ConocoPhillips (NYSE:COP) is ready to sell its stake in the giant Kashagan oil field project, according to Kazakhastan’s oil minister Sauat Mynbayev. The minister said that ConocoPhillips has informed that it is interested in selling its 8.4% stake in the North Caspian Operating Company (NCOC), the consortium that is developing Kashagan. Kazakhastan would have the first right to buy Conoco’s stake through its state oil company, KazMunaiGas, should Conoco look to sell, though it hasn’t commented on this so far. 
Apart from Conoco, the other stakeholders in the consortium developing the Kashagan field are KazMunaiGas, EnI, ExxonMobil, Royal Dutch Shell, Total and Inpex. While ConocoPhillips has a 8.4% stake, Inpex holds 7.56% and each of the remaining partners holds 16.8%. EnI is currently the field operator for the project. 
Below we provide a quick background on this project and analyze the possible reasons why Conoco may want to exit this project.
A Primer On The Kashagan Field
Kashagan is perhaps the biggest oil field discovered after Prudhoe Bay, Alaska, in the 1960s. It is estimated to hold 6 billion tonnes or 38 billion barrels of oil, of which 10 billion barrels are likely recoverable. Discovering giant fields these days is fairly uncommon. This makes Kashagan a very important resource. 
In 1997, a consortium of western companies signed a deal with the Kazakh government to explore the northern Caspian basin. This consortium struck oil in 2000. Although the Kashagan field has immense potential, its development has been a daunting challenge. For one, the oil field itself is geologically complex and fragmented. The winters are harsh and ice packs could potentially wreck the oil rigs. It has oil that is heavily suffused with hydrogen sulfide, a dangerous gas. The concentrations of this gas are high enough to kill a person in a single breath. And the oil is buried around two and a half miles below the seabed under enormous pressure. 
The development of Kashagan is challenging not only from technological and safety perspectives, but also from an environmental one. Kashagan is a breeding ground for rare Caspian seals and caviar-yielding sturgeons, including the endangered beluga. In the past, local environmentalists have blamed consortium operator EnI for the death of a number of baby seals.
The Caspian Sea is an enclosed body of water, and this makes it more susceptible to lasting damages from oil spills compared to open seas like the Gulf of Mexico, where oil can disperse easily by natural forces like ocean currents, winds, and tides. A spill in these waters could have a much more lasting impact than other places. In addition, considering that the Caspian is abutted by five countries in Central Asia, we think there could be geopolitical factors at stake should a spill occur or other issues arise.
Russia, ever so sensitive about western activities in Central Asia, would be quick to fish in troubled waters, and Iran is one of the countries along the Caspian that could create problems for western companies. Apart from Inpex and KazMunaiGas, the other firms are based in the west.
Why ConocoPhillips May Be Looking To Exit
The Kashagan project has seen costs escalate several fold over the last decade. The oil was discovered in 2000, the development plan was approved in 2004, and the oil was supposed to start flowing in 2008. However, costs ballooned from an original estimate of $57 billion for the whole project to $187 billion, resulting in production targets being cut to 450,000 barrels per day. The second phase of the development, expected to boost output to nearly 1 million barrels per day, may not happen until the next decade. First production is expected to come online in mid-2013. 
These delays have made the other companies in the consortium wary of EnI, whom they blame for not managing the project properly. Though the companies have refrained from commenting in public on EnI’s handling of the project, we think that internal deliberations at Conoco may have concluded that the costs were getting out of hand and returns may not be all that attractive to justify further involvement.
Also, the Kazakh government, in recent years, has been seeking to increase its stake in foreign-owned oil and gas projects to boost its share of revenues and profits as well as exercise greater management control. The government’s plans of building schools and hospitals are hinged on funding expected from these revenues, and so the government has become wary of repeated delays and cost overruns. The terms of the contract have been frequently revised, and there is no guarantee that it wouldn’t happen again in the future.
These political and contractual risks and uncertainties, we think, may have convinced Conoco that the best course would be to pull out when it seems fairly certain that production will start in 2013. It might get a better valuation for its stake at this point. Conoco may also have decided to concentrate on its existing oil projects and shift focus to gas projects in the future, in a bid to differentiate itself from competitors Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX).
We recently revised the Trefis price estimate for ConocoPhillips to $60, which is in-line with its market price.Notes:
- Kazakhstan says ConocoPhillips to sell Kashagan stake, Yahoo News [↩]
- Kazakhstan sets eyes on ConocoPhillips Kashagan stake, Reuters [↩]
- ConocoPhillips might exit the Kashagan project: Oil Minister, Tengri News [↩]
- In Caspian, Big Oil Fights Ice, Fumes, Kazakhs, RigZone [↩]
- ConocoPhillips ‘to sell’ Kashagan stake, UpstreamOnline [↩]