OUTLINE. Russian Energy Sector Developments And Asia Strategy. Vladimir Konovalov Executive Director Petroleum Advisory Forum.

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1 Russian Energy Sector Developments And Asia Strategy Vladimir Konovalov Executive Director Petroleum Advisory Forum February 26, 2015 OUTLINE 1 Key Events and Oil Prices 2 Fragility of Russia s Commodity Based Economy 3 Challenges Facing the Russian Energy Sector 4 Impact of Oil Prices and Sanctions on Production 5 Pivot to Asia 6 Conclusions 2

2 1. Key Events and Oil Prices Falling Oil Prices World Economic Crisis Latin American Debt Crisis Sanctions Imposed Against Russia Poil, in $ 2015 prices $/bbl Russia Reopens: JV Deals Go Ahead P - previous critical highest level of oil prices Average = 56, Resource Nationalism: JV Deals Slow Yeltsin as President Russian Default Putin as President Key Events and Oil Prices Sanctions Main projects with foreign participation Start Up Year Foreign Share Sanctions (?) Orenburg difficult oil (Rosneft BP) % S Bazhenov difficult oil (Lukoil Total) % S Magadan 2,3 Okhotsk Sea blocks (Rosneft Inpex) % S Salym difficult oil (Gazprom Neft Shell) % S Kara, Laptev and Chukchi Sea blocks (Rosneft ExxonMobil) % S West Siberia difficult oil (Rosneft ExxonMobil) % S Yamal difficult oil (Rosneft Statoil) % S Stavropol difficult oil (Rosneft Statoil) % S BP share in Rosneft ,75% Chona (Gazprom Neft JOGMEC) % Barents and Okhotsk Sea blocks (Rosneft Statoil) % S Barents and Black Sea blocks (Rosneft Eni) % S Alliance Repsol Oil & Gas (Alliance Oil Repsol) % East Prinovozemelsky Blocks (Rosneft ExxonMobil) % S Yamal LNG (Novatek Total CNPC) % Total share in Novatek ,2% Tuapse Trough (Rosneft ExxonMobil) % S 4

3 1. Key Events and Oil Prices Main projects with foreign participation Start Up Year Foreign Share Sanctions (?) Imperial Energy (ONGC) % Irkutsk Oil Company (JOGMEC, Inpex, Itochu) % South Stream (Gazprom ENI, Wintershall, EDF) %? Nord Stream (Gazprom Wintershall, E.ON Ruhrgas, Gasunie, GDF Suez) % Petronas share in Rosneft ,8% CNPC share in Rosneft ,4% Udmurtneft (Rosneft Sinopec) % Yuzhnorusskoe (Gazprom Wintershall, E.ON Ruhrgas) % Achimgas (Gazprom Wintershall) % Blue Stream (Gazprom ENI) % Sakhalin 1 (ExxonMobil, Sodeco, ONGC Rosneft) % Sakhalin 2 (Gazprom Shell, Mitsui, Mitsubishi) % 1 share CPC % Salym (Shell Gazprom Neft) % Kharyaga (Total, Statoil Zarubezhneft, Nenets Oil Company) % 5 2. Fragility of Russia s Commodity Based Economy Selected indicators GDP decline, % Reserves decline, % Inflation (CPI), % RUB/USD depreciation, % Capital Outflow, bln USD Sources: MinFin, MinEconomy, CBR, IMF, S&P, Fitch Russian economy hit hard in 2008 by oil price drop of 75% RFG tried to protect ruble by running down reserves Lack of output response resulted in sharp drop of GDP of 8% Economy recovered after quick rebound in oil price in 2009 And Russia opened the energy sector to foreign direct investment with JVs 6

4 2. Fragility of Russia s Commodity Based Economy Economy again in trouble in due to: Oil price drop in 2014 of 50% And sanctions as a result of the Ukraine conflict Hitting the finance and energy sectors This time the RFG allows the ruble to depreciate But struggling with weak output response due to impact of sanctions and capital outflow Oil price dynamics point to tough times for the Russian economy Minister of Finance Siluanov does not envisage a 2009 style rebound because producers are not cutting supply Deputy PM Dvorkovich and Energy Minister Novak are hopeful of a rebound in oil prices to a level of $ p.b. More cautious projections are made by oil industry heads with Lukoil President Alekperov suggestions $ p.b. as a realistic price for Challenges Facing the Russian Energy Sector Russian energy sector responding to both short term and medium term structural changes Short term: lower oil prices and sanctions on technology and finance Structural change: decline of mature fields and need to develop capital intensive greenfields Challenge of catching up in technology and services sector (difficult oil, East Siberia and Arctic development) Response of Russian energy companies in short term Cut back in capital expenditure for major new projects Cut back in exploration Focus investment on existing mature (cash cow) fields Russian energy companies are repaying short term debt obligations on time Rosneft most leveraged state company Repayments being managed with CNPC contracts and internal funds 8 Possible resort to RFG Reserve Funds if needed

5 4. Impact of Oil Prices and Sanctions on Production Short Term Russian view suggests Russian oil production will be stable in short term Despite some signs of West Siberian output finally declining Russia's Oil Production, mln tons Russia's oil output, mln tons Western Siberia oil output, mln tons Source: Ministry of Energy, Skolkovo Energy Center 9 4. Impact of Oil Prices and Sanctions on Production Russian Company Oil Production Russian oil output, kbpd Dec 13 Dec change y o y, % Rosneft ,7 Lukoil ,9 Surgutneftegaz Gazpom Neft ,4 Tatneft ,4 Bashneft ,7 Gazprom ,8 Slavneft ,7 All other ,5 Russia total 10,632 10,667 10,509 10, ,7 Source: Ministry of Energy 10

6 4. Impact of Oil Prices and Sanctions on Production Medium Term Views differ on medium term outlook for Russian oil production Deputy PM Dvorkovich projects flat production in 2015, but a decline of 1 mbpd in medium term Skolkovo Energy Center projects oil production will fall by 5 10% or mt p.a. over the medium term (3 5 years) if sanctions remain in force Lukoil has flat production in 2015, but a medium term decline of 25% CERA slashes outlook for Russian oil production and projects oil output decline from 10.6 mbd in 2014 to 7.6 mbd in 2025 Sanctions targeted at new production expected to come on stream in 3 5 years Deepwater off shore and Arctic Shale oil (Bazhenov) These areas were to make up for declining output from mature fields Impact of Oil Prices and Sanctions on Production MNRE structure of oil production (pre sanctions) Russia s oil production by 2035, mln tons Onshore exploration 4 Shale 2 Supplementary exploration of fields 5 New fields 3 Shelf 6 Mature fields 12

7 Russia strategy is to re orient oil and gas sales to Asia Pull Factors Russia finally responding to opportunities in growing Asian market Asia desire to diversify energy supplies and reduce LNG premium Russia need to develop East Siberia and Far East regions Push Factors Sanctions from West as a result of the Ukraine conflict Slowing growth in Europe and its desire to reduce dependence on Russia Impressive progress in the oil sector Oil sales already re orienting to Asia Russia s oil exports to Asia Share of Exports to Asia Oil export to Asia, % 20% 30% Oil export to China, % 9% 13% Oil export to China, mln tons In all, mln tons Source: Minenergo 13 Key is ESPO pipeline Built with help of Chinese funding in exchange for guaranteed oil supplies ESPO planned expansion from 58 mt pa to 80 mt pa Deepening relationship between Rosneft and Asian companies China, Japan and South Korea main buyers of oil from Kozmino port Chinese companies actively participating in JV s in existing oil operations and some MoUs for greenfield development President Putin said: There are no restrictions for our Chinese friends 14

8 Asia key to Rosneft maintaining oil production Large scale investment required for Vankor cluster projects (total up to $100 bln with $20 bln invested so far) Production could go from 25 mt to 53 mt by 2025 But Rosneft needs additional finance and to spread exploration risk Trend is for Rosneft to offer equity shares in existing (cash cow) developments However, assessing profitability is complicated in face of oil price volatility And sanctions risk 15 Sanctions have also exposed Russian dependence on western oil service companies In 2013 Russia imported equipment in the amount of $ 2 bln 57% of which was sourced from countries that subsequently imposed sanctions Western companies have the lead in horizontal drilling and fracking equipment Needed to maintain output in heartland oil fields in West Siberia Opportunity for Asian service companies However, localization of production an issue 16

9 And also in deepwater and Arctic field development New fields require pioneering high technology With Western service companies at the fore front Russia preparing steps for import substitution But needs until to start replacing main equipment Ruble devaluation helps reduce domestic costs But will only progress with availability of finance While facing the challenge of replacing aging oil rigs (over 50% are over 20 years in operation) 17 Russia s gas export to Asia Asia currently taking around 8% of Russia s exported gas 2014 Pipeline Exports (bcm) Russia to Asia 0 14 to EU Source: Minenergo LNG Exports (bcm) But if Power of Siberia (38 bcm) and Altay (30 bcm) pipelines will be build then Asia s share could grow to around 47% On basis of supply from East Siberia greenfields (Chayanda and Kovykta) And excess capacity in Yamal 18

10 Conclusions While Russia s oil and gas sector has been hit hard by lower oil prices and sanctions Rosneft is managing short term debt obligations The Russian view is that oil output will only be marginally impacted in 2015 Ruble devaluation helps reduce local costs With company resources being concentrated in existing fields Where there is scope to increase recovery rates 19 Conclusions Market and political changes will accelerate Russia s reorientation to Asia The structure of oil sales already changing with the ESPO The Russia China gas deal will result in a similar structural change in gas sales in the medium term Russia will look for increased funding from Asia, and opportunities are opening up for equity investment in both existing (cash cow) and greenfields Likewise sanctions will force Russia to source more equipment domestically and from alternative regions such as Asia 20

11 Conclusions The medium term outlook is very uncertain Much depends on the oil price And how long sanctions stay in place Views widely differ, with estimates that oil output could drop by 5 25% over 3 5 years if sanctions remain in place Russia s success in re orienting to Asia will be an important factor in its future energy development 21