Novatek advances in the Arctic
Having demonstrated the viability of tanker exports to the Pacific around Russia's Arctic coast, Novatek should reap the rewards at the Yamal LNG project, writes NJ Watson
IT WAS not Novatek's second-quarter financial results that pushed its shares to record highs in August, but the company's, and Russia's, first oil tanker to sail the frozen Arctic route to the Pacific Ocean.
On 17 August, Russia's largest independent gas producer sent a consignment of gas condensate from the port of Murmansk, in Russia's extreme northwest, to the Asia-Pacific region across the Arctic Ocean's Northern Sea Route (formerly known as the Northeast Passage). On 6 September, the consignment, for China National Offshore Oil Company, arrived at the Chinese port of Ningbo.
The 22-day journey was about "half the time required by the traditional shipping route through the Suez Canal", said Novatek. "The success of the first high-tonnage shipment, combined with the significantly reduced delivery time, demonstrates the possibility for future trade with China and other Asian-Pacific countries using the Northern Sea Route, as well as providing additional logistical options for developing hydrocarbon fields on the Yamal peninsula and Arctic shelf."
On 13 September, Novatek's Global Depositary Receipts hit an all-time high on the London Stock Exchange of $85.80, almost double their trading level a year ago.
The opening of international sea lanes along the northern Arctic coast, between the Barents Sea and the Pacific Ocean, excited investors because it will provide Russia with a direct route to Asia for three of its planned liquefied natural gas (LNG) projects. These projects are ambitious and expensive, and were not feasible given the mounting supply glut in the European gas market and the problematic and congested shipping lanes of the Indian Ocean and Suez Canal.
A new outlook
However, says consultancy Business Monitor International (BMI), the Northeast Passage route has changed the outlook. Novatek can reduce its normal journey to Asia of around 20,400 km around the Suez Canal to around 12,500 km, says BMI "allowing for a significant reduction in transit time, fuel costs and the risk of pirate attacks". Having demonstrated the route's viability, Novatek aims to send six to eight condensate cargoes along the Northern Sea Route in 2011.
Admittedly, the new route comes with its own set of problems. The shipment of gas on Sovcomflot's high-tonnage tanker Baltika required the accompaniment of an ice-breaking ship provided by the government. "That icebreakers were needed in mid-August indicates the scale of the challenge," notes one analyst. Sovcomflot, Russia's state-owned shipping company, is building a new generation of Arctic supertankers for this specific task. Climate change will also make the job easier, points out BMI.
The three LNG projects that could benefit from the new route to Asia are: Pechora LNG, in the Nenets Autonomous region, planned by Russian investment company Alltech Group; the Shtokman project, which is being developed by Gazprom in partnership with Total and Statoil; and Novatek's own Yamal LNG project, in which chief executive Leonid Mikhelson says the firm could acquire an additional 24% stake to bring its total shareholding to 75%.
acquired the controlling stake in Yamal LNG last year for $0.65bn and has an option to buy a further 24% stake from Volga Resources for $450m within two years. Gazprombank holds the remaining 25% in Yamal LNG, which has the exploration and development licence for the South-Tambeyskoye gasfield – estimated to hold reserves of 1.256 trillion cubic metres (cm). Novatek
Analysts say Novatek is looking to secure full control of the project, then sell up to 49% to one or more foreign partners; Total, Shell and Qatar Petroleum are reportedly interested. But before any of this can happen, Novatek needs the Russian government to clarify a number of issues relating to the development of the Yamal Peninsula, such as taxes and the strategic nature of regional production licences.
"The government's commitment to Yamal's development is the main factor to consider for Novatek and its potential international partners. As soon as this issue is resolved, Novatek will continue the process of selecting partners for the LNG project," says Evgenia Dyshlyuk of TKB Capital, an investment bank. Novatek hopes to take a final investment decision on Yamal LNG in 2013 and launch the 15m tonnes a year (20bn cm/y) export facility by 2015-16.
In the meantime, Novatek expects to raise its gas production in 2011 by 12% from this year's level of 36bn-38bn cm. Output in the first half of the year was up by 15% compared with the same period in 2009 at 18.12bn cm. "The  target is based on achieving at least 37bn cm by the end of the year, but that depends on weather patterns," says chief financial officer Mark Gyetvay.
Novatek's second-quarter production declined by 17% from the previous quarter, which is in line with seasonal industry trends (Russian output fell by 17.6% in the same period, while Gazprom's was down by 19.4%). But output exceeded pre-economic crisis second-half levels by 14% and 11% for 2007 and 2008, respectively.
And production growth will resume in the second half of 2010, says Victor Mishnyakov, of Uralsib Capital, a Moscow investment bank, driven by seasonal factors and the gradual recovery of the Russian economy. He sees gas production growing by 6% in the third quarter and by 2% in the fourth – liquids production is forecast to remain almost flat.
However, the company's financial results were not so positive. Novatek reported a 0.5% year-on-year fall in second-quarter net profits to R7.139bn ($233m), which was lower than the consensus forecast, despite a 21% recovery in average gas prices during the period and a 9.4% increase in gas production over second-quarter 2009. The company blamed the dip on a $39m net loss as the rouble fell against the dollar, as well as "a 38% year-on-year increase in employee compensation costs resulting from increased bonus accruals on 2009 performance", and a 27.3% increase in administrative and service expenses.
A call for action
But while currency losses are a variable that is sometimes hard to control and counter, says IHS Global Insight, the substantial increases in administrative expenses look more problematic and could lead to calls from investors for action to be taken. "After a long period of falling gas prices, the relief in the second quarter was looked forward to by many and the company's failure to capitalise fully on the change in the trend does not look good," the consultancy says.
Even so, other analysts, such as Mishnyakov and Dyshlyuk, note that Novatek remains one of Russia's most efficient gas producers. In the first half of the year, Novatek launched seven new production wells at its core Yurkharovskoye field, each costing around $12m to give an average payback period of 70-330 days and some of the highest margins in the business.
Meanwhile, "contracts with new, large end-customers, such as Urals Metals & Mining and Inter Rao, will ensure further growth in earnings, supported by annual 15% growth in the regulated [Russian] gas price for 2011-13," says Mishnyakov.
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