Exxon Readies First Shipment From Huge Kazakhstan Oil Field After Costly Delays

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Kazakhstan recently announced that commercial oil production from the giant Kashagan field is expected to start in October this year. First oil flowed out of the giant field recently, much to the relief of all the players involved in the development of one of the most complex oil projects in the world. It is currently producing around 40,000 barrels per day (bpd). However, it is required to produce at least 75,000 bpd before launching commercial oil production. [1]

The mega oil project located in Kazakhstan’s zone of the Caspian Sea has been plagued by significant delays and cost overruns due to several technical issues. This has also delayed returns from the project increasing the time that participating oil companies such as Exxon Mobil (NYSE:XOM) will have to wait in order to generate a desired rate of return on their investments. Exxon plans its first shipment at the end of October.

Exxon, Shell (NYSE:RDS.A), Total (NYSE:TOT) and Eni SpA (NYSE:E) each hold 16.81 percent in the Kashagan project. Japan’s Inpex and Kazakhstan’s state-owned KazMunaiGaz each own 7.56% and 16.88% stake in the joint venture respectively. Also, China’s CNPC (China National Petroleum Corp.) recently acquired 8.33% stake in the project, which was sold by ConocoPhillips (NYSE:COP) for $5 billion.

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Huge Potential

The Kashagan field is located in the Kazakhstan sector of the Caspian Sea and extends over a surface area of approximately 75 kilometers by 45 kilometers. The reservoir lies some 4,200 meters below the shallow waters of the northern part of the Caspian Sea. It is perhaps the largest oil field to be discovered in the past 35 years, and is estimated to hold as many as 35 billion barrels of oil, of which around 13 billion barrels are likely recoverable. This represents most of Kazakhstan’s offshore proved oil reserves and is roughly equivalent to Brazil’s entire proved oil reserves, both onshore and offshore. [2] Besides, natural gas reserves in the field are estimated at over 1 trillion cubic meters. After the completion of the second phase of the project, it is expected to produce oil at a plateau rate of around 1.5 million bpd, which is equivalent to the average rate of crude oil production recorded by all of Exxon’s subsidiaries in 2012. [3]

Issues In Development

Kashagan, the mega oil project, was initially expected to start producing oil in 2005, at a cost of around $10 billion. However, several technical issues derailed the initial plan and delayed the first oil by almost a decade costing the companies involved in it as much as $50 billion. The field 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. [4]

Moreover, conventional drilling and production technologies, such as concrete structures or jacket platforms that rest on the seabed, could not be used in this project due to shallow water and the cold winter climate of the northern part of the Caspian Sea. As a result, offshore facilities have been installed on artificial islands to ensure their protection from harsh winter conditions. Also, these islands are isolated from their environment by an impermeable membrane, which is laid all across them in order to prevent any potential impact of the project’s operations on the diverse fauna and flora of the region. [5]

Lower Returns

Cost overruns and delayed implementation have significantly impacted oil companies’ prospects of generating huge returns from the Kashagan oil field. The production rate from the first phase of the project is expected to plateau at around 370,000 bpd over the next couple of years. Even if the first phase production ramps up as planned, it would take the private players at least five years of continuous operations just to recover all the development costs in real dollars. Only after that profit oil will start flowing, which will be shared between the government of Kazakhstan and the multinational oil companies. This increases the project’s required duration to yield the desired rate of return significantly.

Not only this, it also raises several concerns over the next phase of development of the reserve, which is required to ramp up the production rate to 1.5 million bpd. The private players will need to determine if they will be able to recoup their expenses and reach an acceptable level of profitability before the project’s production sharing agreement (PSA) terminates in 2041. If not, renegotiations with the state government over the PSA agreement could further delay the next phase of development of the mega project.

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Notes:
  1. Kazakhstan sees Kashagan 2014 oil output at around 8 mln T, reuters.com []
  2. eia.gov []
  3. Exxon Mobil SEC Filings, sec.gov []
  4. In Caspian, Big Oil Fights Ice, Fumes, Kazakhs, rigzone.com []
  5. Development challenge of Kazakhstan’s giant oilfield, bbc.co.uk []
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