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RUSSIAN ENERGY SECTOR: BEYOND SANCTIONS | #7 | DECEMBER 2014/JANUARY 2015
EDITOR’S NOTE
Ekaterina
Zabrovskaya
Editor-in-Chief
© Russia Direct
2014/2015 All rights reserved.
No part of this publication may
be reproduced or transmitted
in any form or by any means,
including photocopying, or by any
information storage and retrieval
system.
For Russian energy firms, 2014 ranked among the most difficult years in recent memory.
After over a decade of generally favorable conditions in global
energy markets, Russian oil and gas companies ended the year
under a cloud of Western sanctions and descending oil prices.
Meanwhile, Russia’s national currency, the ruble, experienced
vertigo-inducing volatility, dropping as much as 20 percent on
a single day in December.
According to Minister of Finance of the Russian Federation
Anton Siluanov, in 2014 Russia lost about $40 billion due to the
sanctions and $90-100 billion due to the fall in oil prices.
The weakening of the ruble has dramatically altered the
strategic landscape for the Russian energy sector. On the one
hand, a cheaper ruble lowers operational costs for energy companies. On the other, it presents new challenges for Russian
firms servicing dollar debts.
The future of the Russian energy sector depends on how long
these conditions last, and on how Russian firms react. Crises
can create opportunities. This one could potentially encourage
Russia to modernize its energy sector, create a more competitive and open market space in the industry and to develop better links with Asian partners.
The authors of this report are Natasha Udensiva of Columbia University, Marat Terterov and Ben McPherson of the Brussels Energy Club, and Ka-ho Yu of the China-based Energy
Research Center. This issue also contains a commentary from
the Russian Ministry of Energy explaining the Russian government’s position on some of the most pressing issues as well as
shedding some light on what to expect in 2015.
The report also includes a list of expert recommendations, infographics, books and articles for further study.
I invite you to read this report and share your opinions with
us. Please send your thoughts, as well as any questions regarding Russia Direct and its products, to me directly at
[email protected].
Thank you,
Ekaterina Zabrovskaya
The views expressed are those
of certain participants in the
discussion and do not necessarily
reflect the views of all participants
or of Russia Direct.
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CONTENTS
3
Authors
4
Executive summary
5
MAP: Russian energy sector
Part I.
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The current state of the Russian energy sector
Russia’s energy sector needs to modernize
Russia faces a growing number of global energy competitors
After Ukraine, geopolitical factors now outweigh economic factors
Russia’s domestic energy market at a glance
Russian energy projects affected by Western sanctions
How Russia can remain a leader in world energy markets
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Official viewpoint: The development strategy of the Russian energy
sector
Two scenarios for the development of Russia’s energy sector
Russia’s response to shifting patterns of supply and demand
New initiatives and priorities to boost the Russian energy sector
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Part II.
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Trends in Russian-European energy relations
An energy relationship based on reluctant interdependence
Russia’s role in the European gas market
Russia’s role in the European oil and nuclear energy markets
Despite obstacles, Russia is fighting to maintain EU market share
Divergent opinions on Russian relations will likely remain calcified until
the Ukraine crisis eases
Part III.
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Trends in Russian-Asian energy relations
Challenges and opportunities for Russia in Asia
Chinese-Russian energy cooperation is the centerpiece of Russia’s
Asian energy strategy
How Russia can enter other markets in Asia
25
Policy recommendations
26
Recommended books and articles on Russian energy
27
Top 10 Twitter accounts for #RussianEnergy
28
Project team
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AUTHORS
McPherson, Ben
Ben McPherson is an energy policy analyst, working for the Brussels
Energy Club in research and content management. He focuses on the
northern Middle East and Russian spheres, working extensively on
conflict and energy relations in the South Caucasus, Syria and Russia.
McPherson has years of experience with natural gas pipelines all over the
United States, primarily involving environmental inspection and regulation. Motivated by a great interest in the EU political system and conflict analysis, he transitioned his career to Europe in 2011 by obtaining a
Master’s degree in international conflict and security at the University of
Kent’s Brussels campus.
Terterov, Marat
Marat Terterov is the executive director and co-founder of the Brussels
Energy Club. He received his education in Australia, the United States
and the United Kingdom, and holds a Ph.D. in political science from St.
Antony’s College, Oxford University (2002). Terterov has written widely
on the countries of the former U.S.S.R. and Middle East from the perspective of their geopolitics, domestic security and international relations. Terterov gained experience in the energy sphere through several
years of work as a conference organizer focusing on the Russian gas industry, and later with the Secretariat of the Energy Charter Treaty.
Udensiva, Natasha
Natasha Udensiva is a lecturer of international affairs at the School of
International and Public Affairs (SIPA), Columbia University. She has also
taught at the MBA Executive program at Moscow State Institute for International Relations (MGIMO-University), Russia. Concurrently, Udensiva is
a managing partner at Eurasia Energy Associates, where she consults for
a number of investment and financial companies as well as organizations
such as the United Nations. From 2007 to 2011, Udensiva was part of
the research team at the Center for Energy, Marine Transportation and
Public Policy, Columbia University. She has authored a number of working papers on Eurasian energy problems. Udensiva’s research interests
include energy security, global energy geopolitics, and changes in the
global energy landscape. She holds a J.D. from New York Law School and
an M.A. in psychology from Moscow State University.
Yu, Ka-ho
Ka-ho Yu is a China energy specialist and a researcher at the Energy Research Center of the China Business Network Institute, a think tank in
Beijing. He is a research associate at the European Center for Energy
and Resource Security (EUCERS) at King’s College London, a research
fellow at the Chinese Academy of Social Science and a lecturer at the
Chinese University of Hong Kong. Yu received his M.A. in international
public policy from University College London (UCL).
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While much has been made of the impact of Western sanctions on Russia’s
EXECUTIVE
SUMMARY
energy sector in 2014, even prior to the Ukraine crisis, signs were emerging that
Russia’s energy sector was facing a period of difficult adjustment and restructuring. Most importantly, a period of high global energy demand, combined with
energy abundance at home and historically high prices for energy, made it possible to ignore the fact that Russia’s energy companies had failed to modernize
GETTY IMAGES/FOTOBANK
their exploration and production techniques or diversify into new geographic
markets. With the shale energy revolution and slumping global energy demand,
the rapidly changing dynamics of supply and demand left Russian oil and gas
firms facing a more uncertain future. Those issues have come to the forefront
now that oil is trading below $70 rather than over $100.
What follows is a detailed look at the current state of the Russian energy sector, focusing on the specific geopolitical and economic trends that are driving
change for Russia’s largest oil and gas firms. In addition, this report includes
an extensive overview of Russia’s energy ambitions in both Europe and Asia.
The growing bite of economic sanctions and Europe’s yearning for energy
independence have forced Russia to look for new business models, new markets
and new customers. The big question, of course, is how Russia’s much-touted
pivot to Asia – and especially to China – will impact the long-term prospects of
Russia’s energy sector.
PRESS PHOTO
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NATALIA MIKHAYLENKO
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SOURCES: IEA, BP
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GETTY IMAGES/FOTOBANK
Part 1
By Natasha Udensiva
THE CURRENT STATE OF THE
RUSSIAN ENERGY SECTOR
The sanctions did not create any new
problems, but, rather, amplified those that
had already existed in the Russian energy
sector
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RUSSIA’S ENERGY SECTOR NEEDS TO
MODERNIZE
Russia has been a major global energy power since the 1970s.
Though it remains one of the world’s largest oil and gas exporters,
its role as a main energy player is slowly eroding. The global energy
community has spent the past decade embracing new technological innovations — advances in deep-water technology, the development of gas hydrates, the rapid construction of liquefaction gas
plants, and shale oil and gas extraction — but Russia has stayed behind. Spoiled by the abundance of conventional resources at home,
Russia has overlooked the resource abundance emerging in the
rest of the world. As other countries develop previously untapped
energy resources with newly developed energy technologies, Russia, despite its vibrant oil and gas industry and the tradition of high
quality engineering education, has been unable to keep up. Instead,
it relies on technologies developed by other countries.
Russia, with its plentiful conventional oil and gas reserves, has
never had the need to search for unconventional energy sources.
As a result, it has lagged behind in technological innovations and is
now on a quest to catch up. In addition, Russia’s mostly centralized
market structure is hardly fertile ground for innovation. Russia has
SERGEY SAVOSTIANOV / TASS
T
o understand the Russian energy sector beyond sanctions,
one should first examine the Russian energy sector before the
sanctions. A closer look reveals that the sanctions did not create any new problems but, rather, amplified those that had already
existed in the Russian energy sector. If the sanctions were removed
tomorrow, the challenges of a centralized Russian energy market,
an ineffective tax system, the absence of financial discipline and an
overleveraged state oil company, among others, would continue to
haunt the energy sector. Before the sanctions, the flow of Western
money and technology, as well as the presence of major global
energy companies on the Russian market, helped to gloss over
these problems. However, the moment the money flow was turned
off, the problems became even more apparent.
For now, the primary problems facing the Russian energy sector are based on the changing global dynamics of supply and demand. Rapidly developing technology that facilitates easier oil and
gas production has led to an increased global energy supply. At the
same time, the world is experiencing lower global energy demand.
Meanwhile, Russia is struggling with sanctions imposed by the West
in response to the Ukraine crisis. Oil prices are falling but Russia’s
energy interests have been trumped by the country’s geopolitical
interests. Russia’s energy sector needs to adjust to new global and
domestic realities. In short, global competition is increasing while
Russia’s domestic oil production is declining.
about 200 small, independent oil and gas companies responsible
for only 2.8 percent of all oil production; compare that to the United
States, where small oil companies (of which there are around
9,000) produce 46 percent of oil. Innovation requires a “liquidity”
of ideas that only comes with a corresponding quantity of market
participants. Russia is the third largest exporter on the oil market.
In 2012, Russia produced 10.4 million barrels per day (mbp/d) of
petroleum and other liquids, trailing only Saudi Arabia, which produced 11.73 mbp/d, and the U.S., which produced 11.33 mbp/d. It is
expected that Russia will produce 10.6 mbp/d in 2014. Russia is also
the world’s second major exporter of crude, exporting 7.5 mbp/d.
RUSSIA FACES A GROWING NUMBER OF
GLOBAL ENERGY COMPETITORS
Competition on the crude export markets remains strong. Despite
ongoing conflicts in the Middle East, conventional oil fields are still
active. Iraq’s production has increased to 3.5 million barrels per day,
and, though Libya’s production went down considerably in November 2014, from 1.4 mbp/d to 0.5 bp/d, it is worth noting that the
country continues to produce oil even in the face of domestic and
regional strife.
In other parts of the world, we see the development of unconventional oil fields. Canadian oil sands and U.S. shale oil have shown
major production growth. According to the Canadian Association
of Petroleum Producers (CAPP), Canada’s oil production1 is predicted to increase by 3.9 mbp/d by 2015 (compared to 3.2 mbp/d
in 2013) and it is expected to double by 2030. The majority of the
growth (5.2 mbp/d) is expected to come from the Alberta sands.
Meanwhile, according to the U.S. Energy Information Administration, U.S. crude oil production will continue to grow in 2015. The
1. CAPP’s crude oil forecast: Oil sands development drives steady Canadian oil production growth to 2030. Canadian Association of
Petroleum Producers, June 9, 2014. http://www.capp.ca/aboutUs/mediaCentre/NewsReleases/Pages/CAPPcrudeoilforecastOilsandsdevelopmentdrivessteadyCanadianoilproductiongrowthto2030.aspx
2. U.S. Petroleum and Other Liquids. Short-term Energy Outlook, U.S. Energy Information Administration, December 9, 2014. http://
www.eia.gov/forecasts/steo/report/us_oil.cfm
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U.S. produced 7.46 mbp/d of crude oil in 2013, 8.57 mbp/d in 2014,
and it is expected2 to produce 9.42 mbp/d in 2015. There is an
anticipated3 decline in the U.S. crude oil production after 2019. However, production should not drop below 7.5 mbp/d until 2040.
Additional oil is expected to come from the Brazilian deepwater oil
fields. According to Petrobras General Manager Anelise Lara, deepwater oil fields have experienced unexpectedly fast development.
Thus, now the expectation4 of those fields coming into production
is much higher. Brazil is planning to expand its liquid production up
to 5.5 mbp/d from its off shore fields over the next eight years.
Mexico and Argentina are liberalizing their laws and opening up to
foreign companies, which will help Argentina develop its vast shale
oil deposits and help Mexico develop its Gulf of Mexico deepwater
reserves. Supply will continue to increase, while demand, according to the International Energy Agency’s prognosis, will continue to
stagnate until 2017.
600
500
400
300
200
100
0
NATALIA MIKHAYLENKO
SOURCE: RUSSIAN MINISTRY OF ENERGY
On the gas market, a new wave of liquefied natural gas (LNG) projects is threatening Russia’s dominance. The first U.S. LNG export
by Cheniere Energy Partners, LP is expected to start at the end of
2015. LNG projects from Eastern Africa and Australia are supposed
to come on stream by 2018. Papua New Guinea’s first LNG cargo has
been shipped already. In 2013, LNG deliveries were estimated 5 at up
to 230 million tons of liquefied natural gas. By 2025, LNG capacity is
expected to double. According to The Economist,6 Australia is in the
middle of seven projects that, combined, are expected to supply 80
bcm/y. By way of comparison, that figure totals half of Gazprom’s
exports to Europe (161 bcm) in 2013. While most of the Australian
gas will go to Asia, it may push Qatar, the biggest LNG exporter,
back on the European market.
AFTER UKRAINE, GEOPOLITICAL FACTORS
NOW OUTWEIGH ECONOMIC FACTORS
Russia’s energy sector has historically been the Russian government’s best geopolitical weapon against the West. Ironically, this
“weapon” has now been almost nullified because of sanctions imposed by the West against Russia. The sanctions, a consequence
of the conflict between Russia and Ukraine, directly target Russia’s
financial and energy sectors, the most internationally integrated links
of the Russian economy. As a result, future projects, such as the Arctic or Bazhenov shale oil formation (Western Siberia), will be much
more difficult to develop. Some current exploratory projects have
already been affected.
At first, Russian leaders insisted that the sanctions were not
working, but this bravado has faded. The reality is best expressed
by Vagit Alekperov, the CEO of Lukoil, Russia’s second-largest oil
producer. He says that the sanctions quickly lowered companies’
credit ratings, which, in turn, lowered their market capitalizations.
Currently, the future of the Russian energy sector depends in many
ways on how soon these sanctions will end. But the political situation between Russia and Ukraine is far from clear, so the end is
impossible to predict.
President Vladimir Putin seems to believe that Russia can get by
with money from Asian investors, but even Putin’s closest ally, Russian Railways chief Vladimir Yakunin, has said7 that Asian money
cannot replace Western loans to Russian companies. The rising tension surrounding the Ukraine conflict has created an investment risk
that is difficult to calculate.
3. AEO2014 Early Release Overview. U.S. Energy Information Administration, December 16, 2013. http://www.eia.gov/forecasts/aeo/er/
early_production.cfm
4. Kenneth Rapoza. Brazil’s Petrobras Says Its Discoveries Developing Faster Than Gulf Of Mexico. Forbes, June 6, 2014. http://www.
forbes.com/sites/kenrapoza/2014/06/20/brazils-petrobras-says-its-discoveries-developing-faster-than-gulf-of-mexico/
5. Global LNG Market Overview 2013-14. BG Group. http://www.bg-group.com/480/about-us/lng/global-lng-market-overview-2013-14/
6. Bubbling Up. The Economist, May 31, 2014. http://www.economist.com/news/business/21603030-international-gas-market-developing-buyers-will-gain-more-sellers-bubbling-up
7. Putin ally says China cannot replace western financing. The Financial Times, November 12, 2014. http://www.ft.com/intl/cms/
s/0/50c327d6-6a57-11e4-bfb4-00144feabdc0.html#axzz3Is7DtuI8
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RUSSIA’S DOMESTIC ENERGY MARKET AT A
GLANCE
41 percent of the Russian budget comes from oil exports and 12 percent from gas exports. The gas export price is indexed to oil, which
means that the price of oil is a major factor affecting 53 percent of
the budget. Thus, the price for Ural oil, the Russian export oil mixture, is the most significant number for Russia’s economy. The Ural
price tends to be $3-4 lower than the price for Brent oil, a major
worldwide benchmark; a drop greater than 25 percent in the Brent
oil price will directly affect the Russian economy.
The question is whether or not these low prices will last. Some
experts believe that they are the new norm, because natural gas is
overtaking oil in the transportation sector. Buses and large trucks,
for instance, are more and more likely to use natural gas for fuel.
The U.S. Energy Information Administration predicts that LNG “will
play an increasing role in powering freight locomotives in the coming years.” LNG is used routinely to fuel marine transportation and a
growing number of tankers use LNG as well. The Wall Street Journal
reports8 that, “A gallon of diesel fuel costs an average of $3.97 last
year. The equivalent amount of energy in natural gas costs 48 cents
at industrial prices.” Meanwhile, there is increasing discussion of
transferring diesel trains to cheaper natural gas. Currently, Berkshire
Hathaway’s BNSF railway is testing a pilot project of substituting
diesel with LNG fuel.
But others maintain that the low oil prices are short-lived. Many
shale oil projects are starting to stall as low prices render production
unfeasible. Meanwhile, the Saudis have signaled that $70 per barrel
is the bottom price before they start cutting production. Wherever
oil prices head, Russia is only a price taker in this game. Despite being one of the world’s largest oil producers, it is not in the position to
dictate oil prices on the global markets. The problem is not that oil is
traded for dollars instead of rubles. The problem is that Russia, unlike the Saudis, who are the swing producers, or the U.S., which is the
game changer because of its breakthrough technology, is neither of
those, and consequently, is unable to change the pricing dynamics
of the market.
Domestically, oil production continues to grow. So far, in 2014, Russia continues to produce 10.6 mbp/d, higher than its production in
2012 and 2013. However, the rate of production growth is dramatically slowing. According9 to Deputy Prime Minister Arkady Dvorkovich, oil production is going to stabilize at 2014 levels. Dvorkovich
recognizes that oil production in Western Siberia, traditionally a
major source of Russian oil, is on the decline. He is confident, however, that with the right tax incentives, oil companies will be ready
to compensate for this decline with new developments in Northern
and Eastern Russia.
Meanwhile, Vice President of Lukoil Leonid Fedun says10 that production has been stabilized for several years already and is going
to decline starting in 2015. Other industry experts think that production may continue to stabilize for another couple of years, and
will certainly start to decline without radical policy changes. Most
experts agree that this is the beginning of stagnation leading to
eventual decline.
Yuri Bobylev from the Gaidar Institute writes11 that new fields have
to be developed in order to offset the effects of decline and return
production growth. However, new fields are located in completely
undeveloped areas with no infrastructure. The distance separating
these fields is huge, and the climate is harsh. Their development will
require enormous investments. Considering the existing sanctions,
it is not clear where this money will come from. Western banks are
currently closed for long-term loans, and it does not seem that China is ready to shoulder the entire investment.
The main challenge is how to supplement declining production.
The development of the Bazhenov formation and the Arctic are two
beacons of hope. The Russian government fully supports these two
areas of growth by providing lucrative tax incentives, which have
even attracted small companies. The technology, however, is not
really there yet. It is in the process of development and is going
to take time. If production starts to decline, there is no immediate
solution except enhanced oil recovery, which can be used for brown
oil fields. There is still plenty of oil in the brown fields that can be
recovered with existing technologies. To attract these technologies
the government should create appropriate tax incentives, but it has
been loath to do this so far.
RUSSIAN ENERGY PROJECTS AFFECTED BY
WESTERN SANCTIONS
As part of the sanctions against Russia, the EU has banned the sale
of equipment there for the extraction of Arctic deep-sea oil. This
ban has affected Rosneft’s flagship project in the Arctic with ExxonMobil. Luckily for Rosneft and ExxonMobil, there is only one annual
window for drilling in the Arctic, and they were able to complete
their exploratory drilling last summer, before the sanctions kicked
in. But, after the exploratory drilling, the companies had to put the
project on hold, at least for now. There is hope, however, that by
the time the window for drilling comes around again next year, the
political situation will change and the sanctions will be lifted.
8. Russell Gold. Berkshire’s BNSF Railway to Test Switch to Natural Gas. The Wall Street Journal, March 5, 2013. http://www.wsj.com/
articles/SB10001424127887324539404578342540494619344
9. Russia’s oil output to remain stable in coming years — vice-premier. Russian News Agency TASS, November 17, 2014. http://tass.ru/
en/economy/760052
10. Jillian Ward. Arctic Offshore Won’t Be Developed in My Lifetime: Fedun. Bloomberg, November 28, 2014. http://www.bloomberg.
com/news/2014-11-28/arctic-offshore-won-t-be-developed-in-my-lifetime-fedun.html
11. Yuri Bobylev. Trends in Russia’s Oil and Gas Sector Development. Russian Economic Developments no. 10, Moscow, October 23, 2014,
pp. 41-43. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2513738
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REUTERS
Meanwhile, Razvedka and Dobycha (“Exploration and Production”) magazine from October 2014 reports that, in the beginning
of October 2014, Rosneft revealed the results from the exploratory
Kara Sea drilling. According to physical and chemical analysis from
the TomskNeft Research Institute, the oil is ultra-light, outperforming Brent, WTI and Siberian Light on key indicators, density and sulfur. Rosneft is impatient to continue the project but it needs equipment and expertise. The exploratory drilling was accomplished with
the help of the Norway North Atlantic Drilling Company (NADL).
However, at the end of the drilling, the company moved its rig back
to Norway.
To further complicate matters, because of the sanctions, the contract between Rosneft and NADL, a subsidiary of the Norwegian
Seadrill Ltd, the world’s largest offshore rig company, has been
postponed.12 Rosneft and NADL had worked on a $4.5 billion merger, involving a number of contracts, for nearly two years. Rosneft
was supposed to sign a series of contracts during the first weekend
of November 2014. However, Norway joined the European sanctions and postponed approving the deal, which would have been
highly beneficial to both parties, until May 2015. Had the deal gone
through, NADL would have been paid $4.5 billion and Rosneft
would have moved a first-class oilfield service company in-house,
strengthening its position on the global market.
The sanctions are hurting the Russian energy industry in other
ways as well. For instance, Rosneft has to refinance its corporate
debt by the end of the year. After it was cut off from Western credit
markets, the company hoped to borrow money from China. However, according to Mikhail Krutikhin,13 a partner in the RusEnergy
consulting agency, China is reluctant to lend to Russia and its terms
for a loan are less attractive than a loan from Europe would have
been. Currently, Rosneft is applying for government help.
The weak domestic currency is a double-edged sword for Rosneft.
On the one hand, the weakened ruble lowers Rosneft’s operational
costs as an export company. On the other hand, Rosneft has to service its debt in dollars. The Moscow Times reports14 that, “Rosneft…
posted 1 billion rubles ($22.6 million) in third quarter net profit, after
taking a hit of 95 billion rubles in foreign exchange losses.” In comparison, Surgutneftegas, which does not carry any debt, can take
full advantage of the falling ruble. According to the same publication, Surgutneftegas has garnered 1.3 trillion rubles in cash reserves.
Another Russian flagship gas project, Yamal LNG, has been affected by a combination of energy and financial sanctions as well
as by sanctions directed against particular persons. Yamal LNG, the
flagship project in developing Arctic gas and future LNG exports has
three shareholders: Novatek (60 percent), Total (20 percent) and
CNPC (20 percent). The Yamal LNG project is one of Novatek’s largest accomplishments. This Arctic project is supposed to bring 16.5
million tons of LNG gas to export markets. Most gas will be transported to Asia but some volumes will be sent to Europe as well. The
main source for LNG gas is the South-Tambeyskoye field, which
holds 481 bcm and 13.4 million tons of hydrocarbon liquid. The field
is expected to produce 27 bcm/y, and the project is supposed to
come on line by 2017-2018, with most of the volume already contracted except 5 bcm that will go on the open market.
The project, however, has encountered obstacles: It needs LNG
technology and further project financing that will be difficult to obtain because of the sanctions imposed on Novatek, Russia’s second
largest gas company and a major shareholder for Yamal LNG.
Novatek has always been perceived by the market as one of the
most innovative companies in Russia but it became another casualty of the Ukrainian conflict because 23 percent of it belongs to the
Volga Group, a Luxembourg-based fund controlled by Gennady
Timchenko, a former partner of Gunvor, who is facing sanctions,15
while his former company, Gunvor, is under a money-laundering
probe launched by U.S. prosecutors. As a result, Western bank-
12. Rosneft Signs Collaboration Deal with Seadrill, NADL. Rigzone, August 22, 2014. http://www.rigzone.com/news/oil_gas/a/134663/
Rosneft_Signs_Collaboration_Deal_with_Seadrill_NADL#sthash.1eJjNXIx.dpuf;
13. Mikhail Krutikhin. How China Overplays Rosneft and Gazprom. Vedomosti, August 18, 2014. (in Russian) http://www.vedomosti.ru/
opinion/news/33554431/poddavki-skitaem
14. The Winners and Losers of a Weak Russian Ruble. The Moscow Times, November 10, 2014. http://www.themoscowtimes.com/business/article/the-winners-and-losers-from-russia-s-weakened-ruble/510862.html
15. Christopher M. Matthews and Andrew Grossman. U.S. Money-Laundering Probe Touches Putin’s Inner Circle. The Wall Street Journal,
November 5, 2014. http://online.wsj.com/articles/u-s-money-laundering-probe-touches-putins-inner-circle-1415234261
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ers have closed their doors for new loans to the Yamal LNG project
and the only hope for Novatek now is assistance from the Russian
government.
According to Razvedka and Dobycha, a RusEnergy consulting
group publication, Yamal LNG has contracted for the necessary
technology with at least eight Western companies that were going to provide heat exchangers for construction. Among them is Air
Product, a U.S. company that promised to deliver a C3MR technology coil wound heat exchanger, a core and necessary component for
LNG building. The company has promised to stick with the contract
unless it is prohibited by law.
It is difficult to find a substitute for this technology and the only
place where it may eventually be possible is China. But China has
no real experience of producing these heaters yet. If the contract
with Chinese is ever signed, the Yamal LNG project will become a
guinea pig for Chinese companies producing this technology for the
first time. Another casualty of the sanctions is the development of
the Bazhenov formation, which depends on the participation of foreign companies. The formation lies beneath the producing fields in
Western Siberia. The Energy Information Administration estimates
technically recoverable shale oil resources at 74.6 billion barrels (for
comparison, the Bakken formation, one of the largest contiguous
deposits of oil and natural gas in the United States, is estimated at
7.4 billion recoverable oil barrels). Russia’s Ministry of Natural Resources hopes to produce 1 mbp/d within 10 years.
The Bazhenov formation was a magnet for major energy companies, both foreign and domestic, as they saw huge potential in
developing the formation. Compared to the Arctic, the short-term
benefits of developing Bazhenov are more obvious. Companies
jumped into development mainly through joint ventures such as
Rosneft/ExxonMobil, Gazprom Neft/Royal Dutch Shell and Lukoil/
Total. Of course, there are companies developing Bazhenov alone.
Surgutneftegas has been doing so for more than 30 years. So far
the results have been mixed. It has drilled more than 600 wells, 37
percent of which have been dry. Yet, 63 percent of wells have been
successful,16 producing a maximum of 300 tons per day.
Can Russian companies develop Bazhenov alone? Probably yes,
but these projects require a lot of time — more than is needed to
supplement slowing production. There is some hope. This year, a
small, little-known Russian company called AFB discovered a huge
oil field in the Astrakhan area in the southern part of European Russia. This is the largest oil field discovered in 20 years. The field is
estimated to have more than 300 million tons of oil and 90 billion
cubic meters of gas. If discoveries like this continue, Russia may be
able to offset declining conventional production, at least, for a while.
But, the chances of this happening are uncertain. There is limited
geological exploration, and major experts are concerned about the
number of shortcomings in the existing regulation system. For ex-
ample, according to the Russian Federation’s law “On Subsoil,” if a
Russian company with foreign participation discovers a field with
more than 70 million tons of recoverable oil, the state has the right
not to issue a mining license. Though it is very likely that there are
major oil fields to be discovered in the Far East, and the government has offered tax benefits for East Siberian exploration, companies hesitate to venture there because of the total absence of
infrastructure to facilitate these discoveries.
HOW RUSSIA CAN REMAIN A LEADER IN
WORLD ENERGY MARKETS
The government needs to participate in infrastructure development. As Denis Khramov, Deputy Minister of Natural Resources
and the Environment, and Grigory Vygon, head of the Energy
Center of Skolkovo Business School, point out,17 there should be
a balanced partnership between business and state. According
to their research, vertically integrated companies in Russia have
little incentive to conduct new geological exploration as they still
have assets that need to be developed left over from the Soviet
era. Because of this, they can allow themselves to be picky.
Independent companies, particularly new ones, are the ones willing to jump into new explorations. In fact, independent companies
have done 17 percent of all geological exploration in Russia, while
their share in overall Russian oil production amounts to only 2.8 percent. However, it is almost impossible for independent companies
to start exploration in Eastern Siberia because of the lack of infrastructure. In conclusion, it should be noted that Russia was, is and
will be one of the major global energy players. However, to remain
in its leading position, the Russian state needs to create an additional workforce as well as an army of small independent companies
that can do the work. Small companies are usually more flexible,
more entrepreneurial and less political.
A large number of small companies will create a needed base
for ongoing exploration and consequently, for ongoing production. This force can be a great support to the government. But this
force will need tax code stability. It will not be able to function on
temporary tax relief measures and the current lack of stable guidelines. This force will need a change in the regulatory framework
that will safeguard its property rights and create a strong incentive
for exploration and production. This force will need real protection
against possible acquisition by state companies through antitrust
law. The existence of multiple independent oil companies is in the
Russian state’s interest. A partnership between business and state
that would stimulate independent companies to enter the market
force and protect their existence in that market space should be
created. This is the time to create a competitive, open market space
in the oil industry.
16. James Henderson. Tight Oil Developments in Russia: Part 2. ROGTEC Magazine, May 22, 2014. http://rogtecmagazine.com/tight-oildevelopments-in-russia-part2
17. Denis Khramov and Grigory Vygon. Stimulating Geological Exploration: Problems and Solutions. Rusenergy, February 3, 2014. (in
Russian) http://rusenergy.com/ru/articles/articles.php?id=72527
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OFFICIAL VIEWPOINT: THE DEVELOPMENT
STRATEGY OF THE RUSSIAN ENERGY SECTOR
By the Russian Ministry of Energy*
R
ussia is the only country in the world to be at once a
major producer, consumer, and exporter of hydrocarbon energy resources. In 2013, the country produced
almost 525 million metric tons of oil, 650 billion cubic meters
of natural gas, and more than 347 million metric tons of coal.
For many years, Russia has consistently ranked as a top three
global producer and exporter of hydrocarbons, and intends to
retain its leading position. The Russian fuel and energy complex (FEC) will continue to make a significant contribution to
the social and economic development of the country. However, to that end, the FEC must itself develop in a purposeful
manner.
TWO SCENARIOS FOR THE DEVELOPMENT
OF RUSSIA’S ENERGY SECTOR
Of critical importance is the mechanism by which that development takes place. Is it advisable to continue along the path
of constant growth across all sectors of production through
the implementation of increasingly large-scale and costly
investment projects? Keep in mind that the unit costs of oil
production of Russia’s vertically integrated petroleum companies over the past decade have increased fourfold. Or should
the way forward be structural change focused on innovation
and technological development, in which decisions on government and corporate investment programs are taken? The
choice of development mechanism — extensive investment
or structural innovation — depends on a number of circumstances, including the situation in the global economy and the
world energy markets.
By all accounts, the coming years and even decades will
see a fairly weak global economy, in which growth will not
be uniform, either by geography or by sector. The final communiqué of the G20 Summit in Brisbane recognized that the
global economic recovery since the crisis of 2008 is still slow,
and that financial instability and the threat of a sharp drop in
demand and investment activity (i.e. new crises) loom large.
Naturally, this is having an effect on demand for energy and
investment in the real economy, and will continue to do so
for the foreseeable future. The evaluation data and forecasts
have particular resonance for oil production and trade, since
the global oil market is not only a raw materials market, but
also a part of the global financial market. The price of oil fu-
tures is impacted not only by supply and demand factors, but
also, for instance, by the policies of the U.S. Federal Reserve.
Lower oil prices indirectly affect gas prices, and the overall
decline in hydrocarbon prices reduces the investment appeal
of renewable energy. However, price is merely an external indicator pointing to a strong imbalance in the oil market under the influence of several factors. Those mentioned above
can be supplemented with the current excess of supply over
demand due to the “shale revolution” and the market entry
of new (or returning) major exporters, which increases competition and can lead, ultimately, to dumping. Mention should
also be made of the difficulties faced by financial and energy
institutions (e.g. the International Monetary Fund and OPEC)
in regulating the world economy and the energy industry. It is
no coincidence that the G20 Summit raised and substantively
discussed the question of reforming the international system
of global energy regulation.
RUSSIA’S RESPONSE TO SHIFTING
PATTERNS OF SUPPLY AND DEMAND
According to all forecasts, gas is a far more promising avenue
of demand growth than oil. Therefore, on the horizon to 2030,
we expect the oil market to at least maintain the existing level
of production, while the gas market will see an annual increase
of 800 billion cubic meters or more. An increase in exports of
both pipeline and liquefied natural gas is planned. The decision to liberalize LNG exports has further stimulated the creation of new capacity on the Yamal peninsula and in the Russian Far East and North West, providing a sound opportunity
to secure a prominent position in the emerging global market
for liquefied natural gas (LNG).
Nevertheless, the current geopolitical crisis does not, generally speaking, require a radical change of direction in Russia’s Energy Strategy. The main priorities of Russia’s energy
policies, outlined back in the early 2000s, remain essentially
the same, despite having acquired a relatively new form. They
continue to be based on the need for coherent and balanced
work on both sides of the market economy: the supply side
and the demand side. The priority in terms of supply is on
structural and innovative development in the FEC to ensure
competitive, efficient, and clean energy production and supply on both the domestic and foreign markets, while the latter
*The commentary was provided on Nov. 19, 2014, updated on Dec. 22, 2014.
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requires a new improved institutional infrastructure to promote
the sustainable, efficient, and environmentally friendly consumption of energy resources.
Changes in the geographical structure (diversification) of export flows mainly pertain to the structural mechanism of development. Even the first Russian Energy Strategy, adopted in
2004, made clear that the center of global development, generating the primary energy demand, was shifting towards the
Asia-Pacific region. The document entailed a series of ongoing
projects and programs, including the ESPO pipeline, the Eastern
Gas Program, and the State Program for the Development of
the Russian Far East and Trans-Baikal Region. In 2014, Transneft
launched a project to expand the throughput of ESPO-1 from 37
million metric tons per year to 80 million metric tons by 2020,
and ESPO-2 from 21 to 50 million metric tons. Likewise in the
coal sector, the major growth prospects for supplies are emanating from Asia.
It should be emphasized that the “pivot to the East” does not
mean that Russia intends to depart from its traditional markets
in Europe.19 As before, Russia remains open to normal trading
relations and mutually beneficial investment partnerships that
bring the very latest technology and equipment to the country.
NEW INITIATIVES AND PRIORITIES
In 2013 the share of foreign companies in the Russian energy
sector stood at 20 percent. Today, however, we are forced to
tighten our policy of import substitution and set the objective
of achieving independence in all key areas of technology, with
the long-term aim of acquiring technological supremacy in two
or three sectors. In July 2014, the Government of Russia approved a roadmap for innovation in the energy sector, in which
all energy companies are to be engaged. The transformation
of the Russian FEC into a high-tech domestic industry will allow the country to manage independently (or at least under an
equal partnership) such strategic tasks as the development of
new regions and unfamiliar deposits (Arctic offshore projects,
shale oil, etc.).
The most important goal for Russia is to attain the highest
standards for quality of supply in accordance with the needs of
consumers. To that end, the priorities are to continue the gasification of the Russian regions, upgrade refineries to improve
fuel quality, and intensify refining operations by bringing new
petrochemical facilities on stream. It is also planned to augment
the power industry’s share of investments through expanding
the role of the sector in energy supplies and as a result of the
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The “pivot to the East” doesn’t
mean that Russia intends
to depart from its traditional
markets in Europe
need to thoroughly modernize it.
In order to maintain the level of oil production, a comprehensive tax reform was carried out to enable companies to recommence the development of reserves previously considered
uneconomical, and to fully compensate the decline in oil production in Western Siberia through higher output in other regions. Development of the oil and gas sector will involve other
measures, too, such as the introduction of a mechanism of state
guarantees and other instruments to grant national oil companies access to “stabilized” and “long” money. Although Russia’s
traditional energy resources will last for many years, the development of renewable energy is a focus of the Government’s
attention, primarily in terms of developing innovative technologies for the manufacture of power-generating equipment, and
as a vital component in building a distributed energy system.
The share of renewables in the power industry is set to rise to
2.5 percent by 2020. A number of issues will be addressed by
exploiting the market principles of pricing and competition. New
models for the electricity and heating markets will be introduced,
and trading in oil, gas, and petroleum products is to be expanded. The Energy Strategy is due to be revamped in 2015, which
will involve updating the general plans for the development of
the oil and gas industries and the installation of power facilities,
and embarking on the implementation of the State Program of
Energy Efficiency and Energy Development.
19. Instead of South Stream another project is being discussed – an alternative gas pipeline route to Turkey. The first step in its
realization will be the official agreement on its implementation and investment guarantees signed by representatives of both states.
Gazprom is already undertaking preliminary assessments of the length and financial costs of the project. As part of the South Stream
project, Gazprom had initially invested 4.7 billion euros in the construction of Russia’s South Corridor gas supply system, linking Russia’s gas fields to the Krasnodar Region and the Russkaya compressor station, from where gas was to have flowed under the Black
Sea to Europe. Now this capital will be crucial for the implementation of the undersea gas pipeline to Turkey.
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Part 2
By Ben McPherson and Marat Terterov
TRENDS IN RUSSIAN-EUROPEAN
ENERGY RELATIONS
Despite ongoing diplomatic tension
between Russia and the West, Russia and
the EU remain locked in mutual energy
interdependence
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Russia still needs as much of the EU market as it can
get, and will continue to make moves to protect its
market share in the face of diversification headwinds
AP
D
espite ongoing diplomatic tension between Russia and
the West, highlighted by Russian President Vladimir
Putin’s apparent snub at the Brisbane G20 Summit and
subsequent early departure, Russia and the EU remain locked
in mutual energy interdependence. Overall Russia is the third
biggest trading partner of the EU and the EU is the biggest for
Russia. Moreover, the bulk of those EU imports are in the form
of critical natural resources.
As winter approached this year, many in Europe worried
about the potential for natural gas interruptions of EU supplies
à la 2006 or 2009, but at the moment, this possibility seems
less likely since Russia’s Gazprom and Ukraine’s Naftogaz appear to have resolved their outstanding issues. Russia, for its
part, is under increasing pressure from sanctions, a collapsing
ruble, and falling oil prices. In short, Russia desperately needs
the EU as a market.
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AN ENERGY RELATIONSHIP BASED ON
RELUCTANT INTERDEPENDENCE
It looks like the interdependence between Russia and the EU,
despite being filled with tension, will remain the status quo
for the near to mid-term future. Since the 2006 and 2009
Russia-Ukraine natural gas disputes and transit shutdowns,
and especially after the current Russia-Ukraine conflict in
Crimea and the Donbas escalated in early 2014, diversification
of gas supply has been a hot topic in EU policy circles. This
is demonstrated by efforts like the development of the TAPTANAP pipelines to bring Azerbaijani gas to the EU, as well as
smaller state-level projects like LNG import terminals.
The EU is stymied, however, by a lack of good alternatives.
While Norway remains a strong supplier and partner, other
non-Russian sources all have their problems. North Africa
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NATALIA MIKHAYLENKO
has seen production hurt by conflict, domestic EU fracking
potential has been mostly unexplored due to environmental and geologic difficulties, and LNG exporters are much
more likely to send their product to Asia, where prices are
higher.
As for Russia, it is understandable that the nation is skittish
about the future reliability of a customer that openly states its
desire to stop or dramatically reduce its purchase of Russian
energy. In the short-term, however, they also have no alternatives that come close to the EU’s scale.
In terms of diversification, Russia is focusing its commercial
and diplomatic efforts on China, as shown by two recent landmark gas deals. The first, signed in May 2014, saw Russia agree
to supply 38 bcm/y, starting in 2018, from currently undeveloped fields in eastern Siberia to China through a soon-to-bebuilt pipeline named the “Power of Siberia.” The second deal
is a Memorandum of Understanding for another 30 bcm/y
supplied to China, announced in November, and sourced from
existing western gas fields.
The Memorandum of Understanding lacks agreement on crucial details such as price, but if the details are worked out and
both these deals are implemented, the supply of 68 bcm/year
to China would make Beijing Russia’s biggest individual gas
customer. However, this would still be less than half the 161
bcm/y Russia sent to Europe in 2013. Clearly, Russia still needs
as much of the EU market as it can get, and will continue to
make moves to try and protect its market share in the face of
diversification headwinds.
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SOURCE: GAZPROM
RUSSIA’S ROLE IN THE EUROPEAN GAS
MARKET
Of the 541 bcm of natural gas imported into the EU in 2013, Russia’s Gazprom supplied 161 bcm, or about 30 percent. Furthermore, countries in the east such as Lithuania or Estonia have
been 100 percent dependent on Russian supplies. Both sides are
reliant on the other, but both sides are also using pricing, supply,
and legal obstructions as political tools in the wider geopolitical
context. The details of the back and forth between the EU, trying
to diversify and reduce its Russian reliance, and Russia, trying to
maintain market share, have most visibly played out in the form
of legal battles over EU law. A primary case has been that of Nord
Stream and EU gas market legislation exemptions.
Nord Stream is a pipeline that runs from the vicinity of St.
Petersburg, Russia, under the Baltic Sea to Greifswald, Germany. It was finished in 2012, has a capacity of 55 bcm/y, and
connects with two smaller lines that carry gas from Greifswald
to the wider German network: OPAL (35 bcm/y) and NEL (20
bcm/y). Given that the combined capacity of OPAL and NEL
(55 bcm/y) exactly matches that of Nord Stream, it is clear
that Gazprom and its German partners intended to use all
three to full capacity. EU third party access provisions, however, require a percentage of the capacity of OPAL and NEL
(as domestic EU lines) to be reserved for use by third parties.
This means that, in practice, Nord Stream cannot run at full
capacity. In 2013 it reportedly carried 23.7 bcm, or about 43
percent, of its full capacity.
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Gazprom and its German partners have applied for exemptions
to these rules. This, however, is where politics comes in. A decision from the European Commission has been postponed
multiple times, initially for needing ‘technical clarifications’ and
most recently due to the then ongoing Gazprom-Naftogaz negotiations. Given that the EU is not in any imminent danger of
gas shortages, most analysts do not see a final decision coming
as long as tension remains between Russia and the West over
Ukraine. South Stream, another alternate pipeline that was intended to avoid Ukrainian territory, was finally abandoned due
to similar legal issues.
RUSSIA’S ROLE IN THE EUROPEAN OIL AND
NUCLEAR ENERGY MARKETS
In the context of Russia-EU energy relations, natural gas dominates headlines due to Ukrainian transit issues and legal maneuvers such as those discussed above. The relationship is also
complicated in oil and nuclear, however, primarily due to the
sanctions.
Despite Germany’s sharp withdrawal from the nuclear scene,
the technology remains an important part of the EU energy
mix, particularly in regard to meeting lower carbon emissions
targets. Russia is involved in the EU nuclear market in two ways:
equipment and fuel for existing plants, and financing for new
ones. In total, Europe has 18 Russian-designed nuclear plants,
primarily in the east. The fuel used for these plants has to be
prepared in a certain form, to match the exact specifications
of the plant, and this is done by Russian company TVEL. Many
commentators have expressed concern that if sanctions affect
the industry, there are no alternative sources for nuclear fuel in
these configurations.
In addition to supplying existing reactors, Russia is also actively involved in financing new ones. Due to their experience
with the reactors of Eastern Europe, Russian companies are
involved in constructing new plants in Finland, Slovakia, the
Czech Republic, and Hungary. The Ukraine tensions and subsequent sanctions have complicated these projects, and there
has been significant anti-Russian political fallout in Finland and
the Czech Republic. Hungary, on the other hand, remains one
of Russia’s strongest allies in Europe and approved a $12 billion
reactor deal with Russian company Rosatom in June 2014.
The reverberations of current events on Russian-EU oil relations have been less noteworthy than in other energy sectors. Supply lines and ocean transport for oil are much more
robust than compared to those for natural gas, which means
the “Ukraine transit bottleneck” and related political problems
are minimized. The primary impact has been the restrictions on
technology use and collaboration between Russian and Western companies.
© VLADIMIR SERGEEV/RIA NOVOSTI
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SOURCE: ROSATOM, WORLD NUCLEAR ASSOCIATION
A significant casualty has been exploration in the Kara Sea,
where substantial deposits of oil and gas have tentatively been
discovered. This work requires cutting edge technology and
equipment, however, and thus the withdrawal of companies like
Exxon and Schlumberger has put a sudden halt to important
projects. If sanctions remain, the halt of such high tech exploration projects will affect production as old deposits dwindle and
little replaces them.
DESPITE OBSTACLES, RUSSIA IS FIGHTING
TO MAINTAIN EU MARKET SHARE
Though it faces the above economic and governmental legal challenges, Russia and Gazprom continue to defend their market position and adjust to the new market environment. Moscow has a
number of effective tools for maintaining good business relations,
including political connections and the ability to offer discounts
and restructure their positions to assuage political concerns.
Importantly, Russia and Gazprom remain on good terms with a
few EU countries, such as Hungary. They have used these connections to put pressure on Ukraine and maintain their near-monopoly of gas supplies to Naftogaz. Throughout the summer, one of
the proposals that Ukrainian and European planners implement-
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ed to supply Ukraine with gas despite the Russian cut-off was
through “reverse flow” schemes that utilized free pipeline capacity
to transit gas from Hungary, Slovakia, and Poland back to Ukraine.
A visit from Gazprom CEO Alexey Miller to Hungarian Prime Minister Viktor Orbán in the fall, however, led to quick results. Supplies
that had been going in ‘reverse flow’ to Ukraine were cut off and
an initiative to use excess capacity to fill underground storage sites
in Hungary instead was announced. At the same time, Hungary
also strengthened its support for the now defunct South Stream,
so the political posturing worked.
The easiest tool to maintain market share and good relations is
one being employed by Saudi Arabia with oil right now: keep the
price artificially low. A number of European companies have taken
Gazprom to negotiation or arbitration in bids to gain lower prices,
and Gazprom has yielded a number of times. A major milestone
occurred in May, when Italian oil and gas company ENI was able
to renegotiate its long-term gas supply contract with Gazprom to
use spot instead of oil-indexed pricing.
As European gas market hubs mature, the spot price has increasingly diverged from oil-linked prices, and is usually cheaper. As
such, the move will cut into Gazprom’s margins, but was seen as
a sign of more modern, amicable business relations. A report by
Cedigaz, in June 2014, reported that European energy companies
who renegotiated with Gazprom in 2013-2014 received discounts
of around 10-20 percent, and a reduction of their ‘take or pay’
commitments (the amount of gas that a company is required to
pay for in a given year, or else face a penalty).
Finally, the case of Lithuania requires some attention. The country
has been in a long-term legal fight with Gazprom over Gazprom’s
ownership stake in Lithuanian energy company Lietuvos Dujos, and
subsequent monopolistic control of the country’s gas sector. Lithuania has also been a key supporter of diversification, including an
initiative to rent a floating LNG import terminal from Norway and
buy a transport ship, aptly named ‘Independence.’ The LNG scheme
has the capacity to completely satisfy Lithuania’s gas imports, and
analysts talk of it being the nucleus of a new Baltic gas hub.
However, once diversification is achieved, many analysts point
out that Gazprom will maintain a healthy market share. Without
the threat of monopoly, political concerns surrounding the relationship greatly diminish, and Gazprom remains able to provide
gas cheaper than via LNG. Gas is, after all, fungible, and a healthy
market hub does not discriminate as to supply origin. Simply put,
Gazprom gave up fighting for monopoly control but may come
out with a happier, no longer antagonistic, and still profitable relationship with its Baltic customers.
DIVERGENT OPINIONS ON RUSSIAN
RELATIONS WILL LIKELY REMAIN CALCIFIED
UNTIL THE UKRAINE CRISIS EASES
Overall, two divergent trends can be gleaned from the various
economic, legal and political moves of the past year. In one, a
substantial chunk of EU legislators and opinion makers remain
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The EU continues to lack alternative options to
Russian energy supplies, given the security situation in
relevant Middle East and North Africa states
skittish of Gazprom/Russian energy supply, spurred on by factors such as a lack of confidence in supply stability following the
2006 and 2009 shutoffs, political concerns regarding Russia’s
use of the “energy weapon” in non-energy negotiations, and,
somewhat hypocritically, similar use of an “energy weapon” via
legislation and legal cases that put economic pressure on Russia. Given the recent escalation of violence in eastern Ukraine,
with allegedly increasing incursions of Russian tanks, artillery,
and other heavy weapons, the political disputes and subsequent
disruptions to energy relations are likely to continue.
On the other hand, substantial business pressure has emerged
against sanctions. This can be seen in the many news articles
discussing how German and British business interests, in particular, have lobbied their respective governments to go easy
on Russia. There has been continued involvement by Western
companies in initiatives like the St. Petersburg International
Economic Forum of May 22-24, and it took the downing of Malaysian Airlines Flight 17 on July 17 to harden the attitudes of
many business and political leaders.
Even then, plenty of other Western companies maintained
energy cooperation in projects like the aforementioned Kara
Sea exploration until sanctions forced the issue. There are a
multitude of other examples, such as the German OPEL and
NEL consortiums, or the nuclear plant construction plans,
that hint at the recurring appeal of Russian energy projects
for the EU.
In the near-term, the likelihood is that energy projects between Russia and the EU will resume quickly once the political
situation calms down and sanctions are lifted. Furthermore, the
EU continues to lack alternative options to Russian energy supplies, given the ongoing security situation in relevant Middle
East and North Africa countries and the economic realities of
LNG pricing. The uncertainty remains in the details. When will
relations normalize, and how much damage will the Russian
economy absorb in the meantime?
As for Russia, the Chinese deals will eventually give Gazprom
flexibility in diversifying their customer list, but completion of
those pipelines is set for 2018 and even then, infrastructure to
connect gas fields in western Russia with eastern Russia does
not exist. Given the geopolitical and economic realities of their
economic relationship, it is clear that neither Russia nor the EU
will be able to escape from their mutual interdependence for
quite some time to come, despite the tensions that will continue to characterize this relationship.
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Part 3
By Ka-ho Yu
TRENDS IN RUSSIAN-ASIAN
ENERGY RELATIONS
Seeking cooperation with emerging Asian
economies in the energy sector could be a
way out for Russia to counter the impact of
Western sanctions
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With the Sino-Russian gas deal as a start, Russia’s
Asian energy strategy will have profound implications
for both energy security and geopolitics
T
will bring a mix of uncertainties to Russia’s oil and gas industry while in the long-term, financial and technical deficiencies
could drag down Russian crude oil production, putting Russia
into the strange predicament of “having no oil to sell.” Seeking cooperation with emerging Asian economies in the energy
sector could be a way out for Russia to counter the impact of
Western sanctions.
Meanwhile, European countries with strong geopolitical fears
related to deep dependence on Russian gas will push for additional LNG import terminals and pipeline connections and will
intensify their search for alternative energy supplies. Oxford
Institute for Energy Studies (OIES) estimates that Europe will
need at least around 100 billion cubic meters per year (bcm/y)
of Russian gas up to the year 2030, which is approximately 60
percent of 2013 imports.4 As a result, Russia urgently needs to
forge closer ties with the Asian market to avoid excessive dependence on the European market.
In Asia, China, South Korea, Japan and other emerging
economies continue to retain positive demand growth momentum for oil and natural gas. Quadrupling the use of gas
he U.S. and EU sanctions against Russia and the major increase in energy demand expected in Asia will define the
future pattern of Eurasian oil and gas trade. According to
the “Energy Strategy of Russia until 2035”1 announced in 2014,
Russia has put forward a target of future oil and gas development and reinforced the position of oil and gas exports in its
national economy.
Yet, the U.S. and EU sanctions are likely to force Russia’s
hand. At loggerheads with the West, Russia will switch its focus to the Asian energy market, and oil and gas trade is central to this strategy. Russia is expected to accelerate its oil and
gas cooperation with energy-hungry Asia where China, India,
Japan, South Korea and other Asian countries have been looking for adequate and reliable energy supply to satisfy their economic growth needs. With the Sino-Russian gas deal as a start,
Russia’s Asian energy strategy will have profound implications
for both energy security and geopolitics.
The U.S. and EU sanctions towards Russia are gradually taking
effect and have limited the channels by which Russia can obtain
capital and new technology for its oil and gas enterprises. They
have also increased financing restrictions in the capital markets
for Russia’s largest energy giants, like Rosneft, Transneft and
Gazprom. Finally, technology sanctions prohibit the transfer of
Western technology to Russia’s oil and gas industry, especially
the drilling, well testing and logging services used to explore
deep sea, Arctic Circle and shale gas.
Energy analyst Grigory Birg argues that the restrictions on access to capital and technology could lead to a decline in production”.2 Renaissance Capital compares sanctions on Russia
with the Iranian case and points out that sanctions related to
energy became the crucial factor that forced the Iranian government to change its policy.3 In the short-term, the sanctions
REUTERS
CHALLENGES AND OPPORTUNITIES FOR
RUSSIA IN ASIA
1. Energy Strategy of Russia until 2035. Ministry of Energy of the Russian Federation, January 23, 2014. http://minenergo.gov.
ru/documents/razrabotka/17481.html
2. Western sanctions to hit Russia’s vast oil industry. Agence France-Presse, September 12, 2014. http://www.afp.com/en/
node/2828200
3. Risk scenarios for Russia if sanctions widen to energy exports. Renaissance Capital, Economics Research, September 11, 2014.
https://research.rencap.com/eng/download.asp?id=17951
4. Reducing European Dependence on Russian Gas – distinguishing natural gas security from geopolitics. Oxford Institute for
Energy Studies, Paper 92, October 2014.bhttp://www.oxfordenergy.org/wpcms/wp-content/uploads/2014/10/NG-92.pdf
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NATALIA MIKHAYLENKO
is a necessary transitional step for China to reduce its reliance
on “dirty” coal before it can move towards to zero-emission
sources.5 The Fukushima nuclear power plant accident in Japan
exacerbates Japan’s demand for imported energy. South Korea
has also maintained a high dependence on foreign energy.
However, oil and gas supplied by Russia to the Asia-Pacific region
is still at a low level currently. Russia exported 16 percent of its total
oil exports to Asia in 2013 and is exporting 10 million tons of gas
per year to Asia via only the Sakhalin-2 LNG plant.6 The “Energy
Strategy of Russia until 2035” proposes to increase the share of
the Asia-Pacific region in the Russian total energy exports to at
least 28 percent; oil and petrochemical products to 23 percent and
crude oil and natural gas to 32 percent and 31 percent, respectively,
by 2035.7 Asian countries, especially China, South Korea and Japan, are expected to grasp the opportunity created by Russia’s
eastward pivot.
CHINESE-RUSSIAN ENERGY COOPERATION
IS THE CENTERPIECE OF RUSSIA’S ASIAN
ENERGY STRATEGY
The Sino-Russia gas deal signed in May 2014 was partly the con-
SOURCE: GAZPROM
sequence of the Ukraine crisis, which pressured Russia to look for
new export markets in Asia. The gas deal has laid out a crucial
foundation for Russia’s Asian energy strategy. It represents a major
breakthrough but is only the first step to facilitate broader cooperation between China, Japan and South Korea. Dr. Paik Keun-Wook,
a senior researcher from OIES, points out that China is a crucial key
player in the big picture of Russia’s Asian energy strategy but it is
also a tough negotiator, particularly in the Sino-Russian gas deal.8
The Chinese stance towards Russia reflects the difficulty of penetrating the Asian market.
China now needs to find a way to free itself from coal’s chokehold, with gas a cleaner alternative. Due to the need for both energy security and environmental protection, China’s appetite for
imported gas is growing. According to Prof. Pang Changwei from
China Petroleum University, the Chinese government is ambitiously
developing unconventional energy and renewable energy. The
entrance of Russian gas into the Chinese market is conducive for
China to improve the structure of its primary energy consumption.
The Chinese government’s intensified efforts in anti-smog moves
by adjusting the energy industrial structure and energy consumption structure will increase China’s gas demand.9 Prof. Xia Yishan,
the leading energy expert at the China Institute of International
5. Energy Development Strategy Action Plan (2014-2020). The State Council of the People’s Republic of China, November 19,
2014. http://www.gov.cn/zhengce/content/2014-11/19/content_9222.htm
6. Draft Strategy Sees Russia’s Oil and Gas Flow to Asia Doubling. The Moscow Times, January 27, 2014. http://www.themoscowtimes.com/business/article/draft-strategy-sees-russias-oil-and-gas-flow-to-asia-doubling/493331.html
7. Energy Strategy of Russia until 2035. Ministry of Energy of the Russian Federation, January 23, 2014. http://minenergo.gov.
ru/documents/razrabotka/17481.html
8. Author’s interview with Dr. Keun-Wook Paik, Senior Researcher from the Oxford Institute for Energy Studies (OIES).
9. Author’s interview with Prof. Changwei Pang, Director of the Institute for International Oil Politics at China Petroleum University.
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Studies (CIIS), points out that the initial 38 bcm/y pipeline gas via
the eastern route is not enough to supply China. China’s demand
for imported gas may account for more than two-thirds of Russia’s
total gas exports. So the prospect of Chinese-Russian gas cooperation could be very broad and, more importantly, decades of negotiation, joint projects and interactions have laid the foundation for
future cooperation.10
How to get China onboard is an important question for Russia.
The Ukraine crisis has boosted cooperation between the two, especially as reflected in the Sino-Russian gas deal. However, Chen
Weidong, chief analyst from China National Offshore Oil Corporation (CNOOC), hardly believes that Russia will be a reliable energy
supply country, based on observations from Europe’s bad experiences in importing Russian gas since 2006.
There is also friction in Sino-Russian energy cooperation. In 2009,
China and Russia started an oil pipeline project to alleviate the extreme capital plight of Russian oil companies during the financial
crisis. However, after this crude oil pipeline was put into operation
in 2011, the two countries had disputes over pipeline loss, which almost caused transportation interruption.11 Criticizing Russia as an
“unreliable” partner, Chen argues that supply diversification is the
main purpose of importing Russian gas. However, Nobuo Tanaka,
former executive director of International Energy Agency (IEA),
points out that Russia moving eastward is an opportunity for Japan to meet its energy demand, particularly in the post-Fukushima
era.12
HOW RUSSIA CAN ENTER OTHER MARKETS
IN ASIA
Dr. Paik argues that Russia’s energy strategy in Asia has a much
broader picture beyond the initial 38 bcm/y pipeline gas to China. Russia needs to treat this window of opportunity seriously in
order to carve out a bigger market share from the Asian market
in the long-term.13 Asian oil and gas markets have the most potential for Russia because energy-hungry Asia has created great
opportunities for Russia energy exports. The gas deal with China
is a breakthrough, but the question for Russia is how to enter the
other markets in Asia.
Currently, Russia is exporting oil and gas to the Asia-Pacific
market via pipeline systems and tankers. Japan is the major
consumer of the LNG from Sakhalin terminal and has significantly (by almost 45 percent) increased its oil import from Russia in 2013. Meanwhile, Russia delivers gas via pipelines and
tankers to other Asia-Pacific destinations, for example 8 per-
REUTERS
RUSSIAN ENERGY SECTOR: BEYOND SANCTIONS | #7 | DECEMBER 2014/JANUARY 2015
cent of South Korea’s imported LNG comes from Russia. Moscow is promoting the pipeline projects to Pakistan and India
via the Himalayas or TAPI pipeline that is yet to be constructed.
These projects will enable Russia to deliver more gas to South
Asia. Besides, Moscow has further LNG plans along the coast of
the Pacific to increase LNG export from Siberia to Japan, South
Korea and other Asian countries but the question is whether
Russia’s LNG from Vladivostok can compete against the prices
of other potential suppliers from the U.S. and Canada, or even
East Africa. Moreover, Japan followed the lead of Europe and
America after the Ukraine crisis by adopting energy sanctions
against Russia. These sanctions restricted Japan from transferring to Russia energy technology of automated control systems and communications equipment in the oil industry. As
a result, Moscow has accelerated further energy cooperation
with China after the eastern route gas deal.
China and Russia have signed a second natural gas deal on
the western route, according to which Gazprom will supply
CNPC with 30 bcm/y from Western Siberia via the Altai Republic to China.14 Together with the eastern route, up to 68 bcm
of gas will be delivered to China annually. The eastern route
between Russia and China has also laid a favorable foundation
for extending another subsea gas pipeline from China’s Shandong province to South Korea, linking the three countries. If
the transnational pipeline network is completed, Japan will not
be far from joining the league for energy security particularly
10. Author’s interview with Prof. Yishan Xia, Former energy counselor of MFA and researcher of CIIS.
11. Author’s interview with Weidong Chen, Chief Analyst of CNOOC.
12. Russia may play important part in Japan’s energy. Natural Gas Europe, October 27, 2014. http://www.naturalgaseurope.com/
russia-japans-energy-iee
13. Author’s interview with Dr. Keun-Wook Paik, Senior Researcher from OIES.
14. Putin, Xi Jinping Sign Mega Gas Deal on Second Gas Supply Route. RT, November 9, 2014 . http://rt.com/business/203679china-russia-gas-deal/
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NATALIA MIKHAYLENKO
in the post-Fukushima era. Russia entering the Asian market
will have serious impacts on both regional and global energy
security.15
First, by materializing the Western route, Russia can become
a “swing supplier” being able to supply either Europe or Asia.
Second, by extending a gas pipeline to South Korea, China
could transform strategically from a gas-importing country
to a gas transit country. Third, extra gas supply options from
Russia could change the terms of LNG pricing in Asia where
consumers in the region like China, South Korea and Japan
are charged a high LNG premium. Reducing or eliminating the
Asia premium for LNG price could take years of time but it is
an aspiration shared among the Asian countries.
Russia is increasing its oil and gas exports to Asia, bringing vitality to Asian energy companies. It is not only oil and
gas supplies from Russia that are benefiting Asia. Moscow
is actively preparing measures to counteract the impact of
sanctions on its economy, such as seeking cooperation with
emerging economies. Moreover, it is possible for Russia to develop new drilling technology independently or jointly with
other Asian countries to break away from its dependence on
Western oil companies.
SOURCE: CHINA NATIONAL PETROLEUM CORPORATION
The most likely partner will be Honghua Group from China,
which is one of the world’s largest onshore drilling platform
constructors. Around 12 percent of its income stems from its
business in Russia, and its Russian partners include Eurasia
Drilling Co. and Eriell Group. According to Gordon Kwan, the
manager of Nomura’s oil and gas research department, the
drilling platform constructed by Honghua is of the same quality as that constructed by Western companies, while the cost
is 20 percent lower.16 Moreover, good delivery of Hunghua oil
is more convenient and efficient since it will be carried by railway rather than cargo ship.
The ship-building market is another area in which Russia
can partner with Asian companies that dominate the industry.
Russia’s largest ship-building company, United Shipbuilding
Corp., has been striving to enter the market but is sanctioned
by the West due to its cooperation with the Russian Navy. It
has to rely on foreign ship-building companies for technology transfer. Daewoo Shipbuilding & Marine Engineering Co.
(DSME) from South Korea is likely to benefit from the sanctions on Russia. It is the leader in producing tankers that can
operate under extreme weather conditions in the Arctic. Russia needs 16 such tankers for its Yamal projects and Daewoo
15. Keun-Wook Paik. With China Deal, Russia Stands at Centre of Energy Geopolitics. Chatham House, May 23, 2014. http://
www.chathamhouse.org/expert/comment/14563. See also: Keun-Wook Paik. Sino-Russian Oil and Gas Cooperation: The Reality
and Implications. Oxford Institute for Energy Studies, Oxford: Oxford University Press, 2012.
16. Western sanctions on Russian oil and gas: The turn of the screw? Natural Gas Europe, August 28, 2014. http://www.naturalgaseurope.com/western-sanctions-impact-russian-oil-and-gas
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Shipbuilding and Marine Engineering (DSME) has already won
a slot reservation agreement.17
Russia has been striving hard to carve out a role in Asia’s energy market. In the short-term, Beijing and Moscow have the
potential to move their energy cooperation forward and in
the long-term, transnational oil and gas cooperation could be
achieved in Northeast Asian. However, if China and Russia do
not respect the market or the agreement, the contract is of no
significance and the specific cooperative details in the future
will change according to the changes of interests of both sides.
Only mutual benefit and fairness will ensure that a long-term
partnership is maintained. The Asian gas market has developed
in such a way as to see growing geopolitical and economic
competition and Russian policy makers and businessmen have
to treat the opportunity seriously. While oil and gas cooperation will be most beneficial for both sides, Chinese-Russian
energy cooperation is the key for Russia to acquire maximum
political and economic leverage in its eastward energy turn.
17. Putin Vetoing 12.87 trillion Won Yamal LNG carrier project with DSME. Business Korea, July 3, 2014. http://www.businesskorea.co.kr/article/5296/bulldozed-putin-putin-vetoing-1287-trillion-won-yamal-lng-carrier-project-dsme
TOP 10 RECOMMENDATIONS
By Natasha Udensiva,
Marat Terterov,
Ben McPherson,
Ka-ho Yu
Russian energy development is fast becoming a casualty of Russia’s growing political isolation. The good news is that, if Russia’s
political behavior changes, energy development could be back on track in terms of project financing and energy equipment supply.
Given the uncertainty of the current situation, Russia should take the following steps:
• Create market conditions for decentralizing the oil and gas industry and limit the dominance of the two state monopolies.
• Avoid spending money on new mega-projects with uncertain prospects.
• Concentrate on the further development of the numerous brown fields in Russia that are left partially undeveloped and then
create the regulatory framework and tax incentives for this brown field development.
• Create state-private partnerships that will support the initiatives of small oil and gas companies to enter the market of exploration and production.
• Liberalize the gas transportation system, as well as LNG and pipeline gas exports.
• Focus on supply stability, which has been a key problem that has concerned European consumers and made them wary of
Russian suppliers. Welcome the emergence of developed regional gas hubs, which lead to supplier choice instead of political
outcomes.
• Continue the move to more flexible business agreements with conditions such as spot pricing, which are more likely to satisfy
customers while still generating profits. Establish new projects with EU requirements in mind, rather than sticking with the typical business structures that led to significant problems in Nord Stream and South Stream.
• Explore cooperative oil and gas links with Asian economies, especially with China, which is the key relationship for Russia to
acquire maximum political and economic leverage in its eastward energy turn. Pay attention to the difference in business culture
and key people-to-people contacts in Asian oil and gas sectors.
• Develop new drilling technology independently or jointly with other Asian countries to break away from dependence on Western oil companies. Encourage knowledge transfer with Asian countries and companies.
• View oil and gas cooperation with Asian countries within a broader geopolitical perspective instead of merely as a matter of
business. Do not underestimate the impact of the shale gas revolution.
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RECOMMENDED
BOOKS AND ARTICLES ON
RUSSIAN ENERGY
1. Dynamics of Energy Governance in Europe and Russia.
Caroline Kuzmenko, Andrei V. Bely, Andreas Goldthau and Michael
F. Keating (eds). Basingstoke: Palgrave Macmillan, 2012.
2. Keun-Wook Paik. Sino-Russian Oil and Gas Cooperation: The
Reality and Implications. Oxford: Oxford University Press, 2012.
3. Daniel Yergin. The Prize: The Epic Quest for Oil, Money and
Power. New York: Simon & Schuster, 1991.
4. James Henderson and Alastair Ferguson. International
Partnership in Russia: Conclusions from the Oil and Gas Industry.
Gloucester: Palgrave Macmillan, 2014.
5. Vagit Alekperov. Oil of Russia: Past, Present & Future.
Minneapolis, MN: East View Press, 2011.
6. Global and Russian Energy Outlook to 2040. The Energy
Research Institute of the Russian Academy of Sciences, Analytical Center for the Government of the Russian Federation, Moscow,
2014. http://www.eriras.ru/files/2014/forecast_2040_en.pdf.
7. Tatiana Romanova. Russian Energy in the EU Market: Bolstered
Institutions and Their Effects. Energy Policy, 2014. http://www.sciencedirect.com/science/article/pii/S0301421514004479.
8. Stanislav Pritchin. The Course of South Stream. Russian
International Affairs Council, December 15, 2014. http://russiancouncil.ru/en/inner/?id_4=4964.
9. Russian Energy in a Changing World: What Is the Outlook
for the Hydrocarbons Superpower? Jakub M. Godzimirski (ed).
Farnham: Ashgate, 2014.
10. Marin Katusa. The Colder War: How the Energy Trade
Slipped from America’s Grasp. New Jersey: Wiley, Vermont: Casey
Research, 2014.
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TOP 10
TWITTER ACCOUNTS FOR
#RUSSIANENERGY
@MinEnergoGov
News and updates from the Ministry of Energy of the Russian
Federation. (Tweets in Russian)
@Rigzone
Rigzone offers industry news and information, company directories
and offshore rig data.
@EIAgov
The U.S. Energy Information Administration (EIA) provides statistics
and analysis on energy markets.
@GazpromNewsEN
Official Twitter account of Russian energy company Gazprom.
@PlattsOil
Oil markets coverage from Platts, a provider of energy and metals
information and a source of benchmark price assessments in the
physical energy markets.
@FTenergy
The latest energy news from the Financial Times.
@EnergyUpdate
Energy updates offers daily information on energy statistics and oil
and gas price dynamics.
@ROGTECMagazine
ROGTEC Magazine provides news and insights on Russian oil and gas
technologies.
@energyreview
European Energy Review provides reports, interviews and analysis
by energy professionals across the region.
@OGJOnline
The latest international oil and gas news and important statistics on
international markets and activity from the Oil & Gas Journal.
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PROJECT TEAM
Ekaterina Zabrovskaya
Editor-in-Chief
Dominic Basulto
Executive Editor, U.S.
Pavel Koshkin
Executive Editor
Ksenia Zubacheva
Managing Editor
Alexey Khlebnikov
Senior Editor
Natasha Udensiva
Author
Marat Terterov
Author
Eugene Abov
Chairman, Russia Direct, Deputy Director General, Rossiyskaya Gazeta Publishing House, Publisher, Russia Beyond The
Headlines
Andrey Zaitsev
Head of Illustration Department
Julia Golikova
Director for Development, Russia Direct,
Deputy Publisher, Commercial and Foreign Partnership Director, Russia Beyond
The Headlines
Natalia Mikhaylenko
Designer
Andrey Shimarskiy
Art Director
Ilya Ovcharenko
Layout Designer
Olga Ivanova
Publisher, Business and Product
Development Director
Ksenia Smertina
Associate Publisher, Sales, Marketing,
Events
Ben McPherson
Author
Maria Shashaeva
Deputy Publisher, Circulation,
Digital Strategy and Operations
Ka-ho Yu
Author
Antonina Osipova
Marketing Director
Ekaterina Olkhova
Consumer Marketing and Promotion
Director
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