January 2015 Caspian Upstream: 2014 in review

The megaprojects were again at the centre of attention in the Caspian in 2014. At Kashagan, most of the year was spent identifying the extent of the issues with the pipelines to shore. The decision has now been made to replace both pipelines. This will be expensive and means production will not restart until 2017. At Tengiz, the Final Investment Decision (FID) on the Future Growth Project (FGP) was postponed from end-2014 to H1 2015. The combination of a falling price and a higher capital cost estimate is understood to be behind this delay.

In Azerbaijan, following FID for Shah Deniz Phase Two in December 2013, 2014 was a year of consolidation and partner restructuring for the Southern Corridor. Total and Statoil farmed out of Shah Deniz and the South Caucasus Gas Pipeline (SCP) to TPAO and PETRONAS respectively, selling an aggregate 25.5% stake for US$3.75 billion. TPAO will become the second largest shareholder in Shah Deniz and the SCP.

Beyond the Southern Corridor, M&A activity has been dominated by Chinese companies. Sinopec is acquiring LUKOIL’s 50% stake in four Kazakh oil projects for US$1.2 billion, while private Chinese firms also came to the fore. Other deals saw Shanghai-listed Geo-Jade Petroleum and shipbuilder China Rongsheng Heavy Industries enter the region.

Regional exploration continues to disappoint, with limited activity both onshore and offshore and the absence of a previously- proposed full-scale licensing round in Kazakhstan.

Fiscal revision, rising domestic oil obligations, collateral damage from sanctions on Russia and the falling oil price have all been a concern to the industry. 2015 is set to be a year of even greater uncertainty. Caspian Upstream: 2014 in review

44°E 52°E 60°E 68°E N N ° ° 4 4 5 5

RUSSIA

RUSSIAN volumes of crude transit Kazakhstan to China

Pipelines to be replaced at KASHAGAN KAZAKHSTAN

Second well on ZHAMBYL TENGIZ expansion N N ° block, KAZAKHSTAN FID delayed ° 6 6 4 4

Line C of Turkmenistan-China pipeline commissioned Caspian Sea UZBEKISTAN CHIRAG OIL KYRGYZ- Project starts-up STAN AZERBAIJAN BP and SOCAR sign PSC Seismic acquisition commences on BOKHTAR AREA, TAJIKISTAN TURKEY on near-shore exploration TURKMENISTAN TAJIKISTAN N N ° SHAH DENIZ ° 8 8 3 - Total and Statoil exit 3 - TPAO increase interest Construction of Line D - PETRONAS farms-in Turkmenistan-China gas pipeline begins

IRAN AFGHANISTAN IRAQ

PAKISTAN km SAUDI 0 200 400 800 N N ° °

0 ARABIA 0 3 3 44°E 52°E 60°E 6 8 ° E Source: Wood Mackenzie

Southern Corridor post-FID: a year of farm-outs and contracts

In May 2014, Total signed an agreement with Turkey's TPAO for the sale of its 10% stake in Shah Deniz and the associated SCP for US$1.5 billion. TPAO will now become the second largest shareholder in Shah Deniz and the SCP, reducing concerns over misalignment between the upstream and the midstream. Later, in October, PETRONAS agreed to acquire Statoil’s remaining 15.5% stake in Shah Deniz and the SCP for US$2.25 billion. This is a major shift in the ownership of the project, where BP was seen as being supported by experienced partners Total and Statoil. The inclusion of PETRONAS is likely to be welcome, given its significant offshore experience, including in the Caspian.

On the midstream, progress has been achieved with the completion of the Front–End Engineering and Design (FEED) study for the Trans-Anatolian Pipeline (TANAP). WorleyParsons was subsequently awarded an Engineering, Procurement and

Insight - 07 Jan 2015 Page 2 of 9 Caspian Upstream: 2014 in review

Construction Management (EPCM) contract for the pipeline. This will help to ensure that TANAP is built on time and on schedule.

Participation also changed at the Trans Adriatic Pipeline after E.ON and Total exited the project. Concerns over the landfall point in Italy were alleviated after the Italian Ministry of the Environment issued a decree of positive environmental compatibility.

Waiting for Kashagan

Kashagan has now been shut-in for more than a year, following the gas leaks identified after start-up in September 2013. Initial hopes of restart by end-2014 proved to be in vain. Both the oil and gas pipelines to shore will require full replacement, at an estimated cost of US$4 billion. Wood Mackenzie does not expect production to resume before 2017. The additional Phase One start-up costs will not be recoverable.

Delays in production start-up have raised further doubts over the profitability of the project and the future of additional development phases. Nevertheless, an initial agreement on potential PSC extensions beyond 2041 has now been reached.

During the downtime, the complex Kashagan operating structure is to be revised once again. The existing operating agents are currently being consolidated into an integrated structure, which will be finalised in 2015.

Chinese investment remains strong in the Caspian

Chinese companies have continued to dominate investment in the region. This follows the limited success of the small Western firms active in the region in recent years.

In April, Sinopec announced the US$1.2 billion acquisition of LUKOIL’s 50% stake in Caspian Investment Resources, operator of four projects in Kazakhstan. Upon completion, this deal will double the value of Sinopec’s Kazakh portfolio. The region’s most active purchaser in 2014 has been Shanghai-listed Geo-Jade Petroleum, which acquired two assets in Kazakhstan: 95% of Maten Petroleum for US$526 million and 100% of the Marsel exploration block for US$107 million. The latter was majority- owned by Condor Petroleum.

In September, a leading Chinese shipbuilder – China Rongsheng Heavy Industries – acquired a 60% stake in four blocks in Kyrgyzstan for US$282 million. This deal could help revive the stagnant Kyrgyz upstream industry.

Regional production remains reliant on a handful of mega-projects

Unlike 2013, 2014 was a disappointing year for production at the Caspian’s mega-projects. At Azeri Chirag Guneshli, production fell slightly despite the start-up of the West Chirag platform. This will be the last new development under the existing PSC. Maintenance outages also caused production to decline at Tengizchevroil. Karachaganak liquids and gas production has and will continue to remain relatively flat at around 250,000 b/d and 790 mmcfd respectively, although ongoing debottlenecking of facilities might allow some minor increases.

In Turkmenistan, the super-giant Galkynysh field continues to ramp up production, following Phase One commissioning in September 2013. The Engineering, Procurement and Construction (EPC) project for Phase Two was launched in May. This will provide another 30 bcm per annum of production capacity by the end of the decade.

CNPC also commissioned the second Gas Processing Plant on the Bagtiyarlyk Area, which will increase production capacity by 870 mmcfd. These will help increase Turkmen gas supply to China.

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In November, Eni announced a ten-year extension to its Nebit Dag contract. Turkmenneft has taken a 10% interest in the PSC as part of the extension. The asset currently produces around 20,000 b/d.

Caspian region liquids production,2010-2020 ('000 b/d) YoY production change (%) at key regional fields 2012-2014

3500

3000 d / 2500 b

0 0 0

' 2000 Others

n

o Uzbekistan i t

c 1500 Turkmenistan u d

o Azerbaijan r 1000 P Kazakhstan 500

0

Source: Wood Mackenzie

15%

10%

5% Azeri Chirag Guneshli

Tengizchevoil 0% Area

Karachaganak -5%

-10% 2012 2013 2014

Source: Wood Mackenzie

*Oil and condensate production only.

Exploration remains disappointing

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2014 was another disappointing year for regional exploration.

In Kazakhstan, NC KazMunaiGas (NC KMG) and KNOC drilled their second well on the Zhetys structure at the offshore Zhambyl block. Testing is underway.

Following the Kazakh government’s decision to lift the licensing moratorium for onshore acreage in April 2013, three exploration blocks were made available for tender in December 2013. In April 2014, it was announced that two blocks – Kosbulak and Adaiski Contract Area – had been awarded. The third block – Mangistau block – was not awarded and has since been re- tendered. This fell well short of the previously-proposed full licensing round.

In June, Eni and NC KMG inked an agreement on the Isatai block, offshore Kazakhstan. The agreement also includes the development and management of a shipyard in Kuryk. Further increasing its footprint in the region, ENI also signed a MoU for potential offshore cooperation in Turkmenistan.

In Azerbaijan, the exploration focus is moving away from high-cost offshore deepwater to low-cost onshore and near-shore. ConocoPhillips processed a 2D seismic survey undertaken onshore Azerbaijan in late 2013 and data interpretation is currently underway. In December 2014, SOCAR and BP signed a PSC for the shallow water area surrounding the Absheron Peninsula in the Caspian Sea. Work is expected to start in mid-2015.

More pipeline capacity to the Chinese market

In May 2014, Line C of the Turkmenistan-China Pipeline became operational. The pipeline runs parallel to Lines A and B and is expected to reach its design capacity of 25 bcm by end-2015. Construction of Line D, which follows a different route to the previous lines, began in September. Upon completion, Line D will increase capacity of the Turkmenistan-China pipeline by 30 bcm per annum.

Following the five-year deal between Rosneft and CNPC in 2013, Russian oil deliveries to China via Kazakhstan started in January 2014. 140,000 b/d were delivered via Kazakhstan’s Atasu-Alashankou route. These volumes will bolster throughput along the Kazakhstan-China Oil Pipeline.

Expansion of the Caspian Pipeline Consortium (CPC) line is underway with capacity increasing at the marine terminal to 1.4 million b/d in three stages from 2014 to 2016. In 2014, commissioning of initial facilities in Russia, including a third single point mooring at South Ozereika, enabled throughput to reach close to 1 million b/d by year-end.

Another year of fiscal changes in Kazakhstan

For the second year in a row, and the third time in four years, Kazakhstan raised its export customs duty (ECD) rate. The tax increased by 33% to US$80/tonne. This primarily affects operators with mature assets and a high cost base, as export duty payments are not offset by a decrease in income tax and excess profit tax payments.

In June, the Kazakh government formally approved a Mineral Extraction Tax (MET) break for the Karazhanbas field. This is the first asset to be approved on a list of low-margin, high-viscosity, depleted fields. MET has been reduced to a flat rate of 0.5%.

In February, the Kazakh Central Bank devalued the Tenge by 19% to combat currency volatility and sustain the competitiveness of Kazakh exports, as the Russian Rouble started to depreciate. This devaluation had little impact on operators: most of them soon increased wages while oil transportation tariffs were revised upwards to compensate.

A challenging geopolitical context

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The depreciation of the Rouble, primarily caused by the falling oil price and EU and US sanctions against Russia, have implications for Central Asia. Operators benefit from lower transportation costs – Transneft's tariffs decreased by 17% in US dollars terms in 2014, compared to 2013. Pressure is also increasing on the Kazakh Central Bank for a second devaluation to protect Kazakh exports' competitiveness. Smaller Central Asian economies – primarily Kyrgyzstan and Tajikistan – are suffering from a fall in remittances from Russia, which are vital for their economies.

With a low oil price and a Russian economy in crisis, 2015 promises to be an even more challenging year for the Caspian region.

Appendix

Licence awards in 2014

Block Name Basin Licence Type Licence Block Acreage Partners Status (km²)

Azerbaijan South Absheron South Caspian Geophysical Exploration 850.0 RWE Dea (50.00%), SOCAR (50.00%) Shallow water Absheron South Caspian PSC Exploration * BP (50.00%), SOCAR (50.00%) Peninsula

Kazakhstan Kosbulak South Turgai Concession Exploration 2,015.0 Nursat-Bauir (100.00%) Block A (Kristall Mngmnt) South Turgai Concession Exploration Kristall Management (100.00%) Almeks Plus Area Precaspian Concession Exploration Almeks Plus (100.00%) Adaiski Contract Area Precaspian Concession Exploration 3,465.0 Ocean Petroleum (100.00%)

Kyrgyzstan West Tien Shan Concession Exploration 264.2 Tunguch Gold (100.00%) Tuz-Shamshin Intermontane West Tien Shan Concession Exploration 176.0 Euro House Buildings (100.00%) Serafim Intermontane Pishkarin Fergana Concession Exploration 192.0 KyrgyzMunaiGers (100.00%) Fergana Concession Exploration 550.0 Hausch Natural Resources (100.00%) Nooshkent Gavian-Say Fergana Concession Exploration 21.4 AS Group (100.00%) Dekabrskaya Fergana Concession Exploration 7.9 AS Group (100.00%) Borki Fergana Concession Exploration 132.0 PetroIks Beta (100.00%)

*Unknown Source Wood Mackenzie

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Completed and pending asset deals in 2013

Asset name Buyer Seller Shore Consideration Interest (*denotes status (US$m) operator)

Azerbaijan Shah Deniz* TPAO Total Offshore 1,500.0 10% Shah Deniz* PETRONAS Statoil Offshore 2,250.0 16%

Kazakhstan CIR Assets* Sinopec Group LUKOIL Onshore 1,200.0 50% Borneo Energy Oil and Sumatec Resources Borneo Energy Oil & Onshore 250.0 100% Gas assets* Gas Caspian Energy Inc Asia Sixth Energy Onshore 47.1 60% Zhagabulak fields* Resources Max Petroleum assets* AGR Energy Limited Max Petroleum Onshore 114.5 100% KTM Contract Area* KazMunaiGas TPAO Onshore 205.0 49%

Kyrgyzstan KyrgyzGaz Gazprom Kyrgyzgaz Onshore 40.0 100% China Rongsheng Heavy Ind. Kyrgyzneftegaz Onshore 281.8 60% Various assets

* Deals Pending Source Wood Mackenzie

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Key drilling activity in 2014

Well Name Block Name Basin Shore Well Type Well Result Partners Status

Kazakhstan KN-E-205 West Precaspian Onshore Appraisal Oil Condor Petroleum* (100.00%) Zharkamys I KNC-3 West Precaspian Onshore Exploration Dry Hole Condor Petroleum* (100.00%) Zharkamys I Zhetysu-1 Zhambyl Precaspian Offshore Exploration Tight Hole Zhambyl Petroleum* (0.00%), KazMunaiGas (ZT-1) (73.00%), KNOC (9.45%), SK Innovation (6.75%), Hyundai (2.70%), LG (2.70%), Aju (1.35%), Daesung (1.35%), Daewoo International (1.35%), Samsung (1.35%)

KZIE-3 Block E Precaspian Onshore Appraisal Dry Hole Max Petroleum* (100.00%) KZIE-4 Block E Precaspian Onshore Appraisal Oil Max Petroleum* (100.00%) KZIE-5 Block E Precaspian Onshore Appraisal Oil Max Petroleum* (100.00%) SAGW-7 Block E Precaspian Onshore Appraisal Oil & Gas Max Petroleum* (100.00%) SAGW-13 Block E Precaspian Onshore Appraisal Oil Max Petroleum* (100.00%) SAGW-10 Block E Precaspian Onshore Appraisal Oil Max Petroleum* (100.00%) AKK20 Akkulkov North Ustyurt Onshore Appraisal Gas Shows Tethys Petroleum* (100.00%)

AKK19 Akkulkov North Ustyurt Onshore Appraisal Gas Tethys Petroleum* (100.00%)

AKK18 Akkulkov North Ustyurt Onshore Appraisal Gas Tethys Petroleum* (100.00%)

NK-14 Northwest South Turgai Onshore Appraisal Oil Shows & Gas Galas & Co* (0.00%), LG (40.00%), Roxi Konis Shows Petroleum (34.22%), Private Investors (25.78%) BNG-801 BNG Block Precaspian Onshore Exploration Drilling Roxi Petroleum* (58.41%), Private Investors (41.59%) NK-31 Northwest South Turgai Onshore Appraisal Gas Shows Galas & Co* (0.00%), LG (40.00%), Roxi Konis Petroleum (34.22%), Private Investors (25.78%) West Aksai Aksai Area Precaspian Onshore Exploration Drilling Sequa Petroleum* (75.00%), BOLZ LLP (Zapadnaya)- (25.00%) 1 Southwest Arisskoye South Turgai Onshore Exploration Oil CNPC Ai-Dan Munai* (0.00%), CNPC Sarybulak-1 (100.00%)

Turkmenista n South Umytly- Kamishldzha South Caspian Onshore Exploration Gas/Condensate Turkmenneft* (100.00%) 1 South South South Caspian Onshore Appraisal Oil Turkmenneft* (100.00%) Kamishldzha- Kamishldzha 27

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North Kotur Barsa South Caspian Onshore Appraisal Oil Turkmenneft* (100.00%) Tepe-208 Gelmes- Kotur Tepe Zhdanov Cheleken South Caspian Offshore Appraisal Oil Dragon Oil* (100.00%) 21/101 Contract Area

Azerbaijan Agburun- Agburun- South Caspian Offshore Exploration Tight Hole SOCAR* (100.00%) Deniz-1 Deniz

Source Wood Mackenzie

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