The Russians Push North in Search of Energy
As you read this, I am somewhere over the Atlantic in route to Moscow. Unlike the unseasonable weather we've been having in Pittsburgh, this is real winter I am flying into.
It's not as bad as the last time you came along with me to Mother Russia, almost a year ago to the day. Moscow has had some snow for a while, but the daytime temperatures have been climbing to about 0° C.
But it's not the capital city that I'm worried about.
My primary purpose on this trip is to assess the progress the state energy majors – Gazprom and Rosneft – are making in their push north.
“Arctic Circle and beyond” north.
Now, I have no intention of going up to the “roof of the world” myself, although there is an offer on the able to meet some company folks in Murmansk (the largest community above the Arctic Circle).
I think a week in Moscow will be just fine, thank you.
Russia's Policy Problem
Now both of these companies are available for retail investors in the U.S. only over the counter, through American Depositary Receipts (ADRs) on London or Frankfurt issuances. But both Gazprom (OTC: OGZPY) and Rosneft (OTC: RNFTF) receipts trade at considerable premiums to the Russian domestic shares, making them less attractive for purchase in New York.
In any event, I am not focusing on their stocks this time around. There is a far more pressing matter.
You see, Russia has painted itself into a policy corner, and it is now trying to wriggle out. The Kremlin changed laws a few years ago to prevent any development of the continental shelf by anyone other than a company that:
(1) is controlled by the state; and
(2) has at least five years experience in offshore development.
Well, those who qualify can be counted on two fingers. They are (you guessed it):
- Gazprom, the world's largest natural gas company. The company also has a division, Gazprom Neft, which has developed into a top-five Russian oil developer in its own right; and
- Rosneft, the largest oil company in Russia.
Aside from the government pulling their corporate strings, the problem is that the two companies have neither the technology nor the capital to avoid a rapidly developing decline in Russian oil production.
An Important Question on the Arctic
Just before I left the United States, I got a question from subscriber Stefan P. about Arctic production and its required technologies.
Stefan, it seems I am flying right into the first attempt to answer that very question.
First off, here is what we do know.
The U.S. Geological Survey (USGS) released its much-anticipated Circum Arctic Resource Appraisal (CARA) a few years back. It confirmed what many of us had assumed for some time.
CARA concluded that about 84% of undiscovered oil and gas is offshore, and much of it is located in three very large basins north.
Again, way north.
And Russia controls access to at least two-thirds of this largesse. However, it is positioned in some of the most hostile environments ever experienced by engineers.
It is also going to be the most technically challenging and expensive series of development programs ever attempted anywhere. And Moscow has no choice.
To offset a crude oil and natural gas production decline that could reach 8% a year within a decade, Russia needs to move into eastern Siberia, to the northern Yamal Peninsula and further icy waters, and out onto the continental shelf of frozen Kamchatka, Sakhalin, and Chukotka.
These regions could likely yield a great deal of crude oil and natural gas, but it will be an enormous undertaking coming at extraordinary expense.
There are No Other Options
The main production basins in Western Siberia, the heart of Russian oil and gas production, are drying up. While some reserves are available elsewhere, only one place carries the promise of enough new volume to reverse the trend.
The far north.
The problems besetting Moscow are twofold.
First, the country can't afford this level of investment. Second, Russia does not currently have the expertise to develop this level of production, even though it has managed to put itself in a statutory straightjacket in its attempt to push north anyway.
Russia needs foreign help, foreign experience, and, most important of all, foreign money. Yet as I said, the present legislation excludes outside companies from providing anything other than services to Gazprom or Rosneft.
And that simply is not enough.
An international major enters expensive new projects to book reserves. That means the company wants to acquire control over a portion of the oil or gas so that it can record those hydrocarbons as resources under its ownership. This is necessary to support share prices, especially under SEC rules in the United States.
Nothing under current Russian laws satisfies what an outside company requires.
Now Exxon Mobil Corp. (NYSE: XOM) has recently entered into a highly publicized joint arrangement with Rosneft to develop areas of the Russian Arctic. But nobody knows what that really means, given the limits on foreign companies working on a Russian shelf.
Veterans both inside Exxon and outside are divided over whether anything of consequence will happen. Even if the laws are revised, Russia will not cede control of these areas to any company other than those run by the government. This is clearly framed as a national security issue.
So an impasse remains… and the clock continues to tick.
Well, I have a proposal to get around some of this. It involves a new way of looking at project finance. And while not realizing it, you have been with me while it has been developed.
Over the past six months, I have brought you along on my trips to Athens, Rabat, London, Mexico City, Krakow, Frankfurt, and now Moscow. Each has involved discussions of setting up the required network to meet the funding and logistical problems meeting me when I get off the plane this time.
Now it is time to see if the idea has any “real-world” traction.