Tengizchevroil Hit with US$609-mil. Fine for Environmental Violations in Kazakhstan

A New Front

In the past, Kazakhstan's annual International Oil and Gas Exhibition & Conference (KIOGE), arguably the biggest industry conference in the Central Asian state, was a time for deal-making, as industry leaders, Kazakh government officials, and Western company heads descended on the city of Almaty. This year, however, the 15th annual KIOGE conference, taking place this week, is being overshadowed by disputes between the government and the top investors in the country's oil sector. The dispute between Italy's Eni and the government over the future of the Kashagan oil project–although not exactly raging, given the recent conciliatory gestures on both sides—is nonetheless still ongoing. Yesterday, Kazakh officials effectively launched a new front in what is shaping up as a war with foreign oil companies, announcing a US$609-million fine had been slapped on Tengizchevroil (TCO) for environmental breaches at its Tengiz oilfield.

Chevron, the leader of the TCO consortium, immediately responded to the fine, which was levied for TCO's stockpiling of sulphur between 2003 and 2006. The U.S. supermajor, whose chief executive officer (CEO) David O'Reilly only last month had visited Kazakhstan and received assurances from Kazakh leaders about Chevron's operations in Kazakhstan, said it would appeal the fine, saying that it "strongly disagrees with the claim and will aggressively challenge it and pursue all available legal remedies" (see "Related Articles" below). TCO said it had received formal notification of the fine from a local court in July, but the fine was only made public yesterday.

This is not the first time that TCO, which is comprised of Chevron (50%), ExxonMobil (25%), Kazmunaigaz (20%), and LUKArco (5%), has run afoul of Kazakh environmental authorities on the sulphur storage issue. Indeed, earlier this year a brewing dispute over TCO's storage of the huge yellow slabs of sulphur, which is stripped out of the oil produced at the Tengiz field, was resolved when the consortium agreed to spend an additional US$300 million on environmental measures at Tengiz. TCO has also been fined in the past for environmental violations relating to the sulphur issue, as Kazakh officials claim that TCO's stockpiling is damaging to the environment. TCO, which disagrees, has been trying to dispose of the sulphur, which can be used to make fertiliser, but the consortium says it does not have enough rail cars to get rid of it fast enough to please Kazakh authorities.

With TCO planning to increase oil production at Tengiz from around 300,000 b/d to between 460,000 b/d and 550,000 b/d next year, the volume of sulphur extracted from this hydrogen sulphide-laced oil is sure to increase, exacerbating the sulphur storage issue. A recent agreement by the shareholders of the Caspian Pipeline Consortium (CPC), which operates the Tengiz-Novorossiisk pipeline, to hike transit tariffs and restructure the consortium's debt could help alleviate the sulphur problem, provided the CPC shareholders finally agree to an early expansion of capacity on the pipeline. Increased export capacity on the CPC pipeline would allow TCO to export more of its existing and future oil production by pipeline, reducing reliance on rail oil export, and—at least in theory—freeing up more rail cars for TCO to use to export and dispose of its sulphur slabs.

Outlook and Implications

In the meantime, however, TCO is faced with the multi-million-dollar fine. The consortium may yet succeed in rejecting or at least reducing the fine on appeal, but the recurring dispute with Kazakh authorities over the sulphur storage issue does not appear to be going away any time soon. Just as with Eni at the Kashagan project, Kazakhstan's environmental regulators appear keen to ensure that Chevron and TCO meet their environmental obligations in addition to their priority in extracting oil. TCO would do well to appease Kazakh officials by making a stronger effort in the short term to dispose of the sulphur pellets, perhaps even by using some rail cars that currently export oil and instead using them to sell more of the sulphur slabs on the export market.

Of course, there is no guarantee that this would actually take the heat off TCO, which could very well then hear from Kazakh authorities over the reduction in oil exports from Tengiz. Such is the problem for foreign oil companies in Kazakhstan, where the investment climate is clearly becoming more difficult, as the government—empowered by high oil prices and unencumbered by the opposition after the ruling party swept all seats in parliament in recent August elections—is apparently keen to take an increasingly active role in the development of the country's natural resources. The government would surely refute the notion that it has "attacked" the Kashagan and Tengiz project operators, pointing out that in both cases, Kazakhstan responded to the failings of both Eni and Chevron—Eni's failure to produce the first oil from Kashagan according to the 2008 timetable, Chevron's failure to store sulphur according to Kazakh regulations—but the perception is that Kazakhstan is becoming more aggressive in dealing with foreign oil companies.

Thus, with the Kashagan dispute still unresolved, the wisdom of opening a second potential battlefront with TCO over the Tengiz field is highly questionable. Even the Russian government, which is clearly more powerful than the Kazakh government, chose to take on Shell (at Sakhalin-2) and BP (at Kovykta) consecutively, rather than at the same time. Kazakh authorities apparently used the venue of the KIOGE conference to publicise the fine against TCO, but the move could easily backfire, bolstering the perception that Kazakhstan is becoming a riskier place to do business. Sure enough, Mamdou Barry, an oil and gas specialist with the World Bank, said yesterday that recent actions such as the amendment to Kazakhstan's subsoil law to allow the government to break oil contracts represented a "slow and subtle" attack on contract integrity in the country. Kazakhstan may be more concerned with boosting oil production and ensuring the long-term growth of the industry than it is with the erosion of the investment climate in the county at present, but the issues are clearly linked, and the Central Asian state may well find that its actions today will have negative consequences tomorrow.

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Kazakhstan: 30 March 2007: Tengizchevroil Boosts Ecology Spending to Comply With Kazakh Regulations

Kazakhstan: 22 February 2007: Environment Minister Threatens Tengizchevroil with Work Suspension in Kazakhstan

Kazakhstan: 19 February 2007: Kazakh Officials Threaten TCO with Environmental Fines, Issue Stern Warning on Kashagan Timetable