russian energy sector at the crossroad: new challenges

Russian Energy Sector At The Crossroad:

New Challenges

Washington

13 September, 2013

Dr. Tatiana Mitrova

Head of Oil and Gas Department

Energy Research Institute of the Russian Academy of Sciences

The role of oil and gas for the Russian Federal budget is huge

Oil and gas taxes and duties in the Federal budget

2

38%

43%

33%

42%

35%

39%

41%

41%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

0

1000

2000

3000

4000

5000

6000

2005 2006 2007 2008 2009 2010 2011 2012

Gas export duty

Gas MET

Oil export duty

Oil MET

Share of oil&gas MET andexport duties in theFederal budget incomes

Source: http://www.roskazna.ru/reports/fb.html

Not only energy sector, but the whole Russian GDP growth is based on the oil prices

3

0,00

20,00

40,00

60,00

80,00

100,00

120,00

0

200

400

600

800

1000

1200

1400

1600

1800

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

ВВП, млрд. долл.

Brent, долл./барр.

Sources: ERI RAS, BP Statistical Review of the World Energy 2013.

Oil price and Russian GDP dynamics$ Bln. $/bbl

GDP, $ bln.

$/bbl

Russian economy is facing recession

4Source: Rosstat

GDP and industrial value added growth (as % to the corresponding quarter of the previous year)

-25

-20

-15

-10

-5

0

5

10

15

IQ IIQ IIIQ IVQ IQ IIQ IIIQ IVQ IQ IIQ IIIQ IVQ IQ IIQ IIIQ IVQ IQ IIQ IIIQ IVQ IQ IIQ IIIQ IVQ IQ IIQ

2007 2008 2009 2010 2011 2012 2013

GDP (in marketprices)

Mining

Manufacturing

Global markets transformations are unfavorable for Russia

5

Slowing demand (crises, structural changes, energy efficiency) and

shrinking market niches for the traditional suppliers (shale revolution, new

market participants).

Growing supply and increasing competition with Australia, Brazil, East

Africa and North America, which will target Russian core markets in Europe

and Asia.

Stagnant prices – shale revolution has already decreased prices in North

America and Europe, additional shale oil will limit oil prices growth. In all

scenarios oil prices do not exceed 100-130 $/bbl, gas prices stay at the current

levels.

Directions of the international energy trade are changing considerably

6

International energy trade, mtoe

Source: Global and Russian Energy Outlook up to 2040. ERI RAS-AC. 2013.

1

2

3

CHANGING GLOBAL GAS MARKETS: IMPLICATIONS FOR THE RUSSIAN GAS EXPORTS

AND DOMESTIC GAS MARKET

HOW TO BREAK THE DEADLOCK?

CHANGING GLOBAL OIL MARKETS: IMPLICATIONS FOR THE RUSSIAN OIL EXPORTS AND

ECONOMIC GROWTH

7

Global gas market development: incremental demand will be concentrated in the non-OECD countries

8

The balance of gas supply and demand in 2040


In the long-term average weighted regional gas prices are not expected to increase significantly on the Russian main export markets

9

Equilibrium gas prices in the three scenarios


Russian gas export might be 70 bcma lower if there would be new breakthroughs in the shale technologies

10

Changes of gas net export and import volumes in 2040 relative to 2010, Baseline and ‘Shale

Breakthrough’ Scenarios


Global LNG supply is expected to boom by the end of this decade with Australia, USA and Canada becoming the largest market players

Mln. tonnes

Global liquefaction capacities (existing and planed)

0

100

200

300

400

500

600

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Other

East Africa

US

Canada

Australia

Existing

Source: ERI RAS11

Situation on the European gas market during the last years did not favor Russian exports…

12

• Unbundling

• Gas Target Model requires all gas to be supplied at the virtual hubs

• Spot volumes are increasing very fast(30-40% p.a.)

• Majority of the European stakeholders support transition to the spot pricing

• Lower than contracted volumes

• Recovers very slowly

• In the power sector gas is strongly competing with coal

• Growing supplies of LNG

• Diversification of pipeline supply sources

Supply Demand

RegulationPricing

12

…but European gas market is going to be tight until 2015-2016

as LNG is diverted to Asia; post 2016 very limited new supplies will become

available and there will be an additional call on the over-take-or-pay

volumes: good opportunity for Russia to enhance its position

Source: WEO2011, IEA; Cedigaz; ERI RAS.

0

100

200

300

400

500

600

700

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Indigenous production (IEA 2013) Pipeline contracts MCQ Russia Pipeline contracts MCQ North Africa

LNG contracts MCQ delivered LNG contracts MCQ diverted New LNG supplies

Available ACQ-TOP volumes Demand (IEA 2013)

European gas balancebcm

13

Russian position in Europe will largely depend on gas pricing: traditional “Groningen” model is questioned now, as even renegotiated oil-linked contract prices are higher than spot-based

-100

0

100

200

300

400

500

Delta

NBP

Russian gas on the German border

European spot and oil-linked gas prices

Source: Bloomberg; ERI RAS.

$/1000 m3

14

Gazprom could give further price discounts and increase its market share, but Russia’s strategic choice is in favor of the short-term profit maximization…

Alexander Medvedev, Gazprom Export

We were faced with the choice of whatever was

to maintain the supply volumes and the

market share, or make the profit our high

priority.

As a public and commercially oriented company,

Gazprom is interested in increasing profits to

provide income to shareholders. Therefore, the

choice was made, the correct one, in favor of

the revenues, and the year results confirmed

that.

«»

15

…ensured by the existing portfolio of the long-term contracts, which guarantees stable sales volumes for Russia until at least 2022

Sources: Cedigaz, Gazprom, ERI RAS.

Contractual quantities and real supply volumes of Russian gas to Europebcm

0

20

40

60

80

100

120

140

160

180

200

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

201

9

202

0

202

1

202

2

202

3

202

4

202

5

202

6

202

7

202

8

202

9

203

0

ACQ

Fact

MCQ

16

Oil indexation vs. gas indexation: "a bird in hand is worth twoin the bush” approach

Strong pressure from the customers side

Investigation of the European

Commission against Gazprom`s pricing

Gazprom could demand financial

compensation for contract review + 3rd

Package exemption for the South Stream

and NEL + transitional period for price

adjustments + European-level financial

support for its mega-projects (like EBRD

and other European financial institutions)

Gazprom could become a dominant

player manipulating the spot market by

adjusting its supply volumes

Disappearing gas glut on the European gas

market in the medium term – gap between oil-

indexed and spot prices already started to

narrow

Gazprom will face next price reopening only after

2015, and contract expiration – only by 2022

With high oil prices even lower volumes are

providing high revenue

New projects demand high prices (they have

negative margins under spot prices, given that

they have to pay export duties) and oil indexation

is more convenient for the project financing

Russian Government needs the money right now

Oil indexation Spot indexation

There are strong commercial reasons for Gazprom to protect the oil indexation at

least during the next 3-5 years

17

Everybody is expecting new opportunities on the booming Asian gas markets, but by 2020 there is already no market niche in China...

bcmChinese gas contracts and gas balance

26

0

50

100

150

200

250

300

350

400

450

2010 2015 2020 2025

Uncontracted market niche

Central Asia

Other LNG supplies

Australia

Qatar

Indigenous production

Chinese demand

Sources: IEA, Cedigaz, Enerdata, ERI RAS.18

…and OECD Asia is quickly contracting the North American LNG

Japan and South Korea contracts and gas balancebcm

Sources: IEA, Cedigaz, Enerdata, ERI RAS.

34 32

65

0

20

40

60

80

100

120

140

160

180

200

2010 2015 2020 2025

Uncontracted market niche

USA and Canada

Others

Russia

Qatar

Other Middle East

Papua New Guenia

Malasia

Indoneisa

Brunei

Australia

Indigenous production

OECD Asia demand

19

Russian “Eastern Gas Program” is moving on, but as there are still no SPAs,

the window of opportunities is becoming smaller and price negotiations

have now to take into account Henry Hub pricing of the potential US LNG

Sources: Gazprom 20

There are 7 Russian LNG projects under consideration currently,but all of them face commercial, technical and regulatory challenges

LNG export permissions might be approved only for special cases and only under very strict

control of the State. Due to the limited volumes and long lead time these LNG projects will not

significantly affect Russian and global balance during this decade. In the longer term Russian

LNG export could reach up to 50-70 bcma.

Baltic LNG

Gazprom

15 mln t

Shtokman

Gazprom

7,5-15 mln t

Pechora LNG

ALLTECH Group

2,6 mln t

Yamal LNG

NOVATEK

15 mln t

Sakhalin-1 LNG

ROSNEFT

5+ mln t

Sakhalin-2 LNG

Gazprom

10 mln t + 5 mln t

potential expansion

Vladivostok LNG

Gazprom

10-15 mln t

21

Independents are improving their positions on the domestic market, though complete market liberalization and Gazprom`s ownership unbundling are not currently under discussion

Russian gas production structure

Sources: CDU TEK, ERI RAS

* Other producers include PSA and APG

bcm

22

But at the same time the industry is consolidating, now there are only

three major non-Gazprom players left on the market: NOVATEK,

Rosneft and LUKOIL

Natural gas production by the companies with access to the UGSSbcm

Sources: CDU TEK, ERI RAS

23

2012 2020 ∆

AGR

2012-

2020

Total consumption 428 468 40 1,12%

Power generation 188 201 14 0,88%

Centralized heating 72 64 -7 -1,36%

Industry and

feedstock79 94 15 2,17%

Residential 75 86 11 1,78%0

100

200

300

400

500

600

2000 2005 2010 2015 2020

Residential

Industry andfeedstock

Centralizedheating

Powergeneration

Russian gas demand by sector until 2020 (optimistic scenario)

GAGR

2,3%

GAGR

0,3%

GAGR

1,1%

Limited demand growth on the domestic market enforces competition

between major players for the most attractive market segments

Sources: Rosstat, ERI RAS.

24

0,00

0,50

1,00

1,50

2,00

2,50

3,00

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Netback price (forecast2011)

Netback price (forecast2013)

MED forecast up to2030

Gas price growth in linewith inflation

Sources: MED, ERI RAS.

At the same time the Government frightened by the industrial output

decline is ready to slow gas prices growth down to the rate of

inflation, which is justified by lower European prices and weak

domestic demand

Different proposed dynamics of the domestic gas price increase (compared to 2010 = 1)

25

1

2

3

CHANGING GLOBAL GAS MARKETS: IMPLICATIONS FOR THE RUSSIAN GAS EXPORTS

AND DOMESTIC GAS MARKET

CHANGING GLOBAL OIL MARKETS: IMPLICATIONS FOR THE RUSSIAN

OIL EXPORTS AND ECONOMIC GROWTH


26

There are tremendous shifts expected on the liquid fuels market,

with declining demand in OECD and booming unconventional liquids

production

27

Liquid fuel supply and demand balance by 2040, Baseline Scenario


Unconventional oil will reach 16% of total liquids production by 2040

28

Dynamics of liquid fuels supply structure, Baseline Scenario


29

Equilibrium oil prices in the three scenarios

Equilibrium oil prices decrease up to 2020 and afterwards do not

exceed 130 $/bbl


30

Changes of oil net export and import volumes in 2040 relative to 2010, Baseline and ‘Shale

Breakthrough’ Scenarios

Russian oil export could decrease even stronger than expected – by additional 50 mln. tonnes per annum - if there would be new breakthroughs in the shale technologies


31

2010 г. 2015 г. 2020 г. 2025 г. 2030 г. 2035 г. 2040 г.

1 2 1 2 1 2 1 2 1 2 1 2

GDP

100 121 119 150 143 185 168 222 192 266 219 316 248

Share of the energy

sector in GDP

28,5 25,6 25,5 22,9 23,1 20,0 20,4 18,4 18,8 17,0 17,3 15,6 15,9

GDP energy intensity

100 87 88 74 77 64 69 56 62 49 57 43 52

Energy consumption

100 106 105 112 110 118 115 125 120 131 125 137 129

Energy export

100 103 95 103 89 105 84 104 85 104 86 100 87

Investments in the

energy sector as a

share of GDP 5,0 5,9 7,2 5,0 4,7 4,5 4,1 4,9 4,8 3,8 3,7 3,4 3,5

Official MED scenario and Outlook-2013 scenario of Russian economy and energy

development, %

1 – official MED scenario, 2 – Outlook-2013 scenario

Taking into account global environment changes dramatically

expectations for the Russian energy and economy

Source: ERI RAS.

32

Decreasing competitiveness of the Russian energy resources

due to depletion of the old fields and tax system makes Russia

most sensitive to the market changes among all the suppliers

Russian energy export by fuel in the official MED scenario and in the Outlook-2013 scenario


MED scenario

Outlook-2013 scenario

33

Limited export opportunities might reduce Russia`s economic growth

by 1% per annum compared to the official scenarios: the economy

cannot any longer count on the hydrocarbons-driven growth


Russian GDP in the official MED scenario and in the Outlook-2013 scenario

1

2

3

CHANGING GLOBAL GAS MARKETS: IMPLICATIONS FOR THE RUSSIAN

GAS EXPORTS AND DOMESTIC GAS MARKET

CHANGING GLOBAL OIL MARKETS: IMPLICATIONS FOR THE RUSSIAN

OIL EXPORTS AND ECONOMIC GROWTH


34

Main measures to support competitiveness of the Russian energy

resources

Cost control together with a thorough evaluation of cost-effectiveness of the new projects

and their potential risks. It is advisable to rank investment projects and reject or postpone the

implementation of inefficient ones. This is confirmed by the results of work done by foreign and

Russian experts, who analysed the cost of domestic energy projects, showing that they were

typically several times more expensive compared to existing analogous projects found elsewhere,

while those projects that were completed were underutilized for years.

Taxation system reform: currently an efficient break-even point for the Russian upstream oil

projects is fixed at 25 $/bbl due to outdated volume-based taxation.

International consortia development – attracting foreign partners into the consortia engaged in

resource development (this refers especially to the eastern part of the country, the coastal shelf,

and deposits of unconventional hydrocarbons). If properly managed, it would enable the country to:

• attract foreign investment and apply advanced technology;

• develop types of business activities with potential, under new conditions;

• ensure tight control over costs and other business results;

• obtain additional assurances for product sales; and

• facilitate access to logistics and adapt to the rules of international markets.

Energy saving. Russia has a huge potential, but it is limited by inappropriate regulatory framework

and lack of access to financing 35

Main part of the Russian conventional oil is concentrated

in the declining Soviet-time fields

* According to the Energy Strategy-2030 and Social-Economical

Development Forecast Up To 2030

Source: ERI RAS.

Structure of the Russian oil production

36

59%

30%

4%3% 4%

Conventional oil

Oil deposits with lowrecovery factor

Heavy oil and bitumen

Oil from gas deposits

Other

Shale and tight oil

2012 2030

518 mln.t 512-535 mln.t*

34%

41%

8%

12%

2%3%

In order to sustain production, Russia needs to develop new fields,

which, however, are not competitive under the current tax regime.

Higher production estimates are justified by the vast resource base,

but require completely different taxation system

Sources: CDU TEK, LUKOIL.

Mln t Forecast for the liquid hydrocarbon production in Russia

37

Russia has a huge potential for Enhanced Oil Recovery: best

practices would provide additional 4 bln t without the need to build

new infrastructure, but adjustments of the tax regime are the must

Sources: Energy Ministry, LUKOIL.

Potential for increasing ORF in Russia

38

Unconventional oil and Artic: huge potential, but high costs and lack

of technologies make these projects marginal under the current

taxation

Arctic production volume forecastMln. t

Unconventional oil reserves

Sources: Energy Ministry, LUKOIL.

39

The normal Mineral Extraction Tax and export tax require much lower

breakeven costs, then all sources of new supply have;

the Government is not ready to change the system for profit-based

taxation, therefore all the exemptions are currently adjusted in the

manual regime

40

0

50

100

150

200

250

Affordable breakevenunder the current taxation

EOR Bazhenov rock Arctic

Source: ERI RAS.

$/bbl

Russia has huge potential to use energy more efficiently: energy

consumption could be decreased by 30%

Primary energy savings potential in Russia

based on comparable OECD efficiencies, 2008

Raising Russia’s energy efficiency to the levels of comparable OECD countries would save the amount of primary energy used in a year by the UK

0

100

200

300

400

500

600

700

Mto

e

30%

Gas

Other fuels

Russian primary energy demand

Source: WEO 2011. IEA.

41

Conclusions

More competitive external environment and domestic challenges are creating less

favorable conditions for the Russian oil and gas industry. It will hardly be ably to provide

the same high share of the budget incomes in the future. ERI RAS estimates show, that

unfavorable situation on the export markets could lead to lower export volumes and

slow down Russian GDP growth by 1% p.a.

Russian gas industry still has a huge potential for export growth, but without strict costs

control, cautious evaluation of the export projects and more flexible pricing system these

opportunities could be lost.

Under current conditions, oil production in Russia can be maintained through

development of the following areas:

• enhanced oil recovery at existing fields

• development of unconventional reserves

• development of the new frontiers: new provinces in the Eastern Siberia and Arctic

offshore

But to develop these areas, the Government has to change the whole taxation system,

not just to give few exemptions. 42

43

Contacts

Nagornaya st., 31, k.2, 117186, Moscow,

Russian Federation

phone: +7 985 368 39 75

fax: +7 499 135 88 70

web: www.eriras.ru

e-mail: [email protected]

Energy Research Institute of the Russian Academy of Sciences

"Global and Russian Energy Outlook up to 2040"

http://www.eriras.ru/files/Global_and_Russian_energy_outlook_up_to_2040.pdf

mailto:[email protected]

http://www.eriras.ru/files/Global_and_Russian_energy_outlook_up_to_2040.pdf

russian energy sector at the crossroad: new challenges

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