Sanctions vs. Cheap Oil: What is More Dreadful for Russia’s Fuel & Energy Complex?

Russia was encouraged by D. Trump assuming the office of President in the USA. Many people considered him to be a Russia-friendly partner. However, the launch of the U.S. military airstrike against the Syrian Air Force base under B. Assad’s control has shattered illusions of the «pro-Russianness» of D. Trump. Now the issue is whether the new U.S. President might strengthen sanctions against Russia.

At the beginning of January 2017, ten Senators created a bill that implies imposing new sanctions against Russia. The new sanctions will be most severe in terms of the Russian economy and its oil and gas sector in particular.

The existing sanctions against the Russian fuel and energy sector have had less influence on the Russian oil and gas industry than low oil prices. However, the new sanctions might become a significant problem for our energy projects.

Russia-U.S. relations remain one of the key foreign policy issues. Events in Ukraine and Syria draw the attention of the international community from time to time, but they tend to be perceived as factors that impact the relations between Russia and the U.S. The beginning of 2017 was very interesting in this context.

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U.S. government disallowed their companies to fund Russia’s largest oil companies.

Russia was encouraged by D. Trump assuming the office of President in the USA. Many people considered him to be a Russia-friendly partner. However, the launch of the U.S. military airstrike against the Syrian Air Force base under B. Assad’s control has shattered illusions of the «pro-Russianness» of D. Trump. Now the issue is whether the new U.S. President might strengthen sanctions against Russia.

Since the presidential elections in the USA on November 8, 2016, the Americans have renewed the list of anti-Russian sanctions for four times:

• On November 15 of the Russian Federation Duma’s deputies from Crimea were added to the «black list»
• December 20 — new sanctions implemented against two oil tankers and 26 NOVATEK affiliated companies (NOVATEK being already sanctioned), as well as against some other companies and individuals
• January 9, 2017, the Magnitsky sanctions list was enlarged with another five Russian citizens

Moreover, on January 13, 2017, B. Obama extended the period of the previously adopted anti-Russian restrictions for another year.

At the beginning of January 2017, ten Senators created a bill that implies imposing new sanctions against Russia. The new sanctions will be most severe in terms of the Russian economy and its oil and gas sector in particular. The “Counteracting Russian Hostilities Act of 2017” was presented to Congress but has not advanced so far. D. Trump might not want to use the document as it is, though the provisions on strengthening the anti-Russian sanctions therein might be implemented.

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Sanctions

This wave of sanctions affected the Russian energy sector companies, though to a less extent than had been projected by the American government.

The Third Year under Sanctions

The Russian fuel and energy complex had sanctions imposed on it back in 2014. Being a Crimean company, the Chernomorneftegaz enterprise was added to the sanctions list, so this case does not represent the attitude of the U.S. to the Russian oil and gas sector in general. The U.S. government disallowed their companies to fund Russia’s largest oil companies. This was supposed to affect the investment opportunities of the Russian majors, resulting in a decrease in oil production in Russia, followed by a decrease in budget revenue, a deterioration of the well-being of Russian citizens, and the growth of public unrest. All this was supposed to force Russian authorities to shift their foreign policy course in order to keep its level of support among the population.

Financial sanctions were backed up by technological ones when on August 6, 2014, the U.S. government forbade American companies to take part (supply equipment and technologies) in the following kinds of projects:

• deep water (over 152 meters) oil field development,
• Arctic shelf field development,
• scavenger oil field development, including shale oil and gas.

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Technological sanctions were a formal cause for some projects to freeze.

This wave of sanctions affected the Russian energy sector companies, though to a less extent than had been projected by the American government. The political elite didn’t turn against the political leader, on the contrary, they rallied around him along ideological lines. Restrictions on borrowing have impeded the life of Russian companies. Local business structures haven’t turned out to be isolated, but they haven’t turned to Asian loan markets either. For instance, V. Alekperov, the Head of LUKOIL stated in September 2015 that Chinese loans were the most expensive in the world. He also noted that Chinese banks are ready to allocate funds under package agreements: either under a long term oil supply agreement or a PRC equipment purchase agreement. Other Russian oil and gas companies faced similar issues. Large loans were only available for those who had agreed to the specific conditions of the Chinese partners. This is how NOVATEK, for instance, sold 20% to the CNPC and 9.9% to the Chinese Silk Road Fund in its Yamal LNG project, and only having provided reassurance for the workload of the Chinese enterprises that it could obtain a 9.3 billion euro and 9.8 billion yuan (EURO 1.33 billion) loan.

Technological sanctions were a formal cause for some projects to freeze. The leading role was played by the global market oil price drop. In 2014 the average price for Brent oil was USD 98.95 per barrel, in 2015 — USD 52.39, and in (2016 it dropped to USD 43 per barrel. One can say with certainty that even without such restrictions imposed against the Russian oil and gas sector, many of the projects from the sectoral list were going to be frozen in 2014-2016 for being unprofitable, for example, drilling in the East-Prinovozemelsky field in the Kara Sea (Rosneft and ExxonMobil project) and feasibility assessment of the Domanic deposits commercial development with Rosneft’s license blocks in the Samara region (joint project with Statoil) etc.

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Without such restrictions imposed against the Russian oil and gas sector, many of the projects from the sectoral list were going to be frozen in 2014-2016 for being unprofitable.

It is important to note that the USA was choosing sectoral sanctions aimed at preventing the growth of oil extraction in the mid- and long-term perspective. According to the Ministry of Energy of the Russian Federation, the West-Siberian fields lowered production by 0.4% (1.3 million tons, from 313 to 311.7 million tons) from 2014 to 2015 because of natural exhaustion. This process will only continue in the future. That is why even before the political crisis of 2014 Russian oil producers had faced the issue of how and at what expense they can increase oil production. The following three options seemed reasonable at that point, as sanctions were imposed on each of them: development of the Arctic shelf, scavenger oil, primarily the Bazhenov group, and development of the fields in the Eastern Siberia and the Far East.

The Arctic projects followed a similar scenario. Sanctions prohibit foreign companies from taking part in the development of the shelf projects in Russia. Though non-residents would have to leave for other reasons. The major reason is the high oil production cost on the Arctic shelf. The average (on water and on land) production cost of the Arctic hydrocarbons is estimated at USD 63 per barrel, according to the Ministry of Energy. The unprofitability is aggravated by another issue — the absence of technology for secure year-round oil excavation on the Arctic shelf.

It was not the Sanctions, but Russian Law that Closed the Shelf

Another important issue for foreign companies taking part in Russian shelf projects are the law limitations. Article 9 of the Federal Act FZ 2395-1 сoncerning Subsurface Resources states that only the companies with a 50% statutory capital (or 50% voting trust) belonging directly or indirectly to the state and a 5-year experience of work on the Russian shelf are allowed to be the users of the subsurface resources of the shelf. Only four companies meet these criteria: Rosneft, Gazprom, Gazpromneft, and Zarubezhneft. At the moment the situation around Rosneft’s shelf projects with foreign companies being involved is still not clear. Rosneft is likely to lobby for the liberalization of access to shelf deposits, as most of the blocks are already split between them and Gazprom. However, it might be difficult to reach a consensus with the Russian leadership in the case that the USA strengthens sanctions against the Russian oil and gas sector.

What Will the New Sanctions Lead to?

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The adoption of the new anti-Russian sanctions will definitely complicate the life of the above mentioned foreign partners, and might worsen relations with the USA, China, Japan, and India.

The legislation introduced to the U.S. Congress by ten Senators calls for an almost total ban for foreign companies to participate in Russian energy projects.

Should the new sanctions be applied, both oil and gas projects will come under threat. In particular, the China Development Bank, China Exim Bank, Japan Bank for International Cooperation, and Intesa (Italy) might have no time to transfer the approved loans for the Yamal LNG project, while NOVATEK’s new project Arctic LNG on the Gydan Peninsula will not be able to raise foreign funds (the project was attractive for Indian and Japanese companies, for Qatar, Total, and CNPC shareholders of the Yamal LNG project).

Dalnevostochny LNG, a joint project by Rosneft and ExxonMobil, cannot be implemented either, like Baltiysky LNG and the construction of the third stage of the LNG plant in terms of Sakhalin-2, as the consortium of foreign companies is not allowed to invest money in liquid gas production.

Gazprom will not be able to acquire foreign loans to build a gas-processing plant in the Amur region in order to separate different fractions from methane to be supplied to China via the Power of Siberia pipeline. The state concern will have to remake its investment program and invest its own money to build the plant. Sibur will have to search for the gas chemical plant construction budgets in the Amur region.

In the West, Gazprom might face issues with the use of Nord Stream-2 and Turkish Stream gas pipelines. It is not only the financing issue, but also a pipe-laying machine issue, as the concern used to hire Italian Saipem and Swiss Allseas.

The adoption of the new anti-Russian sanctions will definitely complicate the life of the above mentioned foreign partners, and might worsen relations with the USA, China, Japan, and India, as the total ban for investment in the Russian fuel and energy sector will affect companies from these countries. Though American companies will benefit from the problems in the Russian oil and gas industry. The decrease in oil production resulting from under-financing will increase the world oil prices, leading to a growth in profitability for the U.S. shale projects. At the same time, Russian gas shipment issues will be one of the reasons for European countries to purchase American LNG. All this will allow D. Trump to successfully implement his promises on raising the number of jobs in the American oil and gas industry.

Thus we can say that the existing sanctions against the Russian fuel and energy sector have had less influence on the Russian oil and gas industry than low oil prices. However, the new sanctions might become a significant problem for our energy projects.