Russia’s energy sector braces for change
If plans to reform Russia’s economy are carried through, the energy sector in particular will require sweeping change, writes Teymur Huseynov of risk consultants Exclusive Analysis
|Teymur Huseynov is Head of Global Energy Consulting at Exclusive Analysis, a specialist intelligence company with headquarters in London and offfices around the world|
The future of Russia’s giant energy sector depends on the extent to which the government modernises the economy by improving efficiency and reducing dependence on oil and gas production. It also requires policies designed to protect the country’s economy from external shocks, such as a sharp drop in global oil and gas prices.
Achieving efficiency is unthinkable without reforming the energy sector itself, so it has therefore been particularly encouraging to witness the increasing liberalisation of Russia’s domestic gas market since the mid-2000s.
This effort is likely to have a growing impact on the investment decisions and export strategies of national champion Gazprom, as well as independent domestic producers and foreign participants.
Issues of modernisation and reform are at the top of Russia’s economic policy agenda, and , as his term begins, “old-new” president Vladimir Putin will need to make a number of wide-ranging, important decisions.
Putin’s rise to power in 2000 and the subsequent evolution of Russia’s gas-export strategy have not always been perceived positively, especially in European policy circles. Europe, as Russia’s major natural gas customer, has viewed Russia’s influence on European gas markets as a tool that the Putin administration was inclined to use for political purposes.
This, the argument went, was in line with Russia’s ascendance in the international arena, which was helped by persistently high oil prices and Putin’s centralising policies at home. Gas transit and payment issues between Russia and its key transit country, Ukraine, witnessed in 2006, 2009 and 2011- 12, have only reinforced this sceptical view of Russia.
Regular disruption of Russian gas supplies to Europe has also raised the critical question of Gazprom’s ability to successfully develop new fields in Russia, as well as its reliability as a long-term supplier to the continent. That energy has become the key irritant in Russia-EU relations is ironic, considering that gas supplies from Russia to Europe started during the Cold War and served as the key driver creating an economic interdependence between Europe and the former Soviet Union.
Pan-European criticism of Russia and the implications of EU’s Third Energy Package have, in turn, acted as a catalyst for Russia to diversify its export outlets. Thus, when Europe was talking about “security of supply,” Gazprom started thinking about “security of demand”.
Gazprom’s export strategy seems to be based on two fundamental principles: maintenance of long-term contract structure; and diversification of export routes not only towards Europe, but also towards Asia. Gazprom has largely been able to preserve the sanctity of the “take-or-pay” clause in its long-term contracts with European customers, while at the same time introducing more flexibility into minimum offtake responsibilities and prices.
Diversification of export routes to Europe at Ukraine’s expense is also becoming a reality, with the first leg of the 55 billion cubic metre a year (cm/y) Nord Stream pipeline already operating. It is also very likely that, as long as disputes with Ukrainian leadership over the 2009 gas contract are not resolved, both Putin and Gazprom’s management will be keen to push ahead with the construction of the planned 65 billion cm/y South Stream pipeline, which together with Nord Stream can largely eliminate Ukraine’s role as a bridge between Russian gas production and European consumers.
That politics, rather than the purely economic rationale, still dominates the thinking behind the South Stream and Europe’s lack of effort to bring the two opposing parties together to resolve the “Ukrainian crisis” is demoralising. European policymakers have rather chosen to criticise Russia for investing in alternative pipeline projects (such as Nord Stream) that would circumvent some CIS countries and would therefore increase Russia’s geopolitical influence over Europe. Ukraine still remains the optimal channel for Russian gas exports to Europe and tripartite (EU-Ukraine-Russia) management of its gas pipeline infrastructure seems to be the best way forward.
Asia’s growing significance
The increasing relevance of liquefied natural gas (LNG) has pushed Gazprom and other domestic players – for example, Novatek in co-operation with Total – to consider boosting investments into that sector as well. It is clear that the main target of both existing and upcoming LNG projects, such as Yamal LNG, will be largely Asian customers, as Gazprom has had to rethink its LNG export ambitions in the Atlantic basin.
Gazprom views increasing volumes of spot LNG at competitive prices as the key risk to the stability of its sales volumes in Europe. Indeed, at the height of the financial crisis in 2009, volumes of LNG imports by European countries increased by 18% to 70 billion cm, despite an overall fall in European gas demand of 7.4% to 555.2 billion cm.
Growing LNG production and regasification capacity, as Russia’s energy sector braces for change If plans to reform Russia’s economy are carried through, the energy sector in particular will require sweeping change, writes Teymur Huseynov of risk consultants Exclusive Analysis. Teymur Huseynov is Head of Global Energy Consulting at Exclusive Analysis, a specialist intelligence company with headquarters in London and offfices around the world well as the write-off of the shale-gas rich North American market as an LNG destination, has created a buyers’ market in Europe since 2009. This has considerably undermined Gazprom’s profitability. The company saw a 12% drop in its gas supplies to Europe in 2009 and the worstever year in terms of its production level at 461.5 billion cm. Russia’s competitors, Norway and Qatar, increased their market share in Europe from 18% to 27% in 2009 at Gazprom’s expense, a situation which has been largely corrected since.
Continuing depressed gas demand in Europe is likely to force Gazprom and other Russian producers to seek alternative markets more aggressively in the years ahead, making diversification into the booming Asian market a logical move. Even projects that were initially designed to supply European and North American markets, such as Shtokman, are now being reconsidered as sources of Asiabound LNG supplies. These volumes, while unlikely to come online before 2016, would be in addition to Russia’s already operational Sakhalin-2 LNG export plant in the far east of the country, which has Japanese and South Korean buyers as key customers.
In fact, it was back in September 2007 that the Russian government decided to start the so-called Eastern gas programme envisaging the streamlining of production, transportation and storage of gas in East Siberia and the country’s Far East. The programme was designed not only to provide gas to Russia’s easternmost regions, but also to put in place the necessary infrastructure to enable Russian gas exports to Asia. Major customers were thought to be China and other countries in the Asia-Pacific region. Two years later, in October 2009, amid a demand crisis in Gazprom’s traditional export markets, Gazprom and China National Petroleum Corporation (CNPC) signed a memorandum under which Russia agreed to the eventual supply of 70 billion cm of natural gas per year to China for a 30-year period. However, Gazprom’s China-bound gas export plans have met serious competition in recent years.
Turkmenistan: a new competitor
Apart from major suppliers of the Asian market, including Qatar and Indonesia, Russia has recently faced a new competitor, its gas-rich neighbour Turkmenistan. In October 2011 independent auditor Gaffney, Cline & Associates updated gas reserves in Turkmenistan’s giant onshore South Yolotan- Osman fields to 13-21 trillion cm from a 2008 estimate of 4-14 trillion cm. The field, which has recently been renamed Revival, is considered to be second to only Iran’s South Pars. The field is the main source for future larger supply volumes from Turkmenistan to China and once again proves the point that Turkmenistan has sufficient reserves to meet gas demand from many directions.
Turkmenistan’s debut in Asian markets came with the opening of a 40 billion cm a year pipeline to China in 2010. The pipeline, which was fully financed by the Chinese side, became operational following an acrimonious dispute between Russia and Turkmenistan over Gazprom’s unwillingness to purchase contracted volumes of gas in 2009, when demand for Russian gas in Europe was falling.
According to recent reports, work has begun in China on a pipeline to transport Turkmen gas through a 29km pipeline from the Chinese mainland to Hong Kong. During a December 2011 meeting between Turkmen and Chinese leaders, the Turkmen side agreed to triple its gas exports to China. This will see Turkmenistan ship up to 65 billion cm/y of gas to China after 2015. Deliveries to Hong Kong are expected to start by the end of 2012.
On the demand side, China plans to raise the share of gas in its total energy mix from its present level of 4% to 10% by 2020. This would bring annual consumption to 250 billion cm from current 155 billion cm, and mean that China expects to importadditional volumes of gas that would equal Germany and France’s combined 2010 consumption.
These prospective volumes raise genuine interest on the side of potential suppliers such as Russia. However, in the medium-term, Turkmenistan seems to have an advantage over Russia’s plans to enter into long-term contracts with Chinese buyers. China pays Turkmenistan only $190 per thousand cm, whereas Russia is looking for a higher price, something close to what it receives in Europe. The average price of Gazprom’s European oil-indexed exports was $384/ thousand cm in 2011, and this price looks set to increase further over 2012.
While Gazprom is aware of China’s tough stance in price negotiations, it is nevertheless unable to accept lower export prices offered by China. This is because of the multi-billion dollar capital investment needed for field development and transport infrastructure, particularly in Russia’s underdeveloped Far East, where many of Gazprom’s new fields are located.
Secondly, Chinese majors such as CNPC have been able to strike very favourable contracts with their Turkmen counterparts by participating as partners in Turkmenistan’s onshore gas fields. It is unlikely that Gazprom would offer CNPC the same contractual terms that the Chinese firm has been able to get in Turkmenistan.
Moreover, Turkmenistan’s central Asian neighbour Uzbekistan joined the Turkmen-China pipeline as a minority supplier of 10 billion cm of gas to China from 1 April 2012. This underlines the fact that competition for pipeline gas exports to the Chinese market is only likely to intensify and Russia’s southern neighbours are likely to fare better in this competition for the foreseeable future.
Domestic reform impact
Russia’s gas production outlook provides opportunities for independent and foreign participants to develop further greenfield projects. It also underlines the fact that Gazprom has the necessary reserves to honour its contractual obligations on its long-term agreements. It is estimated that, together with Gazprom, independent gas producers could produce up to 950 billion cm in 2020.
It is this author’s belief that the government is keen that market forces should gradually come to dominate Russia’s domestic gas market, with independents posing a growing challenge to Gazprom in terms of access to end consumers. Increasing attractiveness of domestic prices in line with government-led price liberalisation could provide increasing marketing opportunities at home for the independents, as well as Gazprom itself.
However, in contrast to Gazprom’s challenging new projects in the Yamal peninsula, such as Bovanenkovo, independents have been able to tap into much lower-cost fields in Gazprom’s traditional operating environment of the Nadym-Pur-Taz region. Increasing attractiveness of the domestic market will also significantly inform Russian producers export plans. The reform agenda, albeit ambitious by current standards, will thus lead to an emergence of new Russian energy giants that are set to compete with Gazprom not only in domestic markets but also for access to overseas customers. This process can only serve the Russian energy industry well. The government’s actions on this key piece of reform will indicate to what extent it is committed to modernisation and making Russia a fully-fledged market economy.