EXPLORATION CHALLENGES OF TENGIZ OIL FIELD AND OTHER FSU JOINT VENTURES

Adapted from a presentation at the American Association of Petroleum Geologists annual meeting, June 13, in Denver.

Richard H. Matzke
President
Chevron Overseas Petroleum Inc.
San Ramon, Calif.

Chevron has been operating a joint venture for the past year to develop supergiant Tengiz field in Kazakhstan.

We've invested about one third of the $1.5 billion we pledged to invest under our initial 3 year work program.

It was just 4 years ago at the AAPG annual meeting in San Francisco that a group of Russian geologists gave the first major technical paper on Tengiz outside the U.S.S.R. (OGJ, Sept. 17, 1990, p. 88). At that time Chevron was negotiating to do an oil field project with the Soviet Union.

We secured the terms for Tengiz-but then the Soviet Union disintegrated. So we started negotiating exclusively and directly with the new nation of Kazakhstan. After a lot of hard work and some false starts, we signed the present Tengiz arrangement on Apr. 6, 1993.

This article contains impressions on doing business in the former Soviet Union, details of some of the unique challenges of working on that part of the world, an update of the Tengiz project, and discussion of the Caspian region pipeline situation.

DOING BUSINESS

The new countries in the former Soviet Union want help and investment from the western oil industry.

It's easy to picture us helping them in the traditional manner, but it isn't working there the way it does in other parts of the world. The reasons for this are not simple, nor are they conclusive. But I believe there are three fundamental considerations.

With the exception of Russia, we are dealing with brand new countries whose systems of government are still evolving and subject to much change.
Russia is undergoing a very uncertain and very difficult economic transition.
Throughout the former Soviet Union, we are still dealing with an oil industry infrastructure that was designed for central management and control. The problem is, the center no longer exists.

But outside oil companies are impatient with all this, and so is Chevron. What we'd prefer is for the former Soviet republics to just make this big transition so we can get in and do our deals. Furthermore, I've been in a lot of meetings where companies are telling top Russian energy officials what they should do to make their country safe for outside investors.

I can assure you the Russians are thinking to themselves, "Who the heck are these guys trying to tell us how to run our business?"

I was at a dinner in Moscow where U.S. government representatives were telling the Russian energy minister all the things he needed to do to improve his industry.

I found it ironic that our government people would be telling someone else how to manage their energy sector, so when I had the floor I pointed out that maybe we should try to look at things a little differently.

After all, both U.S. and Russian production have been in a spiraling decline. One big reason is the failure of energy policies in Russia and the U.S. Each system has weaknesses, but we know from high production levels of years past that we both also have strengths.

My view is that it's more effective to start with a common ground attitude when going into somebody else's country to talk about getting a share of their energy resources.

RUSSIANS IN U.S.?

Let's assume that we were trying to get the Russians to invest in our industry here in the U.S. What would they want?

I think they'd want guarantees that their investments would not be threatened by conflicts between government and the oil business over energy policies. And they'd expect to see policies and rules that would be applied equitably and remain constant.

They'd also want to get rid of all the rules and policies that don't allow drilling in all the prime areas. They'd try to completely avoid paying multiple layers of taxes, which they would view as a ridiculous burden.

In exchange for their expertise and investment, they'd want 25% of our production plus the right to export their share from the U.S.

One more thing: They would want to bring in their own teams of geologists, engineers, and managers and probably their own seismic crews, drilling rigs, and service equipment.

Most of us can't speak Russian, and we're used to functioning in what they see as a peculiar capitalist structure. So they would probably want us to just answer their questions and step out of the way.

If you can picture this situation you will get some idea how a lot of your future partners in the former Soviet Union are feeling about you these days.

How receptive would we be to outsiders who wanted a share of our resources? How would we like it if outsiders came in and told us how to do the things we think we know how to do so well?

To us the former Soviet Union is just one of many areas of opportunity in the world. But to them the deals we seek represent a sort of statement on their failed system, and many of our proposals look more like plans to replace their industry than to help them restore it to its former strength.

Given the impact on their own futures as managers and energy professionals, it's not surprising that these things take a little time to set up.

CEMENTING RELATIONSHIP

Chevron has invested hundreds of millions of dollars in the Tengiz project and has had cost overruns, production is down by half from what we expected because we can't export as much as we want, and we still don't have the pipeline everyone knows is essential to success.

I can't tell you we think we have all the answers, but I can tell you what our experience has been.

We believe that to succeed in oil and gas ventures in the former Soviet Union takes commitment, patience, d trust-in that order. It also takes a lot of money, superior earth science, the best exploration and production technology, and the best oil field management systems.

But commitment, patience, and trust, in that order, are far more important.

Some probably think the former Soviet Union is the last place on earth to play "Mr. Nice Guy." Let me walk you through this.

Commitment is the price of getting in a position to start earning trust.

Patience is what you need to survive paying the price of a true commitment in that part of the world. That means large investments of time, money, staff, technology, all of that.

Trust is ultimately what you build from making the commitment and exercising your patience. And when you've achieved all three, you get more than a partnership. You get a working relationship.

One of our senior geologists puts it this way:

"When your partners raise a toast to you at dinner and they say they drink to you despite your many shortcomings, that's when you know you've made it."

What you want is to get to the point where the relationship is more important than the partnership and its problems.

JOINT VENTURE SETUP

A lot of companies are waiting for change and stability in the former Soviet Union so they can feel comfortable investing. But the reality is that until you're invested you won't make the commitment of full participation.

This commitment-by outside companies-is what's necessary to help the former Soviet countries stabilize and emerge to join the world economy. This is one of the reasons we structured our deal in Kazakhstan as a joint venture that includes tax revenue linked to production growth.

However, we have to keep in mind that our joint venture is a tax based entity in an environment that doesn't know what taxes are. In the former Soviet system the idea of profits or taxes coming out of a resource project is totally alien.

In the past under the old Soviet system opportunity only came on the front end during the investment period, rather than at the back end during the revenue period. There were no sales, no revenues, no margins, only development, production, and distribution.

They knew oil and gas had value, but only as a resource to consume, not as products to be sold for money.

Kazakhstan still has a state owned economy, but at Tengiz the state holds a piece of the action in a private sector sense.

The joint venture is overseen by a partnership council that is much like a board of directors-half Chevron people, half Kazakhs.

We wanted our new partners to work with us within a joint venture because we figured if we didn't help them make the transition to a business viewpoint nothing would ever work. It was our way of both accepting the state economy and blending in with it, and I still think it was the right way to go.

We did have other reasons for being the first to invest in a major project in the former Soviet Union.

When we were first discussing an oil project with the U.S.S.R. 5 years ago, Tengiz was not part of the deal. We were looking only at an offshore exploration project in the Caspian Sea. But after a lot of reflection we decided we wanted a situation where major, proved reserves were part of the deal.

We wanted Tengiz, and we were willing to make a commitment, negotiate with patience, and build trust with our new partners to make a project happen.

We gave up the offshore Caspian opportunity, but given today's regional disagreements on the ownership of Caspian resources we think our decision to go with Tengiz was a prudent one.

Just as important as choosing the right project, it seemed pretty clear to us that in the Caspian region if we were going to get in at all-we would want to get in first.

We believe those who are first with significant new production in the Caspian region will also be first to secure a long term share of the new export systems that the region must have in order to grow.

So for us an early commitment was the only thing to do, even with the risk of instability and having a lot of things still unresolved.

MORE ON COMMITMENT

I want to say a few more things about commitment and building relationships in the former Soviet Union.

Obviously their political transformation is an event of enormous historic significance. But just as significant- from the standpoint of doing oil deals-is the nature of their technical community.

These geologists and engineers are just as good as we are at what they do-and often better. They oversee what was once a 12 million b/d industry, and they're used to managing it as a single, massive company.

If they didn't need hard currency, environmental technology, and enhanced oil recovery technology, they wouldn't be sharing their portfolio with Americans or anyone else.

So if we're going to convince them of our worth as partners, we need to work harder to make it clear that we truly can add value to their industry. Understanding this and acting on it is one area where I feel earth scientists can help make things happen in the former Soviet Union.

Earth scientists are often the first ones who make contact, and deals can't go forward without our judgments, which come from professional relationships built on mutual respect.

Science is our common ground, and we need it because we're going to have a hard time for a long time accepting each other's economic cultures.

We were in discussions on possible oil deals with the Soviets for 4 years and then with Kazakhstan for 2 years before we actually signed the Tengiz joint venture.

Other companies are pushing hard for iron-clad production contracts right up front-and I can appreciate their reasons. But you have to figure that any contract in the former Soviet Union is renegotiable, and you can't renegotiate anything without good relationships.

INTERNAL STRESS

Working with the former Soviet Union, some things are so unfamiliar that you never feel confident that you fully understand them.

Other things are almost too simple.

Oil and natural gas used to flow freely in a common, state owned system, but now they flow between independent countries across brand new international boundaries. When bills aren't paid, shipments sometimes get cut off or curtailed.

News stories imply that Russia is holding energy supplies hostage at the expense of the former Soviet republics, but the Russians have bills of their own now. They have to charge for what they didn't used to charge for.

People accuse Russia of wanting to re-create its old empire. But that's not the way I see it happening.

What I see are a lot of new countries trying to re-establish on commercial terms the relationships that used to be based either on central government domination or socialism. They're making deals where before no deals were required.

Consider the arrangement that Kazakhstan made to rent its space facilities to the Russians. The facilities at Baikonur used to be in the Soviet Union, but when the Soviet Union came apart the Russians had to make a deal with the Kazakhs to use the space facilities.

As for Tengiz, it's no secret the Russians want some kind of commercial connection to the field. The way they see it, they found Tengiz and they had plans, not just for consuming the oil but for all sorts of other economic benefits such as employment for Russian drilling rigs and big orders for Russian pipe mills.

Now Tengiz sits across the border from them, and it belongs to Kazakhstan, so deals must be made. And this has to take place in a part of the world where for most of this century there was no structure or even a premise for business as we know it today.

WHAT RUSSIANS WANT

Whenever I get a chance I ask Russian energy officials what they expect out of deals with outside oil companies.

Most often they tell me they don't want permanent partners. Of course they will have to sign long term deals to attract the major companies, but basically they want outside help to tide them over and get them back on track so they can pay us back and send us home.

They also want new ventures that will help get their people and factories back to work. On top of these they want to earn hard currency from letting outsiders and neighboring countries use their pipeline systems.

They want tariffs and tolls and new metering systems to record them. They want the involvement of outside investors to improve and expand their whole distribution and export infrastructure.

This is a point I can't stress strongly enough.

Improving the pipeline system is extremely important to countries of the former Soviet Union-particularly Russia.

PIPELINE INFRASTRUCTURE

This is not a situation where you can just come in, produce your oil, and go home with a bag of money. You've also got to work with them in improving and expanding their export systems. In other words, you've got to develop capacity for your oil as well as something extra for theirs.

You have to come in with an appreciation for their problems and offer an integrated solution. If you can do that, you will get their attention and probably their cooperation.

At Tengiz an export system is the key to having a project at all, and we don't yet have a deal on a pipeline. In retrospect we didn't do a very good job of planning the pipeline before we started development.

Unfortunately this has left room for speculators and opportunists who continue to interfere with the essential process of building long term relationships based on business terms that are fair and reasonable for all participants.

However we did structure the deal to create some protection for Chevron as well as some very strong incentives for the establishment of a new pipeline. More than half our cash payment to Kazakhstan for the Tengiz deal is a lump sum due only when an export system is in place.

ECONOMIC DIFFERENCES

Getting involved in the former Soviet Union means you have to expect some surprises.

You have to be willing to admit when you're going the wrong direction and act quickly to get turned around. Many stories illustrate this point, and most of them have to do with the enormous differences between our economic cultures.

In particular, I'm talking about the need for outside companies to do a better job explaining the value of tax based projects to their new partners.

We've spent a lot of time communicating this to the top people in the Kazakhstan government, but we've recently come to realize that we have to communicate with a much broader range of government entities as well as the public.

The fact is that a lot of people there don't understand that as the energy sector grows, so does revenue for the country.

We assumed that everyone in Kazakhstan knew about our project and understood its value to their nation. We assumed we could approach Tengiz as if it were just another project, and we assumed we were the most important thing going in all of Kazakhstan.

The lesson is in doing business in the former Soviet Union, check your assumptions at the border.

PIPELINE ALTERNATIVES

Most Tengiz crude is shipped north to Samara and via exchanges is exported to Europe via the Friendship pipeline.

Another route for exporting Tengiz crude is to ship it around the northern Caspian Sea to Grozny, Tikhoretsk, and Novorossiisk on the Black Sea. This crude would have to be tankered through the Bosporus Strait, which can accommodate a limited number of tankers. Also, the western part of the tine runs south and would need to be reversed to transport Tengiz crude.

A third option for Tengiz, Baku, and other Caspian area crudes is to build a pipeline to connect with Iranian pipelines south of the Caspian Sea and ship crude to Kharg Island in the Persian Gulf.

A fourth possibility is to build pipelines across the Caspian Sea and through other former Soviet republics to connect with an existing pipeline in Turkey. That line has been dedicated to moving crude from northern Iraqi fields.

Baku consortium members Amoco, BP, Union, and Pennzoil may have other ideas about shipping crudes.

Our preferred route is to continue to go north into Russia, ultimately to use the existing line south to Grozny and reverse the line north to Novorossiisk.

Caspian Pipeline Consortium, whose members are Russia, Kazakhstan, and Oman, favors a new fine from south of Astrakhan west to Tikhoretsk. Chevron is not a member of CPC and does not understand why Oman is a member.

TENGIZ PROJECT

One 65,000 b/d gas processing plant is operating at Tengiz oil field, and KTL-2, a copy of the first, is almost finished.

Well workovers are challenging due to high pressures, sour gas, and other factors. Most of the wells are in good condition with western downhole equipment and completions.

We serve about 10,000 meals a day out there.

Gas plants produce sulfur at a rate of about 40 lb/bbl of oil produced, and we can't always move that to market when we want.

Export production exchanges have not gone as well as we had planned, and that's one reason we've slowed down some spending, not on the important parts of the project expansion but on things like new housing.

Field production capacity is about 100,000 b/d. We have processing capacity of 65,000 b/d, and we're exporting about 35,000 b/d into Russia by a complex exchange. By yearend with the second processing facility on stream we expect to have production capacity of about 130,000 b/d.

The project has 3,000 employees and expenditures of about $1 million/day. For a few days in mid-June we produced at our capacity of 65,000 b/d. In time Tengiz production will grow to more than 750,000 b/d.

It has the potential to become the economic backbone of Kazakhstan while also providing infrastructure that Russia can expand on.

Tengiz will become the largest most important Chevron project since the opening of Saudi Arabia almost 50 years ago.