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    Novatek digs itself in [NGW Magazine]

Summary

Russia’s biggest LNG producer is fortifying its position in the Arctic, adding acreage for future production and preparing to test domestic technology. [NGW Magazine]

by: Tim Crawford

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Featured Articles, Europe, Premium, NGW Magazine Articles, Volume 4, Issue 11, Market News, Arctic Focus, Yamal/Yamal 2, Russia, Technology

Novatek digs itself in [NGW Magazine]

Novatek has made yet another land grab in the Russian Arctic, acquiring rights to five more blocks on the Gydan Peninsula. Now Russia’s largest LNG exporter, following the launch of its flagship Yamal LNG terminal in late 2017, the company is seeking to expand its foothold in Russia’s gas-rich north. In the past few years, it has secured rights to a number of new areas previously explored by Soviet geologists but passed off at the time as too complex and remote to develop. 

In a statement on May 24, the independent producer said it had obtained exploration licences for the Dorofeyevsky, West-Dorofeyevsky, South-Dorofeyevsky, Khalmeryakhsky and South-Khalmeryakhsky blocks, which collectively encompass around 2,440 km² of Arctic tundra. It gave no more information on the acreage, save that it was in close proximity to its other assets. 

Novatek’s goal is to build up a resource base that can underpin its ambitious plan to scale up LNG production to 70mn metric tons (mt)/year by the end of the next decade, by developing a raft of new projects on the Gydan and Yamal peninsulas.

Yamal LNG, which is currently operating at 16.5mn mt/yr capacity, will be joined in 2023 by Novatek’s larger 19.8mn mt/yr Arctic LNG-2 venture. Around this time the company also plans to commission the more modest 4.8mn mt/yr Obsk LNG terminal, designed to showcase Russia’s own gas liquefaction technologies. It has also mooted plans for an Arctic LNG-3 development, following the recent discovery of more gas in the Gulf of Ob that divides Gydan and Yamal. 

State support

The launch of LNG production was a watershed moment for Novatek, with sales from Yamal LNG helping to drive a near 43% growth in the company’s revenues last year. The company previously lacked access to international gas markets, with state-owned Gazprom’s monopoly on gas pipeline exports confining it to less lucrative domestic sales.

Novatek’s road to success at Yamal LNG was not without difficulties, however. Within a year of taking a project FID, the company was targeted by US sanctions in response to Moscow’s 2014 annexation of Crimea and global oil prices had collapsed. That Novatek and its international partners were still able to complete Yamal LNG on time and within its $27bn was no small feat.

The project was founded on strong economics, boasting a break-even cost of around $3/mn Btu compared with a $5-6/mn Btu average ‘on the water’ for competing US LNG. Its costs and those of Novatek’s other upcoming LNG ventures are set to fall further after the launch of transhipment terminals in Murmansk and Kamchatka in 2022-2023.

But Novatek’s LNG ambitions would not have been realised were it not for the ample fiscal and regulatory support provided by the government, which is eager to see Russia emerge as a leading global LNG player.

“Without the support from the state it would have been impossible,” Fitch Ratings analyst Dmitry Marinchenko told NGW. “You don’t have an environment in Russia where you can simply build an LNG plant.” 

While the bulk of Yamal LNG’s cost was covered by shareholders and Chinese lenders, Russia’s sovereign wealth fund together with state banks also contributed around $7.2bn in funding. The government also assisted in developing necessary project infrastructure, such as the port at Sabetta. During its first 12 years of operation, Yamal LNG will pay no export tax, mineral extraction tax (MET) or property tax, as well as 13.5% less in profit tax – concessions that are expected to be granted to Novatek’s upcoming projects as well. This support has irked Gazprom, which has around the same average break-even costs as Yamal LNG despite having to pay MET and export duties at most of its projects. The company argues that Yamal LNG’s tax-free exports could take market share from its own taxed supplies to Europe, depriving the government of revenues. 

Sanctions risk

According to Marinchenko, the obvious risk to Novatek’s next venture, Arctic LNG-2, is a potential ratcheting up of US sanctions. Existing punitive measures imposed on Novatek and other Russian oil and gas firms have made it harder to tap international capital markets. But there are fears that Washington could also move to bar the supply of equipment and technology to Russian LNG projects. 

While Moscow has trumped up efforts to localise manufacturing in the oil and gas industry, the LNG sector still relies heavily on imports, with much of the core equipment and technology at Arctic LNG-2 set to come from foreign suppliers. “If technological sanctions were enacted [on LNG], Russia would be unable to build LNG plants for some time,” Marinchenko told NGW.

Novatek is taking steps to mitigate this risk, having developed its own Arctic Cascade liquefaction technology. This technology will be deployed at a 0.9mn mt/yr fourth train due to start up at Yamal LNG this year, as well as the three-train Obsk LNG. “Import substitution makes LNG development cheaper but the efficiency of these technologies is lower and they are currently untested,” Andrei Polischuk, an analyst at Raiffeisenbank in Moscow, told NGW. Marinchenko suspects that the capacities of Omsk LNG’s trains are smaller because of limitations with current Russian technology.

Novatek’s CFO Mark Gyetvay told the Flame gas conference in Amsterdam May 13 that Russia would not be held hostage to sanctions, which was why it was developing an LNG centre of excellence and would hire thousands to work at it. He said there are only four major liquefaction plant producers, and Novatek wanted “to unblock the bottleneck. An irrational government wants to sanction everyone but we won’t be stopped,” he said. “We have to develop the technology: we do not want to be stopped.” 

He said that three quarters of the equipment for the Arctic LNG-2 had been ordered, including 68-MW compressors from Italian Nuovo Pignone, which were compact enough for the gravity-based system (GBS) planned for that project. The concrete-pouring for the GBS is due to start in July, he said. 

Other players

Novatek’s position as Russia’s leading LNG supplier looks unlikely to be challenged. Gazprom has not advanced any other largescale projects since the commissioning of the 10mn mt/yr Sakhalin-2 terminal a decade ago, despite government pressure. Its delayed Baltic LNG venture with Anglo-Dutch Shell collapsed earlier this year, and although Gazprom is continuing the project with a private Russian partner, there are doubts it can realise the plan without international assistance. Gazprom’s lack of progress in LNG partly stems from the company’s traditional focus on pipeline exports to Europe.

There are signs Gazprom may be shifting its tack, however. It has hinted that LNG could be an option at the Tambeyskoye field. Given the field’s close proximity to South-Tambeyskoye, the resource base of Yamal LNG, Gazprom and Novatek could benefit from working together here.

Gazprom’s oil arm, Gazprom Neft, is also exploring a plan to convert untapped gas at the Novoportovskoye field into LNG, having held a tender for design work last year. Gazprom could adopt a similar solution for its offshore Arctic fields as well, such as Leningradskoye, Nyarmeyskoye and Rusanovskoye. Production at these projects is not anticipated until the 2030s, however.

Rosneft, despite its long-held ambition to become a top-tier global gas supplier, has been unable to move any LNG projects forward either, partly because of difficulties securing sufficient gas supply and partly because as a state company with close government ties, it has found it harder to form international partners fearful of potential new sanctions.

As such, Novatek is set to continue dominating LNG production in Russia for decades to come. The government in turn should maintain its support for the company’s projects, recognising LNG’s importance in helping Russia diversify its gas exports away from sales in its core market in Europe.