Sanctions and the Future of Russian Oil and Gas James Henderson December 2014

Sanctions on Russian oil and gas companies Transneft Gazprom GazpromNeft LUKOIL Novatek Rosneft Surgutneftegaz

US Treasury EO 13662 Directive 2 (Financing)

Yes

US Treasury EO 13662 Directive 4 (Technology)

Yes Yes Yes Yes Yes Yes Yes Yes

US Commerce Dept. Export Controls

Yes Yes Yes Yes Yes

EU Finance Restrictions

Yes Yes Yes

EU Technology Restirctions

Yes Yes Yes • • • • • US and EU sanctions ban transfer of technology for use in Arctic, deep water offshore (>500 feet) and for shale oil development Financial restrictions on access to capital markets – 90 day debt maturity in US, 30 days in EU Rosneft and GazpromNeft the main overlap. No financial restrictions on Gazprom, Novatek hit hard by inclusion on US list Russian banks also targeted with 30 day debt maturity rule in both areas Importantly Australia, Canada, Japan and Norway have also introduced sanctions

Future of Russian oil production – key drivers Black Sea and Barents Sea 14 Arctic offshore 12 10 8 6 4 2 0 Enhanced recovery at existing fields East Siberia Tight Oil 2010 2013 General Scheme (High) 2015 2020 2025 General Scheme (Low) 2030 EIA • • • •

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

Maintaining oil production above 10mmbpd is becoming a key challenge Slow growth from current levels (10.6mmbpd) had been expected This now seems unlikely as new fields are postponed Long-term challenge to enhance existing fields and develop new regions using advanced technology and international experience

Russian GDP, oil production and the oil price

Oil price and Russian Real GDP

14 12 10 8 6 4 2 0

Oil price and Russian oil output

80 60 40 20 0 140 120 100 kbpd Oil Price (US$2013) Tight correlation between oil price, economic growth and oil production

Development of Russian Arctic now in serious doubt

Russia has largest share of Arctic resources Partnership with Exxon has been key focus

Other , 53.2

Greenland, 51.7

West Siberia, 147.9

Alaska, 77.9

Other Russia, 120.6

• • Arctic development a prestige political project for Russia as well as a long term production solution Opportunity to develop world-leading technology in partnership with IOCs and establish important presence in emerging new region • Rosneft will not be able to move forward with plans without IOC support, both financial and technical

Tight oil in Russia will be delayed despite continued enthusiasm

Bazhenov shale extensive in West Siberia Production potential up to 1.5mmbpd

1800 1600 1400 1200 1000 800 600 400 200 0 2015 2020 Rosnedra RF MoE 2025 2030

Source: Rosnedra, RF MoE

• • • • Russia has the largest shale oil resources in the world Bazhenov shale has been know about for years, but foreign partnership needed to exploit it successfully Shell, Exxon, Statoil, Total and BP have all formed JVs, now on hold Russian service companies cannot offer adequate equipment

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Brownfield recovery through EOR is still possible, but western service companies are needed

Russia’s oil is getting more difficult

Reserves Production • Difficult to recover reserves account for 62% of Russian total • IEA estimates that EOR could account for 500kbpd of output by 2030

Source: E&Y

• Tertiary methods gradually being introduced as tax incentives increase • International techniques brought by IOCs and service companies – 95% of horizontal wells drilled by international service companies • Confusion over exact impact of sanctions here – Clarity still being sought concerning equipment with dual uses

Rosneft faces testing financial issues

Rosneft Debt Profile… …and Repayment Schedule

• • • • Rosneft has $66 billion of outstanding debt, of which half needs to be repaid inside two years Ministry of Economic Development believes that access to capital markets could occur in 2016/17 at the earliest Rosneft has applied to National Wealth Fund for more than 2 trillion RUR (c.$44bn) Company is already being forced to re-prioritise projects and seek new partners

Previous gas market developments – rise of Novatek and Rosneft 650

Gazprom output in long term decline… …due in part to increasing domestic competition

30.0% 25.0% 600 • • • • 20.0% 550 15.0% 500 10.0% 450 5.0% 400 0.0% 20002001200220032004200520062007200820092010201120122013 Gazprom has struggled over the past decade, with output hitting a post-Soviet low in 2014 Increasing competition in all the company’s core markets has combined with the economic crisis, US shale gas, low coal prices and increased support for renewables to undermine sales Independent producers in Russia have also been producing more, leaving Gazprom with a significant supply bubble Outlook in Europe and FSU markets related to politics as well as economics

Gazprom faces an uncertain future in Europe – but continued significant gas sales seem inevitable Europe’s Trilemma Energy Security Environment What is Russia’s role?

Energy Cost

Russia offers the cheapest gas supply

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Capex Yamal Full Cost Lifting Cost Gazprom Supply MET Marginal 2013 Russia Export Price Domestic Transport NBP 2014 Export Transport US LNG (HH at $5) Export Tax Total • • • • Ukraine situation creates a clear security of supply risk for Europe this winter In the long-term, does the risk concern Russian supply or Ukraine transit?

The EU appears split over the desirable place for Russian gas as a source of imports – the South Stream debate has highlighted the dilemma Russia’s competitive commercial position is very strong – it has excess gas at a low cost of supply

Russia has called Europe’s bluff and re-focussed on Turkey

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• • •

11 South Stream project cancelled as EU not supportive Alternative pipeline to Turkey proposed Ukraine transit risk left with EU; Russia targets Europe’s only growing gas market, but is this the optimal route?

Russia wants to balance exports between Europe and Asia

Crude oil export strategy Possible outlook for gas exports

200 180 160 140 120 100 80 60 40 20 0 Europe 80% ToP Power of Siberia Altai • • • • Expansion into Asia has always been a sensible strategy for Russia, with action catalysed by the current political situation China offers a huge growth market, but also a dependency risk China has been ambiguous in its support of Russia in 2014, and its gas consumption plans remain unclear Despite the bold talk, the Russian shift East offers little real threat to Europe, as all parties need a balanced supply and demand picture

The switch to Asia triggered a move to LNG, but this has now reverted to a pipeline export strategy Shtokman - 15mmtpa in Phase 1?

Yamal LNG – 16.5mmt

CNPC - 3mmtpa Negotiations with European and Asian traders Pechora LNG – 2.6mmtpa ?

Leningrad LNG – 10mmtpa ?

Chayanda Sakhalin 1 – 5mmt SODECO – 1mmtpa Marubeni – 1.25mmtpa

Vitol – 2.75mmtpa

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

Altai Pipeline

30bcma to China?

Kovykta 38bcma to China 20-30bcma to China Vladivostok LNG – 10-15mmt Gazprom Novatek Rosneft • • • • LNG expansion posed a threat to Gazprom via Novatek and Rosneft Projects now delayed or postponed due to lack of finance, customer commitment and certainty over technology Pipeline strategy suits Gazprom and Russian budget Possibility of new lines to Korea and Japan could extend political reach

140 120 100 80 60 40 20 0 Russian gas is competitive in Asia, and volumes could grow rapidly by 2030

Possible scenario for Russian gas in Asia Cost of supply of alternative gas to Shanghai

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2010 Sakhalin 2 SKV to China 2015 2020 2025 Power of Siberia Sakhalin 2 Expansion Altai Pipe Yamal LNG 2030 • • • Yamal LNG is likely to proceed, but behind schedule, with expansion of Sakhalin 2 another possibility Three pipelines to China are feasible over time, with two already under discussion / agreement Russian gas can be competitive in China / NE Asia, albeit at very modest returns for Gazprom

Consolidation of state control in the oil and gas sector is an ever increasing theme • • • • • Rosneft and Igor Sechin remain very influential, especially in the oil sector Bashneft example demonstrates that loyalty to the current administration is paramount Competition between domestic companies is being discouraged; reform is not on the agenda Rosneft and Gazprom remain at war, but have bee constrained by sanctions and Russian “fortress” mentality Budget revenues under threat from lower oil price, meaning that pipeline gas exports need to become more important over time

State control of Russian oil production

12000 10000 8000 6000 4000 2000 0 2000 2013 Private State-Influenced State-Owned

Russia sits at the heart of the global energy economy – there is growing competition but it has plentiful relatively low cost resources

Yamal Barents Sea N. Sea E. Siberia W. Siberia W. Canada shale Sakhalin Europe N. Africa Caspian E. Med.

Middle East China Asia

Impact of North American markets on price formation

US shale SE Asia W. Africa E. Africa Offshore N. / N.W. Australia Queensland CBM

Russia’s potential eastern gas exports

Argentina shale Brazil pre-salt N. Sea Legend

Established gas export province / flows Emerging gas export province / flows Gas export / import province name Gas import province • Will politics undermine commercial advantages?

• Will lack of finance cause a lack of investment?

• Can Russia move forward without IOC support?