Russia’s Yamal gas project navigates ice and sanctions

Russia’s Yamal gas project is so far inside the Arctic Circle that purpose-built ships have been built to plough through 2m-thick ice to reach it, and construction has taken place during days that can last as little as three hours in temperatures that can fall below minus 50C.

But the hostile environment that surrounds Yamal has failed to deter its foreign investors. France’s Total and China National Petroleum Corporation each own 20% of the landmark liquefied natural gas project, which began operations this month after overcoming both the natural elements of its location and the hurdles of doing business in Russia during its worst relations with the west since the cold war. For Russia’s energy industry, the $27bn Yamal project has been both a technical and political test. Not only has it aimed to prove the viability of producing LNG just 2,000km from the North Pole and shipping it to China through the Arctic, it has also shown that investments can still flow to Russia despite the restrictions on finance and technology caused by US and European sanctions. “A robust project managed to succeed in a difficult Arctic context, despite the complications associated with the impact of sanctions on its financing,” says Mike Borrell, Total’s senior vice-president for exploration and production in Europe and central Asia. “It is a good demonstration of a partnership at work to overcome the hurdles by using to the best advantage the experience and skills of the partners.” That contrasts with similar big-ticket energy projects between Russian and western groups. ExxonMobil’s partnership with Kremlin-controlled oil major Rosneft to spend up to $550m in the Arctic has been put on hold, Royal Dutch Shell has suspended a project with Gazprom Neft in Russia’s largest shale oilfield, and Schlumberger has struggled in its attempts to buy a controlling stake in Russian energy exploration company Eurasia Drilling.

The Yamal project, which is majority owned by private Russian gas company Novatek, was threatened in 2014 when Gennady Timchenko, the company’s second-biggest shareholder, was targeted by US sanctions following Moscow’s annexation of Crimea. That forced a rapid rethink of the project’s financing. Capital expenditure plans on Yamal’s construction were converted from dollars to euros. Chinese banks provided loans to cover two-thirds of its external financing needs. The Russian government and state-owned Sberbank provided the balance. “Yamal experienced some issues when the sanctions were imposed . . . but they worked around them. And when it is fully up and running, this will be the best proof that such investments are possible,” says Ekaterina Rodina, an oil and gas analyst at VTB Capital in Moscow. “If Russia wants to be present in the global LNG market, this is the project that has to work.”
Russia is keen to present its oil and gas industry, which normally accounts for about 40% of the country’s federal budget, as conducting business as usual despite tensions with the US. Imposed in 2014, the sanctions initially caused havoc as Russian companies found themselves cut off from foreign capital. A restructuring of credit and state support calmed fears and energy companies such as Rosneft, Lukoil and Gazprom are pressing ahead with previously announced projects, often without western support. On the whole, US companies, which have previously been major partners for Russian players, have retreated while European companies have been less affected. Meanwhile Chinese financing and investment has helped fill gaps left by western banks. CEFC China Energy paid $9.1bn for a 14.2% stake in Rosneft in September, while other Chinese energy companies have snapped up oil and gas assets, as well as providing project financing. Yamal will increase Total’s foothold in the fast-growing LNG market and also establishes it as a major foreign player in Russia. “Total has been in Russia for more than 25 years and we have learnt how to be Russian in Russia,” says Mr Borrell. “Russia is an important country for the oil and gas business and Total needs to have a clear position and be present for the long term.”

Novatek, second only to state-controlled Gazprom in Russia’s gas market, will sell LNG produced this year at Yamal on the spot market, while long-term contracts will start in 2018. The bulk of the 16.5m tonnes of gas produced each year will be sold to Asian customers, the company says. That will mean that between July and December, the 15 purpose-built ice-breaking gas tankers will sail east through the Arctic to China. The two-week journey is roughly half the time that it will take during the rest of the year, when the gas will be shipped around Europe and through the Suez Canal.

BCS Capital Markets, a Moscow research house, estimates that Yamal LNG will result in a 20% growth in Novatek’s earnings per share by 2020, describing the launch of the project as “a long-awaited catalyst”. The company will take a decision late next year on the investment required for a second Arctic LNG project, pegged at $19bn, on the Gydan peninsula east of Yamal. Novatek’s chief executive Leonid Mikhelson has said up to 49% of the project could be offered to foreign investors, and Total has said it is interested in participating. Russia has also suggested that Saudi Arabian energy companies could be offered a stake in the project. “No one has made such a project before, delivering hydrocarbons from deep inside the Arctic through a sea route on a constant basis. And this is where the risks may stem from. They will be pioneers,” says Ms Rodina. “This is a learning experience for others.”

Source: Henry Foy for the Financial Times

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