Sanctions and the Future of Russian Oil and Gas

James HendersonDecember 2014

• US and EU sanctions ban transfer of technology for use in Arctic, deep water offshore (>500 feet) and for shale oil development

• Financial restrictions on access to capital markets – 90 day debt maturity in US, 30 days in EU

• Rosneft and GazpromNeft the main overlap. No financial restrictions on Gazprom, Novatek hit hard by inclusion on US list

• Russian banks also targeted with 30 day debt maturity rule in both areas

• Importantly Australia, Canada, Japan and Norway have also introduced sanctions

Sanctions on Russian oil and gas companiesUS Treasury EO

13662 Directive 2 (Financing)

US Treasury EO 13662 Directive 4

(Technology)

US Commerce Dept. Export

Controls

EU Finance Restrictions

EU Technology Restirctions

Transneft Yes Yes YesGazprom Yes YesGazpromNeft Yes Yes Yes Yes YesLUKOIL Yes YesNovatek YesRosneft Yes Yes Yes Yes YesSurgutneftegaz Yes Yes

• Maintaining oil production above 10mmbpd is becoming a key challenge

• Slow growth from current levels (10.6mmbpd) had been expected

• This now seems unlikely as new fields are postponed

• Long-term challenge to enhance existing fields and develop new regions using advanced technology and international experience

Future of Russian oil production – key drivers

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General Scheme (High) General Scheme (Low) EIA

Source: Ministry of Energy, General Scheme of Development of Oil industry to 2020, EIA International Energy Outlook 2013

Enhanced recovery at

existing fields

Arctic offshore

Tight Oil

East Siberia

Black Sea and Barents Sea

Tight correlation between oil price,

economic growth and oil production

Russian GDP, oil production and the oil price

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kbpd Oil Price (US$2013)

Oil price and Russian oil output Oil price and Russian Real GDP

• Arctic development a prestige political project for Russia as well as a long-term production solution

• Opportunity to develop world-leading technology in partnership with IOCs and establish important presence in emerging new region

• Rosneft will not be able to move forward with plans without IOC support, both financial and technical

Development of Russian Arctic now in serious doubt

West Siberia, 147.9

Other Russia, 120.6

Alaska, 77.9

Greenland, 51.7

Other , 53.2

Russia has largest share of Arctic resources Partnership with Exxon has been key focus

• Russia has the largest shale oil resources in the world• Bazhenov shale has been know about for years, but foreign partnership needed

to exploit it successfully• Shell, Exxon, Statoil, Total and BP have all formed JVs, now on hold• Russian service companies cannot offer adequate equipment

Tight oil in Russia will be delayed despite continued enthusiasm

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kbpd

Rosnedra RF MoE

Source: Rosnedra, RF MoE

Bazhenov shale extensive in West Siberia Production potential up to 1.5mmbpd

Brownfield recovery through EOR is still possible, but western service companies are needed

• Difficult to recover reserves account for 62% of Russian total

• IEA estimates that EOR could account for 500kbpd of output by 2030

• Tertiary methods gradually being introduced as tax incentives increase

• International techniques brought by IOCs and service companies

– 95% of horizontal wells drilled by international service companies

• Confusion over exact impact of sanctions here

– Clarity still being sought concerning equipment with dual uses

7

Russia’s oil is getting more difficult

Reserves Production

Source: E&Y

• Rosneft has $66 billion of outstanding debt, of which half needs to be repaid inside two years

• Ministry of Economic Development believes that access to capital markets could occur in 2016/17 at the earliest

• Rosneft has applied to National Wealth Fund for more than 2 trillion RUR (c.$44bn)

• Company is already being forced to re-prioritise projects and seek new partners

Rosneft faces testing financial issuesRosneft Debt Profile… …and Repayment Schedule

• Gazprom has struggled over the past decade, with output hitting a post-Soviet low in 2014

• Increasing competition in all the company’s core markets has combined with the economic crisis, US shale gas, low coal prices and increased support for renewables to undermine sales

• Independent producers in Russia have also been producing more, leaving Gazprom with a significant supply bubble

• Outlook in Europe and FSU markets related to politics as well as economics

Previous gas market developments – rise of Novatek and Rosneft

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E

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Gazprom output in long term decline…

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…due in part to increasing domestic competition

• Ukraine situation creates a clear security of supply risk for Europe this winter

• In the long-term, does the risk concern Russian supply or Ukraine transit?• The EU appears split over the desirable place for Russian gas as a source of

imports – the South Stream debate has highlighted the dilemma• Russia’s competitive commercial position is very strong – it has excess gas

at a low cost of supply

Gazprom faces an uncertain future in Europe – but continued significant gas sales seem inevitable

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Yamal Full Cost MarginalGazprom Supply

2013 RussiaExport Price

NBP 2014 US LNG (HH at$5)

US$

/mm

btu

Capex Lifting Cost MET Domestic Transport Export Transport Export Tax Total

Energy Security

Environment

Energy Cost

What is Russia’s

role?

Europe’s Trilemma

Russia offers the cheapest gas supply

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• South Stream project cancelled as EU not supportive• Alternative pipeline to Turkey proposed• Ukraine transit risk left with EU; Russia targets Europe’s only

growing gas market, but is this the optimal route?

Russia has called Europe’s bluff and re-focussed on Russia has called Europe’s bluff and re-focussed on TurkeyTurkey

?

?

• Expansion into Asia has always been a sensible strategy for Russia, with action catalysed by the current political situation

• China offers a huge growth market, but also a dependency risk• China has been ambiguous in its support of Russia in 2014, and its gas

consumption plans remain unclear• Despite the bold talk, the Russian shift East offers little real threat to Europe,

as all parties need a balanced supply and demand picture

Russia wants to balance exports between Europe and Asia

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Europe 80% ToP Power of Siberia Altai

Crude oil export strategy Possible outlook for gas exports

The switch to Asia triggered a move to LNG, but this has now reverted to a pipeline export strategy

• LNG expansion posed a threat to Gazprom via Novatek and Rosneft• Projects now delayed or postponed due to lack of finance, customer

commitment and certainty over technology• Pipeline strategy suits Gazprom and Russian budget• Possibility of new lines to Korea and Japan could extend political reach

Yamal LNG – 16.5mmtCNPC - 3mmtpaNegotiations with European and Asian traders

Sakhalin 1 – 5mmtSODECO – 1mmtpaMarubeni – 1.25mmtpaVitol – 2.75mmtpa

Sakhalin 2 – 10mmtVarious Asian buyers Potential for 5mmt expansion

Vladivostok LNG – 10-15mmt

Chayanda

Kovykta

38bcma to China

Pechora LNG – 2.6mmtpa ?

Leningrad LNG – 10mmtpa ?

Gazprom

Novatek

Rosneft

Power of Siberia

S-K

-V

Shtokman- 15mmtpa in Phase 1?

Altai Pipeline

30bcma to China?

20-30bcma to China

• Yamal LNG is likely to proceed, but behind schedule, with expansion of Sakhalin 2 another possibility

• Three pipelines to China are feasible over time, with two already under discussion / agreement

• Russian gas can be competitive in China / NE Asia, albeit at very modest returns for Gazprom

Russian gas is competitive in Asia, and volumes could grow rapidly by 2030

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Sakhalin 2 Power of Siberia Altai Pipe

SKV to China Sakhalin 2 Expansion Yamal LNG

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Possible scenario for Russian gas in Asia Cost of supply of alternative gas to Shanghai

• Rosneft and Igor Sechin remain very influential, especially in the oil sector

• Bashneft example demonstrates that loyalty to the current administration is paramount

• Competition between domestic companies is being discouraged; reform is not on the agenda

• Rosneft and Gazprom remain at war, but have bee constrained by sanctions and Russian “fortress” mentality

• Budget revenues under threat from lower oil price, meaning that pipeline gas exports need to become more important over time

Consolidation of state control in the oil and gas sector is an ever increasing theme

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Oil

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Private

State-Influenced

State-Owned

State control of Russian oil production

W. Canada shale

US shale

Argentina shale

Brazil pre-salt

E. Siberia

Sakhalin

Queensland CBM

N. / N.W. Australia

E. Africa Offshore

W. Africa

N. Africa

E. Med.

Middle East

N. Sea

Barents Sea

Yamal

W. Siberia

SE Asia

CaspianEurope

Asia

Russia sits at the heart of the global energy economy – there is growing competition but it has plentiful relatively low cost resources

LegendEstablished gas export province / flows

Emerging gas export province / flows

N. Sea Gas export / import province name

Gas import province

ChinaShale Gas

Russia’s potential eastern gas exports

Impact of North American markets on price formation

• Will politics undermine commercial advantages?• Will lack of finance cause a lack of investment?• Can Russia move forward without IOC support?