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Foreword
Russia is the third-largest crude producer globally after the US and Saudi Arabia, having lost its leadership position in 2010. In addition, Russia remains the world’s second-largest exporter of liquid hydrocarbons (oil-plus products), and the world’s largest exporter of hydrocarbons (including gas). Much more importantly, though, Russia retains the potential to grow its crude output, and from a very high base. Russia is, therefore, a critical element in the world crude oil balance, alongside OPEC and the US.
At the micro level, we find the Russian oil industry very healthy. Investments have remained robust, supported by a more attractive fiscal regime. This led to new highs in
Russia’s crude production in 2018, fuelled by greenfield launches and the temporary suspension of OPEC+ production restrictions between July-November 2018. Well productivity deteriorated slightly in 2018, although there was a stronger start in 2019 with a 2.5% YoY improvement so far. Russia’s continuing efforts to curtail production growth via an agreement with OPEC have an impact on reported statistics and mask the underlying growth potential. Exploration efforts remain solid, with both exploration drilling and licence auctioning at a healthy level, allowing for sustainable reserve replacement rates in excess of 100% to what is already a formidable reserve base with over 25 years of proven reserves life.
Russia’s refining sector has undergone a significant change, with the launch of 33 new hydrocracking, hydrotreating, catalytic cracking, catalytic reforming, delayed coking, visbreaking, isomerisation and alkylation units in 2013-2018, and still 42 more advertised.
We estimate Russia’s average Nelson Complexity Index (NCI) has improved to 6.2 in
2018 (from 5.3 in 2013) and will reach 7.1 in 2021. Accounting for 7% of the world’s refining capacity, Russia is the third-largest refiner after the US and China, and is the world’s largest net exporter of oil products.
The numbers in the gas arena are equally significant. Russia holds the largest natural gas reserves in the world, representing 20% of the world total with a proven reserves life of 58 years, and is the second-largest producer of gas, behind the US. Russia is also the world’s second-largest gas consumer market after the US, and the world’s biggest gas exporter. The envisaged growth in liquefied natural gas (LNG) production and the start of natural gas exports to China (from end-2019) should solidify Russia’s role as a premier exporter of energy in the world, but will also require a more pragmatic approach to the regulation of the Russian gas industry.
In 2019 Russia entered a period of unprecedented regulatory change which saw: 1) the start of the big tax manoeuvre; 2) the introduction of the excess profits tax regime (EPT); and 3) a more structured approach to the regulation of domestic product prices. These changes make regulation of Russia’s oil industry increasingly complex. The Mineral
Extraction Tax (MET) formula now includes 30 coefficients, not to mention 18 different tax exemptions. The EPT regime has reduced economic visibility on a sizable portion of
Russia’s oil output, while the new product price regulation is widely criticised and likely to change further. Increasing regulatory complexity is not unique to Russia, and it is important that such changes do not have a sustained adverse effect on the underlying investment story.
In our view, Russia’s biggest energy policy challenge has remained unchanged for the past 19 years: fixing its gas industry and, in particular, facing up to the need to break up Gazprom. We continue to see this as a reasonable prospect after 2020. We expect that by this time Gazprom’s domestic market share will have declined towards 50%, its pipeline infrastructure will have sufficiently expanded, including links to the China and Ukraine bypasses, and other Russian gas producers will have become sufficiently strong to deliver credible competition in the domestic market.
Renaissance Capital
20 June 2019
Russian oil & gas
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