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Shell walks away in western Siberia

Yamalo-Nenets joint venture with Gazprom Neft falls victim to capex cuts

Shell exited a commitment to partner Russian producer Gazprom Neft by taking a 50pc stake in its Meretoyakhaneftegaz subsidiary in mid-April—despite only having struck the deal last year.

The joint venture (JV) was due to target 8bn bl of in-place oil at the Meretoyakhinskoye field and the surrounding area in the Yamalo-Nenets region. Work was slated to begin before year-end.

Shell’s exit is due to the “challenging external environment,” the major says. And it is hardly a huge surprise given the 20pc cut to 2020 capex announced last month. But it is a blow to Gazprom Neft’s hopes of deepening the firms’ partnerships— having invited Shell to team up at new oil ventures across Siberia and the Far East.

The duo have worked closely together for decades as partners at the 120,000 bl/d Salym Petroleum development in Western Siberia—one of the biggest and oldest JVs involving an IOC in Russia. Their relationship functions similarly to most other upstream IOC-Russian partnerships. Shell accesses low-cost resources, while Gazprom Neft can rely on the major’s technical and financial capabilities—helping to de-risk projects and reduce cost of capital.

“[Russian producers] not have to service the same debts as the IOCs and most of their production is really low-cost” Jennings, Sova Capital

Foreign investment has continued to pour into Russia’s upstream in recent years, despite subdued oil prices and ongoing geopolitical tensions. Gas producer Novatek brought Total and other international partners on board at its $21bn Arctic LNG-2 project last year, which reached financial close in September. Norway’s Equinor also signed off on plans to exploit hard-to-recover oil at Rusian heavyweight Rosneft’s Komsomolskoye field in Western Siberia.

US and EU sanctions in place since 2014 have, admittedly, restricted IOC involvement in unconventional and certain offshore projects. But, without a sustained higher oil price, many of these would have nonetheless remained challenging.

All change

Covid-19, though, promises to change the landscape significantly. IOCs are cutting all but committed capex. And Russia has pledged to cut output to 8.5mn bl/d next month—from almost 11.3mn bl/d in March—and keep some restrictions until early 2022, reducing the incentive to invest in incremental capacity.

The threat of additional US sanctions also looms over Russia’s upstream sector. The Defending American Security from Kremlin Aggression Act (Daskaa), dubbed ‘the bill from hell’, could bar IOCs from participating in a much larger pool of Russian projects.

c.$15/bl; Raiffeisenbank estimate of Gazprom Neft’s Urals breakeven price

But for those retaining Russian ambitions, the prospect of tougher punitive measures from Washington may not deter them unduly. “You have a risk of sanctions anytime you have US elections,” says Mitch Jennings of Sova Capital in Moscow. In his view, IOCs see potential heavier sanctions as an acceptable risk.

Equally, Washington’s sanctions appetite may be tempered by by-products such as inflicting more pain on oil firms that may be US-headquartered or have significant job and tax revenue-generating US operations, or adding materially to price volatility. A case in point: the US Treasury targeted two Rosneft subsidiaries earlier this year, accusing them of trading Venezuelan oil. But it stopped short of blacklisting the state-controlled parent, which counts BP—with its extensive US footprint—among its major shareholders.

Strong position

Russia’s economy is reeling from the price crash, with its government facing tough public spending choices. But its leading oil producers are more favourably positioned, says Jennings. “They do not have to service the same debts as the IOCs and most of their production is really low-cost.”

Gazprom Neft has sub-$5/bl oil lifting costs, says Andrey Polishchuk, an analyst at Raiffeisenbank in Moscow—with recent Russian currency weakness further driving down its costs in dollar terms. If Gazprom Neft is towards the lower end of the cost spectrum of Russia’s top producers, even those higher up boast globally enviable figures.

Before any recovery anticipated—as agreed supply cuts kick in and demand begins its road to recovery—the Russian Urals crude export benchmark has slumped to c.$18.50/bl. But, even after transportation and other costs, Gazprom Neft’s Urals breakeven is c.$15/bl, Polishchuk estimates.

Moscow’s agreed production costs, which will be shared on a pro-rata basis, do mean less short-term capex is needed, so Russian producers are still expected to throttle back investment to boost cash flow and safeguard profits. Gazprom Neft and Rosneft, as firms with a significant state-owned stake, will also face government pressure to maintain dividends.

Gazprom Neft will likely trim its capex budget for 2020 by 20pc, or RUB100bn ($1.34bn), this year, Polishchuk predicts.

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