Top events of March 2012

The National Energy Security Fund introduces top-ten events in the oil and gas industry in March 2012 and is ready to comment on them in detail.

1. Presidential elections in Russia

   They directly influence the oil and gas industry. Vladimir Putin’s comeback means that in May we will face great migration of functionaries; tremendous changes are expected. In March and April we have been trying to define the direction of these changes. Serious rotation is to begin; a window of opportunities will open; in late May we will have a new configuration of power. Although it will systemically stay the same, there will be new people, new posts and powers, which, obviously, creates the main intrigue of this spring. In this regard, the oil and gas sector will not be aside. A new supervisor of the industry is expected; changes in the “government-presidential administration-state companies” triangle are possible.

2. Vladimir Putin chairs meeting on gas sector development in Kirishi

   As president Vladimir Putin will inherit a big set of problems. On one side, Putin has to support our gas business. On the other side, he has to ensure revenues to the state budget. Thirdly, he has to somehow support domestic manufacturing in sectors other than the minerals production industry. But it is necessary to raise taxes to support the budget. The question is where to increase the tax burden? The answer would definitely point to oil and gas companies. But making taxes on gas companies higher, while they need to invest in development, means their revenues should be increased. But how their revenues should be enlarged? The external conjuncture is not controlled by us, which means domestic gas prices should be raised. But higher gas prices will affect gas consumers inter alia in the electrical energy and chemical sectors, and in fact the entire economy. How to find a way-out of this situation? We see that Putin has not found an answer. Gazprom asked for a 26% hike in gas tariffs but Putin rejected. On the other side, Putin promised Gazprom to find investments, but it is unclear where he will find them. Secondly, one should not forget that the transfer to the principle of equal profitability of gas exports and domestic supplies as of 2015 has not been cancelled yet. So, the situation is not that simple. It will be very difficult to find a compromise for president Putin.

3. Introduction of 55-60 oil system, new taxation in gas sector discussed

   The idea of the 55-60 system looks logical, as it shows that taxes on oil companies should be reduced, because oil and gas producers need active investments in new projects. But both the 60-66 and 55-60 systems actually look like a sop to oil companies. There are two problems in this case: the first problem is that this system does not change the principle of taxation in the oil sector. The second issue is that preferences to oil companies do not depend on the necessity to invest in new projects and revive old ones. The objective actually is not just to make the taxation regime easier for oil companies. The task is to ensure that oil producers enlarge their investments in new projects and revival of old ones. On the whole, our taxation system has two drawbacks: it does not encourage operation or revival of old deposits, and it does not facilitate investments in greenfields. The system will not change, if export duties on crude oil are cut. Currently the state seems to be concerned about giving some kind of pacifier to oil producers and changing the system of investments in oil processing. But oil processing is not the main headache now. The main problem is production, although it looks stable judging by figures. The current situation is not solving this complex problem. In the gas sector the tax burden is somewhat simpler. But we see that there is, in fact, an idea to increase prices on the domestic market and collect additional revenues in the state budget. But what is the purpose of such a fiscal policy? Is it to collect more money in the budget or to encourage production? Our government cannot solve this task so far, and there is no guarantee that the next Cabinet will figure it out.

4. Ukraine’s parliament passes law forbidding lease and sale of GTS

   Ukraine is even a more mysterious country than Russia. There seems to be every economic reason to solve the issue of the Ukrainian gas transportation system. For instance, this would reduce gas prices for Ukraine by 2.5 times, because Russia promised its domestic gas prices for Ukraine; Ukraine would preserve its status of a transit state, which generates $3bn to $4bn in revenues per year. Nevertheless, Kiev stubbornly says “no”, and even passes a special law that bans lease and privatization of the GTS. Thus, economic arguments are not perceived at all. They keep insisting that if they give away the pipeline system, they will lose Ukraine. But this will end up with construction of expensive South Stream, and Ukraine will lose its transit state status. As a result, Ukraine will have no argument to demand lower gas prices, while high prices may destroy the Ukrainian economy.

5. Final investment decision on Shtokman postponed until July

   Shtokman is a kind of a litmus test. The whole world is watching whether we will start developing it or not. This is a test to judge whether Russia’s attitude towards nonresidents has altered. Many nonresidents believe that we had resource nationalism. Changes seem to start taking place (Rosneft signed an accord with Exxon, Gazprom with Winterhall and NOVATEK with Total), but the Shtokman project has been on the agenda for more than 10 years: tremendous reserves, an Arctic project. If this project is given up, this would be a heavy blow on the gas industry as well as on the country’s investment attractiveness. They will think Russia is still a closed and uninteresting country, given that such projects as Shtokman are not launched. But there is some simple moment: Shtokman is a state project, while Yamal LNG is private. The paradox of the situation is that amid speculations about state capitalism, the project controlled by a state company turns out to have worse initial conditions than the project that fully belongs to a private firm. It is impossible to understand this situation, but it is true. Shtokman has not been granted preferences that Yamal LNG enjoys. But it is very interesting that right after a meeting of the board of directors of Shtokman Development AG, Vladimir Putin met with Total and Statoil executives, and he said that a decision on tax preferences had been made. It is unclear what he meant, because no public decisions were voiced. But, may be, something has changed, and there is understanding that it is impossible to further delay Shtokman.

6. Moratorium on growth in prices of oil products prolonged unofficially

   The moratorium seemed to be over after the presidential elections, but the government unofficially prolonged it. This is testified to by retreating prices. Meanwhile, there is every reason for the opposite movement. World prices are growing, domestic excises are advancing, expenses are expanding, and fantastic budgets are allocated this year on modernization of oil refineries. Thus, from the economic point of view there is, actually, no ground for prices not to go up. Besides, despite activities of the federal antimonopoly service, the structure of our oil business has not changed – it remains oligopolic. This stirs up rumors about some secret moratorium. It is not clear why our state authorities avoided publicity in this case, because they usually like such situations very much: they would gather oil producers, put their feet down and show how they care about national interests. May be, there is no necessity in such publicity as the elections are over, but sooner or later this situation will burst open. We can predict late spring and early summer to be quite tough; if prices are held artificially now, they will jump later and we have to get ready for that.

7. LUKOIL presents 2012-2021 development strategy

   LUKOIL is a company that openly declares that it will invest in production in other regions and countries, unless the taxation regime and licensing policies change in Russia. This position can be criticized, but it is quite frank. The strategy directly says that the company believes it is right to invest money in production first of all in foreign countries. A funny thing is that lately our state has been supporting this position claiming we need to invest abroad more actively. Nobody thinks why it is possible. If one of the largest private companies makes such a decision, shouldn’t be something done to the taxation regime?

8. Dispute around Novorossiysk trade port and other state assets

   There are active debates around privatization. Bidders are lining for state property. On one side, there is a proposal to transfer the seaport to Rosneft. On the other side, first deputy PM Igor Shuvalov thinks it would not be correct. It is interesting that Shuvalov, who actually stands against transfer of this stake to state companies, fell victim to a discrediting campaign at the end of the month: there were speculations how he profited from Gazprom shares. Thus, we see that the topic of state property is obviously very dramatic and intriguing. By the way, there is constant struggle around Rosneft: the company believes there is no need to speed up its privatization, while economic development minister Elvira Nabiullina argues it is necessary to accelerate this process and put the company for sale in 2012. The privatization issue is one of the lines of divide between Putin clans, and it is definitely a very important topic.

9. Proposal to transfer Sevmorneftegeofizika (SMNG) to Rosneftegaz, Russian Security Council Secretary Nikolay Patrushev warns of foreign oil servicing firms that may force Russian companies out

   There is an idea that the state should establish a powerful oil servicing company on the basis of existing assets; everything that is left with the state should be transferred to this holding. Otherwise, as Patrushev describes it, foreigners will come, although they are already here, and force us out from the market. But the problem is that if you pressurize foreign servicing companies, you will be in a very serious trouble. When production starts declining in Russia (this topic is mentioned in our rating), how you will maintain it at least on some level without employing modern oil servicing technologies? You will simply fail to do this. Servicing companies are capable of maintaining production at a sufficient level. In this regard, it is not quite reasonable to refuse participation of foreigners. Unfortunately, the Russian servicing business cannot compete against foreigners in terms of know-how. This is why artificial restriction of servicing rights of nonresidents may be not quite a beneficial and reasonable scenario.

10. Failure to build Ust-Luga terminal on time

    The project was expected to almost crown Vladimir Putin’s election campaign, but it publicly failed. It showed that we indeed have many drawbacks in the sphere of infrastructure. Putin managed to secure reelection without this terminal. But how could such mistakes in designing and construction be made? Our companies are offended by any criticism of the cost and quality of their work. But when it becomes apparent, everybody gets silent and nothing is investigated. Construction in the East of the country is not that visible but there are problems too. So, there is a lot to be done to improve the quality of infrastructure, and Ust-Luga is a very bright example of that.