Extraction of oil

According to Rosstat, the extraction of oil and gas condensate production in Russia in July 2012 decreased compared to the same period of 2011 by 0.1 percent to 43.4 million tons. The downward trend appeared for the first time since October 2011. From January to July 2012, oil production, according to the agency, grew by 1.1 percent compared to the corresponding period of 2011 and reached some 299 million tons.

According to the Ministry of Energy, oil production and gas condensate production in July 2012 was slightly higher than the Rosstat figure, or 43.7 million tons (i.e., 100.8 percent compared to July 2011).

The growth of oil production supports the growth of domestic demand: the supply of crude oil for refining in Russia from January to July 2012 increased by three percent compared to the results for the corresponding period of 2011 to 153.3 million tons.

The maximum increase in oil production in the first half of 2012 compared to the same period of last year was demonstrated in the Irkutsk region, where production totals were 77.3 percent higher than the results for January-June 2011, Yakutia, with a 25.8-percent increase, and Krasnoyarsk, with a 17.8-percent increase. The largest decline was in the Nenets Autonomous District and the Sakhalin region.

According to the Ministry of Economic Development, the leader in oil production in the current year is Rosneft, with some 1.5 million tons produced this year over the statistics for January-July 2011. The positive results are primarily attributable to increased production growth in the fields of Samaraneftegaz and Vankor, where new wells were drilled. TNK-BP also increased its production of oil from January to July 2012 by 0.9 million tons, attributable mostly to increased production at the Verkhnechonskoye and the Uvat fields.

At the same time, LUKOIL has reduced production by 1.8 percent compared to January-July 2011, as a result of the decline in oil production at the Yuzhno-Khylchuyu field in the Timan-Pechora province. However, the rate of decline continuously decreased from 2.5 percent in April in the annual comparison to 1 percent in June. The company is currently implementing a program to stabilize and build up its oil production, including taking measures to increase oil recovery and the stabilization of oil production in West Siberia.

According to the Russian Ministry of Energy, in January-June 2012, the total amount of drilling down to appropriate level of production rose by 7.7 percent compared to the same period of 2011. Production drilling went up by 8.8 percent, while exploratory drilling went down 13 percent.

The Federal Antimonopoly Service (FAS) in early August had proposed draft amendments to the Law on Subsoil Use, which would give private companies access to the fields on the Russian shelf. Now only state company with at least five years of experience are allowed to produce hydrocarbons offshore, that is Gazprom and Rosneft.

At the same time, the FAS proposes to the Russian government the right to restrict the participation of a particular company in offshore projects, if foreign investors are represented in its capital structure. The Ministry of Defense and the Federal Security Service are expected to introduce the same proposal relating to the restraints placed on foreign investor participation in offshore projects.

As of yet, however, the ultimate course of this initiative is not yet clear, since foreign companies are increasing their participation in offshore projects. As such, in late August 2012, Norwegian Statoil signed a basic agreement with Rosneft to work together on the shelf of the Barents Sea and the Sea of Okhotsk. The partners created a joint venture for exploration in the fields, which will be funded by Statoil. The minimum amount of investment the company has estimated is USD600-950 million, mainly for work that will take place in the Sea of Okhotsk. Earlier this year, Statoil left the Shtokman shelf development project. Under the terms of the framework agreement, Rosneft should also receive Statoil’s assets. Statoil has promised Rosneft to share in the exploration and production projects in the North Sea, as well as in the Norwegian part of the Barents Sea.

Earlier, in April of 2012, Rosneft approved a list detailing the exchange of assets with ExxonMobil.

In the spring of 2012, Rosneft also entered into a partnership with Italian ENI for the Vale Shatsky field in the Black Sea and the Central Fedynsky Barents field in the Barents Sea. The desire to become a partner of Rosneft on the continental shelf has also been voiced by ConocoPhillips and Indian ONGC.

Gas production

In the second half of 2012, gas production in Russia followed a downward trend. According to Rosstat, the volume of natural and associated gas produced in the Russian Federation in July 2012 amounted to 44.6 billion cubic meters, which was 92.1 percent compared to the results for July 2011 and 97.8 percent compared to the figure for June 2012. From January to July of the current year, gas production decreased compared to the same period in 2011 by 3.6 percent to 382.2 billion cubic meters.

According to the Ministry of Energy, gas production in July was slightly more at 45 billion cubic meters. Still, even that figure was 7 percent lower than what had been reported a year earlier. Production decline is attributed to a decrease in gas consumption on domestic and foreign markets, which began in April of this year. Domestic consumption of natural gas, according to the agency, from January to July 2012 decreased by 5.3 percent to 271.2 billion cubic meters compared to the same period of last year, while gas exports for the same period amounted to only 85.2 percent of last year’s level (109.3 billion cubic meters).

The production decrease was primarily the result of declining production activity of the largest producer Gazprom, whose enterprises from January to July 2012 reduced production compared to the previous year by seven percent to 284.3 billion cubic meters.

Also in August, the suspension of the Shtokman offshore field in the Barents Sea was announced. Shtokman reserves are 3.9 trillion cubic meters of gas in C1 and 53.3 million tons of condensate in C1 and C2. The operator of the first phase of the field was Shtokman Development AG, where Gazprom owned 51 percent, Total 25 percent, and Norwegian Statoil 24 percent. The second and the third stages of the project Gazprom initially planned to develop independently, but now the Russian concern is considering the involvement of partners at these phases as well.

Initially the investment in the first phase of the project was planned to be USD12-14 billion, but it later increased to USD30 billion. Another negative factor compounding the effect of the high cost of field development was the rise of gas production in the U.S. In 2001, the share of imports in the U.S. consumption of gas reached 16 percent, or about 100 billion cubic meters. It was then that Gazprom intensified the project of developing the large Shtokman field, originally designed for the export of LNG to the U.S. But the rapid growth of shale gas in North America reduced the potential demand for Russian gas.

After two years of postponing the start in developing Shtokman, board member of Gazprom Vsevolod Cherepanov officially recognized that the development of the field in the current situation would be considered unwise. “All parties have agreed that the costs are too great for us to do that at this stage,” he said.

However, Gazprom has not yet taken the official decision to postpone project development. Total denies the suspension of the project as well. “The parties are still at the stage of technical development in order to make the project viable,” says the French company.

Earlier, the final investment decision was postponed several times. The deadline was set for July 1, 2012, when the framework agreement between the three partner companies was to have expired and after which Total and Statoil were to return their respective shares to Gazprom. The timing for the start of production at the Shtokman field was pushed out for 2016-2017, with the possibility of another two-year postponement. By July 1, no certainty as to the fields had been found, and Statoil in line with the shareholders’ agreement, returned its stake in the project to Gazprom and wrote off the investments already made in Shtokman of about USD340 million. Total opted to wait for the meeting of Shtokman Development AG stockholders.

Experts believe that the work on the development of the Shtokman field will resume no earlier than two or three years from now, after the stabilization of prices on the gas market. Until that time, the forecasts of volumes and prices of Russian gas exports are not too optimistic.

In contrast to Gazprom, independent gas producers increased production in the reporting period. From January to July 2012, oil companies increased gas production by 5.7 percent to 38.7 billion cubic meters. For the same period, NOVATEK increased production by 10 percent to 29.6 billion cubic meters. In late 2011, NOVATEK presented its strategy, which involves doubling production by 2020. The goal set was to increase gas production to 112.5 billion cubic meters and the production of liquid hydrocarbons to 13.3 million tons.

To increase its market share, NOVATEK for several years acquired power generation companies as clients. In particular, in 2009, it began supplying gas to OGK-1, and then to the Inter RAO group together with OGK-3, which was under its control. Contracts with these companies for the supply of gas from NOVATEK are effective until 2015. As a result, primarily due to the expansion of NOVATEK since 2002, the share of Gazprom in the domestic market went down from 88 percent to 76 percent.

In August 2012, it was announced that E.ON Russia in 2013, will purchase gas from NOVATEK to supply fuel to the Smolensk and the Yayvinskaya Shatura GRES, and to the Surgut GRES-2. According to unofficial information, the supplies to be contracted for are about seven billion cubic meters of gas a year. Analysts estimate the total revenue lost by Gazprom to be 600-700 billion rubles. In addition, E.ON Russia now buys fuel from LUKOIL, Surgutneftegaz, and Rosneft. In 2011, the generating company consumed 13.3 billion cubic meters of gas.

Oil exports

According to the Ministry of Energy of Russia, in July 2012 Russian oil exports amounted to 19.3 million tons, which is 3.3 percent less than in July of last year. The decline in exports is correlated with the increase of oil refining in Russia itself (5.1 percent in July 2012) and the fall in production. The total volume of oil exports from January to July 2012 is estimated at 139.6 million tons, which is virtually identical to the corresponding period of 2011.

For seven months of the year, the supply of oil to the C.I.S. totaled 16.56 million tons (98.1 percent compared to January-July 2011), mainly due to reduced supplies to Ukraine, which were down 3.7 times. The share of deliveries to Belarus increased. Russian oil exports to non-C.I.S. countries from January to July 2012 stood at 123.03 million tons, which is 100.1 percent of the results for the corresponding period of 2011.

According to the Russian Ministry of Energy, LUKOIL in the seven months of this year exported through Transneft some 15.837 million tons of oil, representing an increase of 18 percent compared to last year’s data. TNK-BP exported 18.347 million tons, a figure that is 17 percent higher than the result for the same period of the previous year. Rosneft increased exports by two percent to 34.591 million tons. At the same time, Surgutneftegaz reduced exports by five percent to 14.846 million tons, and Gazprom Neft by eight percent to 6.889 million tons.

Gas exports

Gas exports increased in July of this year compared to July 2011 by eight percent to 12.4 billion cubic meters according to the Ministry of Energy. Prior to that, from December 2011, Russian gas exports were decreasing compared to the same months of the previous year. Total exports from January to July 2012 amounted to 109.3 billion cubic meters, a figure that is only 85.2 percent of last year’s performance.

Gas supplies to foreign countries in the last seven months of the year decreased by 2.5 percent to 67.1 billion cubic meters. Supplies to the near abroad during the same period decreased by 31.5 percent, amounting to 33.6 billion cubic meters. The reduction of gas supplies to the C.I.S. countries is due to the reduction of supplies to Ukraine, which is caused by the desire of the Ukrainian side to review the terms of the contract with respect to volumes and the gas pricing formula.

In August, the Ministry of Economy reduced the forecast of exports and the price of Russian gas. The baseline forecast of the Ministry, was that Russia would export 193 billion cubic meters of gas instead of 212 billion. In 2011, for comparison purposes, the country exported 221 billion cubic meters of gas. The forecast also decreased export estimates for subsequent years, such that the anticipated exports figure for 2015 went down to 209 billion cubic meters instead of 253 billion cubic meters. The average price of gas in the C.I.S. should be at USD439 and USD393 per 1,000 cubic meters in 2012, going down to only USD390 in 2015.

Export forecast and gas prices decreased partly due to the good prospects for shale gas in the U.S. According to the calculations of the EIA, with the development of shale deposits, in 2021, gas production in the U.S. will overtake its consumption at the level of 722.4 billion cubic meters and will continue growing at an even faster rate. Export capacity in 2035 will reach 40 billion cubic meters. The share of shale gas in gas production in the U.S. now stands at 34 percent, but is expected to increase to 43 percent by 2015 and to 60 percent by 2035.

The U.S. is not yet exporting LNG, as it does not have sufficient capacity to liquefy natural gas because practically no liquefaction facilities have been built since 1967. However, because of the saturation of the domestic market, the country began to re-export the LNG that was imported. In addition, investors talk about plans to build large-scale facilities for the production of LNG. According to the Federal Energy Regulatory Commission (FERC), as of July 2012, it received seven applications for LNG export terminals with a total capacity of 110 billion cubic meters a year. The FERC is also informed of the intent to implement four more projects with the aggregate capacity of 63.8 billion cubic meters a year.

In addition to the American factor, the reduced demand for gas in Europe also poses negative consequences for Gazprom’s prospects. Due to the fall in spot prices for gas in the European market, Gazprom has recently had to make concessions to some European customers. As such, in January of this year, Gazprom Export revised rates on long-term supply contracts for the German Wingas, Austrian Econgas, Italian and Slovakian Singerie Intaliane SPP. Previously, it also revised contracts with the German E.ON. In July, it was reported that the Polish PGNiG is getting a 20-percent discount on Russian gas. In addition, the ongoing debate of Gazprom over the price of gas supplies to Lithuania is causing some problems for the Russian company.

NOVATEK has plans to start gas deliveries to Europe by the end of 2012. Starting with the fourth quarter of the current year, it will sell natural gas to Germany’s EnBW. According to a statement of the company’s CFO Mark Jetway, the agreement with the German company is NOVATEK’s first commercial contract for the sale of gas to European markets. The contract is effective for 10 years and provides for an export volume of about two billion cubic meters a year. Mark Jetway explained that the contract will allow NOVATEK to take market positions in Europe in anticipation of changes in the Russian legislation on the export of natural gas, which sooner or later will open export market gas pipelines to independent producers.

Domestic prices for oil and gas

The dynamics of domestic prices for oil producers in the first half of the year were mixed and generally in line with the dynamics seen on foreign markets. In the first months of 2012 a sharp increase in oil prices on the domestic market took place. However, in April it reached a maximum of historical significance and the price started to decline. In July, it fell to the lowest point this year, a value of 7,914 roubles per ton. At the same time, a significant increase occurred in the price of gas on the domestic market. Gas rates for households and the industry were increased by an average of 15 percent effective July 1, even though they were initially supposed to have increase effective January 1. As a result, the average price of natural gas in July reached another record high of 1,053 roubles per one thousand cubic meters.

The financial position of the industry

The net financial results in the extraction of fuel and energy resources sector in January-May 2012 increased compared to the performance seen in the same period of the previous year by 0.6 percent to 719 billion roubles.

Yet, the slowdown in profit growth in the industry is due to the fall of energy prices starting in April 2012, rising oil export duties (USD448.6 per ton in May 2012, compared to USD397.5 per ton in January 2012), reduced gas exports, as well as the increased tax load on the gas industry (increased extraction tax on gas). At the same, time the percentage of profitable companies in the production of fuel and energy resources in January-May 2012 increased to 67.9 percent and has already exceeded the pre-crisis levels.

The financial condition of most of the major companies in the sector in the first half of 2012 has improved compared to what it was in the previous year. The maximum growth rate of profit under RAS took place at Slavneft, where profit increased 3.1 times. However, such a result was achieved partially through the company’s low base factor. At the same time, a significant drop in profits was noted at Rosneft, whose profit went down 2.1 times compared to the first half of 2011. As the president of the company Igor Sechin noted, the financial results for the first half of 2012 were affected by the falling oil prices, the growth rates of export duties, as well as by the high volatility of the exchange rate. Less than ideal results were also seen at Gazprom, with profits at only 78.2 percent of last year’s figure and Tatneft, with January-July profits at 83 percent of the performance statistics for the corresponding period of 2011.