The Future of Russian LNG: Thierry Bros

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Thierry Bros, a senior research fellow of The Oxford Institute for Energy Studies sat down with Neftianka to discuss Russia’s future prospects in the LNG market.

Neftianka: You’ve been an analyst on both Russia and LNG markets for decades. You tell us, is LNG Russia’s top energy priority right now?

Bros: The government wants to be a decent player in the LNG world, and again, if you are the government, you have to address the question if you want to be a major LNG player, and ten years later you are a small player, but nowhere near where you wanted to be. It is difficult and risky for companies, therefore we need to partner one way or another.

Today we are in a world where there is too much LNG, other sources are drastically changing merit order system. The Russian government needs to answer one very simple question, is LNG strategic or not? It will need to adapt model to produce. If it decides that the project isn’t strategic, then the market can do it.

We are seeing a relaxed LNG world. I think companies have to think that its still a capitalist world, so you have to think about what type of strategy you want. If you have depletion of historical fields, then you need to find new fields.

You’ve been in the analyst trenches for quite some time now. What do you think about the current slump in LNG prices? Will Russia be able to influence LNG pricing the same way they were able to play with European gas pricing?

I think the Russian state will never be able to control the LNG price, it will be like Brent for oil. The question is, “Do we have sufficient market power LNG to understand the mechanics?” And right now the answer is no. The way to better understand the mechanics is to do more projects.

In order to better understand the LNG market, this means more Russian players and better reporting to the government. In a world where pipeline gas is going to be connected with LNG, Russia has an interest in understanding, but not necessarily controlling, the mechanics of LNG.

There is a very simple question if you are Russia is pipeline gas at discount to LNG, and if so, how can I price this?

The LNG “success” story that everyone is talking about these days is Yamal, an LNG plant with16.5 mtpa that looks like it can break even at $30/barrel prices, even though the area is remote and the technology advanced.

Novatek succeeded in understanding, thanks to Total [partner in Yamal LNG] that costs and CAPEX can’t go through the roof. They understood making it profitable from day one. We can’t twist the spreadsheet, the only way for this to go ahead is for the Russian government to take control, to provide tax holidays, port infrastructure, etc. Novatek and the Russian government definitely came out with a win/win situation.

Yamal has strong state support, provide LNG on time and on budget, a new thing in the LNG world these days. Russian LNG provided by different actors. Remember no monopoly in LNG world. Not enough to put Russia on the LNG map. Still second class player when it comes to LNG. Policy makers would like LNG to become more relevant in Russia.

Conversely, the Shtokman LNG project was thought to be risky, and was postponed. You cant say on your spread sheet you’ll add it up later, it has to be adapted from day one.

Gazprom’s Sakhalin, Russia’s first LNG project, had problems in term of CAPEX during the building phase, but now it operates perfectly fine.

We’ve seen LNG projects on maps for many years, but so far there are only two in Russia [Sakhalin and Yamal].

And what about Gazprom’s Vladivostok LNG project that has been officially shelved since late 2015?

If you are Gazprom, it makes sense to expanding Sakhalin because its cheaper.

Gazprom has never built an LNG liquefaction plant [their partner on the project, Shell, was the operator up until 2009].

Gazprom is extremely good at pipes and conventional upstream. LNG is challenging for them. I think Vladivostok LNG was on the map back many years ago because it was a hedge to Power of Siberia, but with Power of Siberia going ahead, they don’t need

Vladivostok LNG would in theory involve an undersea pipeline from Sakhalin to Vladivostok. Is it really profitable to use pipelines in an LNG project?

Gazprom is used to doing pipelines. They can do the profitability analysis and decide yes or no.

How do energy companies become more vertically integrated? What’s Gazprom’s future in an LNG world?

These big companies have the challenge to adapt – Exxon has the same problem with oil: Their mantra will be “oil, oil, oil” for how long? Gazprom has an advantage as a gas company, its one step ahead in the energy transition. This is why Rosneft is so pushy in breaking into the gas market. Gazprom understands there is a huge risk of unbundling, and for it to try and avoid it, in needs to be profitable day in and day out.

If you are Gazprom, you have to make your case stronger, and that means delivering what the state is expecting.

Gazprom will have a duty to do LNG projects in Russia. If your shareholders ask you do to something that isn’t profitable, you can come back and negotiate.

Of course it is easier to do in Europe, because Gazprom has a long history there, and Asians are tough bargainers. And when we compare this move to what’s going on in Europe, we see it’s a good for Gazprom. They are going to have a tendency to move towards Asia due to financing, sanctions, etc.

Will the Russian government support future LNG projects? How does this change with the 2013 law to “liberalize” the market, letting in new players Novatek and Rosneft to export abroad?

My understanding is that the Russia is creating competition between two national companies, Rosneft and Gazprom, and now Novatek.

It could be a good start. If you want liberalization of markets, this may be a good tool to use later on to move away from regulatory price. If you want to have a price of Russia that is reflective of the market.

Interestingly enough, the Russian government has opened the market to all the companies, and since this law, only one project. Did I pass a law for only one project, or am I going to tell the other companies that its time to deliver?

OK, last question. Do you think that St. Petersburg has the potential to be an LNG pricing hub?

Right now it is for a few players, but you have to start somewhere. You can use a hub as a pricing tool.

The World in 2035: BP Economist Delivers Outlook

Spencer Dale, Chief Economist at BP was in Moscow in mid-February to deliver BP’s most recent Energy Outlook. The report forecasts the upcoming trends in the oil and gas industry in the coming decades. Dale’s presentation focused on global growth, the trend towards decarbonization, and the increasing demand for electricity.

Dale spoke at the Institute of World Economy and International Relations in Moscow, part of his global tour to present this year’s report.

“Do we have a crystal ball that somehow means that can we forecast perfectly for 20 years ahead? Of course not. We now know that any forecast will inevitably be wrong. But I don’t think we should think about forecasting as being right or wrong. The value of forecasting is to better understand the nature of the uncertainty we face.”

The energy demand forecasts are based on the assumption that GDP will grow by 3.4% on average over this period. While some of the growth is driven by an increase in population, a majority will come from productivity growth, led by China and India. More than 2 billion people will shift from “lower income” to middle class, creating more demand for energy.

“The world continues to electrify, with the share of energy used for power continuing to increase,” the economist said.

By 2035, the global demand for energy will increase by 30%, with virtually all growth coming from developing economies.

While oil demand will continue to rise, the real winner will be natural gas with the expansion of LNG, the report says. Coal is expected to see its peak in the mid-2020s. Overall, the three fossil fuels will only make up 77% of the energy mix in 2035, compared to the current 86%.

According to the forecast, in the decades to come, Russia will continue to be the world’s biggest exporter, and in particular, has the potential to increase gas production by 28%.

BP, which recently launched a market campaign to rebrand itself as Beyond Petroleum, is very much oriented towards the role non-carbon sources of energy will play in the future.

“Non-fossil fuels provide almost half of the increase in primary energy in the next 20 years,” Dale said.

Rosneft and Transneft Make Peace

Source: TASS/A. Kolbasov
Nikolai Tokarev and Igor Sechin. Source: TASS/A. Kolbasov

Russia’s largest oil company Rosneft and oil pipeline monopoly Transneft have reached a compromise on the transport of oil and oil products for 2017. Rosneft had held out on signing a contract for 2017, which would have left Rosneft without a means to ship their product and Transneft with billion of lost revenue from transport fees.

The dispute between the two power players is longstanding, and stems from the disagreement over compensation payments.

Novatek CEO Nikolai Tokarev and Rosneft head Igor Sechin are both long-time Putin allies, having worked under the President in the 1990s for the city of Saint Petersburg. The two bosses recently met with Russian Energy Minister Alexander Novak and presented the final resolution.

Under the agreement, Rosneft will transport 180,346 million tons of oil via Transneft pipelines, and will ship oil and petroleum products from its recently acquired company Bashneft. The amount of Rosneft will pay to use Transneft’s infrastructure was defined vaguely as “depending on the tariff, amount of oil, and transportation routes.”

Transneft enjoys a monopoly on the transport of Russian oil, shipping more than 90 percent. Rosneft is Russia’s largest producer of oil, accounting for about 40% of the country’s total output.

In December, the pipeline operator, threatened halt pipeline shipments of Rosneft’s oil if a contract wasn’t signed before the end of the year, but this move was blocked by the courts.

With more than 70,000 of kilometers of pipelines, Transneft is the world’s largest oil pipeline company. The company’s monopolistic position makes it a target of not only Rosneft, but also small independent oil producers vying for access to pipelines.

Louise Dickson

Gazprom Neft gains access to Sakhalin

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Gazpromneft-Sakhalin, a subsidy of Gazprom Neft (itself the oil division of state-owned Gazprom) has received a license to explore and drill on Sakhalin Island, Russia’s budding LNG hub situated north of Japan.

The company got permission to drill and produce hydrocarbons from the Ayashsky shelf, part of the Sakhalin-3 project. The other two blocs in the Gazprom-operated project are Kirinsky and Vostochno-Odoptinsky.

The first exploration well is to be drilled oil going this summer and a 3D seismic survey has already been carried out over a 2.15 square kilometer area.

Gazprom Neft joins Russian energy giants Rosneft and Gazprom on the remote island in the Okhotsk Sea, where the companies respectively head up the Sakhlin-1 and Sakhalin-2 projects. Gazprom Neft’s first exploration well will be drilled this summer. The license, granted by Russia’s state subsurface agency, Rosnedra, is valid through July 2039.

The Ayashsky bloc, which Gazprom Neft estimates contains more than 100 million tons of oil or oil equivalent, is sandwiched between the already operating Sakhalin-1 and Sakhalin-2 fields.

This is the first time Gazpromneft-Sakhalin received a license in the Sea of Okhortsk. Previously, the company had only obtained licenses to drill in Arctic blocs.

Russia considers increasing oil exports to Cuba

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The Russian government is discussing the possibility of increasing supplies of Russian oil and oil products to Cuba. Russian oil giants Rosneft and Lukoil would carry out the deliveries of oil and petroleum products and are reportedly working on contracts, but no prices have been discussed.

The development was reported by Russian business daily Vedomosti on Friday, citing a letter from the Deputy Minister of Economic Development Alexey Gruzdev dated January 11.

Between 2010 and 2015, Russia delivered $11.3 million worth of oil products, according to Rosstat data. In 2016, Russia exported just shy of $1 million of oil and oil products.

Cuba’s oil supplies from neighboring Venezuela have been disrupted due to the political crisis. Venezuela is Cuba’s top energy supplier, but as the country teeters on an economic and humanitarian crisis, it has failed to keep up oil production. Reuters reported that in in the first half of 2016 Cuba received 40% fewer barrels of crude oil from PDVSA, Venezuela’s national oil company, than in the same six-month time period in 2015.

In September of last year, Prime Minister Raul Castro asked President Putin to increase oil supplies, but Russia wasn’t actively receptive of the idea due to its doubts about the small Caribbean island nation’s ability to pay up, RBC reported.

The two Cold War allies have collaborated on a number of strategic issues. In October 2015, Russia issued Cuba a $1.3 billion loan to build two nuclear power plant facilities. In 2014, Russia forgave more than $32 billion in Cuba’s Soviet-era debt.

“From our standpoint, the successful completion of negotiations on delivering Russia oil to Cuba will not only increase trade but also have a positive socio-political and humanitarian impact on Russian-Cuban relations,” Gruzdev is quoted by Vedomosti as saying.

Rosneft and LNG

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Russia’s largest oil company Rosneft is making more definitive moves in developing the Pechora LNG project in northern Russia off the Barents Sea coast. When complete, it will produce have the capacity to produce 10 million tons of natural gas per year. The project will help the state-owned oil behemoth get a foot in the natural gas industry, as well as in liquified natural gas (LNG).

Pechora will develop the Kumzhinskoe and Korovinskoye fields in Russia’s Nenets Autonomous region, and will include the construction of an LNG as well gas transport infrastructure, gas treatment plant, and a sea shipping port. At full capacity the Pechora project could reach production of 10 million tons of natural gas per year. Total reserves are more than 174 billion cubic meters of gas and 6 millions tons of condensate.

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Nenets Autonomous region

On November 11, 2016, Rosneft ordered pre-design work on the feasibility study phase of the project Pechora LNG; oilcapital.ru reported, citing a company statement.

Initially, the project was going to be run by Alltech, but the ownership had to change since Rosneft is one of three Russian companies permitted by law to export LNG (the other two are Gazprom and Novatek). Up until 2013, only Gazprom had the right to export.

Pechora LNG was established in 2015 as a joint venture of Rosneft and Alltech Group, the owner of the licenses. Rosneft tried and failed to buy the surrounding Layavozhsky and Vaneyvissky fields in order to expand the project. It lost the auction to rival Gazprom.

Now Rosneft is looking at the option of slashing LNG capacity in favor of refining the product at a gas chemical facility and producing methanol and urea. Rosneft also isn’t ruling out transporting the natural gas it extracts via Gazprom pipelines. Instead of producing up to 10 million tons of natural gas per day, will reduce LNG to 4.3 million tons and a mix of the above stated gas chemicals. So instead of sending LNG to Western markets, it would send oil and chemical products to Russian consumers.

Analysts aren’t sold on the viability of the project, due to some very complex logistics. Putting too much LNG on the market, especially amid a global slump in pricing, would be risky. At the same time, putting less on the market may mean that Pechora is unprofitable.

Despite the slump in crude oil prices, Rosneft has been increasing assets and ramping up its international activities in Iran, China, and Central America.

In Russia, Rosneft has been focusing on diversifying into other non-crude oil markets, putting pressure on Gazprom, which has long had both a domestic and foreign monopoly on natural gas and natural gas exports.

If successful, Pechora will be Rosneft’s second LNG project after Sakhalin-1, a joint venture between Rosneft, Japan’s Sodeco, and Indian state-owned oil company ONGC Videsh Ltd.

Louise Dickson

Low Oil Prices, Taxes, and the Russian Budget

In ruble terms, the oil collapse has been less severe and has resulted in windfall profits for Russian oil and gas companies, but not a proportionate amount of revenues for the state budget.
In ruble terms, the oil collapse has been less severe and has resulted in windfall profits for Russian oil and gas companies, but not a proportionate amount of revenues for the state budget. Source: EIA

The US Energy Information Administration published the report “Low oil prices have affected Russian petroleum companies and government revenues”.

According to the report, low oil prices are having a significant affect on the Russian state budget due to lower tax revenues from the oil and gas companies. However, the oil companies themselves aren’t feeling the squeeze, since the design of the Russian tax system allows for companies to pay lower taxes amidst lower oil prices. Therefore, the companies, which have their operations denominated in local currency and revenues in dollars, can keep a larger share of revenues, and continue to increase their spending in ruble terms.

In Russia, oil and gas companies pay a mineral extraction and export tax, but there is no profit-based taxation.

“The favorable tax structure and exchange rate for Russian oil companies, the subsequent continued high investment levels at Rosneft, Lukoil, and other Russian oil and natural gas companies,” the report published on October 20, said.

The Russian government is expected to overhaul the tax scheme, but is met with opposition from the energy companies, who argue more taxes will stunt investment.

In June 2014, oil prices hit a record high of $114, and just six months later, a barrel of crude traded for $50 per barrel in January 2015. About a year later, a new nadir was reached: both Brent and WTI benchmarks fell below the $30 per barrel threshold.

Russia’s Central Bank preemptively switched the ruble to a free-float regime in November 2014, which helps offset losses from the collapse in oil prices.

So while Brent (which Russia uses to price its main export blend Urals) declined by 47% in 2015 versus 2014, and then another 31% in the first half of 2015, Russian federal budget revenues from oil and gas only fell by 21% and 29, respectfully.

Rosneft and Lukoil are two of the largest Russian oil companies, and together account for about half of the 11 million barrels of crude oil that Russia produces per day. Following the oil price crash, in 2015 Rosneft increased capital expenditures for exploration and production by 30% compared to the previous year. On the contrary, Lukoil’s expenditures on exploration and production projects fell by 11% in the same time period (see figure below).

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Source: EIA

The EIA notes that the favorable tax structure and exchange rates are responsible for bringing production to record highs.

With the exception of independent producers such as Lukoil and Novatek, the majority of Russian oil and gas companies are state-owned, and the Russian government, as the main stakeholder, collects dividends. In April 2016, the Russian government ordered state-controlled companies to pay 50% of 2015 net income out as dividends, nearly double the dividends companies would normally pay, according to the EIA report.

Low oil prices and Western sanctions hit Russia just as the economy was losing steam and heading into a recession. At present, Russia has a budget deficit of 3.3% of total economic input, and many ministers are pushing for higher taxes for the oil and gas industry to fill the gap.

Louise Dickson

Gazprom announces new daily export record

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On October 18th, Russia’s largest natural gas producer and exporter Gazprom announced that exports to Europe and Turkey reached an absolute daily high of 578.9 million cubic meters. The increase reflects Gazprom’s intensified struggle to gain market share in non-CIS countries. In order to achieve this, Gazprom is implanting new export plans and increasing investment in long-term projects.

By the end of the year, total investments will have amounted to 853 billion rubles (about $1.37 billion USD), an 11 billion ruble increase (about $176 million) from investments in 2015.

“Winter hasn’t started yet, but the demand for Russian gas in non-CIS countries is if as if it is bitter cold in Europe. This demonstrates that Russian gas is highly competitive and in high demand on the European market,” Gazprom CEO Alexey Miller said in a statement by the company’s press service.

He added that the increased demand also verified the need for new Nord-Stream 2 and Turkish Stream to deliver gas to foreign customers.

Traditional Russian gas exports via pipeline must now compete with shale oil from the US, as well as the rapidly developing LNG market. The emergence of both have made the global gas market more liquid, and prices more competitive.

Before, Gazprom held a monopoly on the European market, and was able to index gas prices to oil. With more players on the market that offer greater delivery flexibility, prices move towards spot indexation. In order to stay competitive with lower oil prices, Gazprom has had to negotiate its contracts with European customers and offer lower prices.

Gazprom says that it is closely following trends in foreign markets. The company believes that the US will remain a major producer of shale gas in the mid to long term future. Gazprom doesn’t believe that development of Russian shale gas is necessary since reserves and the traditional extraction method will last into the foreseeable future.

Now that the US has opened the Sabine Pass LNG port, it could, in theory, send natural gas all over the world. However, in practice, this product is mostly destined for Latin and South America, as it’s priced out on the European market by Gazprom and Australia and Qatar so far have a monopoly on the Asian market.

Saxo Bank: What to Watch for at the International Energy Forum in Algiers

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Head of Commodity Strategy Ole Hansen

 

In their latest research note, Saxo Bank speculates on the outcomes of the International Energy Forum to be held in Algiers on September 26-28. OPEC members will be in attendance, along with non-OPEC member Russia. Head of Commodity Strategy Ole Hansen writes that a deal to cut production could trigger a price surge in oil, but that the gains are unlikely to last as long as the supply glut remains worldwide.

Oil traders turn to Algiers

Just as with gold, the oil market remains locked in a range with the pressure from oversupply being offset by renewed hope that OPEC and Russia may reach an agreement to cut production. OPEC members will meet on the sidelines of the International Energy Forum, which groups producers and consumers in Algeria from September 26-28. Non-OPEC producer Russia will also attend the forum.

After recording four days of gains, both WTI and Brent crude oil succumbed to profit-taking ahead of the weekend. A third weekly reduction in US inventories, a weaker dollar, and renewed verbal intervention from producers ahead of the Algiers gathering helped offset bearish news on the supply front.

According to this Bloomberg article, September has seen a rise in production of more than 800,000 barrels/day from Nigeria, Libya, and not least Russia which said its reached a new record of more than 11 million b/d this month. Rising production into an already oversupplied market is the challenge that troubled oil producers have to address when they sit down face to face.

Back in April a meeting in Doha failed to curb supply, which was due in part to Saudi Arabia’s insisting that a deal could not be done without Iran also participating. Fast forward almost six months and Iran has now reached its pre-sanctions production levels and that has raised speculation that some kind of deal can be hammered out. Representatives from Saudi Arabia and Iran met in Vienna ahead of the meeting and it apparently resulted in Saudi Arabia offering to cut production in exchange for Iran promising to freeze output.

Saudi Arabia produced around 10.2 million b/d during the first five months only to see it surge to a record in July at 10.67 million b/d. Offering a cut from those elevated levels, at a time of year where the seasonal production tend to slow anyway, looks like a smart move, but it still needs the unlikely acceptance by Tehran.

With US production having stabilized during the past two months the pressure on OPEC to support the market has grown, particularly considering that the prolonged oversupply has been driven by rising production among its own members.

We maintain the view that the upside remains limited until we see clear signs of the glut being reduced. A deal to cut production may trigger a speculative rush of buyers but once again, the low 50s in Brent crude oil should once again provide strong resistance.

Failure to act would return the focus to the aforementioned jump in production which carries the risk of seeing Brent crude trade below recent support at $45/b, potentially targeting $40/b.

Brent crude has so far been averaging $47.70/b this quarter, more or less in the middle of our $45 to $50/b target range. A “no deal” in Algiers could see the range being extended to the downside while a deal, depending on the content, may prompt a short-term rally above $50/b.

Yamal is 63% complete – Total

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Russia’s ambitious Yamal LNG project in the Arctic is nearly two-thirds finished, Total’s Senior Vice President of Exploration & Production for Continental Europe and Central Asia Michael Borrell said. According to the top manager, 63% of construction will have been completed by the end of August (76% marks the first stage of readiness). The project is on schedule to open in 2017.

Borrell was speaking at the Offshore Northern Seas conference in Stavanger, Norway, which opened on August 29.

Once finished, the $27 billion Yamal LNG project will have a capacity of 16.5 million tons per year, which has been contracted to supply Asia and Europe (already 96% of liquefied natural gas has been contracted under the Yamal LNG framework). According to Borrell, a lot of that gas will supply European markets.

The project involves the construction of three LNG production lines. From the Tambeyskoye field, which has proven and probable reserves that were appraised at 926 billion cubic meters of natural gas in 2014.

To date, shareholders have managed to secure $18.4 billion in investment. According to the French gas major, $12 billion was provided by Chinese banks, $4 billion is sourced from Russian banks, and $2.4 billion is from Russia’s National Welfare Fund. Negotiations on raising more funds from Asian and Russian banks are underway. All tranches must be paid in rubles, euros, or yuan, due to the financial sanctions imposed on Russia by the United States.

Yamal is Russia’s first foray into Arctic LNG. Novatek, Russia’s second-largest natural gas producer, owns a 50.1% share in the project, along with Total (20%), China’s CNPC (20%), and the Silk Road Fund (9.9%).

To date, 57 out of 58 wells have been drilled as part of the first stage of the project. More than 17,000 people are currently working at the construction site, and an additional 24,000 are constructing equipment for a Chinese shipyard project

Total owns nearly 19 percent of Novatek.