From Qatar, with love
Qatar’s engagement with Russia didn’t begin with the Qatar Investment Authority’s (QIA) involvement in the privatization of 19.5 percent of Rosneft’s shares. As far back as 2011, Qatar signaled interest in acquiring stakes in and partnering with independent gas producer Novatek. Last June, Novatek looked to market its future LNG production from its Yamal project with a Qatari firm. On February 20, Russian Ambassador to Qatar, Nurmakhmad Kholov, announced that Qatar was investing $2 billion into Novatek projects and QIA remains interested in acquiring stakes of a joint venture partially owned by Novatek.
Qatargas and Rasgas, Qatar’s oil and gas firms, want a greater share of the European market. To do so, they must compete with Gazprom’s pipelines and decades-old trading relationships largely built on long-term contracts indexed to oil prices. Gazprom’s contract prices are trending upwards as the oil market tightens slightly, likely creating an opening for more LNG sales come summer. Dependent markets like the Baltics or Bulgaria are already headed towards hub-trading status, a development that will add transparency to pricing and further strengthen spot trading. But Qatar’s play with Novatek is less about European market share and more about its ability to set prices in the future and challenging Gazprom on its home turf in Russia.
It was little surprise Novatek applied to prequalify for oil and gas exploration at Qatar’s North Dome gas field with the recent decision to lift a 12-year moratorium on further development. Qatar’s decision came in response to renewed Iranian development of its portion of the field and uncertainty about future market conditions for LNG supply and demand. Qatar’s North Dome field, Qatari capital, and its technical expertise are useful for Novatek as it seeks to claim a greater role in Russia’s natural gas exports and energy security strategy. Though Novatek is barred from developing offshore LNG projects in Russia, no legal prohibition stands in the way in doing so abroad.
Shifting sands for Gazprom
Novatek has become the primary driver of Russia’s LNG ambitions, a leader in localizing production of relevant technologies and gear, and a bridge to bettering energy security ties with China. Much of Novatek’s success hangs on the fact that the gas reserves for Yamal LNG are onshore, making Yamal LNG cost competitive against projects affected by low oil prices. Oxford Energy Institute analyst, James Henderson, projects a possible scenario in which Yamal LNG produces more than 20 mtpa annually by 2025. That figure rises to a prospective 60 mtpa by 2035 in the most optimistic scenario. Gazprom is not on pace to match that production with its expansion of Sakhalin-2 LNG and priorities elsewhere, as financial resources are poured into Nordstream 2, Turkstream, and the Power of Siberia pipelines. Related: Oil Prices Slip Despite Draw In Crude, Gasoline Inventories
The Kremlin is not looking to Gazprom to realize its LNG vision driven by Arctic projects. The decision, in part, reflects a need to foster new partnerships with Chinese companies and funds. Leonid Mikhelson, CEO of Novatek, owns a majority share of Sibur, a downstream petrochemical firm part of various industrial projects associated with the Eastern Gas Program and Russia’s ongoing pipeline diplomacy with China. China’s Silk Road Fund owns 9.9 percent equity of the Yamal LNG project and 10 percent of Sibur. Mikhelson also closed a sale of a 20 percent stake in Yamal LNG to China’s CNPC, Gazprom’s counterpart for pipeline negotiations. Rosneft has also sold upstream gas assets and signed other agreements with Chinese gas firms or consortiums to undermine Gazprom’s negotiating position.
China has also undermined Gazprom by purchasing volumes from Turkmenistan at roughly $185 per 1,000 cubic meters, a little over half of the $350 estimate provided when CNPC and Gazprom reached their historic 2014 supply deal. The cancellation of Line D, the fourth proposed trunk line running from Turkmenistan to Xinjiang, highlights the lack of urgency CNPC feels regarding supply. China’s LNG imports in February were up 28.5 percent year-on-year and are primed to continue growing as China’s coal substitution policy evolves, with little urgency to expanding pipeline coverage.
Japan, South Korea, and China account for 55.54 percent of global LNG consumption and are now in talks to form a buyer’s consortium, a move that will likely reduce prices and aid the formation of LNG trade hubs in East Asia that can end contractual practices like destination clauses. Japan is particularly over-contracted and is seeking to resell volumes it doesn’t consume. None of this is good news for Gazprom, which now needs revenue from China to maintain its profitability. Additionally, greater flexibility on LNG markets in Asia will ultimately affect European markets as long as production outpaces demand and oil doesn’t rise too much in price. Though rising international LNG production affects Qatar’s ability to profit from exports, its low production costs make it the most competitive producer in a market of abundance.
Novatek pressures Gazprom
Just as Gazprom has stumbled with CNPC, it too has been losing domestic market share for years now. For 2016, Non-Gazprom producers accounted for about 35.5 percent of natural gas projection, all of which was sold domestically. Novatek and Rosneft are the two most important firms competing for market share, but Rosneft has placed greater emphasis on supplying gas to domestic consumers. Whereas Gazprom is forced to subsidize prices for remote regions, other firms can choose their customers and use market prices. For now, Gazprom has a tight grip on pipeline exports and control of domestic pipelines but Novatek is less interested in pipeline exports. Its targeted supply deals for electricity generation with firms like Inter RAO, slowly pushing Gazprom back from the most lucrative parts of the domestic market.
With its LNG strategy, Novatek has little need to pursue pipeline exports. Qatar is a gateway. Last year, the Middle East and Asia-Pacific accounted for nearly three-quarters of global LNG production, with Qatar alone taking 29.9 percent of the global market share. Asia is the most profitable market. It’s cheaper to produce in Qatar than in the Arctic and Novatek would also gain the possibility to sell to India, a market into which Rosneft is already moving. Taking Qatari investment is therefore another face of Novatek’s and Mikhelson’s moves to open up the Chinese market as well as a means of gaining entrance to a foreign upstream project that can produce natural gas supplies that will be able to flexibly serve Asia or Europe as market conditions develop.
Structural factors for Novatek’s game of chess
Competitor Lukoil also factors into Novatek’s calculations. Lukoil applied for a prequalification for the North Dome field, but is much less likely to win a bid because of its cozy relationship with Tehran. Novatek still has to win over competitor firms from the Middle East but has fostered better relations with Qatar of late.
Assuming a contract award, it’s important to track consumption patterns. Short-term trades for LNG accounted for 28 percent of the market last year, down slightly as many newer projects coming onstream in the Asia-Pacific have used long-term contracts for buyers. But pure spot trades accounted for 18 percent, a 3 percent increase from 2015, led by China, India, and Egypt, a gateway market to the Mediterranean where potential hub developments may also affect pricing framework. Related: This Rare Metal Just Saw Its Price Jump By 30%
Even with some volatility between supply and demand, many long-term contracts are set to expire in coming years, creating greater pricing flexibility as buyers shift from long-term contracts towards medium/short-term agreements. Icebreaking LNG carriers are just now being tested for the route from the Arctic and shipping indicators are positive for LNG. Preference for short-term trades has arisen with increasing fuel efficiency for LNG carriers, increased ship sizes, as well as greater competitiveness for U.S. LNG volumes traveling to Asian markets through the Panama Canal.
Commodities traders like Trafigura—well connected to Rosneft—are looking to increase their access and control of LNG import infrastructure in the UK and northwestern Europe. As these traders seek to maximize profits and exploit a market shifting away from long-term contracts, Gazprom’s pricing model will face greater competition both because of available supply and the greater flexibility afforded by LNG trades. The Asian Premium is fading as more LNG comes onstream and large importers aim to reduce the pricing power of producers, particularly to trade volumes from long-term contracts signed based on different energy demand calculations in previous years. LNG has also done much to sink Gazprom’s pricing hopes in China already and will soon play a greater role in Europe.
If Novatek starts production in Qatar, its hand against Gazprom will strengthen considerably in Russia. Market reforms of some kind are necessary and likelier as Novatek and Rosneft slowly go after Gazprom’s export monopoly and carve out more influence and power within the gas sector. Increasing Russian LNG production, paradoxically, will undermine Gazprom’s European ambitions in the long-term as it becomes more central to Russia’s export strategy. Price control, not market share, grants Gazprom the most power in Europe. Unfortunately for the gas giant, Novatek has set itself up to weaken that power as it has taken the lead in developing Russian LNG and cutting that same power out at the knees in Asia.
By Nicholas Trickett for Oilprice.com
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