Kazakhstan passed a law on Wednesday allowing the government to break contracts with foreign companies, alarming investors and raising the stakes in its row with an Italian-led group developing a huge oilfield.

Stepping up diplomacy over the Kashagan field, Kazakh President Nursultan Nazarbayev met Italian Prime Minister Romano Prodi for closed-door talks in New York on the project's future.

Hours after that meeting, Kazakhstan's lower house of parliament voted unanimously to let the government break contracts if it saw a threat to the country's national security.

The vote gave the government extra leverage over Italy's Eni and its main partners Royal Dutch Shell, Exxon Mobil Corp and ConocoPhillips, as talks entered their final stage ahead of an Oct. 22 deadline.

Last month Kazakhstan suspended work at Kashagan in a dispute over spiralling costs and delays. Industry insiders say Kazakhstan expects tens of billions of dollars in compensation.

Kazakhstan's new-found assertiveness in the oil sector echoes Russia's row with Shell, which ended with the firm losing control of the giant Sakhalin-2 energy project, the world's largest liquefied natural gas development.

"There's no way you can describe this legislation as positive from an investment perspective," said one Western investor closely watching the case, who asked not to be named.

"What this means is that people will start thinking of Kazakhstan more like Russia. ... (But) what we don't want to see is for Kazakhstan to fall into the same category as Russia, because that would be negative."

The bill will come into force once passed by the upper house and signed by Nazarbayev seen as a formality, since both chambers are packed with the veteran leader's loyalists.

In New York, Nazarbayev and Prodi met on the sidelines of the United Nations General Assembly, officially to lay the ground ahead of Prodi's visit to Kazakhstan in early October.

"Speaking about Kashagan, the sides noted that this matter lies solely in the business sphere and should not be politicised," Kazakhstan's presidential press service said in a statement.

Kazakhstan says Kashagan is an isolated case and not aimed at harming the broader investor community.

RETROSPECTIVE CHANGES

Once the new law is passed, Kazakhstan will have the right to force retrospective changes to contracts with domestic or foreign firms or break their terms altogether.

But analysts said Kazakhstan was unlikely to exercise this right in the case of Kashagan because of the country's limited ability to develop a project of that scale on its own.

"We believe this would be highly unlikely since there are no viable options available to accelerate the technically complex and capitally intensive development of the giant Kashagan field," Citigroup said in a note.

Yerlan Nigmatulin, an parliamentarian who spearheaded the law, said: "I think only dishonest companies that break our country's legislation will feel uncomfortable with regard to this law."

Eni's continued role as the main operator of Kashagan, the world's biggest oil find in three decades, is under question after Kazakhstan demanded a leading role for its state oil and gas company in the project earlier this month.

Other key Kazakh projects include the Tengiz oilfield, developed by U.S. oil major Chevron via a joint venture, and the Karachaganak gasfield, co-led by Eni and BG.

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