Moscow Backs Russia's Fastest Moving Energy Company

The COVID-induced recession that has brought oil and gas prices down to levels that are painful enough for most if not all major producers. In Russia the crisis has hit the populace much more than it did the government – after all, the former had in most cases no (currency) reserves to rely on as a safety buffer. Russian companies remain somewhere in the middle of the suffering scale, most have cut capital expenditure and postponed major projects a couple of years down the road. NOVATEK, a company hardly known to the Western world 5 years ago that has morphed into Russia’s prime LNG producer and exporter, has managed to avail itself of an oft-forgotten but still pertinent way of keeping the company’s financials afloat – government help.  The Arctic LNG-2 project has been for some years already. In many ways it is a natural continuation of what NOVATEK has started out with Yamal LNG – the liquefaction plant will be constructed in Arctic conditions, just across the Ob Bay on the western side of the Gydan Peninsula. Having amassed a noteworthy presence on the heretofore underutilized Gydan, NOVATEK can boast a massive resource base – the base case feed will come from the Utrenneye field (sometimes also called Salmanovskoye), discovered in 1979 but due to Russia’s Arctic gas bounty thus far kept on the back burner as Gazprom rather focused on the Yamal peninsula. Utrenneye’s reserves stand at 1.1 TCm and might be further buttressed by the 0.5 TCm Gydanskoye field and other assets in the vicinity thereof. 

So far everything seems in due order. Arctic LNG-2 will become the largest Russian project in the last 15 years, with an assumed project cost of $21 billion. It has already secured the involvement of several international oil and gas majors – traditional ally Total has taken a 10% stake, along with CNPC, CNOOC and the Japanese JOGMEC/Mitsui consortium. Remarkably warm 2019/2020, COVID-related price depression and domestic Russian economic lassitude notwithstanding, Arctic LNG-2 has not witnessed any delays so far (in comparison with other future NOVATEK projects, as we will see below) – the first 6.6MTpa train should be commissioned in 2023, followed by the equal-capacity second and third in 2024 and 2026. 

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Graph 1. Yamal LNG Exports by Continent in 2018-2020 (million tons LNG).

Source: Thomson Reuters.

Buoyed by the success of Yamal LNG (primarily in Europe, as can be seen from Graph 1), Arctic LNG-2 has also pulled in a plethora of buyers, too. Apart from the equity offtakers, NOVATEK has signed preliminary sales and purchase agreements with Vitol, Repsol, Saibu Gas, Petronet and others. Despite being non-binding in their character, these SPAs make good on NOVATEK’s vow to have half of its production entitlement allocated to long-term partners before Arctic LNG-2 gets commissioned. With the concurrent development on two transshipment terminals – depending on whether the cargoes sail towards Europe or Asia the Arc-7 class icebreaker carriers will deliver the Arctic LNG-2 volumes to Murmansk or Kamchatka – NOVATEK seems well-set for the challenges of the upcoming decade. 

Yet here comes the interesting part. According to Russian media reports, the Russian government will aid NOVATEK’s Arctic LNG-2 exposure by granting it 36 billion rubles ($0.5 billion) in 2020-2021. This is in addition to the Kremlin shouldering 25% of the Kamchatka LNG transshipment hub ($0.3 billion out of the estimated total of $1.2 billion) and financing a minor part of the Murmansk transshipment, too. Needless to say, Arctic LNG-2 stakeholders will avail themselves of “traditional” sweeteners like paying no export duty and being exempted from paying the mineral extraction tax for the first 12 years of production, to the extent that almost 40% of extraction costs will be taken over by the government. This would be perhaps understandable if NOVATEK were a state-owned company but nominally it is not – the only lever the state has over it is Gazprom’s 10-percent stake (reality is much more nuanced). 

Some government help might not even be considered such due to its non-obvious nature. For instance, any incoming or outcoming LNG carrier would use the Northern Sea Route, the management of which lies within the competence of Russia’s nuclear-energy holding Rosatom. When Rosatom dredges the Arctic LNG-2 water area and the connecting access canal, governmental assistance to the project might be imperceptible. It needs to be said that NOVATEK has seen its 2019 profits tumble into negative territory in Q1 2020, compelling the Russian firm to cut capital expenditures for this year by 20%. Against such a background and with no other concurrent LNG projects from Russia’s oil majors, Russian authorities see NOVATEK as the only realistic pathway to fulfilling the stipulated goal of becoming a global top 3 LNG producer. 

In the dark corners of NOVATEK’s operations remains the tacit agreement with the Russian government that Moscow would finance the company’s grand projects provided it seeks to domesticate all costs related to them. For reasons beyond obvious this could not be fulfilled with Yamal LNG, yet has become something of an issue with Arctic LNG-2 equipment – the modules for 3 trains that are to be sunk offshore using concrete gravity-based structures were to be produced in Russia, yet in the end it turned out that they will be built at McDermott’s Qingdao plant in China. Now the only hope for enhanced localization lies in Siemens’ reported promise to produce compressors for the 3rd train in Russia which might explain the somewhat lenient deadline on its commissioning. 

While Arctic LNG-2 has been moving according to its initial plan, partially buoyed by the fact that the Russian government considers it a strategic project (recently included in a set of federal targeted programs that would use funds from the National Welfare Fund), the next step in NOVATEK’s strategy, the 5 mtpa Obskiy LNG liquefaction terminal to the south of Yamal LNG, was postponed into 2024-2025. The main reason lies in the swath of difficulties the Russian firm has been experiencing in bringing its proprietary liquefaction technology Arctic Cascade into operation. Initially the issue was with the suppliers’ pipelines not designed for the low temperatures in the Yamal-Gydan region, however the extent of the delays has raised some issues regarding Arctic Cascade’s applicability for Obsky LNG.

By Viktor Katona for Oilprice.com

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