Report on Industry Barometer Live Polling Results at Sakhalin Oil & Gas 2015
Published on 21 October 2015 by Michael Bradshaw
This short report compares some of the results from previous live polling in 2014 and 2013 with this year’s ‘Industry Barometer.’ A few issues need to be taken into account when considering the results.
First, obviously, the people attending the conference have changed year-on-year, so we are not asking the same people if their opinions have changed.
Second, the nature and size of the audience varies significantly through the conference and this undoubtedly introduces bias. For example, there are times when the balance between Russian and non-Russian participants changes and also when the balance between those who live and work locally and those who are visiting from elsewhere in Russia changes.
Third, there are some questions that we asked for the first time last year and some that we asked for the first time this year; we also experienced some technical issues at the venue, meaning that some questions were not recorded by the system.
And finally, when we first asked the questions in 2013, the year 2020 seemed like a long time ahead. Now it is less than five years and there is more certainty on some issues; that said, since 2013 we have had the imposition of western sanctions, the fall in the oil price and the fall in the value of the Rouble.
Despite the issues discussed above, the insights provided by the electronic polling are very interesting and we know from the feedback forms that participants at the conference value this addition to the conference programme. Below I have presented the various graphs comparing responses and have provided a brief commentary on what we might conclude from them.
What will the price of oil be in 2020?
It is not surprising that views on the oil price have changed significantly since the first poll in 2013. Back then the price was high and people were optimistic on $100 plus being the ‘new normal.’ High prices were good for encouraging new investment and also for the finances of the Russian Government. However, they were bad for the oil and gas importing countries, particularly Japan, that was having to import additional LNG at very high prices in the aftermath of Fukushima. Now, however, the situation has reversed and the high cost of new projects is prompting caution.
Denis Khramov, the First Deputy Minister of Natural Resources and Ecology told us at the conference, that new shelf projects would need an oil price between $60 and $80, to be economic. This seems too low given the high cost of operations in the Arctic offshore, for example; though the current value of the Rouble certainly helps foreign investors.
At the conference there was also discussion about how long the low oil prices would last and some felt that there was unlikely to be a quick rebound. As a result, new greenfield projects in remote regions will be less attractive as it will impact the level of funds available to oil and gas companies, both Russian and foreign, to invest in new projects. In addition, western sanctions have targeted deepwater and Arctic offshore, as well unconventional oil, and have also reduced access to international capital markets.
What proportion of Russia's oil and gas exports earnings will come from the Asia-Pacific region in 2020?
At the conference there was much talk of Russia’s ‘Asian Pivot’, as it seeks to develop new energy trading relations with the countries of the Asia-Pacific region (APR). In part, this is to compensate for problems with Russia’s declining trade with Europe and its post-Soviet neighbours, particularly Ukraine.
Russia’s energy strategy to 2035 foresees a significant growth in the relative of energy trade with the APR, 23% of oil and oil products and 31.5% of gas exports will go to the APR by 2035. The results of the live polling suggest a good deal of uncertainty, as well as the recognition that it is not going to be easy and that significant expansion will be required in the 2020s.
Who should be given the rights to develop Russia's offshore oil and gas reserves?
The response to this question is interesting, but it may be that there was a bias towards people from foreign companies when the question was asked. There seems to be a shift in opinion away from the current situation, which is that only Rosneft and Gazprom can be the Russian partners involved in the Arctic offshore (although this option was never particularly popular). Instead, the participants clearly favoured opening up to foreign companies, and there is some support for other Russian countries, such as Lukoil. The results suggest that participants understand the centrality of involving foreign companies in frontier exploration and development.
Do you think that development of Russia’s 'Eastern Energy Vector' is likely to provide a significant financial return to the Russian state?
Unfortunately, for technical reasons, this vote was not recorded by the system. As far as I can remember, people remain optimistic that increased energy exports to Asia will be profitable for the Russian state. However, developing new fields and infrastructure is very expensive and tax incentives are being provided that will reduce the share of the income coming to the state.
At the same time, the global oil price and the price of gas in the key markets of China and Japan will also determine the profitability of Russia’s energy exports.
Which project is likely to be the first to deliver new Russian LNG directly to Asian customers?
Throughout the conference, we heard from Japanese speakers that the cost-competiveness of LNG exports will be critical, especially as the total volume of imports is likely to fall over the coming years as nuclear power makes a modest return. It is also the case that there are new sources of supply coming onto the market, and we heard that Tokyo Gas, for example, has contracted new supplies from Australia and the US. Thus, it is important for any new LNG projects on Sakhalin and elsewhere in Russia, to maintain competitiveness.
We heard from Olivier Lazare, Country Chair Russia for Shell, that the cost of expanding an existing LNG plant is significantly lower than building a greenfield project. Thus, it is surprising that Sakhalin-2 expansion appears to have lost ground this year to the Rosneft-Exxon Mobil Far Eastern LNG (FELNG) project. We heard very little of plans for the FELNG project, save for the fact that two sites are being considered, one on the southwest coast of Sakhalin and a second at their oil export terminal at DeKastri.
It is also clear that the Vladivostok LNG plant is no longer considered a realistic prospect; this reflects Gazprom’s focus on delivering the Power of Siberia project and agreeing a second pipeline deal with China.
Which project is likely to be the first to deliver new Russian LNG directly to Asian customers?
This related question does suggest that the expansion of Sakhalin is the front-runner in terms of first new Russian LNG to market, followed by FELNG and Yamal. However, we heard at the conference that first deliveries from the third train at Prigorodnoye are likely to be in 2021 and the Yamal LNG project expects to start deliveries in 2017. As no firm commitment has been made to FELNG that is also a prospect for the early 2020s.
What do you think has been the most important factor shaping the pace of development of Sakhalin's offshore potential?
There seems to be a degree of volatility in the answers to this question over the course of three years. At the moment it would seem that conditions in the RFE are the most important factor and that the actions and policies of the Federal Government are of diminishing significance. The latter does not seem to chime with Moscow’s renewed enthusiasm to promote the RFE, as reflected in the recent Far Eastern Economic Forum in Vladivostok.
It is also a little strange that conditions in the global market are seen as being less significant this year. As an export-oriented region, the fortunes of the RFE are tied to the economic prospects of the APR.
What factor do you think has been most important to the successful development of the first generation of Sakhalin projects?
There was a clear winner, as it is clear that the fact that the first generation Sakhalin projects have been developed within a PSA structure has provided essential fiscal stability (more on the PSA next). The falling significance of the technological ability of foreign operators seems strange as the sanctions (more on them below) have demonstrated just how significant foreign technology and know-how are to offshore development.
Would you like to see PSA’s introduced to encourage foreign investment in offshore oil and gas production?
We didn’t ask this question this year, and clearly we should have done. The PSA has always been a controversial topic in Russia, dominating discussions at the conference in 1990s. However, there does seem to be support for a return of the PSA to Russia to support Arctic Offshore developments. Such capital intensive and long-term projects will need some form of investment vehicle to reduce the risk to the investors - both Russian and foreign.
In one sense the PSA is being extended on Sakhalin, as it is expected that third LNG train development will be included with the PSA of Sakhalin Energy’s Sakhalin-2 project. The development of South Kirinskoye as the feed for the LNG plant is part of a separate strategic alliance between Gazprom and Shell and will not be part of Sakhalin Energy.
Do you think that third parties should be given access to Gazprom’s Power of Siberia pipeline when it is built?
This is a question that we have asked the last two years and it is a hot topic. The conference participants clearly think that non-Gazprom gas producers in East Siberia and the Far East should be given access to the Power of Siberia pipeline, but we heard from more than one speaker from Gazprom that it was essential to maintain the company’s monopoly, and it was suggested that third party access would undermine the economics of the project.
However, to deliver the contract volume of 38bcm will require the development of the both the Chayanda and Kovytka fields, both of which are complex and expensive to develop.
A compromise might be to develop Chayanda and then for Gazprom to purchase gas from independent suppliers in the region to delay developing Kovytka. This might be a more cost effective approach in a low oil-price environment. It would not break Gazprom’s export monopoly, but it would marketise the stranded gas of the independent producers in the region.
Will there be an LNG glut in 2020?
Because it takes a long time to build a new LNG plant, at least 5-6 years, we have a clear idea of how much new liquefaction capacity will be coming on to the market between now and 2020 - only 5 years away. The answer is a lot! The only firm Russian element will be the first train of Yamal LNG.
What is less uncertain is how much demand will grow over the next 5 years and the answer is probably not as much as expected. The major consumers - Japan, South Korea and China - seem to have limited appetite to significantly expand imports in the current economic climate and many of the deals for new LNG were signed a few years back. In fact, buyers do not want to enter into new commitments at present. This suggests that more LNG will be sold on a short (spot) to medium-term basis.
One bright spot might be Europe, if the price is low enough (in other words, if it can compete against coal and pipeline gas imports) then LNG might return to the European market. There is significant import capacity in place with only 25% of it utilised at present. Another fact here is the geopolitical desire on the part of Europe to diversify away from Russia - but within the constraints of the take or pay limits of existing long-term contracts. Lots of new supply and stagnant demand reflects the view of the conference participants that it will be a buyers’ market for the foreseeable future; however, it is prospects for the market in the early 2020s that will ultimately influence investment decisions in relation to new LNG in Russia.
Do you think that the sanctions being imposed by the EU and the United States on imports of technology is impacting on the pace of offshore oil & gas development in Russia?
Not surprisingly, the topic of sanctions was ever present at the conference. Since last year, it has become increasingly apparent that the lack of access to western technology and finance has slowed the pace of exploration activity in Russia’s oil and gas industry. It has also promoted import-substituting activities, but these will take time to deliver and may even increase the cost of development (though it would be the Rouble cost).
The assertion that 80%-90% of the equipment used by Gazprom comes from Russian suppliers is all well and good, but if that missing 10%-20% is your subsea production system, then you cannot progress the project.
For Sakhalin the most problematic move has been the US Government’s decision to put the South Kirinskoye block on the sanctions list. Quite what this will mean is unclear, as Sakhalin Energy is interested in the field as the feed for the third LNG train, making it a gas project (the field does have oil and condensate reserves) and the sanctions are aimed at new oil exploration. However, there are alternative sources of significant gas production offshore Sakhalin and this may yet prompt cooperation between the two first generation Sakhalin projects (watch this space).
Other questions of significance
There were a few other questions asked that are worth commenting on in brief, some of which we asked for first time this year.
We asked the conference participants if they thought that domestic gas demand in the RFE could compensate for a shortfall in expected Asian export growth. A majority of 62% said No, 24% said Yes and 14% said Don’t Know.
At the conference Viktor Timoshilov, Deputy Head of the Project Management Department and Head of the Division for Coordination of Eastern Projects at Gazprom gave an excellent presentation on the prospects for the gas market in the Russian Far East. He explained the complexities of the situation and the limited prospects for gasification in the region. He also suggested that growing the local gas market was not really a job for Gazprom and that local independent producers were probably better suited to the task. The response to the polling suggests that he got his message across.
We asked a question about the impact of the slowdown in the Chinese economy on the prospects for energy exports from Russia. It is clear that this is a significant issue and 65% of participants felt that it would slow progress and that there were now limited prospects for a second pipeline deal on Power of Siberia-2 (the Altai route).
When President Putin visited Beijing in September, an agreement was reached on considering pipeline gas exports to eastern China based on Sakhalin production. This is a realistic prospect for the 2020s, but much will depend on what happens to the Chinese gas market, both in terms of demand growth and domestic production (particularly shale gas). Thus, security of demand is fast emerging as a limiting factor in Russia’s ambitions to expand gas exports to Asia.
In that respect, we asked a question about the pricing formula for Russian pipeline gas exports to Asia and 54% thought that a new gas pricing formula was required. Gas price formation and contract structure is also a key source of uncertainty in Asia gas markets. Gazprom’s Deputy Chairman Alexander Medvedev made it clear that oil-indexation and long-term contracts provide the kind of stability that is essential to investors in new supplies and infrastructure; but speakers from gas-importing countries made it equally clear that price competitiveness and flexibility will be essential in securing new contracts in the future.
Next year, the Sakhalin Oil and Gas conference will convene for its 20th Anniversary meeting. This year was the 20th Anniversary of the Sakhalin-1 year PSA and in 2014 Sakhalin-2 also has its 20th Anniversary.
There is no doubting that the first generation Sakhalin projects are a significant achievement and the most important foreign investment successes in Russia. Next year will provide an opportune moment to learn from the lessons and achievements to lay the foundations for the expansion of Russian energy exports to the APR in the 2020s. I am sure that live polling will play a role in the conference and if you have any questions that you would like to have included next year, leave your suggestions in the comment section below.
Professor of Global Energy
Warwick Business School, UK.