ONGC’s questionable Kazakh buy

On the face of it, ONGC‘s decision to splash out $5bn on a minority share in the giant Kashagan oil field in Kazakhstan makes sense, given the Indian national oil company’s pressing need to build up strategic oil reserves. But analysts dissecting the company’s most expensive ever overseas acquisition say the deal is fraught with risk and smacks of desperation.

ONGC announced plans this week to pay $5bn for an 8.4 per cent stake in Kashagan from ConocoPhillips, which is exiting the project in its efforts to shed debt.

Kashagan is one of the last of the world’s so called “elephant” oil fields, capable of making a significant impact on global energy security. It holds 38bn barrels of reserves of which 13bn barrels are proved to be recoverable. But it is also hugely difficult, dangerous and expensive to develop.

However, the most immediate risk for ONGC is that it has spent time and resources negotiating a deal that may end up in the bin. Even as the announcement was made, Kazakhstan said it was considering exercising its right to buy ConocoPhillips’ share in Kashagan itself and would need up to six months to mull over the matter.

Assuming that things go ONGC’s way, the Indian company will begin work at Kashagan in early 2013, just as the first phase of the development begins pumping oil. While its new partners including Exxon, Shell, Total and Italy’s Eni have been bickering for years over operator rights, technical risks and ballooning costs, the Indian company will arrive just as the champagne corks pop and the group sees the first return on the estimated $47bn piled into the project so far.

In a statement ONGC said it was likely to receive an average 20,000 b/d of oil for 25 years from Phase 1 with a peak of about 32,000b/d. That sounds good, but it’s a drop in the ocean compared to ONGC’s goal to boost oil production more than tenfold by 2030 to 1.2m b/d.

For Kashagan to make a sizeable impact on Indian energy security, it will be essential for phase two and three of the project to go ahead, which are designed to boost production at the field to 1.5m b/d.

Before that happens, foreign oil majors will have to settle their latest dispute with Kazakhstan, which has balked at the estimated $100bn cost of the project’s expansion. For their part the oil majors are demanding that the government extends the lifetime of the Kashagan contract to give them more time to recover their investment.

Welcoming the deal with ONGC this week, ConocoPhillips said it was pleased that the Indian company “recognizes the value of the (Kashagan) asset.”

Analysts however have questioned the arithmetic.

CreditSuisse for one, valued the 8.4 per cent of Kashagan at $3.5bn without building the uncertain second and third phases of the project into its price model. “ONGC’s purchase price of $5bn therefore implies it has paid a large part of Phase 2 valuations upfront, which is still to be de-risked,” the bank said in a note.

If the deal goes through, Kashagan will be ONGC’s third acquisition in the Caspian Sea in less than two years. In 2011 it joined forces to explore a large block in the Caspian with KazMunaigas, the Kazakh state oil company. There are no results yet, but then it’s still early days.

In Azerbaijan, ONGC bought a 2.72 per cent stake in the BP-operated Azeri-Chirag-Guneshli deep water project this year from Hess of the US. It also bought a small interest in the Baku-Tbilisi-Ceyhan export pipeline that links the Caspian with the Turkish Mediterranean.

With production of more than 700,000 b/d, ACG is by far Azerbaijan’s biggest oil project. However, ONGC has joined a bit late in the day. More than a decade after coming on stream, the field is expected to go into decline in the next few years.

The spate of Caspian acquisitions shows that ONGC “is really serious about getting into the region,” says Julia Nanay, senior director at PFC, the Washington DC-based energy consultancy.

Offering an explanation for ONGC’s choice of assets, Nanay says the main priority of national oil companies is to obtain equity oil. They are less fixated than privately owned oil majors on high rates of return.

A test of the majors’ confidence in the future of Kashagan will come if any of the partners decide to pre-empt the ONGC acquisition and buy out ConocoPhillips themselves. So far they have not reacted publicly to the deal. “Maybe ONGC sees something in Kashagan that other shareholders do not,” says Edward Chow, senior fellow at the Centre for Strategic and International Studies.

Related reading:
India’s $5bn Kazakh oil deal, beyondbrics
Kashagan: a Caspian dream turned headache for oil majors, beyondbrics
India gains a foothold in Kazakhstan, beyondbrics
Kazakhs to offer crown jewels to investors
, FT