Russia's Shale Gas Revolution (July 17th, 2014)

Shale oil production in the United States has soared, reversing a decades old decline in America’s crude output. One of the principal reasons is because of fields like North Dakota’s Bakken shale which could yield 24 billion barrels of oil in the decades to come. The Bakken is a huge boon both to the economic health of the Northern Plains states, but also to the petroleum balance of the USA> From just 60,000 barrels per day five years ago, the Bakken is now giving up 500,000 barrels per day with 210,000 barrels per day coming in just the past year.

However, as great as the Bakken is there is another oil shale play called the Bazhenov which is significant. The Bazhenov is in Western Siberia and while the Bakken is big, the Bazhenov covers 2.3 million square kilometers or 570 million acres which is the size of Texas and the Gulf of Mexico combined-80 times bigger than the Bakken.

Getting access to the Bazhenov is the focus of a new joint venture by both Exxon Mobil and Statoil with the Russian Federation’s Rosneft to jointly develop light oil production techniques in Western Siberia. The exploration work will take years to establish if the reserves are commercially viable. According to analysts, it won’t be hard for companies like Exxon and Statoil to export their shale fracking techniques to Siberia if Russia is able to deploy 30 drilling rigs to the area and then the Bazhenov could be producing one million barrels per day by 2020. The Russian Federation already produces about 10 million barrels of oil per day, putting it about a million barrels a day ahead of Saudi Arabia, the largest producer in the Middle East. Given the fact that Putin recently announced tax incentives for exploration of shale oil in Western Siberia and is forecasting production of 2 million barrels per day by 2020, the potential for profit from Russia’s shale gas boom is enormous. This is quite evident now that Russian oil companies such as Gazprom Neft, Rosneft and Lukoil have teamed up with such international players like Exxon Mobil, Total, Statoil and Royal Dutch Shell to share costs and obtain the technology needed to explore for unconventional oil.

Lukoil’s Andrei Kuzyaev estimated that the cost of one horizontal well in Russia is $15-20 million compared to around $3.5 million in the United States-a figure which dropped from around $8million recently due to the highly competitive environment among drilling companies. Consequently, while Alexander Dyukov, CEO of Gazprom Neft, Russia’s fourth largest oil producer, acknowledged that Moscow is 5-7 years behind the United States in terms of technology needed to drill for unconventional oil, the gap is narrowing and with the help of their technology partners, Russian oil companies will eventually achieve the requisite knowledge.
The United States Energy Information Administration estimates that Russian recoverable shale oil reserves at 75 billion barrels, more than the 58 billion barrels held by the United States which is now the leader in shale oil production. Furthermore, Dyukov told reporters that Russia may look to domestic suppliers or those in Asia for drilling rigs which may allow the pumping of another 1 million barrels per day by 2020-2022 from the Bazhenov formation alone. To extract these volumes, Russia needs an additional 250-300 heavy drilling rigs, either domestic or Asian, most notably Chinese drilling rigs to facilitate Russia’s shale gas revolution.

However, Russia’s shale gas revolution could be hampered by Western sanctions which are limited for now, but already preventing some companies from making new investments in Russia which needs advanced technology to explore for unconventional oil. In fact, the United States and the European Union could ban exports of modern technology and application for use in the Russian oil sector which would affect further oil production. While this measure is only a possible option, according to a recent statement by Alfa Bank, it could affect primarily Artic shelf projects as well as hard to recover oil projects where foreign technology is required the most.

An interesting point to note is that despite the push by Western governments to isolate Moscow because of the situation in Ukraine, energy giants are deepening their relationships with Russian oil and gas companies by investing more money into the country. Exxon Mobil’s Exploration Chief, Neil Duffin, recently signed an agreement with Igor Sechin, head of Rosneft, to expand its joint ventures to drill offshore in the Artic Ocean, to explore for shale oil in Siberia and to cooperate on a liquefied natural gas plant in Vladivostok. This deal came just weeks after the United States imposed sanctions on the personal dealings, though not the corporate activities, of Sechin who is a longtime aide to President Vladimir Putin. Along with Exxon Mobil, British Petroleum and Total of France also signed contracts at the recent Russian business forum in St. Petersburg to explore for shale oil. Furthermore, Exxon Mobil plans to drill its first exploratory well offshore in the Russian sector of the Artic Ocean this summer. Statoil of Norway is in talks for another shale joint venture, Shell’s CEO, Ben van Beurden, met with Putin in April and said to him, “Now is the time to expand”, referring to a liquefied natural gas plant project.

It is acknowledged by many CEO’s who represent global oil and gas companies that they are taking a calculated risk, given the threat of further sanctions, but they also want to protect their long-term interests in Russia, the world’s largest energy exporting nation. According to David Goldwyn, who served as the State Department’s special envoy and coordinator for international energy affairs during President Obama’s firs term, “They are likely to continue to engage until there is a clear policy signal that they should stop. It is not rational to think they would act in any other way. If the government wants them to stop, it needs to say louder that they should stop.”

So far, the United States and the European Union have imposed only limited sanctions aimed at individual Russians and a handful of companies. The existing sanctions don’t explicitly bar the energy giants from operating in Russia. Though President Barack Obama authorized an executive order on March 20th, 2014 that could outlaw such deals, it has not yet been put into effect by the Treasury Department.

The risk for energy companies is that the next stage of sanctions will be broader, cutting off dealings with major sectors of the economy like finance, metals and energy. The United States and its allies proposed these kinds of sanctions at a Group of Sevens summit to be carried out if the violence in Ukraine did not subside (one month time frame).

The energy companies are walking a fine geopolitical line and are betting that the Russian oil and gas industry won’t be hit by direct sanctions. The energy industry provides financing for the Russian government and its military, making sanctions a threat to action in Ukraine, but the United States and Europe should tread cautiously given the industry’s strong role in affecting world markets. In short, most analysts and corporate CEO’s believe that Russian energy companies like Rosneft are too big to punish.

With Russian-West tensions at an all-time high, Moscow has started to look closer to home for partnerships and recently secured a 400 billion contract to supply natural gas to China. Furthermore, Gennady Timchenko, President Vladimir Putin’s key person for developing ties with China, stated publically that Russia could also import technology from China that would be very beneficial to Russia’s oil and gas industry.

Over the course of 30 years, the 400 million deal will involve piping natural gas from Russia’s Far East to China starting in 2018. There was initial skepticism that the deal would come to fruition because for almost two decades China and Russia slowly moved along the path of energy politics, attempting to carve out their respective roles. Russia wants to sell, the “voracious” Chinese market needs to be satisfied as millions of Chinese are moved out of poverty and into the middle class. Between 2006-2013 Chinese gas demand tripled from 56 billion cubic meters to 169 billion cubic meters, China is set to receive 38 billion cubic meters of gas under the deal over a 30 year arrangement starting in 2018. Such a deal reflects Putin’s assessment that “our Chinese friends drive a hard bargain” but “we managed to settle on contract terms that are not just acceptable conditions, but actually satisfy both sides.” All I will say to Putin is be careful that the Chinese do not try and re-negotiate the deal at a later point in time.

According to analysts, the Chinese-Russian 400 billion energy deal has made it imperative for European countries to diversify their gas imports away from Russia. Gazprom has kept an eye on Europe in terms of their desire to find other markets and the Chinese arrangement in that sense works out perfectly as it provides Russia’s energy industry an outlet to sidestep any kind of dependency and offers options for developing the Russian Far East which is a much neglected part of the Russian Federation. A huge investment will be required, but it is a gamble Putin is willing to take. From the Chinese perspective, natural gas is seen as vital to curbing China’s pollution problem which has caused many affluent Chinese to leave the country and settle elsewhere. This issue will continue to be on the reform agenda for some time given that Premier Li Keqiang has called for a “war on pollution.”

The other side of the deal is what it will do to other exporters. The United States is pertinent in this regard. The shale gas revolution not only weaned the United States off of any pending sense of energy dependence, but allowed the United States to turn its eye towards becoming a key supplier of natural gas to the East Asian region and Europe. In fact, in 2012 Barack Obama claimed that the United States was becoming “the Saudi Arabia of natural gas.”

The Russian-Chinese energy pact is Moscow’s statement to Washington that it too has an interest in the Far East and Asian markets. Some analysts allege and try to identify a Cold War Mentality in the deal, indicating the pedigree of Gazprom’s managers and the alleged shadow of the KGB. They allege that the “New Cold War is in part a struggle for market share.” Russia is building its clout as an energy supplier while diversifying its customer base.

While the Obama administration has tried to curb Chinese ambitions in the Asia-Pacific region with its statement of a “pivot” to the region, the Russians are exerting a tremendous amount of patience and resourcefulness in an effort to forge alliances and potential new energy markets. It can be inferred that other deals are bound to follow in an effort to exert energy independence and identify new sources of energy markets with countries such as India, Japan and South Korea, Furthermore, the 400 billion deal between China and Russia to supply 38bcm of natural gas a year has been widely interpreted as setting a new bench mark for what the Asian market can pay for gas. While the price was not disclosed, sources have put the price around $10 per million British thermal units which is close to what Russia receives for supplies sent to Europe. An improving Russian economy will allow its limitless resources to enable the country to emerge as a major gas supplier to the Asia Pacific as well.

Finally, some Russian analysts have criticized the China-Russia deal believing that the deal was rushed through to neutralize worries of political isolation and to convey the impression that Russia can easily switch sales to the East. Mr. Putin’s arch critic Boris Nemtsov said that the terms, to the extent that they are known, amount to “total loss and robbery” leaving Russia to foot the bill for $55 billion of investment needed to find the gas and build the pipeline infrastructure.

It will be 4-6 years before any gas is shipped to China. The Kremlin said that China may advance up to 25 billion to help defray the costs, but has conceded that this is not a fixed obligation, a point that has been widely discussed on Russian blogs, The haggling on terms has been contentious because, according to Putin, “Our Chinese friends are difficult, hard negotiators.”

In the Russian Federation, people have been funneling their money into usable assets like fridges, computers or cars. This effect has kept the country afloat for now and should prevent contradiction of GDP this year. The IMF expects growth in Russia to be .2pc this year, but figures could be worse if major sanctions go into effect. Therefore, Russia’s shale gas revolution presents many opportunities and challenges for the nation as it seeks to expand its role as a global energy superpower and create viable economic and political relationships.