Corporate Debt Review

Moscow Makes a Saudi Move

Leavin’ on a LNG Train from Russia

Last week, Russian Energy Minister Alexander Novak floated a trial balloon involving Saudi participation in Arctic natural gas development. But my sources indicate the real objective may lie elsewhere.

The offer was to Saudi Aramco and addresses ongoing Russian attempts to secure partnership commitments by major foreign companies in the Arctic LNG-2 project on the Yamal Peninsula.

LNG-2 is technically controlled by Novatek, the country’s second-largest natural gas producer. Given the gas export monopoly held by giant Gazprom (who has a position in all Novatek LNG projects; thereby providing de facto government control over development), Novak was clearly expressing a Kremlin approved initiative in his offer.

LNG-2 is designed to provide up to 16.5 million tons of liquefied natural gas (LNG) annually from 2022-23, with Novatek prepared to offer a combined 49% position to foreign partners.

The initial Saudi response has been guarded. The Saudi Minister of Energy Khalid al-Falih has indicated in early June, in response to an LNG-2 question from the Russian Itar-TASS news agency, that it was “premature to talk about specifics,” while keeping the door open.

Riyadh has been attempting to develop its own considerable domestic natural gas reserves, some of which is shale and tight gas. There is also significant associated gas to tap from the extensive crude oil fields currently operating in the country.

Strange Bedfellows

Initially, Aramco had contracted with Russian private oil major Lukoil. The choice had been a strange one. While Lukoil does develop gas prospects, it is neither a primary gas producer or particularly adept at shale/tight production. It does, on the other hand, have a possible connection neither state-controlled national leaders Gazprom or Rosneft has.

Lukoil is not only a private operator, but also features a majority of both its project assets and its stockholders outside of Russia. Saudi contacts confirmed to me several years ago (when the Lukoil arrangement was first announced) that the attraction in having Aramco pair with the company was its likely access to foreign expertise in unconventional gas extraction.

Rosneft has since partnered with ExxonMobil. In addition to technology and capital needed to develop the Arctic shelf, the Russian state company also received minority positions in over twenty Exxon projects in the U.S. and elsewhere in the world. All are heavy oil/unconventional fields.

Rosneft wanted access to Exxon’s expertise and technology in developing such fields for two reasons. First, it is a necessary component for enhanced shelf production.

Second, the Western Siberia Basin – from which the bulk of primary traditional Russian crude oil production comes – is rapidly maturing. There is considerable technically recoverable oil in lower strata. But at least 60% seems to be heavy oil for which Rosneft does not have adequate domestic expertise.

However, the rise of Western sanctions against Russia in the aftermath of the Ukrainian crisis has significantly hampered Rosneft-Exxon joint work. That means Lukoil may again be an option for the Saudis or Aramco (for Russian Arctic LNG).

Turning ‘Nyet’ into ‘Da’

One other observation. Over the weekend, there emerged some indications that the invitation conveyed by Novak is also to include the exploration into jointly controlled fiduciary trusts through which both capital investment and LNG sale proceeds would flow. None of these would be domiciled in Russia or Saudi Arabia.

Yet the actual reason for the LNG-2 option is centered elsewhere. Recently, OPEC has been giving indications that it would consider an expansion of the cap in any additional round of production adjustments.

Part of this is because the continuing pressure from rising U.S. volume has thwarted attempts to improve the oil market price. This is tempered by an accelerating decline in PDVSA exports from Venezuela and the continuing uncertainty over the reliability of both Libyan and Nigerian volume.

Nonetheless, any forward success of the cap initiative requires an ongoing agreement from Russia to comply. Without that assurance, an OPEC only move would not make sense.

Détente Under De Tent?

Minenergo (Russian Energy Ministry) sources are telling me that the indications last week of a Russian refusal to increase cuts are quite genuine. Moscow is again slipping into central budgetary shortfalls because of the ongoing low price of oil. Russian exports trade at significant discount to Brent.

The short-term solution is for Russia to emphasize ESPO exports to Asia. This is becoming a separate benchmark crude rate, taking its name from the East Siberian-Pacific Ocean (ESPO) pipeline that has been providing increasing crude both to China on a spur line from Skovorodino and globally via the Pacific coast terminal at Kozmino.

ESPO crude is of better quality (lighter and sweeter) than the Russian staple Urals Export Crude, thereby commanding a higher price. It is also of better quality than the higher sulfur content (i.e., sourer) Saudi export.

Of added interest, the ESPO crude price spread would allow a significant reduction in, or even elimination of, the so-called “Asian premium.” This is the excess rate for crude travelling to Asian end users over exports to Western Europe or the U.S. Gulf Coast.

That has set the stage for a major export battle in Asia. All indicators point toward the Asian market comprising the brunt of increasing worldwide import requirements over the next several decades.

While most commentators in late 2014 fixated on a Saudi concern over the rising impact of U.S. production being the main reason for OPEC deciding to defend market share rather than price, I observed at the time that the real concern was the rising competition with Russia over export share to Asia.

The Thanksgiving 2014 OPEC decision drove the price of oil down below the level at which Russia could export profitably on ESPO. That has introduced a point of friction in Russian-Saudi relations ever since.

Overall Russian oil exports require rising pipeline and tanker deliveries of ESPO crude to Asia. For Moscow, this is becoming a pressing budgetary consideration as export volumes to Europe result in declining revenue and stagnant volume.

My contacts in both Moscow and Riyadh confirm that a parallel round of discussions is underway seeking Asian market access for ESPO exports. Improving options for Saudi investment in Russian projects elsewhere (LNG-2, for example) may be an element in working out a rapprochement.

But it is Asia, not the Arctic, that comprises the real objective in all of this.

About the Author

KentMoors

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk management, emerging market economic development, and market risk assessment.

He serves as an advisor to the highest levels of 27 countries, including the U.S., Russian, Kazakh, Chinese, Iraqi, and Kurdish governments, to the governors of several U.S. states, and to the premiers of two Canadian provinces. He’s served as a consultant to private companies, financial institutions and law firms in 29 countries, and has appeared more than 2,300 times as a featured radio-and-television commentator. He appears regularly on ABC, BBC, Bloomberg TV, CBS, CNBC, CNN, NBC, Russian RTV, and the Fox Business Network.

A prolific writer and lecturer, his six books, more than 2,700 professional and market publications, and over 650 private/public sector presentations and workshops have appeared in 47 countries.