Top events of October 2017

The National Energy Security Fund introduces top-ten events in the oil and gas industry in October 2017 and is ready to comment on them in detail.

1. Saudi king’s visit to Russia

   This event drew huge attention. Everybody believes that at present oil prices depend on relations between Moscow and Riyadh. However, all reports about Saudi investments in the Russian LNG sector and joint projects in the petrochemical sector are nothing more than information noise. In reality there is only one question on the agenda – what should be done to the OPEC+ deal. Both Russia and Saudi Arabia are interested in high oil prices. Both sides do not want to reduce oil production. So, who will take the main burden in this case? Last year the output reached its maximum, and then it began easing back from peaks. In 2018 production will have to be really cut; Russia, however, put into operation new projects in 2016 and 2017, and it is not clear how to deal with this situation. By the way, resistance to prolongation of the deal is becoming more and more evident in Russia. Igor Sechin plays the main role in this regard; the Rosneft head criticizes the deal more and more often; he says main problems of the oil market have not been solved, and it is a big question whether the employed strategy is correct. The Saudi king’s visit has not made the situation clearer. It is evident that Russia and Saudi Arabia will be trying to sell politics to each other. Both sides have arguments. The idea is understandable: to press a counteragent by implying a possibility of creation of political difficulties. The Saudis may refer to Muslim regions in Russia’s North Caucasus, while Russia has Iran and Qatar behind, the sharply changed situation in Syria, and Kurdistan. We will be watching who will win in the next six months.

2. New contracts between Rosneft and Chinese companies

   First of all it concerns CEFC that bought a 14.16% block of shares in Rosneft. The Russian company introduced the new structure of shareholders to the public when all key executives of new partners attended the Eurasian Economic Forum in Verona, Italy. Rosneft also declared that it had signed a new contract on oil supplies. China is clearly becoming Rosneft’s strategic partner, and it is no surprise. These days their partnership is developing very actively. It is not only about enlargement of oil supplies to the PRC. The main thing is that the Chinese side buys Russian assets and becomes a shareholder in the company and its projects. In this regard Sechin is like a gateway that the Chinese use to enter the Russian oil and gas sector, and to go beyond it. It was announced that CEFC and Rosneft would establish a joint investment fund. Thus, this tandem of Sechin and China is strategic. CEFC is a very interesting partner, because a businessman with a very obscure background runs it; it seems to be a project to transfer the money of party elites to independent businesses. It is remarkable that at the moment this person represents Chinese interests in Russia, although the list of Chinese partners of Sechin is obviously not limited to CEFC.

3. China says it is ready to buy Transneft shares

   It is a bright example of Sechin-China partnership being put into practice. The Chinese side declared it was ready to spend $300m on shares in Transneft. The latter sells only preferred stocks that are nonvoting. However, an idea has been voiced to convert preferred stocks into voting shares. This will be followed by privatization of Transneft. It is also possible that the question of Rosneft acquiring Transneft through privatization will be raised. This game will obviously continue.

4. LUKOIL, Surgutneftegas, Gazprom Neft ask government for tax preferences to watered deposits

   The request voiced by these companies was the reaction to Russia’s finance ministry’s unexpected decision to provide Rosneft with huge mineral production tax preferences on the Samotlor field. The companies say they also have watered deposits, they are not inferior to Rosneft, and it is actually not clear why Rosneft gets such large benefits and others don’t? And that’s a fair question. At first the finance ministry argued that all preferences should be eliminated, and a new taxation system should be introduced. There are no doubts that allocation of preferences is a wrong and faulty practice. Later, however, the ministry approved a huge preference of 35bn rubles to one company, and then tried to explain in a very awkward manner to other market players why they were not entitled for the same benefits. The criteria of preference allocation are not understandable. The ministry referred to Rosneft’s promises to raise production at the deposit, but other companies said they would also do that. Another reason was that Rosneft was a state company, although when Rosneft was buying Bashneft they claimed Rosneft was not a state company, because it formally belonged to Rosneftegaz that does not pay dividends to the state. Thus, explanations are very confusing. The Russian tax policy is too selective, nontransparent and unpredictable.

5. Idea of replacing network tariff with linear tariff at ESPO

   At present companies pay the same rate regardless of whether oil is delivered to the Russia-China border at Mohe or to the port of Kozmino. The transportation distance to the Chinese border is obviously much shorter than to the port of Kozmino. The reason for having the price of transportation to the port of Kozmino and to the Chinese border equal is that from Kozmino oil can be shipped to other countries, e.g. Japan and South Korea. The idea is to encourage companies to diversify supplies to reduce national risks of being dependent on one buyer. If linear tariffs are introduced, delivery costs to the port of Kozmino will sharply rise, and companies will not have incentives to ship oil there. As a result, our oil exports to Japan and South Korea may reduce in favor of supplies to China. The latter may demand reduction in prices, because costs of pumping oil to Mohe will become lower for Rosneft. Thus, it is again Rosneft and China that will benefit, while Transneft, Japan, South Korea and companies that deliver oil to the port of Kozmino will be neglected. Is there any geopolitical reason in it? The question remains open.

6. FAS says it is ready to identify monopolistic segments in Gazprom

   It is an old idea. The proposal is to indicate monopolistic and competitive segments in Gazprom and to try to restructure the gas giant into monopolistic and competitive segments. It is an old idea cherished in Europe - production is a competitive segment, while transportation is a monopolistic segment. Thus, competition is required in production, but monopoly in transportation may remain. The idea is to reduce Gazprom to the size of a transportation operator and let it remain a monopolist, but to organize competition in the production segment. Though, it is absolutely incomprehensible why the production segment would need competition. Firstly, competition is already there, as independent producers have been biting off their market share confidently without any restructuring of Gazprom. We can observe it in the context of Rosneft. Besides, what is the real objective of the competition? It looks like a reform for the sake of reforming. What is the reason? Is it aimed at reducing gas prices for final consumers? In reality no independent producer suggests reducing prices; these producers put themselves first, not interests of consumers.

7. Debates about possible takeover of LUKOIL

   Sechin said Rosneft did not want to take LUKOIL, while Alekperov specified that the only way to obtain LUKOIL was to buy it, but he doubted that. Besides, the LUKOIL head doubted that the government needed such developments. Since Sechin continues his aggressive policies, the natural question is who the next victim is. When Sechin says he does not want to take over LUKOIL, everybody starts thinking he obviously wants to, because it is the rules of the game. In reality taking over LUKOIL will not be easy. Firstly, LUKOIL does not want it. Secondly, it is a serious company that will defend fiercely. An attempt on Transneft has not succeeded yet, but Igor Sechin is not giving up. His policy is based on constant expansion and increase in pressure. On the other side, he has spread his aggressive policies onto too many companies, e.g. an attack on Gazprom, and an attack on LUKOIL; the number of the discontented will keep rising. As a result, in accordance with the laws of physics, at some point the resistance force may become equal to the pressure force.

8. Energy Week in Moscow, Gas Forum in St. Petersburg

   No big statements were actually made at these events. Though, it is important to point out that the major sector of the country’s economy does not have some flagship event so that everybody could understand that it is the main forum. In February there was an oil and gas forum that claimed the status of the main event, but suddenly it was rescheduled for October. Putin and some prominent figures indeed attended it, but there was some noticeable chaos in organizing procedures that was accompanied by technical faults and a half-empty hall where Putin delivered his speech. It is also important that Gazprom did not refuse to hold its Gas Forum in Saint Petersburg. Organizers obviously tried to find a way out and called the events an Oil and Gas Week held in two capital cities. Yet, it was evident that these events were separate. Therefore, the issue is still open whether the sector will have a dominant and key event.

9. Yamal LNG is said to expand

   The date of the project’s launch has not been reported yet. NOVATEK cannot indicate the date of official unveiling of the LNG plant, though speculations about the project being almost complete continue. There are debates that the project may be expanded. Simultaneously there is an aggressive campaign promoting Arctic LNG 2. Will the latter project get the same amount of state support as Yamal LNG has received? Will it have the same preferences? This project is not viable without investments in the infrastructure and the icebreaker fleet. The question is whether the government has resources to support all these projects?

10. EU Council approves new measures ensuring uninterrupted imports

    It is another set of well-known slogans: we need diversification, and we need new supplies. The reality is that the more often the European Union speaks about diversification, the larger Gazprom’s share on the European market becomes, and the larger the amount of supplies is. The year 2017 will set new records, as natural gas is relatively cheap in Europe, and its consumption has been steadily rising over the past three years. In this situation there are no alternative suppliers that can offer cheaper gas. The European Union certainly continues its rhetorical exercises, but the reality is different, fortunately for us.