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Uzbekistan bets on China as prime export market

A difficult investment and political climate has held back Western investors

Uzbekistan harbours ambitions to triple gas production to 66 billion cubic metres a year (cm/y) by 2020 and stem declining oil production. That will need considerable finance and expertise to achieve, especially for a government that has so far only allowed limited foreign direct investment in energy projects.

Despite sizeable hydrocarbons reserves, Uzbekistan’s strategy, for much of the period following the break up of the Soviet Union, has been for state energy company Uzbekneftegaz to target oil and gas production for the domestic market. Around 80% of gas produced is consumed within Uzbekistan, with around half of the rest going to Russia. Almost all oil production has been consumed domestically at subsidised prices.

Almost two thirds of the country’s discovered oil- and gasfields are located in the Bukhara-Khiva region, close to its border with Turkmenistan. Uzbekneftegaz leads most oil and gas projects, but Lukoil, Gazprom and China National Petroleum Corporation (CNPC) are all important players.

Oil reserves, estimated at 590 million barrels, are relatively modest and crude production has been declining in recent years, as existing fields mature. Output totalled around 63,000 barrels a day (b/d) in 2013, compared with over 150,000 b/d a decade earlier.
But there is plenty of room for expansion on the gas side. Proved gas reserves are estimated at 1.1 trillion cm, though some sources suggest the amount could be much higher.

The US Energy Information Administration provides a reserves estimate of around 1.84 trillion cm, making Uzbekistan’s the fourth largest reserves in the region after Russia, Turkmenistan and Kazakhstan. Gas production stood at 55bn cm in 2013, according to BP.

Russian dominance of exports may be about to end, amid suggestions from Gazprom executives and others that Russia could consider cutting imports from Central Asian suppliers. (Nothing official has yet come from Gazprom on the subject.) Weakness in demand for gas from Gazprom within the Russian market and the relative cheapness of Russian gas – imports to be consumed in Russia are subject to duty – mean Central Asian supply is becoming largely superfluous, they argue.

While the need to maintain geopolitical ties may prevent Russia from completely eliminating Central Asian gas supply, imports from the region could be set to decline over coming years. That would leave the door open for China to strengthen its growing presence in the Uzbek energy sector. In September, an Uzbek government official was quoted by local media as saying that China would be the biggest recipient of Uzbek gas exports by 2021. China took delivery of 6 billion cm of Uzbek gas in 2013 and that figure would rise to 10 billion cm/y by 2015, according to the official.

Uzbekistan exported 13bn cm of gas in total in 2013, Uzbekneftegaz data show. Of that, 7.5bn cm went to Russia under the country’s agreement with Gazprom, a fall from 8.7bn cm in 2012 – a statistic that suggests waning Russian demand for Uzbek gas is already evident. 

Diversification potential

If Russian demand for Central Asian gas does fall, then Uzbekistan risks becoming as heavily reliant on China to prop up its economy as it was on Russia previously. This could encourage the government to open up to investment from Western firms, if it decides to seek diversity in supply. If the terms are right, and the relevant pipelines installed, there would be no shortage of takers, especially in Europe. But that appears a distant prospect for now.

The Uzbek domestic market, which is being augmented by several gas-feedstock industrial projects, also provides opportunities for increased gas sales. However, heavily subsidised domestic prices will deter some investors. “If Gazprom stops buying gas from Uzbekistan, the question is: what will happen to that gas? More will go to China, but Uzbekistan will have to look for other lucrative markets, which could be quite tricky to find,” said Samuel Lussac, head of the Caspian upstream team at Wood Mackenzie. Domestically, the country has limited oil and gas pipeline infrastructure and what they have needs upgrading.

Meanwhile, delicate geopolitics and high costs have prevented pipeline routes that run westwards from the eastern part of Central Asia, into southern Russia, from being built. There is little indication that situation is about to change. The government has sent out conflicting signals over foreign investment by international oil companies in the energy sector recently. There have been pledges to reform investment rules, while at the same time some officials still say the country can exploit its natural resources best without direct investment from foreign companies. Pragmatism may triumph, but more reforms must happen to spur any real foreign interest. Limited access to foreign currency markets and an undeveloped domestic securities market are among many issues that need to be addressed in a dictatorship that remains disconnected from the rest of the world. A lack of exploration success in recent years has also prompted a number of companies to quit the country to focus on richer pickings elsewhere.

One to leave was central Asian pioneer Tethys Petroleum, which has had much more exploration success in other parts of the region. Tethys, which had been exploring in Uzbekistan, also cited “recent changes in the business climate and political environment” for its decision to put exploration activities on the back burner and leave a project to boost output from the North Urtabulak field, which it took over in 2009.

In January, Tethys chief executive David Robinson drew attention to the time it takes to negotiate the country’s bureaucracy and the government’s past lack of enthusiasm for Western investment, but added the company does not rule out a return to Uzbekistan at some point in the future. For now, Uzbekneftegaz, Russian and Chinese operators dominate the upstream sector.

Russian independent Lukoil said in 2012 it had managed to beat Gazprom to be the first Russian company to export gas to China, by feeding supply from its Uzbek operations into the Central Asia-China pipeline network that traverses through the country. Lukoil has produced a total of 25bn cm of gas from its operations in Uzbekistan since they started in 2004, according to a November 2014 corporate newsletter.

The company operates the Kandym-Khauzak-Shady field in Bukhara, where it has a 35-year production-sharing agreement (PSA) signed with Uzbekneftegaz a decade ago, and the Hissar fields in the Kashkadarya region, all in the southwest of the country. It is also exploring in the Aral Sea region in the north as part of a production sharing contract with Uzbekneftegaz. CNPC, Petronas and South Korea’s Korea National Oil Corporation are also involved.

First step

Lukoil started production from its first project, in Khauzak, in 2007 and then West Shady in 2011. It produced around 4bn cm in 2013 and aims to increase its Uzbek gas production to 18bn cm/y by 2016 and produce 320bn cm of gas over the term of the PSA. Lukoil says its investments in Uzbek projects had exceeded $3.5bn so far and could total more than $8bn in the long term.

Gazprom’s output of 315m cm/y of gas from its Uzbek operations is relatively small, but its heft as principal foreign gas buyer means it has had a pivotal role in the economy since the collapse of the Soviet Union.
However, in keeping with changes in the export markets, Chinese firms are also becoming increasingly important players. CNPC has expanded its oil and gas exploration acreage in various locations and has also signed an agreement with Uzbekneftegaz to boost output from some of the country’s declining mature oilfields.

CNPC’s increasingly prominent role has been reinforced by its role in constructing four pipelines – A, B, C and D – which take gas from Turkmenistan to China across Uzbekistan. 

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