Battling on all fronts in Russia
Rival supplies in Europe, less urgency in the east and competition at home will be the motifs of Russian gas in 2017
For Russian gas, 2017 will see many of the themes from 2016 play out, and maybe gather pace towards significant conclusions. That means the battle between US liquefied natural gas and Russian supplies in Europe will intensify, Russia's own LNG plans will start to come good, pipelines in the east will advance slowly and pipeline politics in the west will continue. The most important question might be whether Gazprom's dominant role in Russia's own gas sector will come under threat.
Gazprom has faced growing competition in its three main markets over the past five years - and 2017 will see that trend continue. Domestic gas demand is declining and competition from Rosneft and Novatek will not diminish in 2017, meaning Gazprom's sales will fall for the fifth consecutive year. Exports to former Soviet Union countries won't recover - Ukraine continues its efforts to cut imports from Russia to zero, a feat it may pull off by the end of 2016.
So the Russian gas "oversupply bubble" will continue: Gazprom will have up to 150bn cubic metres a year of spare export capacity pointed at the European market. Sales have increased in 2016 thanks to lower prices - and because Ukraine's purchases of reverse-flow gas are, in fact, indirect imports from Russia - but Russia's gas exports to Europe also face commercial and political threats.
The excess LNG in Europe in 2017 will pose a major commercial challenge to Gazprom. Although the first cargoes of US LNG were delivered in 2016, volumes were low and competition limited. This will start to change in 2017, as exports from America increase and more Australian LNG floods the Asian market, spilling over into Europe. This will leave Gazprom with a significant choice to make: price its pipeline gas to compete with potentially low spot prices, or maximise price at the expense of market share. This choice will be particularly complex if oil prices rise much above $50 per barrel, as Russian gas prices are still largely linked to oil, even if the share of market-based pricing is increasing. If the company decides to defend its customer base against higher-cost producers, the outcome could well be a price war in Europe, at least in the short term.
One reason Gazprom might plump for maximising its sales into Europe is that the Russian government wants it to generate more tax revenue. The federal budget is likely to run a deficit of 3.5-4.0% in 2016 due mainly to a lower contribution from the oil sector.
But extra taxes on oil firms might crimp oil production, leaving Gazprom as the source of extra tax. The main argument for this move is that the company is the only gas-sector beneficiary of the ruble devaluation, as it has a monopoly on generating dollar revenues from export sales. So, in 2017, its tax burden is likely to rise. And to compensate, Gazprom will need to get the most from exports through an aggressive sales strategy in Europe.
But this is complex too. Politically, Gazprom is running into ever-deepening problems with the European Commission (EC), catalysed by the EU reaction to Russia's involvement in Ukraine. Not only are sanctions likely to continue into 2017, indirectly affecting Gazprom's business, but objections to its plans to expand its export pipeline system to Europe will also persist. The one exception is Turkish Stream, where the recent agreement with the Turkish government means that at least one string (with a capacity of 15.5bn cm a year) will be laid in 2017. Exports could start in 2018.
In northern Europe, though, the fight over Nord Stream 2 will drag into next year. Gazprom, its international partners and the German government remain keen on the project, which would add 55bn cm/y to Gazprom's export capacity in northwest Europe.
Other EU countries (especially in the east) remain opposed, and the EC is keen both to diversify supply and to maintain Ukraine's transit-pipeline revenue. Expect more negotiations over Nord Stream 2 in 2017, and for the EC to use courts to delay development if Russian plans advance too rapidly.
Pipelines will also be a focus in Russia's east, where exports to China remain key to Gazprom's strategy. Construction of the Power of Siberia pipeline has begun and 2017 will see the completion of the cross-border connection under the Amur River.
But it remains to be seen how fast overall progress is. China's demand for gas is now less certain and LNG prices in Asia have sharply weakened since the project started. So it may make sense for both sides to slow progress towards the end of the 2019-21 contractual window. The pipe itself may move ahead on schedule, but eight planned compressors are likely to be installed more slowly than expected, meaning supplies will ramp up over a longer period during the 2020s.
Activity in 2017 will provide more evidence of this. In any case, with Power of Siberia underway, don't expect any new pipeline agreements in the east to be reached over the next 12 months. Negotiations over Power of Siberia-2 (previously known as Altai) have stalled and the third pipeline-export option from Sakhalin remains more theoretical than realistic.
This is partly because a final decision to invest in a third LNG train at the Sakhalin 2 plant should take place in 2017, which would consume at least 8bn cm/y of new gas. Where will this gas be sourced? The logical answer is for Gazprom to buy the spare gas at Sakhalin 1 from Rosneft and ExxonMobil, but negotiations are difficult. Gazprom's other option, to develop the South Kirinskoe field in the Sakhalin 3 licence, has been hit by US sanctions. A solution must be found in 2017 if the expansion plan is to meet its 2021 deadline. Further delay is the likely outcome.
One certainty for 2017 should be first gas from Novatek's Yamal LNG project, which is due online by the end of the year.
Financing was confirmed in 2016 and the project has kept to its schedule, meaning a cargo should leave the first train in the fourth quarter. Thereafter, trains 2 and 3 should start up before 2020, meaning Novatek could well be Russia's largest LNG player by the end of the decade. Indeed, if plans for a second project (Arctic LNG on the Gydan Peninsula) keep moving ahead in 2017 Novatek might come to dominate Russia's LNG business.
This second project is popular because it would provide the foundation for a domestic LNG industry based in Murmansk, supporting the government's plan to reduce reliance on imports in strategic sectors. Although its progress will rely on the success of Yamal LNG, it seems that Gazprom is facing significant competition from a domestic competitor in the LNG business.
Although 2017 won't see Gazprom challenged in the arena of pipeline exports, as President Putin appears to have opted for stability and continuity ahead of the 2018 presidential election, the success of a third party in the LNG business might point towards possible change in the sector as a whole, once the electoral cycle is complete.
This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here