Russia and Alaska share similar oil and gas export challenges

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An analysis of Russia's natural gas export prospects sounds a lot like those for Alaska.

"The next 30 years could, quite reasonably, be considered as 'the era of gas,' but Russia runs the risk of missing the resulting opportunities," a pair of Russian research offices said in a long-term global energy report.

"High costs and the current taxation system both limit the competitiveness of Russian energy resources in global markets," is a key finding in the report, "Global and Russian Energy Outlook up to 2040," produced by The Energy Research Institute of the Russian Academy of Sciences and the Analytical Center for the Government of the Russian Federation.

"Despite challenging conditions, Russian LNG projects are competitive, though they require strict cost management," said Tatiana Mitrova, head of the energy research institute's oil and gas department, at a presentation sponsored by the nonprofit Energy Policy Research Foundation Dec. 6 in Washington, D.C.

Cost control is paramount for Arctic mega-projects costing mega-billions, especially as the LNG world grows more price competitive.

EXPENSIVE PROJECTS ARE CHALLENGING

Russia, like Alaska, has lots of gas. Both regions are big — Russia is the world's largest country, and Alaska is the nation's largest state — and while size means more acreage for oil and gas exploration it also means more remoteness, more distance from some buyers and the need for long, expensive pipelines to market.

A map of eastern russia showing pipelines, potential pipelines and projects.

Source: Gazprom

The 2,500-mile “Power of Siberia” gas pipeline (red line on the map) would feed the proposed LNG export plant at Vladivostok, on the Russian coast across from Japan, and could supply China with pipeline gas, too (Click to enlarge.)

The proposed 800-mile, Prudhoe-to-Nikiski inch-thick-steel Alaska natural gas pipeline, the most expensive gas line in North America, is just one-third the length of Gazprom's proposed 2,500-mile "Power of Siberia" line to deliver gas to an LNG export terminal in the Pacific Far East. That Russian project, including field development costs, is estimated at $40 billion, not counting the liquefaction plant.

LNG from the Vladivostok plant proposed for the end of that 2,500-mile pipeline would have lower profit margins than U.S. Gulf Coast, East Africa or Australia LNG deliveries to Asia, Mitrova said. But projections show it still could be profitable, she said. The margin might be $2 per million Btu vs. twice that for East Africa and Australia LNG, adding to the importance of cost management.

Russia "will remain an important participant in the gas market" — the country supplied one-fifth of the world's gas exports in 2012, almost entirely pipeline gas shipped to Europe — but expensive projects will make Russian gas "susceptible" to market fluctuations, the energy outlook report said.

GOVERNMENT REVENUES AT RISK

Just as Alaska depends on oil and gas for most of its state revenues, so, too, does Russia depend on the flow of hydrocarbon tax dollars. And just as with Alaska, that flow is at risk.

It's a double-squeeze for Russia. Growing competition for oil and gas customers worldwide will cut into export profits and government revenues, Mitrova said. And domestic consumers will challenge the higher energy prices that are necessary to cover rising development costs.

Oil and gas taxes and export duties provided 41 percent of Russia's federal revenues in 2012. But the country's oil and gas sector "will hardly be able to provide the same high share of the budget income in the future," she said in her presentation. "Decreasing competitiveness of the Russian energy resources due to depletion of the old fields and tax system makes Russia most sensitive to market changes."

The country holds huge potential for enhanced oil recovery of conventional reserves, "but adjustments of the tax regime are necessary," Mitrova said. Russia assesses:

  • A mineral extraction tax that functions as a royalty.
  • A corporate profits tax.
  • A value-added tax on domestic sales.
  • An export duty when hydrocarbons leave the country.

With booming global demand for natural gas, especially as an electrical-generation fuel, there is room for Russian exports. "Russia's gas industry still has a huge potential for growth, but it requires strict cost control, cautious evaluation of the export projects and a more flexible pricing system," as well as changes to the tax regime, Mitrova said.

SHALE PRODUCTION A BIG UNKNOWN

Just how much gas the world will draw from Russia depends in great part on shale and other unconventional production worldwide, according to the Russian research report.

"North America will achieve the largest increase in unconventional gas production," the report said, acknowledging the booming success of U.S. shale drilling. Forecasting new gas production in other countries is tougher. "Other regions are only in the initial stages of geological exploration, and this entails great uncertainty regarding the potential of shale gas production."

China, with Japan and South Korea, are the prime customers for LNG suppliers in the 2020s and beyond, Mitrova said. The researchers forecast almost 9 billion cubic feet per day of total uncontracted demand in the three countries as of 2025, providing a tempting target for proposed gas export projects in Russia, North America and elsewhere.

There are at least five possible LNG export projects in varying stages of planning in Russia:

  • Expansion of Sakhalin-2, the country's only export terminal. Controlled by gas titan Gazprom, Sakhalin-2 in Russia's Far East has been operating since 2009.
  • Development of neighboring Sakhalin-1 by partners ExxonMobil and Russian oil giant Rosneft.
  • Gazprom's proposed Vladivostok terminal, across the Sea of Japan from the world's largest LNG customer.

The proposed Yamal LNG project is on a peninsula jutting out into Russia’s Arctic waters, about midway between Iceland and Nome, Alaska, near the top of the world.

Source: Yamal LNG

The proposed Yamal LNG project is on a peninsula jutting out into Russia’s Arctic waters, about midway between Iceland and Nome, Alaska, near the top of the world. (Click to enlarge.)

Yamal LNG, under development by Russian oil and gas company Novatek on the Arctic fringe of northwest Siberia. The government has granted substantial tax breaks for the project, including a waiver of the export duty. Shtokman, also a Gazprom project, but stymied and shelved for the near future by high development costs in the Barents Sea.

To a large extent, as goes shale gas production, so goes pricing, the researchers said. They predict a spread of several dollars per million Btu for gas sold into China and Japan in 2030 between their shale-failure, baseline and shale-breakthrough scenarios.

The shale-failure scenario includes higher production costs, new environmental constraints and a rapid decline in U.S. shale oil and gas production after 2020 — all of which leads to less product on the market and higher prices for consumers.

Shale breakthrough assumes a lifting of environmental restrictions on shale production, new technology to allow waterless fracking in areas of the world with shale reserves but little water, and low production costs — all of which leads to more oil and gas on the market and lower prices.

The baseline scenario is sort of a middle ground, and the most likely, the report said.

Each scenario forecasts a different price.

For example, the 2030 global oil price forecast for the shale-breakthrough scenario is more than $20 a barrel lower than under the baseline. Volume matters. U.S. shale oil production alone averaged more than 2 million barrels a day in 2012, and the researchers forecast that global shale oil flow could top 9 million barrels a day by 2040.

Assuming no major changes in shale gas technology and production — either good or bad — the researchers figure global pricing for LNG might not change all that much in the coming years. There is a lot of gas that can be produced at $4 per million Btu, though they are quick to add that the high costs of liquefaction and transportation will keep prices up for LNG buyers. They also noted that the traditional link of LNG to oil prices reduces development risks for producers, making it easier to attract investment funding.

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