Novatek growth threatened by sanctions
The company is experiencing growing pains as it seeks to challenge Gazprom
Novatek is entering a new phase in its evolution from oil-and-gas upstart to one capable of challenging the dominance of the Russian state gas firm Gazprom. Sanctions against Russia and other growing pains threaten to complicate its progress, though.
Liquefied natural gas (LNG) is at the heart of Novatek's development from bit player in Russia's gas sector. In 2013, in a major break with the past, the Kremlin decided to partially end Gazprom's monopoly over the gas sector by allowing competitors, namely Novatek and state-run Rosneft, to start exporting LNG.
This change will especially benefit Novatek in the shorter term, as it is the most advanced of Russia's gas producers in LNG. The Yamal LNG plant, which it's building with partners France's Total (20%) and China National Petroleum Corporation (CNPC 20%), is due to come on stream in 2017 with a capacity of 16.5 million tonnes a year. "The end of this export monopoly could prove to be a game-changer for Novatek," says one hedge fund manager.With so much at stake, Novatek has been manoeuvring to secure the future of the $27 billion Yamal LNG plant. It has also moved to reassure investors as the US and EU imposed sanctions on Russia over the Ukraine crisis.
Novatek is particularly exposed to the sanctions issue because of its connection to Gennady Timchenko, a close ally of president Vladimir Putin. Timchenko, placed under US sanctions in March, owns a 23% stake in Novatek through his Volga Group (the other major shareholders in Novatek are chairman Leonid Mikhelson with around 28% and Gazprom with 10%). On 31 March, the US Export-Import Bank said it had halted a review of financing for Yamal LNG due to the sanctions.
However, on 22 May, Timchenko said that Chinese banks would be 'likely able' to provide as much as $20bn of the estimated $27bn cost of the Yamal LNG project, essentially replacing western banks as sources of project finance. The first tranche of the loans could come by the end of the year, he added.
Novatek has agreed to sell up to 3m tonnes of Yamal LNG output to Gazprom's trading unit, meaning production from the plant is now almost fully contracted. On top of this, chief financial officer Mark Gyetvay said the company is in talks with unnamed Asia-based companies about the sale of a 9% stake in the project. "We're still on target to deliver the first stream by 2017, sanctions haven't delayed anything," Gyetvay told the press.
Analysts say Yamal LNG's future has now been all but secured, though Renaissance Capital cautions "the project remains one of the world's most complex in terms of its location and natural conditions, which creates risks of cost overruns, delays and more difficult monetisation."
Novatek has come a long way since its creation in 1994. It began commercial gas production in 1998, and it now has 32 licences in the Yamalo-Nenets Autonomous Okrug, which includes the Yamal peninsula, holding 12.5bn barrels of oil equivalent (boe) of total SEC proved reserves as of 2013.
However, such rapid growth inevitably comes with growing pains - evidence of which came on 30 May when Novatek revealed it has had to slash its forecast for 2014 production growth because of a fire at its Urengoyskoye gasfield in April.
Gyetvay estimated that Novatek's total gas output would now increase by just 2-3% this year, down from previous forecasts of a 7-8% rise. At the same time, Novatek also cut its production of liquids, which is now expected to rise 20-30% in 2014, down from the 40-50% it was talking about in February.
The company said the fire would not influence 2015 production, adding it is confident it can restore normal production in the fourth quarter. However, analysts say it could nevertheless threaten Novatek's goal to double gas output by 2020 from 2012 levels of 53bn cubic metres (cm). It produced 62bn cm of gas in 2013, almost 10% of total Russian production, and it hopes to see this top 100bn cm by 2020.
Novatek's management called the forecast cuts "a major disappointment". However, Alexei Kokin of Moscow investment bank Uralsib, which has a 'Buy' recommendation on the stock, says it's important to stress that Novatek is not revising its 2015 production plans. He added the repairs should cost 1.5bn-2bn rubles ($51m-$57m), less that 5% of Novatek's expected capex this year.
For Nadia Kazakova, a London-based Russian energy expert, the question is whether investors should buy on the present dip in the share price. "Historically, the company has proved it can reach for the sky. But it might be different this time, in my view," she says.
Kazakova points to a number of accidents at the firm's facilities, including a fire at a well under construction at Samburgskoye field in August 2013. Reports said a "gas fountain burnt for a week and was only extinguished when the military arrived with a cannon, which fired a 100mm shell at the burning well".
"As companies' operations expand, so do the risks of accidents. Novatek, however, places itself in a separate - and higher - league for transparency, investor confidence and, one assumes, safety. It might want to prove that it truly belongs there," Kazakova says.
Growing pains can also be seen in its first-quarter results. The company's ebitda grew by more than 30% in the first, third and fourth quarters of 2013, to give annual growth of 28%; first-quarter ebitda growth was just 18%. Uralsib's Kokin believes this is a temporary slowdown, with major field launches planned this year aimed at boosting liquids production.
But Novatek faces other, bigger challenges over the longer term. While independent Russian producers might have won the right to export LNG, there's little sign the Kremlin intends to break Gazprom's export monopoly over piped gas. Also, analysts point out that state-controlled Rosneft's growing gas business may perhaps prove the greatest threat to Novatek.
Other analysts say the talk of "independent" Russian gas producers misses the point. During a panel discussion at the Washington-based Brookings Institution in May, Edward C Chow, a senior fellow at the Center for Strategic and International Studies' Energy and Natural Resources Program, said he was amused that Gazprom's two biggest Russian competitors, Rosneft and Novatek, are considered independents when one is the national oil company and the other has substantial government backing. "They're independent only from Gazprom," he wryly noted.