Top events of 2016

The National Energy Security Fund introduces top-ten events in the oil and gas industry in 2016 and is ready to comment on them in detail.

1. Bashneft and Rosneft ownership story

   This is an absolutely top story of 2016. It played a big role in defining the political and economic landscape in the country. It includes the sale of Bashneft, the arrest of Ulyukayev, and privatization of a stake in Rosneft. The struggle for Bashneft was promised to be competitive, but there was a much-fancied deal that obviously destroyed the privatization logic. In the end, Bashneft was bought by another state company – Rosneft. Thus, a state asset was purchased by another state company, and this deal was called privatization. Afterwards minister Ulyukayev was arrested. These were preparations for selling a 19.5% block of shares in Rosneft. At first, there was a variant that Rosneft would buy out its shares. However, unexpectedly for everybody, the 19.5% stake was divided between two buyers: Glencore and Qatar’s sovereign wealth fund. Shocking information was reported later: Russia contributed 18bn rubles in Rosneftegaz dividends to the purchase of the stake, meaning that the state had given the money to the new owners. Thus, they bought Rosneft shares using resources borrowed from, inter alia, Russia’s Gazprom Bank that had taken the money from a deposit of Rosneftegaz. The scheme was so indecorous that it was not commented on; instead, the phase “the budget has received the required money” was employed to shield from speculations. The budget indeed received 710bn for the shares, but it turned out that the budget had partially paid for that. And this is not the end of the story, because the question about the future of Rosneft shares is still open. There is a feeling that the new owners are temporary. So, the second question is how Rosneft will be managed? Although many think that the deal was devised and prepared by Sechin, Glencore is not a favorite company of the Rosneft head. Moreover, it is known that Sechin prefers dealing with other companies in the sphere of oil trading. Thus, the story of ownership has many unknown details, and it is unlikely to finish in 2017.

2. Oil prices, OPEC agreement

   Oil prices were obviously a key topic in 2016. Throughout the year changes in oil prices were unusual for adherents of the market theory. At the beginning of the year they dropped below $30 per bbl and then starting going up slowly. There were preparations for the OPEC summit in Doha, where OPEC and Russia were to make an agreement on the oil production freeze. Although this project failed because of Saudi Arabia’s refusal to sign documents, oil prices kept surging. Among the excuses mentioned in this regard there was a strike in Kuwait that lasted for just three days, and wildfire in Alberta, Canada, that was soon extinguished. And then they stopped figuring out other reasons for the oil price growth. Later, prices surpassed $50 per bbl without any summit, production freeze and other serious changes on the market. It actually means that traditional explanation of oil prices does not work. Yet, Russia decided to embark on preparations for a new agreement with OPEC. This time it ended with an absolute hit of the year: Russia decided to cut its oil production, and OPEC and some other countries agreed to join this move. Russia pledged to reduce its output by 300,000 bbl/day. However, later it turned out that the accord was not that large-scale, because Russia is to reduce its output by 300,000 bbl not on a daily basis for six months, but by the end of this period. Thus, in reality Russia’s production in H1 2017 will be only 4.5m tons lower. Major part of this decline will be ensured by natural decrease in production that regularly occurs after the sector starts the repair and maintenance season at the end of Q1. These activities always cut daily output by 160,000 to 170,000 bbl. They almost openly say that these losses at the beginning of the year will be offset at the end of 2017. Nevertheless, this agreement triggered further growth in oil prices that reached $57 per bbl in late December 2016. Does this reaction of the market mean that it believes in production cut? Certainly, it does not. It means that the market is ruled by speculators, who use information the way they need it. Sometimes they need some fresh stuff. In this regard, the deal with OPEC is positive. At least, we have already benefited from it. However, it will create serious risks in H2 when speculators may assess the refusal to prolong the agreement and growth in shale oil production in the USA. So, we will keep watching creative approaches in this sphere.

3. Russia’s daily output of 11.3m bbl record high over 25 years

   The total 2016 output was also very significant. There were several momentous events last year, including the launch of Messoyakha and Filanovskogo. The question is why we need this record, if in 2017 we are to cut oil production? Thus, this record seems unnecessary. Yet, it is a pleasant success. It demonstrates that the sector has some potential, that it can launch quite difficult projects. The sector’s record enables the finance ministry to maintain its simple logic: ‘You say a new tax system and investments are necessary. Why do you need it? You are capable of setting records in the current tax system.’

4. Discussion of new tax regime

   This issue was discussed throughout the whole year 2016. Moving towards taxation of profit, not revenue, and parameters of the excess profit tax seemed to have been agreed. However, the devil is in the detail. And what a devil it was! In reality it was like in a popular joke: “They say you have won $5,000 at roulette. – Yes, I did; however, not at roulette, but at cards, and not won, but lost”. The same thing happened in this story. It turned out that the new tax regime would be introduced at few pilot projects; it would last for many years and would be accompanied by cancelation of preferences. Besides, the finance ministry came up with a plan of imposing other payments to return 50bn rubles in potentially missing revenues to the budget. Actually, the idea was to enable the sector to find some money to invest in new projects. But now they are told: “Well, haven’t you saved the money? Bring back the money to the budget”. Imagine the government has decided to encourage people to use public transport: “Let’s reduce the fare to encourage more people to use it. It’s a good idea. Let’s cut the ticket from thirty to twenty rubles. More people will travel. But, let’s charge them ten rubles at the exit”. It is absolutely bizarre thinking. From the point of view of taxation, it will end up very sadly for the sector. In reality there will be no new taxation regime. But the finance ministry will use this experiment to fight individual preferences. By the way, we agree with the finance ministry that individual preferences should be removed. But their abolishment should be accompanied by introduction of a new taxation philosophy in the whole sector.

5. Record gas exports to Europe

   Some 179 bcm of natural gas was supplied to the European Union in 2016. The daily supplies record was set. The 33% share of Russian gas in the European market was record high. Some evil tongues say it was possible because of reverse supplies to Ukraine, but it is just partly true. Even if reverse supplies are deducted, 2016 exports grew by 20 bcm against the 2015 level. By the way, there were reverse supplies in 2015 too. Therefore, the record is correct, which means the presence of Russian gas in Europe is confident, and there are many reasons for that. Firstly, domestic gas production is going down in Europe. Secondly, low gas prices have restored gas consumption. Thus, there is some positive thing in low gas prices; they facilitate advance in consumption, and Russia wins from increasing supplies. Thirdly, American LNG had a positive psychological impact. It did not damage our market, because it is approximately 2.5-fold more expensive than Russian LNG. There was a lot of scheming with statistical data in 2016. For instance, estimated prices often did not include liquefaction costs. Besides, it all happened during the period of low prices, when Russian gas was even below $150 per 1,000 cu m on the German market. Gas prices have begun surging, and in 2017 prices will be certainly higher. Let’s see how the high prices test is passed. In reality, there is no alternative to Russian gas, and it is the main reason for its increased supplies to the EU.

6. Nord Stream-2, construction of pipelines bypassing Ukraine

   There were battles throughout the whole year in this sphere. It is clear that the project is necessary to further reduce gas transit through Ukraine and ensure gas supplies to the Italian market. Poland has been in fierce opposition. Warsaw managed to ruin the initial shareholder arrangement: Gazprom was to have five European partners, but this plan is unlikely to be carried out. However, the project has obtained a permit from Germany; there is some construction in shallow waters at present. In 2017 other countries will authorize construction. Thus, the project fully corresponds to the European Union’s new philosophy and conditions of the Third Energy Package. Obviously some questions arise in this regard. How will land sections of gas pipelines be built? How will access to them be regulated? It’s good that a solution on OPAL was found, and Gazprom received a possibility to use up to 90% of its throughput capacity; by the way, the gas giant increased the level of the latter’s utilization to 80 something percent at the end of last year. Poland pursues its own commercial interests. It would like to continue transiting gas pumped through Ukraine, but it certainly resorts to political slogans and demagogy to cover its real interest.

7. Turkish Stream, southern projects

   It is another European story. It was developing swiftly. We entered the year 2016 being in tough conflict with Turkey, which started when a Russian bomber was downed by the Turkish air force in November 2015. In summer the situation made a U-turn. Political reconciliation began. The apogee of this process is a truce in Syria guaranteed by Russia and Turkey. Politics obviously had an impact on energy projects. Putin and Erdogan again made friends and effectively revived the Turkish Stream project with signing of intergovernmental agreements. The documents were ratified by the Turkish parliament and signed by Erdogan. At the end of the year the documents were submitted to the Russian parliament. The intergovernmental accords clearly stipulate construction of line 1 of the Turkish Stream that Ankara really needs, since half of current consumption in the country is imported through Ukraine. The question is about line 2. The memorandum reads that line 2 can be built. Consumers in Southern Europe need it; the line should run through Turkey making it a transit country. However, Russia has not pledged to lay this line. Russia is waiting for some sound proposals. If Europeans do not want to get gas through Turkey, they should also realize that they will not get it through Ukraine either. Perhaps, they should revive the project of building a pipeline to Bulgaria, while it is still possible.

8. Relations with Ukraine

   The year 2016 was marked by the intention of the head of Naftogaz of Ukraine to unilaterally increase the gas transit tariff, although, in accordance with the contract, it cannot be done, as tariffs are firmly fixed. Thus, throughout the whole year there were unpleasant negotiations with Kiev that ended up with a decision of the Kiev arbitration court to penalize Gazprom by $6.6bn. Thus, at any moment Ukraine may start siphoning off transit gas. So, we are entering the year 2017 with uneasy expectations of a new gas war. In reality, such whims mean the issue of transit via Ukraine must be solved. Well, we created this great gas transportation system, but its normal functioning is impossible due to shallowness of Ukrainian politicians.

9. Struggle for domestic gas market

   Independent producers keep attacking Gazprom, and their nervousness keeps rising. It is understandable: their successes in gas production become more and more ephemeral. NOVATEK’s output has reached its maximum, if its share in production by joint ventures is excluded. In 2016 NOVATEK began demanding new licenses from Gazprom by offering its shares in exchange, which looked rather strange. Gazprom’s reluctance was interpreted as unwillingness to assist independent producers that, instead of negotiating, were complaining and writing letters to the government. There were other letters in 2016, e.g. a proposal to allow NOVATEK’s JV Arcticgas to export gas to Europe, which would allegedly expand sales of Russian gas in Europe, and etc. Nevertheless, Putin has not approved such proposals yet; everything remains intact on the domestic gas market. At the upcoming meeting of the presidential commission for FES scheduled for early 2017, independent producers are expected to raise questions of the domestic gas market restructuring and gas exports. Therefore, the domestic gas market will be a top issue in 2017.

10. Paris Agreement on climate change

    Debates about the necessity to ratify the Paris Agreement lasted throughout the year. Fortunately, it has not been ratified, because the idea that we must pay for emissions means that such agreements are about discrediting hydrocarbons over the climate impact, not about fighting for the happy future of the humanity. Environmental issues obviously ought to be addressed, and at the end of the year the State Council held a meeting devoted to environmental problems. Its participants said many wise things about waste and emissions, and advanced technologies. There are evident environmental problems, and 2017 has been declared Year of Ecology. But will payments for greenhouse gas emissions facilitate real solution of environmental problems? It is very questionable. By the way, we should not forget that US president-elect Donald Trump promised to withdraw from the Paris Agreement, as he thinks that Barack Obama ratified it with violations. Thus, debates on this issue will continue in 2017.