Published on 19 May 2016 by James Henderson
Gas prices have fallen dramatically across the world over the past six to twelve months, driven lower both by the 60% fall in the oil price and also by a growing imbalance between gas supply and demand. A number of major new projects in Australia and the US have started to come online at a time when gas demand in Europe remains relatively stagnant while the growth in consumption in Asia has been less than expected, especially in China.
The result has been not only a fall in LNG spot prices to below $5/mmbtu, but also a removal of the “Asian premium” which had been a feature of the global gas market in the aftermath of the Fukushima nuclear disaster in 2011.
Prices in Asia and Europe are now at almost equivalent levels, suggesting that the marginal gas supply in the global market is indifferent to the transport cost between the two markets and that any new projects aimed at Asia can no longer expect a preferential price.
Within this context, it would seem that the outlook for Russian LNG projects aimed at eastern markets is relatively poor. Indeed, Gazprom has officially postponed its plans for Vladivostok LNG while Rosneft has also pushed back the original timetable for its Far East LNG project. These decisions reflect the outlook for LNG globally, where expectations for any new FIDs being taken in the period up to 2020 are very limited. Indeed, there are concerns that some of the projects currently under construction, or which have recently come online, may fail to make adequate returns for their investors and that gas could even be left in the ground if prices do not improve.
This rather bleak scenario would not suggest a positive outlook for any new LNG projects on Sakhalin Island. However, prospects beyond 2020 are likely to improve, especially for those projects that can keep costs down and can provide competitively priced gas. At some point, the slump in investment in new LNG projects will cause the market to tighten (most likely in the early 2020s) and at this point projects that are ready to produce will be able to take advantage of an improving market situation. In particular, brownfield projects can take advantage of cost synergies and existing customer relations to position themselves for a cyclical rebound in the LNG market.
This outlook clearly points to a role for Train 3 at the Sakhalin 2 project, especially if it can optimise its gas supply. It has been clear for some time that the expansion of Sakhalin 2 is Russia’s most economic new LNG project, given the fact that the area for a new train has already been cleared and many of the necessary facilities are in place. The key question has always been the source of additional gas that will be required, with the Yuzhno-Kirinskoye field on the Sakhalin 3 licence being the obvious source of Gazprom equity gas, while the concept of putting the surplus gas at the Sakhalin 1 fields through a new train at Sakhalin 2 has been another possibility. Both have had their problems, though, and if the Sakhalin region and Russia as a whole are to benefit from a new LNG project then these must be resolved in the most commercially logical fashion, because any new scheme must be able to offer low-cost gas into an increasingly competitive global energy market.
Yuzhno-Kirinskoye Field, Photo courtesy of Gazprom
Yuzhno-Kirinskoye offers significant gas reserves, but is a relatively complex field to develop and includes oil as well as gas. Gazprom appeared to have finally acknowledged the benefits of bringing in a foreign partner to help with the development when it reached a co-operation deal with Shell in 2015 that included partnership at Sakhalin 3, but the subsequent imposition of US sanctions on the field then appeared to undermine plans. It is still possible, of course, that ways around the sanctions may be found (specifically by not using US technology), and Gazprom continues to pursue this route, but realistically the option of using Sakhalin 1 gas now appears ever more logical. To date differences over the gas price that Gazprom has been prepared to offer have been the key stumbling block, but this disagreement has masked what seems to be a broader competition between Rosneft and Gazprom for dominance of the Russian energy sector. Indeed, Rosneft’s decision to announce its own LNG scheme, Far East LNG, and to demand the right to export gas via LNG (which was granted in December 2013) was a clear challenge to Gazprom’s export monopoly and its dominant position in the gas sector. Competition between the two companies has developed in the domestic market too, and Rosneft has even lobbied for access to Gazprom’s export pipelines, threatening competition in its premium market in Europe. As a result, it is perhaps no surprise that the two have failed to reach agreement on a mutually beneficial outcome on Sakhalin.
Can an agreement be reached between Gazprom and Rosneft?
However, if Russia’s position in the global gas market is to be optimised, these domestic political issues may need to be put aside. Although Novatek’s Yamal LNG project is set to come online from 2017, it is difficult to see how another stand-alone, and therefore expensive, Russian project such as Far East LNG can proceed without the significant state support that Yamal has received and which is now much less likely in a low commodity price environment. Instead, optimal use of existing upstream facilities at Sakhalin 1 combined with the synergy benefits of a third train at Sakhalin 2 would provide the Russian gas industry with a very competitive new project that could come online at a time (2021 on current estimates) when the global gas market is ready for new LNG output at a reasonable price. This could then be a platform for further expansion using the reserves at Yuzhno-Kirinskoye, or could free up gas for pipeline exports to Asia (via a sour from the existing Sakhalin-Vladivostok route) over the decade of the 2020s. In either case, the setting aside of corporate differences to provide an optimal outcome for Russia could be a platform for the country, and its major energy companies, to underpin the planned pivot to Asia using Sakhalin as a key base for expansion.