Top events of November 2010

The National Energy Security Fund introduces top-ten events in the oil and gas industry in November 2010 and is ready to comment on them in detail.

1. Government posts Rosneft privatization plan

   The NESF has long been claiming that privatization of the oil and gas sector is quite an important trend of Russia’s political and economic development, this is why we are not surprised with the plan to sell even 51% in the oil producer. There is a firm belief, which is a myth, that there is nationalization in the country. In reality there has been privatization for a long time and it is no secret that a stake in Rosneft may be acquired by investors with connections. The matter is whether foreign partners will be involved in this process. In the Rosneft case, given Rosneft board chair Igor Sechin’s love to China, the question is whether Chinese companies will be engaged? Since the privatization scheme stipulates a possibility of asset swap, some block of shares is likely to be sold directly to Chinese partners, which will mean further strengthening of ties between Rosneft and China.

2. Russian-Bulgarian JV to build South Stream established

   Signing of such accords is usually delayed but this time it occurred sooner than expected, as the official signing was scheduled for the end of Q1 2011. Russia managed to exert quite a strong pressure on Bulgaria. Every means has been used – Russia hinted it might lay the pipeline through Romania; Silvia Berlusconi, who has very good relations with the Bulgarian PM, was engaged; German partners were involved expressing their readiness to join the project. This was all necessary for South Stream to become a more or less real project, to demonstrate it to Ukraine that is still considering establishment of a joint venture. However, to make Kiev think quicker it is better to have a functioning project.

3. Ukrainian court rules Naftogaz must return gas to RosUkrEnergo

   Ukraine has to recognize the decision of the Stockholm arbitration court, and Naftogaz is now facing a bitter reality. The company has to return 12bn cu m of gas to RosUkrEnergo that belongs to Gazprom (50%) and businessman Firtash and partners (50%). Now Naftogaz has to take from underground storage facilities the amount of gas equal to about 25% of the country’s annual consumption and transfer it to RosUkrEnergo. This is a huge volume that may ruin Naftogaz. The fact that Gazprom later signed an agreement with Naftogaz regulating this problem demonstrates that Russia made concessions to Ukraine not having buried Naftogaz making it bankrupt. In return one should obviously expect a JV to manage Ukraine’s gas transportation system to be formed soon. This is the matter of time and agreeing of conditions. Psychologically Ukrainian elites are ready for this; they simply need to persuade the population of this necessity as the latter over the past 20 years have been told that the GTS is a guarantee of Ukraine’s statehood.

4. Web scandal around corruption in ESPO

   On one side, there is nothing extraordinary. Everybody is aware of embezzlement at Transneft. But guessing and speculating is different from showing official documents; besides the documents produced were prepared by Transneft. There is another important moment: in Russia such big leaks of discrediting information mean the beginning of another phase of struggle between elites, which is probably attributed to the upcoming election cycle. This method has been used before not only to attack Transneft but also Gazprom; thus, next year we may see a record number of publications of interesting documents.

5. Gazprom’s draft budget and investment program approved

   Gazprom’s investment program shows that the company is still keen on large pipeline projects. Nevertheless we observe a certain reduction in serious production projects, including Shtokman, which is an alarming signal especially on the background of emerging signs of the European market recovery. This means we should not forget about production. We probably had some breathing space in 2008 and 2009 caused by the decline in output and now it look like the Russian gas is not required. But without launching new projects like Shtokman we will face serious challenges soon. We hope that next year Gazprom will pay certain attention to the upstream segment and large projects, e.g. Bovanenkovo and Shtokman, will develop more intensively.

6. Signing of contract on gas deliveries to S. Korea as of 2017

   Gazprom is completing construction of the Sakhalin-Vladivostok pipeline. It means 30bn cu m of gas will arrive in Vladivostok. Prospects of selling such a volume of gas on the domestic regional market are very vague. Thus, Gazprom has to think where to sell this gas. Given its geographical location, South Korea is a logical continuation of the route; moreover, it long ago proposed to buy 10bn cu m. But there is North Korea en route from Vladivostok to South Korea. It is interesting that after Russian president Dmitry Medvedev’s visit to South Korea, Pyongyang and Seoul were on the brink of full-scale war. They not only exchanged fire but it is important to realize that the threat of war still remains. Obviously nobody will start laying a gas pipeline through North Korea under such conditions. There is a variant of an underwater pipeline but this variant is also rather risky considering seismic conditions in this area. This is why it is necessary to consider other options of transportation. For example, using tankers would be an optimal solution. In this case new technologies can be employed such as compressed natural gas. This know-how has not been used yet but here it may come in handy.

7. E.ON voices plans to withdraw from Gazprom capital

   It would be incorrect to interpret this fact as evidence of E.ON’s total distrust of the Russian market or Russian gas. There is a wide-spread opinion in the expert community that high prices on long-term contracts are to be blamed. They resulted in serious losses of E.ON and the company sold Gazprom shares amid general disappointment. By the way, it is interesting that in early December Russian gas prices on long-term contracts probably for the first time over the past two years turned out to be lower than spot prices in Europe. Thus, Russian gas was cheaper than gas at spot prices, although experts claimed that Russian gas would be overly expensive in the next ten years. The matter is likely not in E.ON’s disappointment. This company is German only because of its brand-name; its capital is American. And American investors like profits to grow every year. The German concern could not show profits, as the year 2009 was not very successful, and its top managers decided to find money immediately to cover financial holes and demonstrate growth in annual profits. Thus, the deal with Gazprom shares led to profits. But this does not mean E.ON will break off relations with Gazprom as they have quite long and sizeable contracts.

8. Finance and energy ministries reach compromise on oil product export duties

   Reaching the compromise does not mean we know exact future tariffs. The process of achieving agreement means its constant revision. In November the ministries came to some compromise but in early December there were some changes and problems again. Meanwhile tax duties are a stimulus to invest in oil production and processing. The situation is absolutely stupid. This confusion just demonstrates the government lacks understanding which direction to follow in developing the sector. On one side, the state says it is necessary to encourage processing in Russia but simultaneously suggests raising duties on light oil products. Then, on the contrary, it suggests decreasing duties on oil products. Then it turns out we are in conflict with Belarus and customs duties would be collected at the customs border of Belarus and Europe meaning another rise in customs duties on these oil products. So, if we increase duties, why we should invest in domestic refining? Unfortunately the government does not have any distinct taxation policy. Oil producers probably dream of having clear-cut fiscal procedures, not preferential taxation, so that they could know what to expect in the next few years.

9. FAS reconcile with oil firms

   This was a large-scale campaign in November. In summer and early autumn we heard loud statements by the federal anti-monopoly service claiming it had driven oil producers into a corner. But now the cases are collapsing. By peaceful settlements with oil producers FAS again confirmed that unfortunately it was not a full-fledged instrument of struggle against monopolists. It seems a special consent by the prime minister is required amid complaints of oil producers about their hardships. They are indeed taxed at high rates but in return they are allowed to do whatever they want on the domestic fuel market. Now this accord seems to be violated given attempts to bring the domestic fuel market into order, and companies certainly submit their complains to the PM. As we see, the premier did not allow violation of the accord, which resulted in amicable arrangements, the monopolistic situation on the fuel market and high petrol prices that exceed the US level.

10. Summit of Caspian states

    This event once again demonstrated a desire of some of our partners to organize gas deliveries to Europe bypassing Russia. This concerns first of all Turkmenistan and Azerbaijan that persistently suggest making the Caspian issue a global problem, i.e. to engage Europe and the USA. The task is simple: to urge Russia to sanction construction of a pipeline on the Caspian Sea bottom. But our position remained unchanged at the summit: the Caspian case is an internal affair of the five states and this issue should be settled through a consensus. Obviously there is no consensus as it is not beneficial for Russia to have a pipeline on the seabed. It would be a strategic mistake to allow Turkmenistan to connect to Azerbaijan through a pipe. So far Russia is defending its position.