find that thePSA in Azerbaijan will currently allow you to bring in

goods with greater flexibility than in Kazakhstan.

One egg, one basketThe Azeri, Chirag, and deepwater Guneshli Contract No.1 was not only central to Azerbaijans oil and gas evolu-tion, it also served to cement the place of BP as the coun-trys most prominent international oil company (IOC).

BP, which established an office in Baku in 1992, has adominant stake in the majority of the countrys largeprojects. In addition to being the operator of the ACGfield, BP has heavily invested in the giant gas field ShahDeniz and will lead the field into its second phase of

development. Other projects in which BP has a signifi-cant interest include the BakuTbilisiCeyhan (BTC)pipeline, which transports crude oil from offshore fieldsin the Caspian Sea to the Turkish coast of the Mediter-ranean for further shipping into Europe; the South Cau-casus Pipeline, designed to transportgas from Shah Deniz through Georgiaand on to the Georgia-Turkey border;and the Western Route ExportPipeline, which transports oil to Supsaon the coast of the Black Sea and theSangachal Terminal that feeds it.

BPs longstanding pre-eminence hashad implications across the strata of theAzerbaijani oil and gas value chain.Service companies face fierce competi-tion for a contract with a single opera-tor that can be regarded as somethingof a golden ticket; the success of someof the largest engineering, procure-ment, and construction managementin the region can at least partly beattributed to the long-term relation-ships that they have cultivated with BP.

The reason we came here so early ishaving worked extensively with BP inthe North Sea. We followed them herewhen they needed our asset supportservices, Peter Ward, AMECs generalmanager in Azerbaijan, said. AMEC,the main provider of rig support andengineering services for BP, has beenin Azerbaijan for 14 years.

In a shift that can be consideredreflective of the importance BP nowplaces on the Caspian region, BPs

relationships in Azerbaijan are, in some cases, providingthe parameters for activities elsewhere in the world.Aker Solutions Drilling Lifecycle Services, a division ofAker Solutions, has four rigs operating in the ACG fields

and has maintained a long-term operational serviceagreement (OSA) with BP. BP is considering usingthe Caspian contract template model in other areasof the world. Aker Solutions is a Norwegian company,and the fact that the Caspian region is leading the rela-tionship is hugely significant for us, George Taggart,regional manager of Drilling Lifecycle Services at AkerSolutions, said.

Shah Deniz Phase 2The Caspian region was BPs largest operation globallyat the time of writing and particularly in the wake of

BP losing out to ExxonMobil in the Arctic. The com-panys handling of Shah Deniz as it enters its stagetwo development will be keenly watched by investorslooking for assurance that BP can still deliver on world-class projects.

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Shah Deniz was discovered by BP and SOCAR in May1999 and contains more than 1 Tcm of gas. In 2006, justseven years after the initial discovery, Shah Deniz came

into its first phase of production, which is expected tomaximize at 8.6 Bcm of gas per year and about 50,000b/d of condensate.

The planned Phase 2 expansion, or full-field develop-ment, is the largest gas development project operated byBP in the world and could take production at the fieldup to 16 Bcm per annum and 100,000 bbl of conden-sate. Shah Deniz Phase 2 is significant for both Azerbai-jan and the wider world. It will mean that we can delivergas not only for local consumption, Georgia, andTurkey, but also to Europe, said Rauf Aliyerov, manag-ing director at SOCAR Shah Deniz LLP.

Phase 2 will involve the construction of two newbridge-linked production platforms, 26 subsea wells tobe drilled with two semisubmersible rigs, and 500 km(311 miles) of subsea pipeline. The technical difficultyof Shah Deniz wells, augmented by uncertainty overtransit routes, means that at present it is difficult to getmuch certainty on production timelines. Our bestguess is that Phase 2 will be producing in 2017, but itdepends largely on how the commercial issues are final-ized, Aliyerov said.

Commercial issues aside, Azerbaijans operators andservice companies alike are gearing up for what prom-

ises to be an extremely technically challenging project.The South Caspian Sea and Azerbaijan have a verycomplex tectonic history, and there are a lot of variantpressures both shallow and deep, said Rob Algie,Schlumbergers Azerbaijan general manager. Whendrilling, these create a lot of complexity, so there is ahuge role for technology.

One of the biggest challenges for Azerbaijan will bewell integrity. The region is tectonically very active,which creates numerous over-pressure and under-pres-sure zones. Reservoir pressures change very rapidly, andthis narrows operational margins. Narrow drilling mar-

gins such as the difference between pore pressure andfracture pressure require advanced technology andprocesses to control and good execution to deploysuccessfully, Algie explained.

SOCARThe most striking consistency throughout Azerbaijansvariant landscapes, its giant oil and gas fields, its oilyrocks, its numerous transit pipelines, and its refineriesis the ubiquity of SOCAR. Government-owned SOCARis now one of the largest oil and gas companies in theworld and an integral player in all of Azerbaijans PSAs.

SOCAR was established in 1992 with the merger ofAzerbaijans two state oil companies, Azerneft andAzneftkimiya, in part to ensure that Azerbaijan reaped

the benefit from its abundant hydrocarbon resources.While post-Soviet Azerbaijan was left not only economi-cally but also technologically depleted, SOCARs collab-oration with foreign players and active engagement inmajor project development has precipitated a stepchange in the country: SOCAR has transitioned fromsimply being a necessary partner for foreign E&Ps wish-ing to undertake projects in Azerbaijan to a global forceto be reckoned with in its own right.

As a multinational, SOCAR currently holds represen-tative offices in Bucharest, Frankfurt, Geneva, London,Istanbul, Vienna, Astana, and Tehran and has made sub-

stantial investments overseas.In a move that embodies the distance SOCAR has trav-

eled, both in terms of technical capability and financialclout, November 2010 saw the company announcing thediscovery of 200 Bcm and 30 to 40 million tons of gascondensate at the Umid field. For the first time sincethe Contract of the Century, SOCAR conducted explo-ration activity independently and was able to unlock thesecond largest gas field in Azerbaijan. SOCAR leader-ship estimates that with further drilling, the overallreserves at Umid are likely to reach 300 Bcm, whilethose at the Babek field, which lies under Umid, are

estimated to reach 600 Bcm.

Totals discovery at Absheron X2SOCARs discovery at Umid is not the only indicationthat the current one egg, one basket situation, with BPas the sole foreign operator, is set to change. Back in1997, ChevronTexaco and SOCAR signed a PSA for theAbsheron field, 100 km (62 miles) to the southeast ofBaku. In 2001, gas condensate beds were found at adepth of 6,500 m (21,326 ft), but back in the early 2000slow gas prices, compounded by the deepwater and com-plex tectonic structure that make Caspian oil wells espe-

cially challenging, lead Chevron to the conclusion thatAbsherons gas reserves were commercially unprofitable.The company quit the project in December 2005.

Total, which had been a partner with Chevron duringAbsheron 1, maintained that the Absheron block hadcommercial potential and on Feb. 27, 2009, signed anagreement with SOCAR to re-explore the area. Theagreement set the framework for the drilling of threeexploration wells over the following three years. In Sep-tember 2011, Total announced a major gas discovery atits exploration well Absheron X2, drilled by the HeydarAliyevrig (nowMaersk Explorer) operated by Maersk

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Drilling. The Absheron field is expected to contain 350Bcm of natural gas and 45 million tons of gas conden-sate, subsequently boosting Azerbaijans gas reserves

from 2.2 Tcm to 2.5 Tcm.The market conditions for gas have changed signifi-

cantly since 2005. European demand has soared, andthe success of Shah Deniz and the South CaucasusPipeline (SCP) means there is already good access tomarkets, with another pipeline purportedly on the way.

The discovery at Absheron X2 is not only significantfor PSA partners Total, SOCAR, and 20% stakeholderGDF Suez, but additionally the likelihood of Totalbecoming a second major operator in Azerbaijan willhave repercussions across the entire value chain of thecountrys oil and gas industry.

Yet Total is not the only IOC with potential to becomean operator in Azerbaijan. Austrian company OMV hasbeen present in Azerbaijan for a few years on the back ofthe companys interest in the Nabucco project. However,in May 2011 the company signed a memorandum ofunderstanding on enhanced cooperation with SOCAR.At the time of writing, OMV was in talks with SOCARconcerning possible various upstream positions. We arevery positive about the South Caspian, and we are con-sidering several options, Dorin Baru, exploration andproduction, general manager at OMV Gas & PowerGmbH Azerbaijan, said.

One of the critical success factors in the developmentof both Shah Deniz and Absheron will be Azerbaijansability to manage the ramp-up of rig capacity. With onlytwo rigs in the Caspian Sea today capable of drillingwells as complex as Shah Deniz, this will require incre-mental rig capacity investment, said Rob Algie, Schlum-bergers Azerbaijan general manager.

Nationalization, economic diversification,and the broader implications for AzerbaijanHydrocarbon investment might have propelled Azerbai-jans economy through the first decade of this century,

but for the country to develop sustainably, the revenuethe oil and gas industry has generated must in turninvigorate other sectors of the economy.

The State Oil Fund of the Republic of Azerbaijan wasestablished Dec. 29, 1999, to manage foreign currencyand assets generated from oil and gas exploration anddevelopment. In recent years, the Azerbaijan govern-ment has placed increased emphasis on diversifyingthe countrys economy through the reinvestment ofthese funds. The approach has started to pay dividends,according to Movlan Pashayev, country managing part-ner at PricewaterhouseCoopers Azerbaijan (PwC). PwCs

market study predicts that the oil and gas industry willremain the countrys main revenue provider for thenext 10 to 20 years, but its long-term future will be

driven by local investments. The emphasis is shiftingto the government and private investments, whereasthe vast majority of investment in the past came fromforeign investors. This is probably one of the moststriking differences and changes in the last few years,Pashayev said.

However, the hydrocarbon sectors contribution towardthe wider economy transcends the basic provision of

wealth for reinvestment. In addition to profit sharing,Azerbaijans PSAs oblige foreign contractors to undertakea process of workforce nationalization. This is facilitatedthrough Azerbaijans heritage as an oil-producing nation.

In Soviet times, Azerbaijan was the nerve center for theoil industry in the region, and consequently there aresome outstanding universities with very strong trainingfor petrotechnical expertise, Algie said.

While the countrys heritage sets a precedent for thedevelopment of local expertise, the technical complexityof contemporary projects necessitates investment instate-of-the-art training systems. The technology-drivenAker Solutions group, for example, is planning to builda new facility in Azerbaijan including training class-rooms and a simulator facility. In our niche we havebeen reasonably successful, and this has allowed us to

invest more into our infrastructure in Azerbaijan, saidGeorge Taggart, regional manager at Aker SolutionsDrilling Lifecycle Services. We currently have four plat-forms with state-of-the-art drilling control systems; thesimulator facility will enable to us to have a virtual asseton each of these four rigs, enabling us to test upgradesand train operators.

Workforce nationalization filters through all levelsof the industry, from IOCs throughto contractors such as AMEC andAker Solutions and to smaller sub-contractors and service companies.

Formed in 2008, Absheron Engi-neering provides electrical andmechanical solutions for many ofthe drilling companies operating inAzerbaijan. Absheron Engineering isfully registered in Azerbaijan, and95% of its workforce consists ofAzerbaijani nationals.

As well as guaranteeing eligibilityfor project tenders, employing localstaff has enabled Absheron Engi-neering to leverage a cost advantage

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Morgan Phillips, general

manager of Absheron

Engineering &

Construction LLC

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over its competitors. You receive the same service fromus as you would from an international company but forquite a big reduction in costs, Absheron Engineering

general manager Morgan Phillips said.Through investment in training and the enforcement of

industry best practice, foreign contractors and sub-con-tractors have been able to induce a step change in Azer-baijans safety culture. This has in turn contributed to thepromotion of a more responsible attitude to safety on theclient side. Absheron Engineering withdrew its staff froma project last year when the company was unhappy withonsite safety provisions. There is no compromise whatso-ever on safety, Phillips said. My engineers know they arefully empowered to stop the job if they are not happy witha safety aspect.

Demonstrating successful engagement with a localworkforce is key for companies looking for regionalexpansion. Buoyed by its strong reputation in the localmarket, Absheron Engineering has recently won con-tracts in Kazakhstan and Turkmenistan. We are an

Azeri company with a good reputation, which carries alot of weight, especially in the Caspian and Central Asiaregion, Phillips said.

he ancient traditional nomadic life on the steppeposes a stark contrast to the emerging market

economy of this vast and mineral-rich land. According

to scientists, the Caspian region contains the thirdlargest reserve of oil and natural gas in the world,behind the Gulf region and Siberia. But drilling for oilin the region is by no means a recent phenomenon, witha presence of oil production clearly visible across the

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Kazakhstan:Land of the free

T

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landscape since the latter part of the nineteenth cen-tury. However, it is only now, through a mix of foreigninvestment and government control, that the Kazakh

people are truly benefiting from their natural resources.

Uncovering the wealthWhile Kazakhstan also can claim a history of hydrocar-bon production going back more than a century, itsoil and gas industry, unlike Azerbaijans, has onlyrecently initiated a trajectory of rapid growth and tech-nical modernization. In 1993, the newly independentKazakh government invited international oil companiesinto Kazakhstan for the first time, but oil prices werelow and the country lacked a developed oil and gas sec-tor. In the same year, Kazakhstan signed its first agree-

ment with a foreign oil company, establishing the jointventure between Chevron and KazMunaiGas (KMG)for the development of the Tengiz oil field.

It was this agreement that paved the way for interna-tional oil companies to play a major role in Kazakhstansenergy sector. Western firms had beeneager to exploit the former Sovietempires massive oil reserves, but theclosed market of the Soviet Uniondid not allow this as an option. It isnow a reality. Kazakhstan has theCaspian regions largest recoverable

crude oil reserves. In 2005, Kaza-khstan produced approximately 1.29MMb/d of oil, and its productionaccounted for almost two-thirds ofthat of the entire Caspian region.

However, as Johan Vanderplaetse,vice president of Emerson ProcessManagement, points out, it is not justforeign companies who are benefitingfrom the opportunities presented byan open market. There are few placesin the world, particularly considering

the uncertainty in the Middle East,where there are so many upstreamopportunities. This is why the bigcompanies such as ExxonMobil,BP, Total, Chevron, and Shell areoperating here in the CIS and in theCaspian region. But besides theseinternational players, the domesticcompanies have stepped up theirinvestments in upstream and down-stream as well: KMG in the case ofKazakhstan, Lukoil and Rosneft in the

case of Russia, and SOCAR in thecase of Azerbaijan, to just name afew of them. Ten years ago, these

companies were considered bymany to be local players, but nowthey have expanded significantlyto become global players.

Lukoil, for example, enteredKazakhstans market only two yearsafter Chevrons agreement wassigned and expects the republicwill continue to play a central rolefor the company. According toAndrey Kirillov, director of LukoilOverseas in Astana, investors are

attracted to Kazakhstans politicalstability, sustained economic growth, and geographicallocation. The country has set a goal of attracting invest-ment as a key factor in its economic development and isthus constantly improving its legislative and regulatory

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Johan Vanderplaetse,

vice president of Emerson

Process Management in

CIS and Turkey

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framework, Kirillov said. Potential investors have seenan undeniable advantage in the development of specialeconomic zones whose members are exempt from all

taxes. So the investment climate prevalent in Kazakhstantoday allows investors to operate stably and develop.

By encouraging foreign investment, Kazakhstan

already has seen an impressive growth in the sector andnow expects the majority of future growth to come fromthe four elephant fields: Tengiz, Karachaganak, Kur-

mangazy, and Kashagan. The large-scale investment intothese fields has led the Kazakh government to increaseprojected production levels to approximately 3.5

MMb/d by 2015.While a majority of developed oil

and gas economies are struggling tokeep up production levels, it is thebasic estimate of resources that allowsthe government to be so optimistic.There are very few countries in theworld with significant untapped oiland gas potential; Kazakhstan happens

to be one of these countries, saidNorman Storm, Kazakhstan managingdirector of Condor Petroleum, a jun-ior E&P company that began opera-tions in the country in 2007. Almost45 billion barrels of oil have been dis-covered in the pre-Caspian basin todate, but many experts predict thatthis is only around one-third of thetotal potential of the basin. I believethat most of the easier discoveries havebeen made, but at the same time,

there will still be significant additionalresources discovered in the comingyears through the application of newtechnology and ideas.

Yet despite such high resource esti-mates, little of the investment hasgone into new exploration efforts and,with large-scale projects being plaguedby heavy delays in recent years, thelack of a more diversified strategy hasbeen considered by many to be a mis-take. The priority for the industry

should be new leads and new acreagesince the major blocks and fields areknown, Aslanbek Jangirov, interpreta-tion manager at PGS, said. Most ofthe current leads are not necessarilyattractive to foreign investors becausethey are old, with low-quality geologi-cal and geophysical data.

PGS has had a presence in Kaza-khstan since 2002. Dmitri Khitrov, whoheads the Seismic Data ProcessingDivision, is optimistic that exploration

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prospects will crop up due to a mix of better technolo-gies and the overall global economic situation. Thepolitical stability we are seeing here, conjugated with the

slowdown of the oil industry in Egypt and Libya due tothe civil unrest in these countries, is providing the rightenvironment for major oil and gas companies to investin Kazakhstan. In addition, seismic processing is con-stantly advancing and allowing us and our clients toreview their reservoir potential through improved imag-ing after reprocessing. We are definitely upbeat, and webelieve that exploration and seismic data processing willonly improve over the course of the coming years.

Government action to stem the decline of explorationefforts will likewise be crucial, saidGennady Bannikov,chairman of the board for Geostan, a newly established

company specializing in seismic data services. If I hadto compare the situation from the Soviet era to now,previously there was a more systematic and centralizedapproach in the exploration of new hydrocarbondeposits. Now the Kazakhstan government is tryingto resolve this situation by creating anew government company called Kaz-Geology, which is just at the beginningof its work.

These proactive actions by the gov-ernment have not been isolated tospurring the countrys exploration

efforts alone. In 2002, President Nur-sultan Nazarbaev created the countrysnational oil and gas company, KMG,which has since been an effective gov-ernment vehicle for state influenceand has actively sought to securestakes in the countrys major oil andgas projects and infrastructure.

KMGs intervention has not alwaysbeen greeted kindly, as many considerthe Kazakh government to be a pri-mary reason for the multiyear delays

in expanding major projects in thecountry, such as Kashagan. However,Curtis Masters, partner at law firmBaker and McKenzie, sees the govern-ments desire to secure a greater stakein Kazakhstans most profitable indus-try as being reflective of any emergingworld economy.

Many emerging market economieswant to have greater ownership oftheir natural resources, so there is con-stant pressure on oil companies to

accept greater state ownership of natural resource assets.This can create some tension between the oil companiesand the state. So far it has always been resolved amicably,

but it is something that requires careful attention andwill continue to be an issue going forward.

As the concept of a resurgent state has dawned onmultinationals operating in the country, the attitudegoing forward has become one of acceptance and adesire to overcome hurdles in order to move on majorexpansion programs. One recent example of this policyshould take effect this year when KMG is expected totake a 10% ownership in Karachaganak, an enormousgas field in Kazakhstans northeast containing an esti-mated 9 Bbbl of condensate and 48 Tcf of gas. MarkRollins, president of BG Kazakhstan, which operates the

field, described KMGs entry into the consortium.We have been in discussion for quite some time with

the Republic of Kazakhstan; the primary objective of thediscussions was to resolve some past issues relating tointerpretation of the production sharing agreement.

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This has been very successful, andpart of the resolution is for KMGto become a partner in the consor-

tium. We are very much looking for-ward to having KMG as a partner.This will allow us to benefit fromdifferent insights into the consor-tium, and now that many of the pastissues have been resolved, we canmove forward with the next phaseof development. KMG has an enor-mous amount of expertise and closerelationships to the various govern-ment stakeholders, which will be

enormously helpful to the consortium going forward.

Backbone of the nationPipelines have long been the backbone of the Kaza-khstan oil and gas industry. Though oil production waswell established throughout the Soviet period, Kaza-khstans gas production remained less significant; thebulk of the gas was a by-product of oil production andwas usually flared. The gas sector did not begin to evolvein Kazakhstan until the 1970s, although at this time itwas basically a conduit, when the USSR initiated theconstruction of several major Central Asian gas trunkpipelines. These were centrally planned and executed as

a system of transportation for Turkmen and Uzbek gasthrough the territory of Kazakhstan to Russia, the Cau-casus, and Europe. As a result, the pipelines were notdesigned with actual production in mind, do not coverthe entire territory of the country, and are not united.

Oil and gas infrastructure is still a challenge withinthe country. If you do not have a gas pipeline in thenear vicinity, or even in the extended vicinity of yourfields, then utilization of the associated gas during com-mercial production, or even test production, is an issue,said David Barker, the country manager for CondorPetroleum.

This underdevelopment has put enormous constraintson the countrys emerging gas industry, and Kazakhstanis still completely dependent on Russia for access tomajor gas markets to the north and west.

The energy sector in the Caspian region has a brightfuture, providing oil prices remain robust and localcompanies continue to be internationally competitive.We think the demand for carbon-based fuels will remainhigh in the medium term, but there is clearly increasingcompetition from other supplier countries aroundthe region. Kazakhstan and other Caspian countriesunderstand that they must deliver a reliable and

dependable supply, so transparency at the fiscal, opera-tional, and regulatory levels is important, said Christo-pher Renwick, general director of Lloyds Register

Kazakhstan LLP.In the meantime, major developments also have been

taking place in the countrys oil pipeline infrastructure.The Caspian Pipeline Consortium (CPC), which oper-ates and runs Kazakhstans major oil and gas pipelinerunning from the Caspian to the Black Sea, is investingin a $5.7 billion enlargement project to double the exist-ing pipeline capacity of roughly 28.2 million metrictonnes annually (mta) in anticipation of additional oilflow from Caspian oil fields.

Since the moment that the project was sanctioned inDecember of 2010, we have been actively working on its

realization, said Nikolai Platonov, general director ofthe CPC. In this period of time, we have signed agree-ments with the contractors who will be undertaking thework of upgrading the existing CPC infrastructure, whichincludes reconstruction of existing and construction of10 additional pump stations, upgrading the Marine Ter-minal facilities including the Tank Farm, as well as thereplacement of the 88 km pipeline section in Kazakhstanwith a larger diameter pipe. We already have begun work-ing on the first phase of the project. The expansion proj-ect is very complex, so the development plan was thussplit into the three different phases, whereby each phase

will achieve a consecutive expansion of the pipelinescapacity. After the first phase is completed, the consor-tium is expecting to increase oil flow to 35 mta.

Weathering the stormDespite investments in infrastructure for the industry,with the issues surrounding the recent global financialcrisis one has to ask what the current investment climatelooks like for Kazakhstan.

When oil and gas prices fell in 2008, this had a heavyeffect on the countrys economy. Kazakhstan was hithard by the global economic crisis, and Kazakh banks had

to accommodate liquidity to repay foreign obligations,Murat Koshenov, chief risk officer and compliance con-troller for Halyk Bank, one of the leading Kazakh domes-tic banks, explained. Oil and gas prices collapsed,forcing the central bank to devalue our currency by25%, and a lack of liquidity in the banking sector led toa financing cut for the construction sector, leading tosignificant price reductions in the real estate market.

Added Marc Brenneiser, president of STS Logistics,a leading logistics company in Russia and Kazakhstan,Investment in developing markets are always a risk, butthere is still much talk in the air about the region being

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Mark Rollins, senior vice

president, Central Asia,

BG Group; president,

BG Kazakhstan

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in a crisis, and that is misleading. Its true that industrieswere hit quite hard in 2008-2009, but the potential is hereand the demand in the long term is only going to increase.

The risks are low compared to the benefits and the profitsone can achieve by investing in these territories. We areplanning to double our business in the next three years,and this is a conservative approach because of the marketand the potential.

Indeed, the economic situation in Kazakhstan today isquite different than the difficult years following the eco-nomic crisis. We still see new investors in the oil and gassector; however, probably 80% of them are now comingfrom the service sector rather than exploration, like drillingcompanies, companies providing human resources, orsafety services. Many companies are coming to render serv-

ices for oil and gas to subsoil users, observed Almat Dau-mov, partner at Grata, a leading independent law firm inthe country.

The key areas that have attracted service companies havebeen diverse and varied, but certain industry segments suchas environmental services have seen more growth than oth-ers. When Ecoenergogas, a Kazakh engineering company,was hit particularly hard in 2008, rapid diversification intoecological work helped turn the companys fortunes around.The crisis forced us to group together, and we seriouslyundertook environmental work, said Bolat Yegeshbaev, thecompanys general director. We opened a whole new divi-

sion dedicated to the protection of the environment andthus attracted several ecologists. These efforts have resultedin us winning several projects already.

In a conversation with Westdala, the first private companyestablished in western Kazakhstan to take on waste manage-ment, Managing Director Dias Khabiyev said that competitionhas grown tremendously in the past few years. Westdala wasthe first private company in the Atyrau region of Kazakhstanto get involved in the business of providing comprehensiveservices in the field of waste management. Due to the lack ofeffective competition, for a long time the company could tosome extent dictate terms to its customers and prices for its

services. Today the situation is quite different, thanks to thefact that the market for waste management solutions has con-stantly been evolving and expanding. What is helping themarket is the rule of law and the fact that agencies and localauthorities are paying ever more attention to environmentalissues, Khabiyev said.

In the wake of the global financial crisis, a large number ofdomestic companies say the rule of law and positive govern-ment policies have allowed them to regain their previous posi-tions. However, according to Linsi Crain, deputy generalmanager of policy, government, and public affairs at Ten-gizchevroil, government policies have not completely

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addressed the investment issue, and not all companies areseeing foreign investment materialize quickly enoughsince the 2008 decline in the market.

I do not see many new investors coming in, so the ques-tion should be posed: is it an attractive investment climatefor new investors? Kazakhstan seems to be focused onlocalized issues; they should look internationally becausethere are so many examples around the world of great leg-islation and policies that could be introduced to improvethe climate for new investors, Crain said.

Nurlan Abdrasulov, deputy general director for market-ing at KazRosGas, agrees that reaching out and develop-ing relations abroad is key to economic success. Onemust admit that business is a risk, and companies shouldbe encouraged to take on this risk and invest in Kaza-

khstan, he said. We have a young country with a lot ofambition. For development to happen, we need constantand open dialogue with foreign countries to exchangebest business practices.

Reaching out?Despite Kazakhstans proactive efforts to be seen as afriendly investment destination, the question posed by

most foreign companies operatinghere has been whether govern-ment regulations have indeedpromoted a culture of dialog and

whether they have allowed themto assimilate smoothly into thecountry. A major concern hasbeen Kazakh laws on local con-tent. The law itself has beenaround for some time, but begin-ning Jan. 1, 2012, ratios for thepermitted number of foreignworkers relative to local workerswere further tightened, and thishas caused concern from certaincompanies.

We recognize the transition thatthe government has made over thelast 20 years and are very keen tosupport it, said Dougal Monk, sen-ior manager of business develop-ment for oil and gas at KBR, aglobal engineering company thathas been involved in the Kashaganproject since 2003. In Kazakhstan,labor laws have changed rapidlywithin the last 18 months, directedtowards establishing, expanding,

and stabilizing local content in technology and experi-ence. We feel that this is the right thing for the countryand are one of the international companies that take the

legislation most seriously.John Kirby, project director of the Kashagan PMSC proj-

ect, explained some of the training that KBR has under-taken. We have spent a lot of time recruiting nationals,and at present around 180 out of our 250 people areKazakh. National middle managers within the companyundergo extensive training in communication and othersoft aspects of management that are important to theirdevelopment. Our local staff is trained to internationalstandards by in-house company trainers who we bring toAtyrau from our regional headquarters in the UK.

Kazakhstan has a very particular culture, added Mark

Peck, general director of YKK, a major training solutionsprovider in Kazakhstan. YKK first arrived not long afterKazakhstan achieved independence, and the Kazakh regu-latory framework was very much in its infancy, but we havemanaged to grow our company with the industry here; asit has developed, so have we. The key to operating here ishaving a robust, committed, and well-trained nationalworkforce. Some of the regulatory information is not asvisible as you would like from time to time, but once youget used to the system, compliance is achievable.

As companies have complied with the laws, there havebeen different perspectives on the exact way to implement

them. Crain said that retaining a certain amount of expa-triate staff will ultimately benefit the Kazakh workforce.From our experience around the world, we see that thereis a need to keep 10% of the workforce expatriate. Thisallows for the movement of Kazakhs to go to other parts ofthe world to gain experience and learn new skills. Expatri-ates are then able to fill in for those jobs as required andalso mentor and improve the skills of the Kazakh staff theyare working with, she said.

Though many companies are in support of the localcontent laws and can see the benefit to Kazakhstans work-force, others are struggling to source suitably qualified

workers as a result of the recently implemented quotas.The government has not adjusted the education systemto meet its regulatory requirements, Cyril Bainbridge,branch director for Intertek, explained. It is a positiveinvestment climate, but you have to appreciate the chal-lenges. Encouraging investment into the country is oneof the countrys top foreign agenda policies. However,despite having tremendous resources and being a greatcountry, if the skills and education was there, it would bea much more attractive market.

Telling signs that the government recognizes the chal-lenges spurred by the implementation of local content

Dougal Monk, senior man-

ager of Business Develop-

ment, Kazakhstan, at KBR

John Kirby, project director

at KBR, Kashagan PMSC

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laws have been the large-scale investment into technicaleducation and the lack of implementation of these laws atmajor projects. There will be a delay in the application of

all local content laws at the major fields including Kasha-gan, Tengiz, and Karachaganak until Jan. 1, 2015, saidDaulet Argandykov, head of the employment departmentat Kazakhstans Ministry of Labor and Social Protection.This decision was taken in October 2011 and was due tothe enormous value of these projects for the Kazakh econ-omy. At the moment we are negotiating with companieson the subject of training local workers to replace foreignworkers by 2015.

Dominic Lewenz, director of oil and gas research forVisor Capital, one of the leading investment banks in thecountry, argues that at the end of the day, there will be a

need to have a degree of stability in legislation. Govern-ment legislation and intervention can significantly affectinvestors both positively and negatively. The progress onprojects can be greatly influenced by the governmentsattitude towards a project, which impacts those who have

invested in the projects. This is espe-cially true in a sector like oil and gas,where investors place a high pre-

mium on the stability of the legisla-tive system due to the longinvestment horizons, he said.

Despite concerns that such lawsmay affect levels of standards byforcing companies to source prod-ucts and services from locals, thereality remains that local contractorsstill have to comply with very toughstandards to cooperate with foreignventures. Yuriy Belyayev, generaldirector of Zeinet, a company spe-

cializing in automation and techno-logical processes in Kazakhstan, saidthat it was the companys own efforts and not local con-tent laws that have allowed them to work with foreigners.In order to work with foreign companies, one must meet

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Daulet Argandykov, head

of Employment Depart-

ment, Ministry of Labor

and Social Protection,

Kazakhstan

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strict requirements in order to receive certificates andaccreditation by the specialists, Belyayev said. Receivingsuch accreditations previously was very difficult, but we

are getting closer to the level where we can comfortablywork with foreign companies. Many multinationals ini-

tially had a particular distrust of local contractors, whichis why major projects in the country usually ended upbeing executed by foreign firms.

The Kazakh government is using both policy andinvestment to ensure that the Kazakh people benefitfrom this mineral wealth; however, the future of theindustry ultimately will be determined by the relation-ship between foreign companies and domestic politics.This balance is understood well by Yerzhan Bilyalov,executive director of Kazakhstan Petroleum Association.

The oil and gas industry in Kazakhstan is making oneof the most significant contributions to the prosperityof our country, Bilyalov said. What we have achievedshould be used effectively to ensure the continuousimprovement of industry as a whole, a better economy,and a higher quality of life for the Kazakh people.We should use this opportunity now and not leave itto the future.

Region on the riseAzerbaijan and Kazakhstan stand out among theCaspian countries. They are the two largest economies,

the only two countries where GDP-per-capita exceeds$10,000, and the most integrated into the global market-place. In their exploitation of the regions vast hydrocar-

bon resources, the countries enjoy a dominance thatcannot be explained through access and reserves alone.

As Uzbekistan and Turkmenistan seekto build their own oil and gas industries,they will no doubt be looking towardthese giants for guidance. Despite differ-ences in the particulars of legislation, theprimary lessons to be learned from thedevelopment of an oil industry in Azer-baijan and Kazakhstan are very similar.

Since independence, both Azerbaijanand Kazakhstan have gone through sev-

eral stages of development, from an ini-tial reliance on foreign expertise to anewly emerging operational independ-ence. Both countries are enforcing poli-cies that aim to ensure wealth generatedfrom oil and gas benefits their nation, allwhile taking into account the fine linebetween nationalization policies and anti-investment behavior.

While there are many positive aspects

to the current state of the hydrocarbon

sector in Azerbaijan and Kazakhstan,

there are nonetheless obstacles to over-come before these countries take the inte-

gral role in the global oil industry that the size of their

reserves indicate they should.

Ensuring the generation of more wealth and its benefit

to the countries peoples will depend on their ability to

overcome corruption. While faring better than Uzbek-

istan and Turkmenistan, the two countries continue to

perform poorly on Transparency Internationals Corrup-

tion Perception Index rankings. Improvement, however,

is evident. The Ministry of Taxation is taking the situa-

tion seriously and is one of the most forward-thinking

ministries in Azerbaijan. They are now moving towardsmaking their services totally electronic and have taken

those steps to become more transparent and user-

friendly for the tax payers, said Ziya Ibrahimov,

partner at Baker Tilly in Azerbaijan.

In addition to these challenges, questions remain over

Kazakhstans ability to facilitate greenfield exploration,

and in Azerbaijan the issue of how best to transport gas

from Shah Deniz to international markets. The one

certainty, however, is that the rise in the economic and

geopolitical importance of the Caspian region is set

to continue.

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Emerson office opening in Almaty with Johan Vandeplaetse and Andrey Tian,

General Director at Emerson LLP, Kazakhstan

caspian o&g2012

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