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Novatek hopes to tough out Ukraine related sanctions

Russia’s largest independent gas producer still has bold plans for expansion

Novatek, the most active independent Russian energy company, is confident Ukraine-related US sanctions on key shareholder Gennady Timchenko will not have a significant impact on its projects in Russia, which include the Yamal liquefied natural gas (LNG) development. Novatek, Russia’s second largest gas producer after state-controlled Gazprom, is not directly subject to sanctions. But it has not been left unscathed by those on Timchenko, a close ally of Russian president Vladimir Putin, who owns 23% of the company through his Volga Resources vehicle (it received sanctions of its own in late April, too). In March, the US export credit agency, Ex-Im Bank suspended its consideration of backing for the Yamal LNG project.

Mark Gyetvay, Novatek’s chief financial officer, told a results conference call at the end of April that, although the fallout from the Ukraine crisis had affected the company’s share price and hit Russian capital markets, Novatek continued to trade normally, noting the company itself was not subject to sanctions. 

He said Novatek believed that, in any case, the Yamal LNG project had adequate financial support from China to enable it to progress as planned. Initial sales agreements are in place and Chinese financial institutions have already agreed to provide a substantial portion of the total financing package to the $27 billion, 16.5 million tonne a year Yamal project on the Kara Sea coast in the north.

Yamal is being developed by Novatek (60%), France’s Total (20%) and now China National Petroleum Corporation (CNPC, 20%). Novatek closed the sale of the stake to CNPC in January 2014. LNG shipments from the plant – supplied mainly from the Yuzhno-Tambeyskoe gasfield on the Yamal Peninsula – are scheduled to start in 2017.

Chris Weafer, a partner at Moscow-based consultancy Macro-Advisory, says he expects the sanctions in force in early May 2014 to have minimal impact on Novatek’s business. “Its two core businesses of gas supply within Russia and the lucrative LNG contracts are either domestic or eastern facing, so they aren’t really affected,” he says.

However, if Russian gas sales to Europe are curtailed by tougher sanctions in the event of a worsening of the Ukraine crisis, Novatek’s European plans could be affected. While Novatek has no pipeline gas export licence – Gazprom retains a monopoly on Russian pipelines exports – the company has been establishing a position in gas marketing within Europe.

In 2012, Novatek signed an agreement to supply Germany’s EnBW utility with 2bn cubic metres of non-Russian gas procured by a new European trading operation. The move gave Novatek a foothold in the continent, laying the ground for potential future LNG sales from Yamal or via pipeline.  

Should Russian gas exports to Europe be reduced, Novatek’s strategy could be thrown into doubt. However, Macro-Advisory’s Weafer says a change in the relationship between Europe and Russia may not necessarily prove negative for the company. If Russia decides to liberalise Gazprom’s monopoly on European gas supply as part of a future bridge-building exercise, then Novatek’s European operation puts it in a good position to take advantage.

Clearly, Novatek sees more pluses than minuses in the present climate. In April, Leonid Mikhelson, the company’s head and co-owner, said the company was interested in buying more gas trading assets in Europe. The company’s most recent results – for activities that largely pre-date Ukraine-related sanctions on Russia – showed strong growth, bolstered by new projects. Novatek recorded a 10% rise in revenues in the first quarter 2014 over the same period in 2013, to 88.68bn rubles ($2.47bn). It attributed the rise to an increase in average prices for natural gas and liquid hydrocarbons, driven, in part, by the start-up of sales of higher value added products from its recently opened Ust-Luga gas condensate fractionation and trans-shipment complex on the Baltic Sea.

Gyetvay said Novatek had executed contracts for the drilling of 124 wells to supply gas to Yamal and that it expected a contract for the drilling of at least 84 more wells would be concluded during 2015, the precise number depending on well tests. The engineering, procurement and construction contract group includes France’s Technip and Japan’s JGC and Chiyoda.

Lukoil’s mixed results 

Privately controlled Lukoil has been seeking expansion on both the domestic and foreign fronts with mixed results, as it seeks to take on its state-owned rivals. Russia’s second largest oil company – after Rosneft – released disappointing results for 2013, which showed a 29% fall in net profits to $7.83bn. These were dragged down by $2.1bn of impairment losses – effectively write offs – due to factors including poor sales and other expenses at Italian and Ukrainian refineries and weak results from an Arctic oilfield and West African exploration campaign. However, even allowing for these, profits were still lower than many analysts had expected. 

Despite the poor headline performance, Lukoil’s overall sales did rise 1.6% to $141bn, while oil and gas production rose 1.5% to 2.2mn barrels in 2013. Some 6% of total oil production came from foreign operations, largely in Kazakhstan.

The Arctic project on the Yuzhnoe Khylchuyu oilfield suffered a setback in 2012 when co-developer ConocoPhillips pulled out, due a downward revision in reserve estimates. In 2008, when the project started, reserves were estimated at 505m barrels. The estimate was later cut to 150m.

Two years ago, Lukoil said its West African assets – five blocks in Ghana, the Ivory Coast and Sierra Leone – could hold prospective resources of up to 5bn to 6bn barrels of oil equivalent. However, the company has now taken a charge of almost $300m after exploration wells failed to show commercial hydrocarbons reserves. Such setbacks and the company’s withdrawal from Venezuela and Vietnam could jeopardise Lukoil’s plans to secure 17% of its production growth from overseas projects over coming years. 

Lukoil has said it plans to invest $27bn in all its existing foreign projects, plus new assets outside Russia by 2017. Central to that strategy will be the success of its West Qurna 2 project in Iraq – the world’s second-largest undeveloped field, with recoverable oil reserves of around 14bn barrels. The company said in March that the field was producing at 120,000 barrels a day (b/d) and was expected to ramp up to 400,000 b/d by end-2014 with peak production of 1.2m b/d scheduled for end-2017. 

Also in March, Lukoil confirmed it had signed a memorandum with Total to develop the Bazhenov Shale in western Siberia, as the company seeks to bolster its presence in the domestic market, where it has been struggling to find fresh reserves. 

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