The psychological effect of EU sanctions, as much as the specific effect of them, is causing companies to hesitate when getting involved in any transactions with Russia, James Henderson told EURACTIV Czech Republic in an interview.
James Henderson is a senior research fellow at the Oxford Institute for Energy Studies. He has analysed the Russian oil and gas industry for the past 20 years. He spoke to EURACTIV Czech Republic’s Adela Denkova.
In July, the EU adopted sanctions against Russia which, among other measures, limit its access to capital markets and to sensitive oil technologies. How powerful are these measures in combination with other sanctions from the US? Will they have a significant impact on Russia’s energy sector?
In the short term, I think the financial sector sanctions will be a harder blow than the oil sector ones. The energy sector measures are still rather unclear in terms of which particular projects are included and which are not. Certain companies will want to bypass the sanctions and, in the end, certain projects may be able to bypass them. The projects that are being targeted are also relatively long-term.
Unconventional oil in Russia and offshore oil in the Arctic have a lot of potential. But they are not going to have an impact inside two to three years in terms of the unconventional oil, or inside 15 to 20 years in terms of Arctic oil.
The implications are potentially serious in the longer term, as Russian oil production from traditional sources is starting to decline, and they need to develop more technically challenging and expensive sources that require partnership with foreign companies.
The other point to make is that partnership with foreign companies does not necessarily mean partnership with western companies. Chinese and Asian partners can also be found, particularly with financing. Then again, the impact of sanctions could be limited in terms of unconventional sources. Obviously, the expertise is with the American and European companies. On the other hand, some of the technologies can be certainly purchased from China.
What will be the impact of the financial sector sanctions?
The reduction in the ability of companies to gain long term financing is important. It is already having shorter term consequences for some companies in Russia. In terms of the energy industry, it can have consequences for financing important projects – for example some LNG projects that Russia wants to develop. It can also have consequences for oil sales.
Some companies that would like to purchase Russian crude oil are not receiving financing from banks, because the financial institutions are concerned about the long term implications of further sanctions. The psychological effect of the financial measures, as much as the specific effect of them, is causing companies to hesitate when getting involved in any transactions with Russia. There is also a specific issue of companies, and particularly banks that will need to be refinanced, and also the additional complication of companies not wanting to get engaged in issues that involve financing. If there is another level of sanctions, they might find themselves stranded with investments they cannot monetise.
Are there any oil and gas projects in particular that could be affected?
In the gas sphere, there is, for example the Yamal LNG (liquefied natural gas) project which involves Total, Novatek and also China National Petroleum Corporation. Project financing has become more difficult with western institutions and the companies had to turn much more to the East for Chinese bank investments. That is not impossible to achieve, but you become more exposed to different markets, and negotiations can prove to be more difficult. In public, Total has questioned the desire to aggressively invest in Russia in the short term. There are some possibilities of delay with this project.
Another example is Exxon’s involvement with Rosneft. Rosneft itself has said there was a possibility that some of their projects may have to be delayed. These projects involve drilling in the Arctic and a project to test the potential for unconventional oil in West Siberia. It also potentially involves investment in further development of the Sachalin I fields in the Far East. It means you have three projects where Exxon is involved and that may be delayed, or at least reconsidered.
Regarding unconventional oil, there are projects by Total and Lukoil which may have to be delayed as well. There is also a question mark over Shell and its Salin unconventional project. Both Eni and Statoil made commitments to drill with Rosneft offshore. It is less specific than the commitments from Exxon. But again, it is a sort of project that may have to be pushed back if the current environment continues for much longer.
The Foreign Ministry of Russia has claimed the energy sanctions would lead to an increase in oil prices for Europe…
I think they essentially meant that if you reduce global supply, or the potential of that supply, and increase the risks for oil producers, the market will eventually lift prices. That is quite a long term argument, because at least at the moment, nobody is suggesting stopping buying Russian oil or gas. They only suggest that Europe and the US will inhibit the ability of Russia to develop its business in the longer term. The EU and the US are trying to avoid a short term negative impact of sanctions on the countries imposing them. The oil price has not really reacted that significantly to the current crisis. It had a spike, and then it came back.
Europe’s future direction
What are the current and future challenges for Russia in its EU energy relations?
The overarching challenge is the future of gas in Europe. Russia is looking at the European energy policy and trying to work out where gas fits into the mix. There has been a drive towards renewable energy, which is understandable, as it is one of the possible ways to meet both environmental targets and security of supply target. Recently, we have also seen the return of coal to Europe. Gazprom is trying to understand where European demand is going to go. It can see very clearly that production is going to decline and imports are likely to increase. But who is it competing with to export gas to the EU and under what pricing scenarios? I think that it is trying to work out how much LNG is really going to be available and at what price, figure out the US action in terms of exports, and what the reaction in Europe is going to be to new supplies from unconventional sources.
I think Russia feels itself to be in a fairly powerful position in all those areas. On the other hand, even in a relatively powerful position in terms of supply viability, the next challenge is to deal with the European competition policy – the Third Energy Package particularly – and fully understand what the European legislation is going to mandate. European legislation has some principles in terms of third party access or unbundling, but these specifics have not been fully established yet. Thus, Russia is quite understandably concerned about what impact it will have on its contracts and its ability deliver gas to consumers. It is still in a situation where it is looking for greater certainty about how the market will operate. If the market does come to operate in more liberal fashion and if Gazprom does have to change the way it prices, transports and delivers its gas, it is going to be a challenge to be resolved.
Any examples of this uncertainty?
In terms of its future investment – South Stream, for example – it has been a challenge from the Russian perspective to understand what the EU legislation is going to allow to do with gas coming through that pipe. The question is whether the EU ultimately wants to see new pipelines being built from Russia, or whether it does not and if the EU and its various members have similar views on security of supply. If you look at the Ukrainian transit question, countries in south-eastern Europe have a different view of Ukrainian transit risk than countries in north-west Europe. Russia is trying to understand the balance of various directions within the EU.
Asia on the Rise
What is the role of the Asian market in relations between the EU and Russia?
The question for Russia is how much focus to place on ensuring growth in its European market as opposed to investing in expansion towards Asia. There is only a limited pot of money. At the moment, the answer appears to be a greater interest in Asia, because the market is growing much more rapidly than in Europe.
Russia has currently a limited exposure, and following the recent deal with China, it has a commitment to sell a significant amount of gas to Chinese market. There is also a potential for the LNG project to serve the Asian markets. We are going to see a shift in strategy towards the Far East. We have seen this shift in coal and oil sector already. Now there is a question for Russia to balance its exposure to both markets – that means increasing exposure to Asia and maintaining exposure to Europe until there is a level playing field.
Is Europe a more reliable energy partner for Russia than the Asian countries?
I do not think there is much doubt about Europe being a secure partner in terms of the current contracts. I also do not think there is any question that Europe is going to renegotiate its entire relationship with the Russian gas industry. The real question with Europe in the longer term is its real intentions towards gas, and particularly towards Russian gas.
Russia must decide whether to focus on having gas available for growing exports into Europe, or whether to focus on Asia, where there are clear uncertainties in terms of bargaining power and competition as well. In Asia, the growth of the market is much stronger and opportunities for suppliers are much greater. That mitigates some of the risks from Europe, where the market is relatively stagnant. The risk for suppliers is not just the market risk and changing market circumstances. In Asia, there is a market risk, but it is also a risk in a very different market dynamic.
Is it better for Russia to keep relying on pipelines or is there potential for Russian LNG?
The Russian view on pipelines is quite interesting, because pipeline gas is seen as a security of supply risk for Europe. Quite clearly, a pipeline can get cut. From the Russian perspective, pipeline supplies also mean a security risk. They only link you to a small group of customers. If that group has a problem with your gas or your price, you are very exposed to them.
With LNG, you can send your gas wherever the customer will buy it at whatever price. From a diversity of demand perspective, Russia is keen to develop LNG to gain more flexibility in terms of customers it can offer it to. There is a very clear political drive in Russia to increase LNG – not only to say that Russia is truly global gas player, but also to reduce the risks of gas suddenly being stranded because someone decides to adopt a different energy structure.