Top events of 2019

The National Energy Security Fund introduces top-ten events in the oil and gas industry in 2019 and is ready to comment on them in detail.

1. Druzhba oil pipeline incident as test for state administration system

   This exceptional case did not finish even at the end of 2019, although it began in late April 2019. The investigation started more than half a year ago, but no distinct answers have been given to the questions: what happened, whose fault is it and what lessons have been learnt? The Druzhba incident is not just about the delivery of dichloroethane contaminated crude to refineries in Europe and not that it fueled discussions about reliability of Russia as a supplier (in fact, this issue was not debated in the context of oil). The main thing is that the incident led to a real war between two Russian companies – Rosneft and Transneft. Conflicts between them had occurred before, but the Druzhba case made us observe full-fledged battles of two state companies vehemently accusing each other of disruption of operation of the Russian oil exports sector. This case became a test for a new system of state administration of the sector formed in spring 2018. Deputy PM Dmitry Kozak acted as an arbiter in the dispute of the two state companies. It is the role that Vladimir Putin expected him to perform. The public arbiter’s job is to go into details of an argument. However, the two state companies suggested their own and absolutely opposite versions of this story. Besides, these versions ruled out a possibility of reaching a compromise. The companies put forward not only their value judgement, but also ideas on reforms in the system of oil quality control in the pipeline system. It took a long time to prepare a special meeting devoted to this conflict, but it did not result in any practical decision. It means there is no arbitration at all – this system of public arbitration backed down, when two real giants came up with their arguments. Nobody dared to take responsibility for choosing between points of view of Igor Sechin and Nikolay Tokarev, who are too serious and significant figures. It means that companies in Russia are much more influential than ministries and agencies, though it was a good opportunity for regulators to demonstrate their authority.

2. Russia-Ukraine gas transit talks

   The future of Russian gas transit via Ukraine and rulings of the Stockholm arbitration court were discussed throughout the year 2019. Luckily, the New Year “show” was avoided. It was indeed a good luck. The main result of the agreement is that there is no gas war. A popular question is, why did not Russia take extreme measures? And the answer is, because gas war would have affected mainly the reputation of Gazprom. Preventing this war was the main objective. Reputation is a key asset, and Gazprom has started to realize that. Reputation is a very significant factor on the energy market these days. Therefore, the 2009 gas war cost us dearly. The reputation of a reliable supplier that does not meddle with politics but puts the interest of consumers first is a very important asset. Gazprom has one year to complete construction of bypassing capacities. It is quite a sufficient period. Ukraine is also rewarded: transit quantities in 2021 and the following three years will be 40 bcm per year. It is the main positive outcome for Ukraine, as it means that Russia will underutilize new bypassing facilities. Some 65 bcm must be pumped in 2020 via Ukraine, as in this period the Russian side obviously does not count on the Nord Stream 2 and part of the TurkStream (over protracted construction in Bulgaria). The situation concerning the Stockholm arbitration court should not be perceived as Russia’s defeat, because payments under the court’s ruling could not be avoided – the arbitration procedure was stipulated in the contract that we must observe. We have to pay anyway – the payment may have been delayed by a year, but not paying was not an option. On the positive side, Gazprom avoided other penalties, including for violating the pump-or-pay provision in 2018 and 2019 that Ukraine could have demanded citing the precedent. Tariff rates have remained on the 2019 level, which also can be credited for Gazprom. The contract duration is a kind of arithmetical compromise: Ukraine wanted 10 years, and we wanted one year. The outcome is five years.

3. Construction of alternative gas pipelines – TurkStream, Nord Stream 2

   The TurkStream was laid and then launched on 8 January 2020; supplies began as of the beginning of the year. World records in the length of pipes laid daily and monthly were set during its construction. The progress of the Nord Stream 2 was different. At the end of the year Allseas refused to continue its construction over US sanctions; therefore, the question on the agenda was whether Gazprom would manage to finish the offshore pipeline independently. It is the main intrigue for Gazprom in 2020. The state company possesses technical capacities to complete construction. Completing the Nord Stream 2 construction despite sanctions is also the question of reputation, pride and prestige. Moreover, it is not the first time for Russian gas pipelines to be under sanctions (in December 1981, President R. Reagan imposed much heavier sanctions, but the Urengoy-Pomary-Uzhgorod pipeline was built, it still functions and will keep functioning at least in the next five years in accordance with Russia-Ukraine gas agreements).

4. Power of Siberia launch

   It is the first time Russian piped gas reaches China – the fastest growing gas market in the world. The gas is delivered to the region where gas consumption is insignificant and where alternative gas is very expensive. In this regard, it is indeed a very successful project. Whatever the amount of money invested in the Power of Siberia is mentioned, even amid relatively low oil prices at present, cumulative profits of Gazprom from this contract will stand at some $250bn.

5. Belarus

   This story was developing throughout the whole year with its ups and downs, and it continues in 2020 without any clear ending. There are two components in it – oil and gas. Belarus is a victim of the tax maneuver in Russia. Everybody knows that the idea was in substituting export duties with higher NDPI taxes charged on production. Russian refineries were awarded a compensatory mechanism in the form of a negative excise. Belarusian refineries did not get it and obviously began demanding similar conditions. Some questions were settled at the end of the year, although Minsk insisted on discounted oil prices. It even led to suspension of consumption of Russian oil. The question of gas supplies is still outstanding. The sides have reached an agreement to be valid for two months. Minsk wants gas prices to be equal to prices in the Smolensk Region, not $127 as in the 2019 contract and as they are in January and February 2020. The question is, why should we supply energy resources at dumping prices to Belarus? What do we get in return? Do we get political support? – If there is any, why does the Chief of the Belarusian General Staff declare about readiness to have joint exercises with NATO? Why does President Lukashenko say that NATO will protect Belarus, if Moscow presses Minsk, and that the sovereignty of Belarus is protected by the Alliance? Do such statements demonstrate allied relations? Therefore, in our opinion, the Belarus case is a bright example that the strategy aimed at buying friends does not work. It is necessary to find out, firstly, why it does not work. And secondly, what can substitute this policy.

6. Tax policy

   A new mechanism – the excess profit tax (EPT) – was launched on 1 January 2019. There were many fiscal novelties in 2019: correction of a dampening component, introduction of the negative excise on kerosene and etc., but the EPT case was the main one. This tax was expected to be a prototype of a new tax system and transition from taxation of revenues to taxation of profits. Giving rapid development of digitalization in the sector, the idea of taxing profits is quite feasible. However, the main argument of the Ministry of Finance against the EPT is that parameters of every deposit and, possibly, of every well are unique, and it is difficult to calculate economic parameters of every well. However, with the Âig Data processing system you can easily do that. Meanwhile, Russian fiscal authorities have digitalized in fact all taxpayers; cash registers are everywhere; they submit information to processing centers online enabling tax authorities to monitor money transfers and tax collection. Thus, if all cash registers in the country are registered with the Âig Data system, it is possible to do the same to oil wells and their economic parameters, given that cash registers outnumber oil wells by thousands of times. This is why saying that oil producers will cheat is not convincing, as it raises doubts about the Ministry of Finance’s competence. If tax authorities subordinate to the ministry have succeeded, why not studying their experience more thoroughly? At the end of the year the Ministry of Finance showed that it perceives the EPT not as a prototype of a new tax system, but as a problem that should be solved as soon as possible. At the end of 2019 the Ministry of Finance launched a fierce offensive on the EPT having declared that the state budget had lost 140bn rubles. It is actually not clear where such estimations come from. Representatives of the ministry claims that oil producers have cheated them to receive compensations. The icing on the cake was Minister Anton Siluanov claiming that his ministry did not observe growth in investments in these projects. The question about the sector’s place in the Russian economy remains open. If you believe that the oil industry will not be needed in the near future, then it is obviously possible to suppress it by taxes and to finish it off. If you think that the oil industry creates a financial cushion and remains not only the major donor of the state budget but also the main source of economic growth in the country, since you are unable to create anything else, then, probably, you should think how to maintain investment activities inter alia through tax incentives.

7. Paris Agreement, new energy agenda

   Russia joined the Paris Agreement in 2019. Although it was done diffidently without ratification by the parliament, it anyway happened and led to active discussions about the energy transition and a new energy sector in Russia. It was obviously influenced by the world context, Greta and etc. This topic became quite dominant, and in 2020 it may reach the top place of this rating of the most important events. Another question is about the near future of hydrocarbons and the way that Russia should choose to follow. There are quite active lobbyists of the new energy policy in Russia; they suggest that the state should change priorities. What does “to change priorities” mean? It is absolutely evident that the Paris Agreement is a form of nonmarket attempts to discredit hydrocarbons that have been declared the main threat to the planet. Are we ready to play this game to discredit our main export commodity? By the way, the difference between policies of American and European companies is very distinct in this case. All European oil and gas companies apologize for producing oil and natural gas and promise to be green and good. Some firms even change their names. American companies say they produce energy for the world, and they have nothing to apologize for. The difference between European politicians and Donald Trump is also evident and bright. The USA withdrew from the Paris Agreement. Brazil did it too. Are we ready to participate in defamation of our main exports just because others do that? In this regard, it is possible to refer to the financing of green energy. Producers of the latter make contracts on supplies of capacities, their investments are returned with a 12% profit, the markup is added to tariffs, and prices of electrical energy grow. According to some estimation, electricity prices even for industrial consumers are higher than in some European states. It is considered as the main direction that the country should follow. And then we wonder why the pace of our economic growth is retreating to zero.

8. Piped gas vs. LNG

   At the beginning of 2019, Russian liquefied natural gas reached Europe. Active supplies of LNG continued throughout Q1 2019, and it became clear that, despite all promises and assurances, Russian LNG was competing with Russian piped gas. The discussion that followed was about the question, why do we need it? NOVATEK’s position supported by the Ministry of Energy is that these supplies to Europe are supplementary. However, the statistics shows that they are not supplementary – it is in fact gas cannibalism. And again, there is the same reasoning that we should do what others do – since everybody produces LNG, we also should do that. Meanwhile, what is more profitable for the state – to export LNG or piped gas to Europe? In this regard it is necessary to mention that LNG is released from a 30% export duty, and that projects of NOVATEK enjoy an extremely preferential tax regime, i.e. they practically do not pay taxes; besides, the government invests in the infrastructure of such projects. The whole project is actually sponsored by the state. It concerns the port of Sabetta and development of the icebreaker fleet. Different forms of state participation are found in new projects of NOVATEK. Although these projects are not mentioned in the 2020 state budget, they have a possibility to employ a tax maneuver, i.e. taxes that one of the projects of NOVATEK should pay, may be spent on development of the infrastructure of other projects. Thus, this money, instead of being transferred to the state budget, can be spent on what the company needs. And the Ministry of Finance does not mind it. We should repeat once again: it is indeed the question of strategy. Russian LNG eats away the share of Russian piped gas in Europe. From the point of view of the state budget, such supplies are certainly rather loss-making.

9. The Arctic

   Everybody says we need the Arctic, and Russia will increase with it. The question is just about economic parameters of this process. What should Russia get from that? It looks like some Arctic Keynesianism. They say we will have many new jobs, demand for our commodities and technologies, and that the Northern Sea Route will equate the Suez Canal in importance. However, these are far-fetched plans that have little to do with the reality. Some companies find plans of NOVATEK quite attractive. For instance, Rosneft has put forward the idea of Vostok Oil that stipulates oil production in the Arctic. The latter case is not about zero taxes – the idea is much more interesting: to take taxes paid by operating projects and use them on development of Vostok Oil. In fact, it is subsidizing through a tax maneuver. NOVATEK actually enjoys the same tax maneuver, and now it is Rosneft’s turn to demand it. So, what is the Arctic for us? Is it a national project that should consume the state money to create the demand in a Keynesian way? But why is it done in the Arctic? Infrastructure projects can be implemented in Siberia or in the central part of Russia – it would be more useful than burying money in snow.

10. Reshuffle at Gazprom

    It was the first such large-scale reshuffle at Gazprom in years – two deputies of the Gazprom head left, and serious turmoil began at the company. For many years Aleksey Miller is expected to resign; therefore, such changes in the company were naturally perceived by opponents as the beginning of the end. Nevertheless, Miller actually strengthened his influence in the company having removed several top managers who had joined Gazprom together with him but had not been part of his team. He prevented appointment of outsiders to top positions. In this regard, the company has become more consolidated. On the other side, Miller certainly had to make sacrifices. Objectives of the Gazprom head for 2020 are clear: first of all, the Nord Stream 2 and completing construction of gas chemical capacities next to the Russia-China border to make the project of supplies to China more substantial.