Week 31 Overview
With the new round of Western sanctions on Russia approved on Thursday, Moscow appears to be clearly intentioned to divest assets in Europe and redirect its money elsewhere.
It is all a matter of risk diversification, the same criteria leading the choices of European countries. The only difference is that Russian decisions are consistent. The 31st week of the year did indeed show that Russian companies are able to take decisions promptly enough to offset Moscow’s strategic disadvantage. Brussels lags behind.
RUSSIAN STRATEGY
Moscow is perfectly right. The confrontation might last way longer than previously expected. Hence, the country needs to combine long-term measures and short-term policies.
The European Union approved sanctions against Russian defence, energy and banking sectors on Thursday and just a few hours later, Lukoil announced it reached an agreement in principle to sell 100% of Lukoil-Ukraine CFI’s assets in Ukraine to Austria’s AMIC Energy Management. Quite appropriate and really fast decision.
According to a note released by Lukoil on Thursday, the assets comprise around 240 filling stations and 6 petroleum tank farms.
“The sale of the filling-station network and petroleum tank farms in Ukraine to AMIC will help Lukoil optimise its asset structure and distribution-network management system in Eastern Europe, to which we attach great importance seeking to enhance the efficiency of our business in terms of petroleum-product sales," Vadim Vorobyov, Lukoil Vice-president, commented.
On the other hand, Russia perfectly knows that, if it wants to be credible, it needs to invest elsewhere to diversify the risk. Coherently, on Friday, Rosneft announced the close of the deal for the acquisition of land drilling and workover assets of Weatherford in South America.
‘Rosneft acquires 8 companies (part of the Weatherford group) involved in drilling operations in Russia and Venezuela,’ the company wrote on its website on Friday.
All these decisions make perfect sense. However, the most important Russian project does not depend much on the Kremlin's will. The South Stream project is increasingly under threat and there is little Moscow can do to push it forward, despite the prompt Gazprom's attempts.
‘Led by Alexander Medvedev, Deputy Chairman of the Gazprom Management Committee the company's delegation paid a working visit to Bosnia and Herzegovina today,’ reads a note released on Wednesday.
According to the document, Medvedev met with several Government officials.
‘The meetings were focused on the prospects for cooperation in the energy sector, particularly, the implementation of the South Stream project and the possible construction of a gas branch to Bosnia and Herzegovina.’
The visit signals the "all is normal" approach of Russia to South Stream, with even OMV CEO Gerhard Roiss commenting that sanctions against Russia are expected to have "no influence" on the construction of the gas pipeline project. Sanctions clearly take aim at South Stream gas pipeline and Novatek’s Arctic Yamal LNG site. The two companies are likely to be the first entities to pay the price of a confrontation.
In particular, sanctions could reverse Novatek’s positive trend. This week, the company reported rock-solid results for the first six months of the year, registering a 27.7% increase in total revenues with respect to the first half of 2013 and a 52.3% growth of total revenues with respect to the first quarter of 2014. But, despite the positive results, the next financial quarterly report could tell a drastically different story. After taking advantage of the liberalisation process initiated by President Vladimir Putin, the company will have to face the consequences of the European sanctions.
EUROPEAN STRATEGY
Europe needs to strike the right balance between short-term economic measures to cope with financial difficulties and long-term strategic decisions to maintain its international weight. Its position is less tragic than Russian ones, but it remains still dangerous. Escalations might have long term consequences on energy-intensive European companies.
That is why, the example set by the United Kingdom should be well kept in mind by other European countries. Despite being sometimes clumsy in its approach, the British government understood that it is the right moment to support indigenous production and to promote green technology. It is probably happening by chance, but the timing is extremely appropriate.
The first example of this approach came on Monday, when London published details of the bidding processes for onshore oil and gas licences. As a result, more than half of the country will be open for bids.
The only problem with its announcement is an excess in enthusiasm. Launching its 14 onshore licensing round, the government did indeed refer to shale gas as a central instrument for its energy strategy.
“Unlocking shale gas in Britain has the potential to provide us with greater energy security, jobs and growth. We must act carefully, minimising risks, to explore how much of our large resource can be recovered to give the UK a new home-grown source of energy. As one of the cleanest fossil fuels, shale gas can be a key part of the UK’s answer to climate change and a bridge to a much greener future,” Business and Energy Minister Matthew Hancock commented on Monday.
The declarations did indeed seem overly exuberant, but the approach did seem extremely careful. The Government published an online planning guidance, a regulatory roadmap and an illustration of onshore licences.
The second example of this British method to take advantage of the crisis came on Friday, when the country passed into law some reforms to stimulate low carbon energy investment.
‘The new system is designed to bring more competition and encourage private sector investment in electricity generation, by providing long-term Contracts for Difference, which reduce risk for investors; and by introducing a Capacity Market to ensure security of supply,’ the British government wrote on Friday.
This effort correctly made the headlines and it seems logical that other countries are trying to learn the lesson. For instance, the Italian government said last week that tax incentives for extracting oil and gas could help to attract €17 billion over the next 20 years. The approach seems quite similar to these British experience. And this is good news for Italy. Rome is progressively understanding that if international investors don’t go to the Bel Paese, it is all Italian fault.
"Most financing for investments is private. We need to simplify and redefine incentives to increase investment possibilities,” Economy Minister Pier Carlo Padoan said on Friday, a few hours signing a deal to sell a stake in its energy grid holding company to China’s State Grid Corp for a cash consideration of around €2.1 billion.
In this sense, the British government is leading the way and Italy could soon follow. Politics permitting, the European countries can find their a solution in renewable energies and new infrastructures, triggered by private investments made easier by reviewed and more business-friendly legal framework.
WHY ADDITIONAL EFFORTS ARE REQUIRED
If it wants to maintain its power, Europe has to do something. Doing nothing is not a solution, especially in a moment Norwegian production is decreasing and Polish efforts are not paying out.
According to a report released on Tuesday, Norway’s gas production decreased in June for the third consecutive month, with preliminary figures indicating that production levels are lower than expected.
‘Total gas sales were about 7.4 billion Sm3, which is 0.7 GSm3 less than the previous month.’
As for May, June production was also lower than 12 months before.
Similarly, Poland is encountering high hurdles in its gas hunt. Despite reporting the largest multi-stage stimulation well executed to date in the country, Warsaw had indeed reviewed downwards its estimate for the year.
This week, Environment Minister Maciej Grabowski did indeed say he expected just over 80 exploratory wells would be drilled in the country this year, down from the 100 wells he hinted at less than two months ago.
GLOOMY PROSPECTS IN EUROPE AND IN RUSSIA, BUT BRUSSELS CAN LEARN THE LESSON
The truth is that Europe and Russia are bound to go through additional difficulties. China and probably the United States will take advantage of this confrontation that looks increasingly likely.
A report by Wall Street Italia, referring to a work by Morgan Stanley, said that Russia could soon announce its intention to cut its gas exports to Europe. The decision would immediately have an impact on European gas prices and EU’s competitiveness.
The European Union is still the first region by nominal GDP in the world, but it could soon lose its leadership in case it did not find its way to take coherent, consistent and fast decisions. At this point, Brussels should look at Moscow and learn from the Kremlin how to fast-track decisions. That is the main lesson the EU can learn from the current crisis. If the European institutions manage to create consensus with little hesitation, the present difficulties will not be fruitless.
Sergio Matalucci