International  Partnership  and  the  Future  of  Russian  Oil  and  Gas  James  Henderson    May  2014  

Structure  

  Current  issues  for  the  Russian  oil  sector  

  Areas  of  IOC  par�cipa�on  

  Challenges  for  foreign  partners  in  Russia  

  Some  thoughts  on  addressing  the  risks  

2  

The  oil  sector  underpins  Russia  

  The  oil  sector  makes  by  far  the  largest  contribu�on  to  Russian  budget  revenues,  dwarfing  the  gas  sector  

3  

0

2

4

6

8

10

12

14

2010 2013 2015 2020 2025 2030

Prod

ction  (m

mbp

d)

General  Scheme  (High) General  Scheme  (Low) EIA

Russia’s  oil  production  outlook  

  Maintaining  Russian  oil  produc�on  above  10mmbpd  is  becoming  more  challenging    IOCs  will  be  important  contributors  of  technical  experience,  management  exper�se  and  financing  for  difficult  projects    Partnership  is  vital  to  the  future  of  Russia’s  oil  (and  gas)  sector  

4  

Source: Ministry of Energy, General Scheme of Development of Oil industry to 2020, EIA International Energy Outlook 2013

Enhanced recovery at

existing fields

Arctic offshore

Tight Oil

East Siberia

Black Sea and Barents Sea

Russia  has  an  oil  tax  problem  

  Russian  oil  produc�on  would  already  be  in  decline  if  tax  concessions  had  not  been  made  to  specific  types  of  projects    Produc�on  must  not  be  allowed  to  fall  below  10mmbpd  or  the  tax  revenues  problem  will  be  compounded  

5  

Tax concessions have underpinned stable oil output

Source: Mitrova 2014

The  Russian  gas  sector  is  adapting  to  a  new  role  SUPPLY SOURCES:   2002   2008   2012   2013

Gazprom production   522   550   487   487 Non-Gazprom production   73   114   169   181

Central Asian imports   34   68   29   33 TOTAL   629   732   685   701

MARKETS:        Russian gas demand (UGSS)   412   462   465   461

Exports to CIS countries   89   89   63   57 Exports to Europe (physical Russian gas)   129   159   139   162

LNG Exports to Asia   0   0   14   14 TOTAL   630   710 681   694

Source: Gazprom

  Gazprom  and  gas  sector  have  had  to  balance  poli�cal  and  commercial  objec�ves,  but  this  is  becoming  increasingly  difficult  

  Gazprom  has  lost  a  significant  amount  of  control  over  the  Russian  gas  matrix  

  Russian  gas  sector  will  need  to  generate  more  budget  revenues  while  adap�ng  to  increasingly  compe��ve  global  market  

6  

W. Canada shale

US shale

Argentina shale

Brazil pre-salt

E. Siberia

Sakhalin

Queensland CBM

N. / N.W. Australia

E. Africa Offshore

W. Africa

N. Africa

E. Med.

Middle East

N. Sea

Barents Sea

Yamal

W. Siberia

SE Asia

Caspian Europe

Asia

Is  Russia  becoming  the  global  gas  swing  producer?  

China Shale Gas

Source: WEO 2013

0

100

200

300

400

500

600

700

800

900

1000

2012 2020

bcma

Gazprom Independents Total  Demand

Russia’s oversupply of gas

7  

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

mmbp

dA  short  history  of  IOCs  in  Russia  

8  

Competition for ROC equity –

IOCs not wanted

Technology and finance needed -

Offshore and tight oil JVs

Technology and finance needed – JVs

and initial PSAs

Soviet Period

Privatisation Increased

State control Consolidation

Major governance issues and

economic crisis – IOCs not interested

Consolidated ROCs - Limited equity sales to IOCs

Corporatisation

IOC  activity  in  Russia  in  2014  

9  

Black Sea Exploration

Yamal LNG

Tight Oil

Barents Sea Exploration

South Kara Sea Exploration

Sea of Okhotsk

Sakhalin production and development

Laptev and Chukchi Sea Exploration

Arctic partnership

East Siberia JV

Tight Oil

19.75%

16%

Equity stakes

Gas

Brown�ield  recovery  through  EOR    Difficult  to  recover  reserves  account  for  62%  of  Russian  total  

  IEA  es�mates  that  EOR  could  account  for  500kbpd  of  output  by  2030  

  Enhanced  waterflooding  techniques  and  reservoir  management  already  in  use    Water  cut  averages  80%  

  Ter�ary  methods  gradually  being  introduced  as  tax  incen�ves  increase  

  Interna�onal  techniques  brought  by  IOCs  and  service  companies  

10  

Russia’s oil is getting more difficult

Reserves Production

Source: E&Y

Tight  oil  developments  for  medium  term    Expecta�ons  for  unconven�onal  oil  are  running  high    Largest  prospec�ve  resource  base  in  the  world  

  The  Bazhenov  shale  is  current  focus  

  Exxon,  Statoil,  Total  and  Shell  all  have  JVs  with  Russian  companies  

  Produc�on  es�mates  range  up  to  1.5mmbpd  by  2030  

  Many  issues  need  to  be  resolved    Tax,  service  industry  capacity,  technology,  funding  

  Commercial  environment  not  conducive  to  fast  development  

11  

0

200

400

600

800

1000

1200

1400

1600

1800

2015 2020 2025 2030

kbpd

Rosnedra RF  MoE

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

0

5

10

15

20

25

30

2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E 2015E

mm  m

etres

mm  m

etres

Drilling  (LHS) Horizontal  (RHS)

Output expectations from shale oil

Drilling set to increase sharply

Source: OIES

Source: Rosnedra, RF MoE

Arctic  exploration  –  long-­‐term  upside    Arc�c  explora�on  set  to  begin  in  August  2014  

  Rosne�  the  leader,  with  huge  acreage  posi�on  

  JVs  signed  with  ExxonMobil,  Statoil  and  ENI  

  South  Kara  Sea  the  ini�al  focus,  with  IOC  involvement  vital    Technology    Experience    Funding  

  Huge  commercial  and  geo-­‐poli�cal  significance  

  Vital  for  Russia’s  long-­‐term  produc�on  profile  

12  

West  Siberia,  147.9

Other  Russia,  120.6

Alaska,  77.9

Greenland,  51.7

Other  ,  53.2

Russia owns 60% of Arctic resources

1mmbpd of output estimated by 2035

Source: E&Y

Source: USGS analysis

Black  Sea  is  an  area  of  increasing  strategic  importance,  with  exploration  and  pipeline  activity  

Russia

Ukraine

Turkey

  Russia’s  involvement  in  Black  Sea  explora�on  has  become  a  more  sensi�ve  issue  

  The  South  Stream  pipeline  will  become  a  major  strategic  asset  partly  funded  by  European  companies  and  causing  fierce  debate  with  the  EU  

South Stream Pipeline

Eastern  partnership  becoming  a  greater  focus,  with  export  sales  and  �inance  the  key  drivers  

  Development  of  Russia’s  eastern  regions  a  domes�c  priority  

  Asia  to  become  a  vital  source  of  extra  export  revenues  

  Oil  produc�on  and  exports  set  to  rise  based  around  ESPO  pipeline  

  Gas  export  deal  with  China  to  catalyse  eastern  gas  programme  

  Foreign  partnership  focused  on  Chinese  and  Japanese  companies  

  IOCs  involved  in  Sakhalin  and  could  have  a  greater  role  to  play  as  region  developed  

14  

0

500

1000

1500

2000

2500

kbpd

Other

Irkutsk  Oil

Slavneft

SurgutNG

TNK-­‐BP

Rosneft

ESPO  Capacity

Eastern oil production to fill ESPO

Eastern gas programme to cost $80-100bn

LNG  developments  –  technology,  marketing  and  �inance  all  needed  from  foreign  partners  

  LNG  has  become  a  priority  in  the  gas  sector  as  Russia  seeks  to  confirm  its  role  as  a  global  player  

  Interna�onal  partnership  is  vital  to  the  development  of  new  LNG  schemes  

  Gazprom  is  facing  a  challenge  from  domes�c  peers  with  IOC  support  

15  

Yamal LNG – 16.5mmt CNPC - 3mmtpa Negotiations with European and Asian traders

Sakhalin 1 – 5mmt SODECO – 1mmtpa Marubeni – 1.25mmtpa Vitol – 2.75mmtpa

Sakhalin 2 – 10mmt Various Asian buyers Potential for 5mmt expansion

Vladivostok LNG – 10-15mmt

Chayanda

Kovykta

38bcma to China

Pechora LNG – 2.6mmtpa ?

Leningrad LNG – 10mmtpa ?

Gazprom

Novatek

Rosneft

S-K

-V

Shtokman - 15mmtpa in Phase 1?

Financing  of  projects  will  be  a  key  issue    Development  of  Russia’s  emerging  regions  implies  huge  capital  expenditure  

  Project  financing  will  be  a  necessity    

  A  spread  of  interna�onal  lending,  IOC  equity  investment  and  state  support  will  be  needed  

  Banks  will  always  be  more  prepared  to  lend  if  partners  have  credibility  and  experience  

  Poli�cal  uncertainty  clearly  a  key  risk  –  IOC  presence  can  offset  this  to  an  extent  

16  

-­‐50%

-­‐30%

-­‐10%

10%

30%

50%

70%

90%

-­‐40.0

-­‐20.0

0.0

20.0

40.0

60.0

80.0

Rosn

eft

Gazp

rom

LUKO

IL

Nov

atek

Net

 Deb

t/Eq

uity

US$

bn

RR  Debt Non-­‐RR  Debt Net  Cash Net  Debt/Equity

Major ROC debt positions – Rosneft’s burden is heavy

Almost $2 trillion of investment needed to 2035

Source: IEA WEO 2011

Source: Company IFRS accounts

Russian  Business  Environment  –    The  “Triangle  of  Tension”  

Poli�cs  

Managed  Tension  

Vested  Interests  Business  

17  

Russian  Business  Environment    

……  characterised  by  complexity  and  ambiguity:    Fac�onal  and  fragmented;  managed  tension  between  fac�ons;  trade  offs  but  not  always  connected  business  and  interests    Tenacity  –  determined  and  persistent    Confronta�onal  and  aggressive        Conflict  and  mistrust  are  the  norm    Unconven�onal  business  model  –  not  linear  and  not  transparent    ‘Win  lose’  is  preferred  outcome  …..the  partnership  model  in  Russia  is  compe��ve  -­‐  specifically  compe��on  for  knowledge   18  

Theoretical  context  for  FDI  in  a  weak  state  environment  

19  

Ownership

Internalisation

Location

Local Knowledge

Foreign Partner

Host Country

Domestic Partner

Joint Venture Theory

Weak State / Local Knowledge Theories

Bargaining Theories

FDI in Resource Sector Theories

Key  Themes  from  Case  Studies  and  Interviews    Key  themes  from  1990s  included:    Foreign  partner  brought  a  combina�on  of  technology,  management  skills  and  money  

  Domes�c  partner  brought  access,  assets  and  local  knowledge    Transfer  of  knowledge  tends  to  be  a  one-­‐way  process    DP  local  knowledge  is  an  asset  to  a  JV  but  also  a  key  risk  for  the  FP    In  any  conflict  over  JV  issues  the  DP  normally  wins  

  Interviews  from  2000s  confirmed  that:    The  business  environment  for  interna�onal  partnerships  in  Russia  has  not  changed  drama�cally  over  the  past  decade  

  Ins�tu�ons  remain  weak  and  dominated  by  key  individuals    Business  outlook  remains  rela�vely  short-­‐term  as  faith  in  reliability  of  laws  and  regula�ons  remains  low  

  Status  quo  unlikely  to  change  soon,  as  it  benefits  the  domes�c  elite    Local  knowledge  and  influence  remain  vital  commodi�es    Interna�onal  skills  and  work-­‐force  not  always  welcome,  which  can  undermine  foreign  partner  posi�on  

20  

Survey  of  partnerships  provided  objective  con�irmation  

21  

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Rank  Score

Initial  Control Final  Control

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Rank  Score

Initial  Control Confidence

FP initial and final control

FP control and confidence

  Foreign  partners  in  33  joint  en��es  surveyed  

  Confirmed  that  domes�c  partner  learning  took  place  and  was  encouraged  

  FPs  learning  iden�fied  through  change  of  control  over  key  responsibili�es    No  significant  change  iden�fied  

  Remained  strong  in  original  areas,  made  no  progress  on  local  knowledge  issues  

  No  gain  in  confidence  either    Related  to  internal  partnership  issues  as  no  change  in  external  environment  

  However,  there  was  a  range  of  FP  performance  around  this  average  

More  local  knowledge  =  more  success  Overall  Model  explains  61%  of  FP  success  FP  success  =  K  +  (0.46  x  Increase  in  Local  Knowledge)  +  (0.32  x  DP  Success)  –  (0.31  x  State  Influence)  For  every  25%  increase  in  FP  Local  Knowledge  his  chance  of  success  goes  up  by  12%  

22  

Joint  Venture  Model  explains  58%  of  FP  success  in  JVs  FP  success  =  K  +  (0.63  x  Increase  in  Local  Knowledge)  +  (0.31  x  DP  Success)  For  every  25%  increase  in  FP  Local  Knowledge  his  chance  of  success  goes  up  by  16%  

The  Corporate  Model  makes  a  significant  contribu�on  to  FP  success  on  its  own  Joint  en��es  using  a  corporate  model  are  sta�s�cally  more  successful  than  normal  JVs,  but  no  other  factor  makes  a  significant  contribu�on  

Managing  Risk  and  Protection  -­‐  Principles  

  What  you  see  is  not  what  you  get    What  is  really  happening  vs.  what  you  are  being  led  to  believe    Understand  interfaces  and  mo�va�ons  –  the  real  drivers    Always  triangulate  poli�cs,  business  and  vested  interests  to  build  an  integrated  picture  (be�er  than  75%)….and  develop  a  response    Persistence  is  key  to  protec�ng  yourself  

Bo�om  line:  Difficult  to  manage  and/or  nego�ate  if  you  don’t  understand  the  drivers  and  what  is  really  mo�va�ng  a  decision     23  

Foreign  Entities  in  Russia  –    Common  Mistakes    

  Over-­‐reliance  on  intermediaries  who  promise  understanding  of,  and  access  to,  key  decision  makers  but  who  cannot  deliver    Overconfident  senior  leadership  who  underes�mate  the  level  of  complexity  and  ambiguity    Misunderstanding/  misinterpre�ng  the  signals  due  to  poor  intelligence  –  send  and  receive  capability    Quality  of  human  resources  you  have  on  the  ground  in  Russia  –  do  they  really  have  insight  into  what  is  happening?    Lack  of  persistence  in  protec�ng  and  defending  yourself    Complacency  and  arrogance  once  you  have  established  a  foothold  

24  

Key  Moments  in  the  History  of  TNK-­‐BP  

BP buys 10% in Sidanco

1997 2011 2003

BP increases Sidanco stake to

25% TNK-BP formed

Shareholder dispute resolved

and TNK-BP stabilised

2008

TNK-BP buys BP Intl assets

(Vietnam/ Vzla)

Sakhalin exploration agreements with Rosneft

Arctic Cooperation Agreement

with Rosneft

BP participates in Rosneft

IPO

Strategic Alliance with Rosneft announced

2012

BP announces potential sale of its 50% stake in TNK-BP

Rosneft purchases

100% of TNK-BP from AAR

and BP for $55bn

Strategic Alliance with

Rosneft lapsed

AAR / TNK-BP minorities

litigation

2006 2001

Shareholder dispute with

AAR at TNK-BP

2007 2010 2013

Bob Dudley leaves Russia

Everything  revolves  around  Foreign  Partner  Relevance   26  

The  “7  Rs”  Engagement  Strategy  

Relevance Relationships

Reality

Rigour Reciprocity

Renewal

Resourcing

Protection Proactivity

Conclusions    Never  underes�mate  the  degree  of  complexity  and  ambiguity  or  be  complacent  –  Russians  have  a  strong  sense  of  when  and  where  a  partner  is  weak  –  and  they  will  fully  exploit  it    Russian  partnership  model  is  compe��ve,  specifically  compe��on  for  knowledge    In  a  weak  state  environment  balance  can  only  be  maintained  if  a  FP  gains  local  knowledge    It  is  vital  to  understand  the  business  and  poli�cal  environment  and  your  partner’s  key  drivers  as  fully  as  possible    This  requires  an  integrated  engagement  strategy  –  7Rs  Model    to  ensure  con�nuing  relevance  and  balance  in  the  rela�onship      

27