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-- Posted Friday, 25 September 2009 | | Source: GoldSeek.com
Renaissance Capital oil and gas analyst Alex Burgansky, who ranks at the top of the list of sector analysts in Russia, shares his insights on the industry and its issues in this exclusive Energy Report interview. Russia's 2009 oil production is up a bit, but issues remain. Alex worries that Russia's oil production will decline unless its tax regime stops discouraging investment that taps into the strong reserve base in core producing areas. He also explains how Europe's infrastructure affects the gas it imports from Russia and other parts of the world.
The Energy Report: You focus on the oil and gas markets in Russia and the Commonwealth of Independent States. Can you give us your perspective on the oil market there?
Alex Burgansky: Russia is the biggest oil producer in the world, but the Russian domestic market is not as big as the oil production. Russia's consumption of hydrocarbons is only about 25% of the domestic oil production, so Russia exports the majority of oil it produces and whatever it refines.
I think the biggest issue that concerns most investors as far as Russian oil production is concerned is the growth rate or decline rate. At the start of the year, there were calls made by quite a large number of commentators that Russian oil production would decline this year by quite a considerable amount. The numbers published were between 1% and 5% and even 7%.
In actual fact, the Russian production is up this year. Year to date it is up 0.4% and we believe it will be up 0.3% for the full year. This growth has really surprised a lot of market commentators.
Although we probably will experience some decline next year because we're simply not going to see as many new projects launched as we have this year, I think we'll still end up with a relatively robust production. We certainly do not believe that it's going to fall off a cliff the way people had expected.
TER: You indicated that you expect some decline in Russian oil production because there aren't as many projects moving forward. Is that due to lack of good projects or lack of financing like we're seeing in the rest of the world?
AB: It's not really a lack of good projects. The Russian reserve base is very strong. The average life for proved reserves of oil is 22 years, which is a very lucrative figure compared to most other oil producers in the world. For most of the listed companies in Russia, the figures are even higher.
There are plenty of projects in Russia, both new projects and existing brownfield projects. Russia is a very mature producer. If you exclude all the drilling activity taking place every year, then Russian organic decline in production is close to 19%. To compensate for that organic decline, Russia drills somewhere between 5,000 and 6,000 wells every year.
And then there are two important questions. One, is there enough oil in Russia for 5,000 or 6,000 wells to penetrate? In my view, the answer is yes. As I explained, we are dealing with a very large reserve base. And the second question: is there enough money in Russia to do that, and can it be done economically? The answer to this question is not so obvious.
TER: Why is that?
AB: Certainly this year, particularly in the first half, coming from a significant financial crisis, the Russian oil companies did suffer from a certain lack of operating cash flow and, therefore, the amount of new activity came down. Thus, even with the existing brownfields, they haven't been drilling as many wells as required to keep production more or less flat. We did have the benefit, however, of new fields being launched. That not only offset the decline in the underlying production but also compensated for the insufficient number of wells being drilled.
But the Russian tax regime is unfortunately not very conducive to investment in the new projects. As a result, outside of five or six projects being launched this year, very little has been formed in the pipeline over the past few years. We need further action on the part of the Russian government, further relaxation of the tax regime to encourage Russian oil companies to invest in the greenfields.
TER: How likely is such action?
AB: The Russian government has made some significant changes already, but those specifically relate to the new production provinces. Instead of unifying the tax regime across the whole of Russian oil production, the government just gives certain tax breaks if the oil companies move into the specific territories. For example, tax breaks are in place for the East Siberian fields, for Timan-Pechora (which is far north) and certain other areas.
The problem is that those tax breaks do not really address the fundamental issue of the core producing areas. They are very mature, and additional investment is required to slow down or stop production declines. There are some deeper horizons, for example, that could be targeted in the existing production areas in West Siberia. Changing the tax regime to acknowledge and accommodate higher costs in the existing production areas would be very welcome by the oil industry.
At the moment, the Russian government tells the oil industry where the incentives are and where development should take place. So far, the government seems reluctant to give decision-making power to the oil companies themselves. But presumably the Russian oil industry is best positioned to identify where the incremental capex should go and whether it should go into the existing brownfield developments in West Siberia as opposed to the new production provinces. The greenfields might be too difficult to develop and too far away in terms of timeline, and infrastructure might be lacking. Instead of investing in those places, the decision might be to invest in the existing production provinces and try to drive production growth from there and just utilize the existing assets a bit better.
Going to the deeper horizons is certainly more expensive, oil quality is different, flow rates are much lower, the drilling costs are much higher and, in the absence of any tax changes, it will be very difficult for the oil companies to do that economically. Therefore, they are not now doing the work that otherwise probably would have made sense for them and we are waiting for the government to make some further decisions insofar as the regulation and taxation issues are concerned.
TER: Do you have a sense of when some decisions will be made?
AB: This is constantly on the government agenda. However, as the financial crisis erupted and the oil price collapsed to the point that it was hovering around $40 or $50 per barrel, Russia was not in the mood to change the tax regime significantly. Now that the oil price has recovered and prospects for it to stay at this level are a lot better than at the beginning of the year, I think the government is actually coming back to the idea of reforms in the Russian oil sector.
There is not a lot of clarity on whether harmonization can be achieved across the new fields and the old fields. That would be ideal. At the moment we're just looking for some additional tax breaks for the individual production provinces. In October and November, we expect some further tax breaks on export duties for oil produced in East Siberia. Then in 2011, we expect that the government might come up with a totally new taxation regime for the new fields. At this stage, that's unlikely to affect the existing fields but we certainly expect more incentives for the new developments.
TER: Are the potential tax breaks for the existing fields required to make current production companies profitable or more viable?
AB: No, not at all. They are very profitable as they are. If no more tax breaks are given, there will simply be less investment going into Russian oil production and therefore you will see production start to decline. We saw this last year when Russian production fell for the first time since the mid-1990s, certainly for the first time in more than 10 years. It declined last year by 0.8%.
This year, as I said before, some people expected production to collapse. We certainly never thought it would collapse, but we did think it would decline. Instead it's actually growing as a result of benefits from past investments in the new fields coming on stream this year. But we're simply running out of the pipeline of these new fields. Therefore, next year there will be a lot fewer fields coming on stream; in the absence of new incentives to put more money to work to grow Russian oil production, it will naturally start declining, with organic decline rates of around 19% and growing.
Every year, Russia will have to drill more and more wells to try to keep oil production flat and that requires more capex every year. If tax breaks are not forthcoming, the oil companies will simply not have enough cash flow to grow. In that case, their production will decline faster despite the fact that there are plenty of reserves for them to recover.
TER: How do you view opportunities for investors in the Russian natural gas market?
AB: The Russian market and the European market are very different from the U.S. market. The U.S. gas market is predominantly a spot market, with about 95% of total U.S. gas supplies being bought on spot terms and only about 5% on a long-term contract basis. In Europe it's the other way around, and the difference is due to the fact that Europe does not have as much infrastructure as the United States does.
The U.S. has an extensive gas pipeline network, very transparent pipeline access rules and plenty of underground storage facilities. That's a massive infrastructure to maintain the spot trading in gas. The infrastructure does not really exist in Europe. There are certainly pipelines, but underground storage is quite limited and there are no clear third-party access rules. For these reasons, Europe is really a long-term contract market.
There is a small but growing share of the spot market and it is natural that investors are concerned these days, inasmuch as there seems to be quite an abundance of gas around the world and they worry that excess gas supplies will make their way into Europe and displace existing suppliers.
This year, those off-take commitments are close to 140 billion cubic meters. Next year they will be 160 billion cubic meters and growing to 168 billion cubic meters by 2020—and that's not taking into account the new additional supplies that could go into Europe through the new pipelines that are likely to be built.
The North Stream and South Stream pipelines will potentially further increase supplies into Europe.
TER: Most North American discussion about Russia's natural gas exports centers on European countries being the primary importers—almost to the point that Russia has a monopolistic control. What is your perspective on that?
AB: That is not true. Europe consumes around 600 billion cubic meters of natural gas and Russia supplies about 150 billion cubic meters on average. TER: What's the biggest misconception North Americans have about Russian oil or gas production or markets?
AB: This year, I think certainly the biggest misconception on the oil side is that Russian oil production is going to collapse. As we discussed, I don't think that's the case. We've actually had similar issues about gas production. As Managing Director of Moscow-based Renaissance Capital, Alexander Burgansky, CFA, heads both Equity Research and Oil & Gas Research team. He joined the company in May 2004, initially serving as Utilities Analyst. The Institutional Investor's All-Russia survey in 2005 and 2006 ranked him No. 1 in that role. In 2007, Alex took responsibility for covering the Russian oil and gas sector, and was subsequently ranked No.1 Oil & Gas Analyst in 2008. He also ranked No. 1 Oil & Gas Analyst by Institutional Investor's Emerging EMEA Research Team survey in 2008 and 2009. Before joining Renaissance Capital, Alex spent six years as Equity Research Analyst with Credit Suisse First Boston in London. He has significant and diverse experience in equity research, with his prior coverage responsibilities ranging across different sectors (including healthcare as well as utilities, oil and gas) and geographies (Western Europe, Russia, Ukraine). He holds PhD in Engineering from Moscow State Bauman Technical University and an MBA in Finance from the University of Rochester. Streetwise - The Energy Report is Copyright © 2009 by Streetwise Inc. All rights are reserved. Streetwise Inc. hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part. The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report. From time to time, Streetwise Inc. and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise. Streetwise Inc. does not guarantee the accuracy or thoroughness of the information reported. Streetwise Inc. receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734. Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.
-- Posted Friday, 25 September 2009 | Digg This Article | Source: GoldSeek.com
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