Chevron and Exxon: Concession on the Caspian

A fresh concession by Chevron and Exxon Mobil in Kazakhstan is evidence of the shrinking influence of Big Oil.

After years of playing tough guy on the Caspian Sea, the two companies have knuckled under and paid their share of a whopping $309 million environmental fine to the country, according to an announcement yesterday. The story is posted on the Forbes website.

Just a few years ago, the companies went to the mat when Kazakhstan levied a $71 million fine for alleged violations at the supergiant Tengiz oilfield, in which they hold a combined 75% interest. They hollered, griped to journalists, deployed their lawyers, and the fine was reduced to $7 million.

But that was four years ago. Now, Big Oil has been knocked on its heels around the world, as national oil companies from Russia, Venezuela, Saudi Arabia and China have become the new, big and swaggering force in global energy.

So when Kazakhstan offered a cut of almost half in a newly levied $609 million fine for fresh alleged violations at Tengiz, Chevron and Exxon agreed.

This comes on top of conspicuous concessions the companies have made in recent months in Russia. There, Shell and France's Total have surrendered majority positions in oilfields, and Total and Norway's Statoil have agreed to be effective contractors at the giant Shtokman natural gas field.

Their calibration is that their bargaining position simply is too weak at the moment. Perhaps when crude oil prices drop they can talk tough again.

Photo: Niklas
Rights: Creative Commons

Sell Your Oil Shares

I just got back from Houston on the book tour, and managed to get in some private conversations with oilmen I know from the Caspian. As we've been discussing over the last week or so, the private talk within the industry is that short of an evolutionary shift in business plan the oil majors as we know them are done for.

Oilmen know that, short of an innovation of the magnitude of the invention of the transistor, Big Oil has little growth ahead of it in the next five years, and no growth – and probably absolute shrinkage – over the next decade and beyond.

The reason is that the oil majors can't maintain the foundation of their value – how much oil and natural gas they possess in total, or their so-called booked reserves. State-owned oil companies in Russia, Iran, Saudi Arabia, Venezuela and elsewhere control between 80% and 90% of the world's oil reserves, leaving the oil majors the remainder, and that is a slender reed indeed. Some of the majors may actually replenish their reserves for the short term, or even in some individual years beyond that. But they can't do so over the long term.

So why are oil shares largely buoyant this year? Because Wall Street hasn't yet seemed to absorb the fact that the current explosion in oil company profits is smoke – a deception. It's not company growth, but the oil price bubble. But it will figure it out.

And that's why, for those who own shares of the big integrated oil companies, it seems best in my opinion to pocket one's profit from the price run-up. Oh, there's some time, some more profit to be eked out because of the price bubble, now heading to break the inflation-adjusted 1980 record of $101 or so, depending who is doing the calculations.

But look for the smart money to start migrating elsewhere. If one wished to stay in oil, for instance, one could go for where the real, long-term growth will come – in the service companies like FMC, Schlumberger or Halliburton, or pure drilling plays.

These companies are going to be used more and more as a replacement for Exxon, Chevron, BP, ConocoPhillips, Shell, Total -- the states will identify the fields to be developed, and simply hire the service companies as contractors to bring them to market. It is they who will pocket the big margins, and not Big Oil.

The oil companies are innovators, so there is always the chance that one or more of them will discover some new way of making cars move, cities light up and factories work. But short of that, they are dinosaurs.

The Cheshire Grin in Kazakhstan

Talks under way between Kazakhstan and Big Oil are about much more than the nation's unhappiness with the work on the world's largest oilfield discovery of the last three decades.

It's about the future of oil. And what is it?

Despite their unprecedented profits, the Big Oil companies are on the decline, and in our lifetime -- except for those that manage to reinvent themselves -- will largely go the way of former industrial behemoths like United States Rubber, Goodyear and Bethlehem Steel.

Petro-states like Kazakhstan and Russia, meanwhile, are demanding and obtaining more control over their own fields, and increasingly marginalizing the once-omnipotent oil majors. In just two decades or a bit longer, they will be the world's big, self-contained providers of energy, and companies like BP, Shell and Exxon Mobil will either be transformed into something else, or be far smaller and mousier. They will be employees -- contractors -- for Kazakhstan, Azerbaijan, Russia, Nigeria and so on.

Already, the petro-states control between 80 percent and 90 percent of the world's oil reserves; the clock is ticking for the companies, based on reserves booked long ago, something that Wall Street will recognize at some point too.

The talks in Kazakhstan make it plain that at least Exxon -- long the most far-sighted of the companies -- understands this shift. The discussions are on the supergiant Kashagan oilfield, which is at least five years behind schedule for first oil and well over two-times over budget.

As partial compensation to irate Kazakhstan, the companies (Exxon, Shell, France's Total, Italy's ENI, ConocoPhillips and others) yesterday agreed to grant the state a larger share of the field. It's clear that Kazakhstan wants an equal share with the bigger companies, and since no dollar figures were mentioned there is still the question of whether it's willing to pay market price -- or anything at all -- for that increased stake.

In this gentlemanly form of back-alley extortion, Exxon had the gumption to insist of the man wielding the knife the equivalent of train fare home so as to live another day. Kazakhstan could have this increase, Exxon said -- but only if the contract were extended beyond its current expiry in 2041.

Kazakhstan so far has refused (it's not clear, for instance, if Exxon -- as brazen as any petro-state -- offered any money extension), but the demand is brilliant.

If such an extension is granted for, say, a decade or longer, Exxon and its partners would be on the road to extending their lives just that little bit.

There has seemed to be a Cheshire grin on some of the Kazakh and Russian oil officials in recent months.

Where's My Cut?

What does $86 oil mean in the former Soviet Union? More muscular attitude from Russia's already swollen President Putin, and greater petro-assertiveness from Kazakhstan.

Putin is on his way to Tehran, where there will be much in the way of chest-beating from him and the leaders of the other Caspian Sea states with whom he is meeting tomorrow.

But Kazakhstan in particular will be in a fighting mood over the now 41% surge in crude oil prices this year (read New York Times account). Why, when it is earning more money than it ever expected from contracts negotiated years ago on the basis of $17-$20 a barrel oil?

Because it would be receiving much more money had its foreign partners -- Big Oil -- fulfilled their word and begun producing oil by now at the supergiant Kashagan oil field. The Italian-led consortium -- which includes most of the big names in Big Oil -- was supposed to produce the first barrel in 2005, but now says that won't happen before 2010.

Some people interpreted a recent public remark by Kazakhstan President Nazarbayev as proof of a calming ocean on the topic of Kashagan. If it was, the storm is back.

Over the weekend, Prime Minister Karim Massimov made that plain with a renewed demand for a higher state stake in Kashagan, according to a report in The Independent of London. If he was having sleepness nights over such assertiveness, it did not show, as he said there was "big line of potential investors" should anyone be excessively discomfitted.

Chevron is in the same stew. The California company cannot seem to close a deal with Russia over doubling the size of the dedicated export pipeline from Kashagan's sister oilfield, Kazakhstan's supergiant Tengiz, of which it has a 50% share. That is sure to slow down and complicate Chevron's plans to vastly increase Tengiz production next year, and to vex Kazakhstan over the relative stagnation of its bottom line.

Kazakhstan has already made it plain to Chevron that, as with the Kashagan partners, it means business. It recently levied a $609 million environmental fine for sulfur deposits from Tengiz, demonstrating that the country expects the companies to think of Kazakhstan, too, when they are counting their windfall profits.

A Few Hundred Millions Dollars Between Friends

Just two weeks ago, Chevron Chairman Dave O'Reilly scurried aboard the corporate jet to Kazakhstan after a legislator urged a shutdown of the company's supergiant Tengiz oilfield for environmental violations.

But O'Reilly emerged cheerily from a meeting with President Nazarbayev -- the Kazakh leader had called Tengiz "an excellent example of how the government and a foreign investor can work together successfully," O'Reilly crowed.

In other works, he seemed to imply, Chevron wasn't in the same boat as the Eni-led Kashagan development, a sister oilfield whose work the Kazakhs have suspended.

Maybe, depending how one defines working successfully. Yesterday, the Kazakhs quantified their own view, and the number is $609 million. That's the fine the Kazakhs have levied against Chevron for three years of alleged sulfur violations at Tengiz.

Dow Jones reports that Chevron is challenging the fine. And it is true that, five years ago, Chevron successfully resisted a similar ecological penalty by the Kazakhs, who sought $71 million but finally accepted $7 million.

Yet, nothwithstanding the warm and fuzzy shoulder massaging that went on between O'Reilly and Nazarbayev last month, look for the current dispute not to end as peaceably.

For one thing, it's a wholly different atmosphere, both in the global oil industry in general, and in Kazakhstan specifically.

Big Oil has been knocked on its heels by a sea change in who gets access to the newest oil fields around the world -- by far, it's nationally owned oil companies and state ministries, not publicly held oil majors like Exxon Mobil, BP and Chevron.

In addition, Russia is leading the way locally in tearing up 1990s-era oil contracts in order to take control of its most promising oilfields. While Kazakhstan is acting under different circumstances, the impact could be similar -- Kashagan (the largest discovery on the planet in more than three decades) is under threat of a Kazakh state assumption of joint operatorship.

In the 2002-2003 row, Chevron played brinksmanship with Kazakhstan, even temporarily shutting down the Tengiz operations to demonstrate its resolve. It will hardly try such antics today, given the possibility -- even if remote -- that Kazakhstan could simply push the envelope all the way and find ready companies or contractors, in China or India, say, prepared enthusiastically to take over Tengiz.

The Biggest New (Suspended) Oilfield in the World

Kazakhstan eliminated any uncertainty today about where foreign oil companies stand in the country: on the defensive.

After weeks of salvos regarding work on the Kashagan oil field, Kazakhstan forced a three-month halt to development of the supergiant. The field is the largest found anywhere on the planet in three decades. But Ecology Minister Nurlan Iskakov says it has unresolved environmental problems. As Reuters stated: The dispute is reminiscent of Russia's row with Royal Dutch Shell, which ended up with the multinational oil firm losing control of the giant Sakhalin-2 oil project to Russia's Gazprom.

Here is Reuters' quote from Iskakov: “In 2003-2005 we specified a number of offshore sites and we put forward our demands. As of today, these ecological requirements have not been fulfilled. That's why we decided to carry out such an unprecedented step. I think you will hear in the nearest future what will happen next." Read story

Steve's comment: It's been clear that Kazakhstan has tough demands in store for the foreign consortium developing Kashagan. The companies, led by Italy's Eni, look to be about six or seven years behind schedule in producing first oil, plus they are far over budget.

That alone put Kazakhstan in the driver's seat in terms of changing the 1997 contract negotiated on Kazakhstan's behalf by the country's then-oil adviser James Giffen. But other objective factors have now also conspired in Kazakhstan's favor: the world crude oil supply shortage, expected to last at least through 2012; the shortage of fresh oil reserves for the major oil companies to exploit; and Russia's new, tough approach to the oil companies.

The last item on the list -- Russia -- may be the most influential at the moment. Like Russia, Kazakhstan seems to have taken off the gloves.

Before today's escalation of combat, Eni CEO Paolo Scaroni publicly conceded that the contract would have to change. In another soothing move, the company has arranged for Italian Prime Minister Romano Prodi to visit Kazakhstan on Eni's behalf.

But the field suspension shows that Kazakhstan isn't ready to be soothed.

So what does Kazakhstan want? For starters, a lot more money, and much earlier than the companies had planned.

Like most such deals, the Kashagan contract calls for most of the expenses to be paid out of initial oil production before the partners and government begin to take their big profit. But now look for the companies to be forced to cough up larger profit from virtually the first oil to come out of the ground, probably around 2012.

Another reason why the Kazakhs will play especially tough is that whatever ultimately happens will be a model for a probable follow-on challenge to the contracts governing production at the country's other two supergiants -- Tengiz and Karachaganak.

The Russian Solution

Taking the cue from Russia's triumphant taming of Western oil companies, Kazakhstan says the partners in the super-giant Kashagan oilfield have violated environmental laws, and could lose their license. The upshot: Kazakhstan has a big profit demand in mind.

Here is the first paragraph of today's Reuters account: Kazakhstan threatened on Tuesday to revoke an Eni-led consortium's permit to exploit the giant offshore Kashagan oilfield due to environmental law violations. Read story

Steve's comment: The 1997 contract for Kashagan, negotiated by James Giffen, was regarded at the time as extremely tough on the oil companies, with an upside clause for instance that makes the Kazakh take higher as oil prices rise.

The terms are much stiffer toward the companies for instance than those at Kazakhstan's Tengiz field, whose contract includes no upside clause (look for Kazakhstan to demand one from Chevron and Exxon Mobil, and for them to agree).

Kazakhstan's greater assertiveness precedes the activism in Russia, in which Moscow has successfully demanded concessions from Shell, Total and BP. But the Russian strategy of beginning negotiations with accusations of environmental violations (bound to make any Western company nervous) has changed the underlying equation: Western oil companies are no longer in the driver's seat, regardless of their superior technology; if they want to continue to operate in the former Soviet Union -- in Russia, Kazakhstan and probably Azerbaijan -- they now have to agree to better terms for the countries.

ENI's CEO, Paolo Scaroni, whose company operates Kashagan, has put aside the game of charades and effectively conceded that Kazakhstan will get a better money deal.

But today's threat amounts to bringing out the heavy guns. The Caspian Seal is one bit of potent ammunition -- though previous reports blame the deaths of hundreds of the seals on a parasite or some other culprit rather than the Kashagan operation, the Kazakhs now say they want the issue studied again.

That Kazakhstan followed Scaroni's concession with such a threat shows that it probably plans to demand somewhat more than he and his partners expected.

The Old Game is the New Game in Big Oil

Russell Gold, my former colleague at The Wall Street Journal, has an interesting piece today describing how, as contrarian as it can possibly appear, the Middle East is open for business to the oil majors. The upshot: Russia and the Caspian states have a lot of leverage, but not wholesale negotiating power with the western oil companies, which do have options in terms of replenishing their reserve base.

The first paragraph of Russell's piece: Since the 1970s, major oil companies have been shut out of oil production in much of the Middle East. Now, the doors to foreign investment are opening again, this time for natural gas. Read rest of story

Steve's comment: Russia in particular but also Kazakhstan have been wringing concessions from the western oil companies, which have fewer and fewer places to go around the world for new reserves as national oil companies and ministries take control of their own energy supplies.

Though the big-earning companies will deservedly generate little public sympathy, they have been on the front lines of the combat under way at the intersection of geopolitics and commerce.

But the willingness of countries like Qatar and the UAE to grant equity shares in their natural gas fields to western majors is a poke in the eye of the former Soviet petro-states.

Why after making such a fuss over their economic independence are the Middle Eastern countries willing to go back into an equity relationship with the previously expeled majors? In an e-mail exchange, Russell says the majors are "very wary" of Russia now, along with Venezuela, while in their view the Middle East offers some welcome stability.

Russell goes on: "Most of the natural gas projects open to western investment are technically challenging, including Abu Dhabi's $10 billion sour gas project and BP's work in Oman. The Saudi exploration isn't so much technically challenging, but offers the Saudis an opportunity to cement ties with a number of companies from powerful nations, including Shell (UK/Netherlands), Lukoil (Russia), Sinopec (China), Eni (Italy). Add in the big export refinery projects under consideration and you have ties with Total (France) and ConocoPhillips (the U.S.). That's most of the permanent members of the U.N. Security Council."

Chevron, Exxon Will Have to Blink Against Russia

Chevron and Exxon Mobil so far have suggested that they have a lot of leverage with Russia. But next week they will be tested when they meet Transneft for the first time since the pipeline company took control of Moscow's interest in the 1,000-mile oil pipeline from Kazakhstan's giant Tengiz oilfield to the Black Sea.

The stakes are these: the two American oil companies want finally to get Russia to fulfill its more than decade-old promise to allow full export of Tengiz's oil (meaning 700,000 barrels a day and more). Transneft wants the companies to pay a lot more in per-barrel tariffs for shipping the oil across Russian territory and, more important, to tie the shipments to a geopolitically driven, Russian-controlled pipeline spoke through Bulgaria and Greece; Russia sees the proposed Burgas-Alexandroupolis pipeline as a way to undercut the U.S.-supported Baku-Ceyhan oil pipeline, which bypasses Russian territory and began shipments last year.

The upshot: Chevron and Exxon Mobil will have to compromise. Transneft has all the upside and little downside in forcing the companies to continue paying expensive barge and rail costs to ship their extra oil, while the multinationals -- especially Chevron -- are under pressure to unlock Tengiz and its contribution toward their oil production.