Saturday, 22 April 2017 20:11

Russian oil groups brave cold of western sanctions to explore Arctic

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Putin urges energy companies to develop know-how for drilling in the far north.

His fur coat heavy with snow and protecting him from temperatures of minus 18C, Igor Sechin, the chief executive of Russian oil company Rosneft, clutched the radio in his thick gloves and relayed to his engineers the simple order he had just been given by Russian President Vladimir Putin: “Start drilling.”

A rig operator confirmed his request. Moments later, a drill began its 5,000m journey downwards, in search of oil deposits that the country is banking on to provide more than a quarter of its future output. Perched on the edge of a peninsula deep in the Arctic Circle, Tsentralno- Olginskaya-1 will be Russia’s northernmost oil well. Closer to the North Pole than to any city, it is a feat of engineering that uses equipment shipped 3,600km through icy waters navigable only for two months of the year.

The well is one of the most technologically challenging ever attempted in Russia. With the deposits located beneath the icy, frequently frozen waters of the Laptev Sea, cutting-edge horizontal drilling techniques will be used to reach up to 15,000m from the main site. But it was also a moment of triumph for Mr Putin, who was beamed in via video conference from St Petersburg as Mr Sechin braved the frigid elements and who celebrated the start of drilling as an act of homegrown ingenuity.

Three years ago, when the US and EU imposed sanctions on the country that restricted companies such as Rosneft from foreign capital and technology, complex wells were exactly the kind of ambitious projects that were supposed to be rendered impossible. Western governments hoped that pressure on Russia’s main energy companies would help change Mr Putin’s political calculations. But as projects like Tsentralno-Olginskaya-1 attest, Russia’s oil and gas majors have found ways to carry on regardless. “Horizontal drilling is a complex and high-tech operation. This is just the first well. There is much more work ahead,” Mr Putin told Mr Sechin in the heavily scripted conversation.

The ability of the companies to overcome the impact of sanctions is critical for Russia’s economic future. Preliminary estimates suggest as much as 9.5bn tonnes of oil equivalent lie below the ice where Rosneft’s drill is headed. Experts believe Russia’s Arctic shelf region in total holds as much as $20tn worth of oil and gas, and will provide 20-30 per cent of its oil production by 2050. State-run Rosneft and Gazprom have been granted the sole rights to exploit it.

“I would like to wish you good luck and I hope for this undertaking’s success,” Mr Putin said. Mr Sechin nodded. “We will keep you informed.” The US, EU and other western countries first imposed sanctions in March 2014 after Moscow invaded and annexed Crimea and provided military assistance to separatists fighting in the east of Ukraine. They targeted some of the country’s major banks, defence and oil and gas companies that are largely controlled by the Kremlin and are the country’s economic heartbeat. Foreign financing dried up, as banks pulled funding streams directly targeted by the sanctions, and took a safety-first approach to others as lawyers began to pore over the small print.

International joint ventures came shuddering to a halt, and prospective investments were abandoned. “At the outset, a lot of companies were scared off from doing business with us or investing,” says a senior executive at the Gazprom group of state-run oil and gas companies. “The sanctions were brought in, and straight away the lawyers and compliance teams [at foreign companies] got way more powerful.”

The sanctions remain firmly in place despite Donald Trump’s election as US president. Given that Mr Trump had called for closer relations with Russia and he appointed as his secretary of state Rex Tillerson, who in his previous role as chief executive of ExxonMobil signed an agreement worth $300bnto work with Rosneft in the Arctic, there was initial speculation that the sanctions could be diluted or removed. But given the scrutiny the Trump administration has received over its ties to Russian officials, the prospect of a shift in policy has diminished. Yet the penalties have not had a lasting impact.

Sanctions may have caused some short-term headaches for the Russian economy — Rosneft requested more than Rbs2tn ($36bn) from a state bailout fund in October 2014 to meet foreign debt repayments. However, the much more important factor was the simultaneous crash in oil prices — a blow that is being partly reversed. As the price of oil sunk to decade lows, Russia pitched into recession: real gross domestic product fell 3.7 per cent in 2015 and 0.2 per cent last year. But over the past nine months, as the oil price has staged a mild recovery, Russia’s economy has done likewise. Even without any sanctions relief, GDP growth of about 1.5 per cent is forecast next year, according to the economy ministry. “There is a pretty uniform consensus that the oil price shock dwarfed the sanctions,” says Apurva Sanghi, lead economist for Russia at the World Bank in Moscow.

“If you look at what the authorities have done over the past few years for macro stability, it has been pretty outstanding and the results are there to be seen.”

At the same time, energy companies have found ways round the restrictions. Indeed, 2,000km south-west of Tsentralno-Olginskaya-1 in western Siberia, Gazprom Neft, Russia’s third-largest oil producer, is showing few ill effects. Late last year, it became the first Russian company to demonstrate shale oil fracking expertise with a 1km-long horizontal well 2.3km below ground at a site in the vast Bazhenov field, estimated to be the world’s largest shale oil deposit.

Gazprom Neft was able to use homegrown technology that it was forced to develop after the sanctions prompted its international partners to walk away from the project. “We are like a snowball,” says Sergey Vakulenko, head of strategy and innovation at the company, a unit of gas giant Gazprom. “The harder you squeeze, the harder we get.” “In terms of today’s projects, we are not at all affected [by the sanctions],” he says in an interview at the company’s St Petersburg offices, where engineers use vast computer screens to remotely control drills at more than 600 wells across the country. “At their current configuration, they aren’t and won’t be painful, irrelevant of how long they are in place.”

Between 2013 and 2016, Russian crude oil production rose almost 6 per cent, more than twice as much as the rise in combined output from the Opec group of countries. Revenues at the country’s three largest producers have risen 11 per cent in that period. The curtailment of foreign cash forced many to restructure their balance sheets with the help of domestic lenders, cut lossmaking or costly new projects, and increase their efficiency.

Acquisitions and international expansion projects have followed. “The accepted narrative is that there is only upside risk from sanctions [being lifted] as the majority of the companies affected have shown few ill effects,” says the head of a western bank in Moscow. “In fact, lots of them have been forced to be smarter and have increased their competitiveness.” A $11bn agreement in December to sell 19.5 per cent of Rosneft to a consortium including Qatar’s sovereign wealth fund and Swiss commodities trader Glencore served two purposes for Mr Putin’s administration: it raised much-needed cash for the recession-battered budget, and sent a message to those who thought such a transaction impossible under the sanctions regime.

The international oil and gas community is beginning to show a change of heart in response. In meetings with Russian energy ministry officials and company executives at a recent energy conference in Texas, sanctions were barely mentioned by delegates from European and US oil companies, two people present told the Financial Times. Gazprom Neft held talks with major oil services companies at the conference and expects to co-operate with them on upcoming projects, deputy chairman Vadim Yakovlev said last month. He estimates that just 1 per cent of Russian oil projects are affected by the sanctions, and that the “emotional” reaction among US or European energy companies to their imposition is receding.

Russia’s energy companies still lag behind the technological might of their western rivals, and would be keen to restart the knowledge-sharing agreements and joint ventures terminated by the sanctions. Mr Sechin, whose good relations with Mr Tillerson helped seal ExxonMobil’s 2012 deal to develop Arctic deposits with Rosneft, says foreign partners could join his company in exploring the deposits targeted by the Tsentralno well, known as the Khatangsky block. “It is possible, we do not rule it out,” he says, without providing examples. “We can after some time work to attract a partner.”

But isolated examples such as Tsentralno and Bazhenov have buoyed hopes in the industry that even if the restrictions remain, domestic expertise is advancing quickly enough to ensure future exploration and production. Gazprom Neft estimates that in-house technological advances since the sanctions were imposed have increased average production per well by about 11.5 per cent, and it extracted an additional 25.3m barrels last year thanks to deploying new techniques. Some experts even suggest that the majority of the projects hit by sanctions, such as the offshore Arctic deposits, are so technically challenging and expensive that they are not viable at current oil prices.

If prices stay at current levels of about $55 a barrel, it could be some time before full exploitation of the Arctic shelf is profitable. “Sure, in terms of shale technology, we are a little behind the Americans.

But in time, and definitely before we absolutely need to, we will get to where we need to be, sanctions or no sanctions,” says Mr Vakulenko. “We could do it now, but we don’t need to,” he adds, referring to even more complex fracking techniques that will be required to fully exploit the Bazhenov field’s 75bn barrels of estimated reserves. “Why go after the high-hanging fruit when there is lower stuff available right now?”

The high-hanging fruit will be picked soon enough, given Moscow’s heavy reliance on keeping crude production and exports high to pay the bills. Mr Putin last month used a trip to the remote Franz Josef Land archipelago, the northernmost point in the eastern hemisphere, to reiterate his desire for development of the Arctic region. Following its drilling under the Laptev Sea, Rosneft will shift its exploratory work west, to the Barents Sea next year and the Kara Sea in 2019. The latter project was initially planned in conjunction with ExxonMobil, but Mr Sechin says the work will stay on schedule, sanctions or no sanctions. “It is important to demonstrate our consistency in dealing with partners,” a spokesman for the company said. “Sanctions may last for years, but business relationships last for decades.”

Henry Foy



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