Brownfield sites curb Russian growth
Producers profit from post-devaluation oil prices—but oil fields are depleting
As we had predicted in the last year's article, oil production in Russia continued to grow in 2018. According to the Russian Ministry of Energy, in 2017 oil output totalled 11mn bl/d, in accordance with the Opec agreement when Russia had to cut production by 300,000 bl/d. In the ten months of 2018 so far, output grew on average to 11.1mn bl/d. In October production exceeded the previous historic maximum of 11.4mn bl/d recorded in October 2016, just prior to the Opec deal.
Production growth in 2018 was driven by the June decision of Opec to increase production to offset output losses in Venezuela, Iran, Mexico and Angola. That prompted Russia to accelerate the launch of new projects and the development of the existing ones. In the period from June to October 2018 alone, oil output rose by 400,000 bl/d, according to the Ministry of Energy data. That is, oil production did not just reach pre-Opec deal levels, but exceeded them. The breakthrough was prompted by unprecedented oil prices measured in roubles following devaluation, making production extremely profitable for Russian companies.
Even those oil deposits, which two years ago seemed economically unviable, are becoming attractive given the current pricing environment. In 2019 we are expecting some further, although more modest, growth in production to 11.5mn bl/d, primarily as a result of commissioning new fields including Srednebotuobinskoye, Tagulskoye, Kuyumbinskoye and Russkoye. However, this increase could be limited by global market conditions and the necessity to once again make production cuts under Opec if oil prices were to fall further. It is possible that control over output will now become a long-term reality for all of the Opec members, including Russia.
Oil production in Russia in the next two or three years depends little on sanctions and technologies: these projects have already received investment and will be brought online in any case. The only factor which could boost or slow down their development would be the new Opec agreements. Further outlook for oil production looks less optimistic because of rapid depletion of the existing fields: by 2030 production at the brownfields is likely to decrease to 5mn bl/d. To maintain current output levels after 2020, Russia will need to use several measures.
29mn t/yr—Russia's estimated LNG production capacity in 2019
First, the commissioning of conventional greenfields should offset declining production at the existing ones. However there are very few undeveloped new conventional reserves left and geological exploration has to be intensified.
Second, in-depth development of the conventional brownfields would be necessary, using hydraulic fracturing, development and utilisation of tertiary recovery methods.
Third, taking into account the deteriorating resource base and the increasing proportion of hard-to-recover-reserves, Russia will have to develop technologies and equipment for unconventional and hard-to-recover oil fields. These areas are under sanctions. Also, Russia is just beginning to develop its own technologies. And the main issue is that their implementation would require a change in taxation—all of these projects are not viable given the current tax regime.
Fourth, offshore fields will have to be developed. Here, domestic technologies are also lacking and fairly tough sanctions are already in effect.
Therefore after 2022 it will only be possible to maintain current oil production provided that the companies develop and implement new technologies and that the government ensures a preferential tax regime. Official plans to maintain domestic oil output at a level not less than 10mn bl/d in the next decade require redistribution of the oil rent.
This year the most influential events, which will to a large extent determine the outlook for 2019, took place in the domestic rather than the foreign market. In the spring of 2018 the Russian fuel market faced a price crisis. As oil prices were rising around the world, gasoline and diesel prices in the retail sector went up 10-15pc in the period from April to June. The government took measures to stabilise the situation. Instead of a planned increase, excise taxes were lowered. There are also plans to complete by 2024 the so called Tax Manoeuvre—a proposed zero rate of export duty on oil and petroleum products. The government also proposes introducing a dampening "negative excise duty" on oil, to be calculated according to petroleum prices in the domestic and foreign markets. In addition, the government secured the right to introduce a preventative duty on petroleum products up to 90pc of oil duties, in the event of a sharp increase in prices.
The effect of the adopted measures only lasted two months however. From August 2018, retail stock exchange prices of petroleum products increased by an average of 5pc across Russia. The main reasons were the attractiveness of petroleum exports and their resulting shortage in the domestic markets as well as planned maintenance works at oil refineries, a hike in excise duties and VAT rates to apply from January 2019.
The government intervened again and entered negotiations with the companies. Under temporary agreements, the companies have undertaken to maintain prices at the current level, including inflationary increases, until March 2019. They will also increase supplies of fuel to the domestic market at prices not exceeding the set indicative prices. Additionally, traders were barred from dealing on the stock exchange to ensure that petrol stations could purchase petrol without the mark-up. Let's note that this has had the reverse effect and wholesale prices at the stock exchange actually rose.
After 2022 it will only be possible to maintain current oil production provided that the company develop and implement new technologies
Various options are now being considered as mechanisms that will stabilise the situation in the petroleum product market. They include floating rates of excise duties on petroleum products with an inverse negative relationship to changing oil prices; transfer of excise duties from refineries to petrol stations; licencing of exports and increasing obligatory volumes of shipments at the stock exchange.
The eventual shape of the new taxation structure and domestic market management in 2019 will to a large extent determine future investment activities of the Russian oil companies, the corporate structure of the industry and export volumes of petroleum products. Judging by the current trends, the industry is on the way to further consolidation in the form of vertically integrated state companies and can expect growing direct administrative intervention of the government in its operation.
In October, energy minister Alexander Novak announced that Russia will supply record-setting volumes of gas to Europe: export volumes could reach 204bn cm. Gas output has been growing alongside record-setting exports in 2018. The successful expansion of the Yamal LNG project, already operating at over 100pc load capacity, has become the main event of 2018. The success of this project prompted a review of Russia's gas export policy, with its priority shifting towards accelerated LNG production and export growth under the lead of the new national champion, Novatek.
After the commissioning of the third and fourth phases of technological production lines at the Yamal LNG project in 2019, LNG production capacities in Russia will total around 29mn t/yr. The Russian leadership is already talking about constructing 80mn tonnes of liquefaction capacities by 2035 and becoming one of the three leading LNG-exporting countries.
In turn Gazprom, as usual, is focusing on completing its pipeline projects. Both the Turkish Stream and Power of Siberia projects should come online next year while more than 200km of the Nord Stream-2 project have also been built. For the Russian gas industry, the coming year 2019 will mark difficult negotiations with Ukraine on the transit contract and a new round of negotiations on Altai and Eastern pipeline with China.
Tatiana Mitrova and Ekaterina Grushevenko, Energy Centre Skolkovo School of Management