The world’s largest producer of natural gas, Gazprom, plans to significantly expand its extraction activities by 2020. To this end, new gas fields are to be developed in remote regions under challenging climatic conditions. Together with their modern technologies, European partners are welcome to join in, as long as they accept Gazprom’s terms. 09/2008
 At the Urengoy gas field in western Siberia, the temperature remains below freezing 250 days of the year, dropping in winter to 60 degrees below. For 30 years the “gasoviki” have been producing natural gas under these conditions for the domestic market and Europe. Rich rewards have been reaped from Russia’s largest gas field to date: 6,000 billion m3 are said to have been extracted already. However, during the last years the production rate has dropped significantly. So far, the wells drilled by the gas field workers reach down as far as the layers of sandstone that lie 1,200 metres below the surface. In the meantime, there are good prospects for the extraction of big gas reserves from the sandstone layers at depths of 3,500 metres.
Because in July 2008, the German-Russian company ZAO Achimgaz began test operations for natural gas production in the first section of the Achimov horizon in the Urengoy field. Here, the joint venture between the German company Wintershall Holding AG and Russia’s OAO Gazprom is operating a gas processing plant and three gas and condensate wells. A total of 531 million m3 of gas and 188,700 tons of gas condensate is to be produced by the end of 2008. Gas condensate accumulates during the extraction of natural gas and is particularly suited to being refined into fuel.
In developing the Achimov formation the two partners complement each other through their specific fields of expertise. At the start of operations, Hans-Ulrich Engel, Chairman of the Board of Executive Directors of BASF SE, Wintershall’s parent company, noted that ‘Gazprom specialises in producing gas in the extreme north, while Wintershall has many years of experience working in challenging geological conditions. In this ideal partnership risks and rewards are equally shared.’
Achimgaz was founded in July 2003 as a joint venture between Gazprom and Wintershall, each holding an equal number of shares, to develop the first section of the Achimov horizon in the Urengoy field. Over a projected development period of 43 years, which will require investment in excess of €1 billion, a total of 200 billion m3 of gas and 40 million tons of condensate are to be produced. Annual production of up to 7.5 billion m3 of gas and 2.8 million tons of condensate is anticipated.
As project manager, Achimgaz owns the infrastructure on this section of the gas field, while the extraction licence, all rights of title and distribution rights relating to the products extracted are owned by Gazprom. Seventy-five percent of the gas produced by Achimgaz will be sold in Russia and 25 per cent abroad. Profits will be shared by the partners in accordance with their respective stake in the project, i.e. 50:50. Gazprom sees the model adopted here as a template for building relationships with foreign companies, according to Chief Executive Alexei Miller.
Achimgaz has obviously done the pioneering work to develop other major energy reserves in neighbouring field sections; the administration responsible for the Yamal-Nenets region estimates potential reserves in the Achimov horizon of the Urengoy region at 12,600 billion m3 of natural gas, 4 billion tons of crude oil and 2.8 billion tons of gas condensate. ‘We regard these deposits as reserves for extraction in our region,’ explained Vladimir Rylkov, a representative of the regional administration, at the Russian Petroleum & Gas Congress 2008 (RPGC) held at the end of June in Moscow. The Yamal-Nenets region is by far the most important area for the extraction of Russian natural gas. Gazprom is obviously already developing additional sections of the Achimov formation of Urengoi. As the company has announced, by 2010 the annual extraction is to rise to 16 billion m3.
Wintershall and Gazprom are already partners in gas production in the newly developed Yuzhno-Russkoye gas field, which began in October 2007. The operator there, SevernefteGazprom (SNGP), is gradually increasing gas production, so as to reach the planned annual volume of 25 billion m3 by 2009. Wintershall holds a 25% stake minus one share in this Gazprom subsidiary and also holds one privileged share without voting rights, giving it a 35% interest in future profits. In return, Gazprom has been able to increase its access to the German and European market, boosting its own holdings in the jointly owned gas partnership Wingas from 35% to 50% minus one share. It has also received a 49% stake in a Wintershall subsidiary that produces crude oil in two concession regions in Libya.
The gas produced in Yuzhno-Russkoye is fed into Gazprom’s nationwide transportation network and brought to market by Gazprom via a company called Yurgm Trading, which sells half the gas at Russian domestic prices and the other half at the export prices applicable at the German border. To date, SNGP has invested €850 million in opening up gas fields. Wintershall is currently anticipating total costs of €1.9 billion, of which the company will bear 35%, corresponding to its stake. The majority of these costs will be incurred in the first development phase of the project up to 2009. Surprisingly, the two partners are giving quite different details of the natural gas deposits available in Yuzhno-Russkoye. While Wintershall puts the extractable gas reserves at 600 billion m3, Gazprom cites measured gas reserves of 825 billion m3, estimated reserves of 209 billion m3 and crude oil reserves of 5.7 million tons. According to Gazprom, the difference is accounted for by recently measured or estimated reserves.
The Düsseldorf-based group Eon is also currently in negotiation with Gazprom over a minority stake in Yuzhno-Russkoye. The Germans have proposed that the Russians take a holding in power plants in various western and central European countries as well as in underground gas storage facilities. So far, however, the companies have failed to reach agreement over the value of these holdings. In June 2008, Gazprom’s export executive, Alexander Medvedev, pointed out that the price of oil had risen from US$40 a barrel to US$130 since negotiations began. In his view, these market conditions had to be taken into account. ‘This means that pricing conditions and the selection of assets will change,’ he said.
The level of natural gas production envisaged by Gazprom until 2010 is to be secured by means of the Yuzhno-Russkoye and Achimgaz projects alongside new plants at existing production sites. ‘After 2010 the company plans to expand to new strategic areas of gas production on the Yamal peninsula, the Barents Sea shelf, the Ob and Tazov bays, in Eastern Siberia and the Far East’ explained Miller at the general meeting held at the end of June.
Expanded exploration of new natural gas reserves
Nevertheless, the company keeps some surprises up its sleeve. Miller was first to deliver the good news to shareholders at the general meeting that ‘our exploration work increased our gas reserves in 2007 to 592.1 billion cubic meters, which exceeds our production by more than 7%’. In this context, Miller permitted himself a swipe at ‘many other world oil and gas companies, whose average reserve replacement ratios in recent years are less than 90%´. The bad news about Gazprom reserves only becomes apparent by looking at the company’s annual report. According to the report, the natural gas reserves of the world’s largest producer have actually fallen slightly to 29,785 billion m3 for various reasons, including the fact that the company had to surrender 144 billion m3 of natural gas from the giant Shtokman field in the Arctic to the state reserve fund for licensing reasons.
Whether further adjustments will be made to Gazprom’s reserves in the coming years may also depend on the results of the survey carried out by US engineering firm DeGolyer & McNaughton. So far, the firm has examined 95% of Gazprom’s reserves in accordance with the PRMS international standard (Petroleum Resources Management System) and has arrived at a figure of 20,820 billion m3. On the question, what the reason is for the significant difference to the official reserves, Gazprom didn´t give an answer. One possible explanation is that the Russian statistics focus solely on geological criteria, while PRMS also analyses the economic efficiency of extraction.
All the same, Gazprom plans to significantly expand geological exploration. Miller has announced that investment in this area is set to reach RUB 70 billion by 2010 (€1.9 billion)in Russia alone, representing a 250% increase. In addition, Gazprom is already carrying out exploration activities in Vietnam, India, Venezuela, Libya, Uzbekistan, Kyrgyzstan and Tajikistan. Relevant negotiations are currently underway with Turkmenistan, Nigeria and Iran.
670 billion m3 gas production by 2020
Although in the financial year 2007 Gazprom’s production fell slightly to 549 billion m3 in 2007/08 due to a mild winter, Miller is confident that volumes will easily reach 563 billion m3 this financial year, climbing to 615 billion m3 by 2015. Even now, Gazprom has the capacity to expand production by a further 40 billion m3 if needed, he explained. By 2020, even volumes of up to 670 billion m3 are to be achieved.
A considerable contribution to these rising production volumes will have to come from the 26 gas fields that have already been surveyed on the Yamal Peninsula in north-western Siberia. According to Gazprom, they have reserves totalling 10,400 billion m3, allowing an annual production of at least 250 billion m3 after 2020. Gazprom hopes to bring the first section of the major Bovanenkovo field, with an initial annual extraction volume of 15 billion m3, into operation in 2011. In the long term, Bovanenkovo will provide 140 billion m3 of natural gas each year. This way it would reach a similar size as the major field Zapolyarnoye, located more in the south. Zapolyarnoye went into operation in 2001, reached a production level of 100 billion m3 in 2004 and will be expanded by another 30 billion m3 by 2010.
Gazprom is developing another major project, in collaboration with foreign partners, in the Russian area of the Barents Sea, which is part of the Arctic Ocean. Six hundred kilometres off the coastal city of Murmansk, where the icy water is up to 340 metres deep, experts from the Russian exploration firm Sevmorneftegas have so far measured 3,800 billion m3 of natural gas and 31 million tons of gas condensate. The Shtokman gas field, first drilled in 1988, is the largest of its kind in the world. The parent company, Gazprom, spent a long time negotiating with major international oil and gas companies on the joint development of the area before finally deciding to go it alone in October 2006. However, foreign companies are welcome as technology partners in the first phase of the ambitious Shtokman project. The French energy group Total holds a 25% stake in the infrastructure company Shtokman Development and the Norwegian StatoilHydro group holds a 24% stake. Gazprom retains the majority stake with 51%.
Shtokman Development is responsible for project planning, financing, construction and operating the infrastructure in the initial development and production phase. It will own the infrastructure for 25 years from the start of commercial production. This includes the extraction equipment in the sea, pipelines to the coast and the gas processing and liquefaction plants on the mainland. After 25 years of extraction, Total and StatoilHydro will assign their shares back to Gazprom.
Gazprom puts gas production in the initial development phase at 23.7 billion m3 per annum. Deliveries of gas are set to commence in 2013. Annual production could later rise to up to 94 billion m3. This is approximately equivalent to natural gas consumption in Germany. Part of the Shtokman gas is intended for Europe. To this end, a new 2,000-km-long pipeline is to be built through the Murmansk region to the Russian Baltic port of Vyborg. From there, the gas will be transported on to Germany and other European countries via the Nord Stream pipeline through the Baltic Sea. Another part of the Shtokman gas is to be marketed globally as liquefied natural gas (LNG). To this end, a gas liquefaction plant will be built, which is to produce 7.5 million tons of LNG each year from 2014. A final decision on the investment required is due in the second half of 2009.
Through the smaller-scale Norwegian projects at Ormen Lange and Snohvit, StatoilHydro already has experience of natural gas extraction in deep marine environments and under harsh climatic conditions. For Bengt Lie Hansen, President of StatoilHydro Russia, Shtokman opens up a whole new dimension. ‘I call it the “mother of all projects”,’ he said at the RPGC in Moscow. ‘It includes all the challenges I can dream of. But I also think that we have the background to develop it in a proper manner.’
Work on the project is already under way. In July, the Vyborg Shipbuilding Plant started assembling the first of two semi-submersible platforms for drilling production wells on the Shtokman field. The platforms are designed to operate in a harsh natural and climatic environment, and to withstand low temperatures and waves up to 32 metres high. The platforms are capable of performing exploration and production drilling oil and gas wells of up to 7,500 metres at 70-500 metres water depth.
Gazprom is also the coordinator of a largescale state programme to develop the gas industry in eastern Siberia and the Far East. A unified system for extracting, transporting, supplying and exporting natural gas is to be created in both regions. The investment needed in this regard has been put by the responsible authorities at RUB 2,400 billion (€65 billion) to 2030. As part of the project, four new centres for gas production are envisaged: this includes the Pacific island of Sakhalin, where several oil and gas fields are already being developed in the surrounding waters. Yakutia, with its major Chayanda field, the Irkutsk region and the several fields in the Krasnoyarsk region have been named as the other gas production centres. Known fields in the Irkutsk region include the Kovykta field with reserves of at least 2,000 billion m3 of natural gas. In June 2007, following lengthy negotiations and state intervention, Gazprom essentially reached agreement with the British-Russian company TNK-BP regarding the takeover of the Kovykta field. However, there is no final contract to date. Instead, an acrimonious dispute has flared up between the Russian shareholders and BP over the management of the company.
In all four centres, regional systems for processing and supplying gas are to be established. In addition, plans are also in place for natural gas to be exported via pipeline from Sakhalin and Yakutia to the Asia-Pacific region. Exports of LNG are also envisaged from Sakhalin. It will also be possible to feed the gas from the fields in Irkutsk and Krasnoyarsk into Russia’s existing gas transportation system (GTS). The ministry responsible is confident that more than 27 billion m3 of natural gas will be consumed in eastern Russia and 35 billion m3 will be fed into the GTS by 2020. In addition, 25-50 billion m3 of natural gas will be piped to China and Korea, as well as exports of 21 billion m3 of LNG to the Asia-Pacific region.
As part of the Sakhalin II project, two LNG plants with an annual capacity totalling 9.6 million tons are currently under construction. These will supply customers in Japan, South Korea and the US not later than January 2009 onwards. Gazprom acquired a majority stake in the project, which was developed by the oil group Royal Dutch Shell and the Japanese companies Mitsui and Mitsubishi, in April 2007. The construction of further LNG production facilities in the region with an additional annual capacity of 9.6 million tons is now being discussed.
Increasing income from gas sales makes it easier for Gazprom to invest in production, transport and acquisitions. So the company has increased its current investment programme by RUB 112 billion to RUB 822 billion (€22 billion). According to earlier statements, half of Gazprom´s investment flows into the development of the gas transport system. Another 30% is used for gas production. Overall, the company is planning investments of up to RUB10,000 (€272 billion) from 2007-2009.
In addition to its own production, Gazprom is also looking to buy increasing volumes of gas from producers in central Asia. For a long time, the company was able to pay these producers significantly lower prices for their gas than it could fetch on the European market. Now that the central Asian states are increasingly exploring their own export options, Miller has improved his offer: ‘We understand the need to work with European prices,’ he says. Such news is music to the ears of producers in central Asia. In the Ukraine however, where these producers were discovered following the gas crisis in early 2006 as an alternative to Russian suppliers that had abruptly hiked prices, this news may trigger deep concern. At present, the Ukraine buys gas from central Asia at a price of US$180 (per 1,000 m3), negotiations on deliveries after 2009 have been stalled for some months. It is hard to imagine how the Ukraine, which is traditionally dependent on natural gas, will cope with another price shock.
Gazprom is not giving away any further details about how much natural gas it buys each year from Central Asia at the moment. However, it is known that an annual supply of 50 billion m3 has been agreed from Turkmenistan alone. According to Russian press reports, the company buys about 60 billion m3 annually from Turkmenistan, Kazakhstan and Uzbekistan. So as to further expand transportation capacity from Central Asia, plans are in place for the construction of the new Precaspian Gas Pipeline in the neighbourhood of the Caspian Sea. This is set to transport an additional 10 billion m3 of gas from Turkmenistan and 10 billion m3 from Kazakhstan to Russia each year. This Caspian pipeline will compete for gas from Turkmenistan and Kazakhstan with the Nabucco pipeline that European gas providers want to build from this region to Austria.
Furthermore, several companies in Russia which are more or less independent from Gazprom are producing increasing volumes of natural gas. These include the gas producer Novatek, which extracts 28 billion m3 each year, and several oil companies. Privately-owned Lukoil and state-owned Rosneft each produce 16 billion m³ of natural gas per annum, while Surgutneftegas reaches 14 billion m3. According to the regional administration in Yamal-Nenets, the independent producers could produce much more gas if they had better access to Gazprom’s pipeline system and were able to sell their gas on the lucrative export market. ‘Even today their resource base could ensure production of 130 billion m³’, Rylkov explained at the Moscow congress. His presentation showed that only half of this potential is being exploited at the moment.
Another resource to be used in gas production is associated gas, which accumulates during crude oil production. The oil producers, including Gazprom, are obliged by the state to use this gas extensively by 2011. According to conservative estimates, 55 billion m3 of this associated gas is accrued in Russia each year, 20 billion m3 of which is flared off. Russia is still in the early stages of using methane from coal deposits. Gazprom itself is conducting a production trial in the Kusnezk Basin, anticipating that it will be able to obtain 5 billion m3 of methane per annum from 2010.
Miller explained to shareholders that an ‘unusually mild winter in 2006/07’ was responsible for the slight fall in Gazprom’s natural gas sales to 576 billion m3 in 2007 despite this production potential. The company sold noticeably less “blue fuel”, particularly in its home country. The considerable growth in sales in “foreign countries”, which provided for a significant result in terms of profit, could not compensate for this domestic fall. The category “foreign countries” comprises 22 European countries, not including the countries formerly in the Soviet Union. In keeping with these lower sales, own production was also lower than the previous year at 549 billion m3.
Lucrative exports to foreign countries remain a mainstay for Gazprom that it cannot do without. With scarcely a third of its gas sales, the Russian company generated almost half its entire turnover in the gas business. In order to expand exports, Gazprom and its European partners are planning the new Nord Stream pipeline through the Baltic and the South Stream pipeline through the Black Sea which, with transport capacities totalling 85 billion m3 per annum, will pump Russian natural gas to Europe.
The Nord Stream consortium headed by Gazprom, which also includes the German partners Wintershall and Eon and the Dutch company Gasunie, is currently having to battle to gain approval for the project from countries bordering the Baltic. Miller himself has not given a date for the start of the pipeline’s construction or for its completion. According to earlier statements, the pipeline was expected to be transporting Russian natural gas to central and western Europe by 2011, with an annual capacity of at least 55 billion m3 from 2012 upon completion. He has indicated that further expansion may be possible: ‘If needed, the capacity of the Nord Stream pipeline may be further increased in the future,’ says the Gazprom chief.
In the south, Gazprom is preparing for the construction of the South Stream pipeline together with its Italian partner Eni. The pipeline is set to have an annual capacity of 30 billion m³, running through Bulgaria and other countries into Italy and Austria. According to Miller, Gazprom has already signed agreements with Bulgaria, Hungary, Serbia and Greece for the pipeline. Arrangements are also in place with Slovenia and Austria.
More money from Russia than from Europe - soon
With the transition to market prices in Russia, where Gazprom sells the most natural gas, the activities of the company, which have previously been significant primarily on a social level, could also become more important in financial terms. ‘In three to four years a market will form in Russia, where revenues are twice as high as in the traditional European market,’ Miller believes. In this respect it remains to be seen how the rising prices will impact sales – not to mention the consequences for domestic policy. At present, 1,000 m3 of natural gas costs US$70 (€45) on the regulated Russian market. If prices were calculated by European formulae, it would probably cost some US$200 (€128). Miller anticipates that the rising price of gas will prompt customers to use this resource more efficiently in the future and that an appropriate price ratio between the competing resources of gas, coal and fuel oil will emerge. He points out at the same time that some industrial customers are already willing to pay European prices. By this he presumably means additional supplies over and above those volumes which industrial customers can buy in Russia at regulated prices. Initial experience has already been gained in exchange-based gas trading via an experimental exchange. A regular gas exchange is to begin operation in St. Petersburg in 2009. There is still an enormous amount of energy saving potential in Russia. Top politician Valery Yasev said in the beginning of this year in Berlin that with the use of efficient technologies, the domestic consumption of 461 billion m3 natural gas in 2006 could be lowered by 100 billion m3.
The Italian gas producer Eni, which has managed to enter Russia’s downstream gas market, is also focussing on an increase in Russia’s domestic gas prices. In July, Eni signed gas sale agreements with TGK-9, a company that owns power plants in Russia’s Perm region. Under the terms of the agreements, 350 million m3 of gas will be sold by 2010. Eni wants to achieve the targeted sales of 900 million m3 by 2011. According to the Italians, the Russian Government is pursuing a programme of gradual price increases which, given the trends in world energy projections, will bring domestic gas prices in line with European ones between 2011 and 2014, net of transportation costs and export taxes. Eni is already operating in the Russian upstream business. In April 2007, after the oil company Yukos was declared bankrupt in a controversial manner, the Italian company was able to acquire the two smaller gas producers Arktikgas and Urengoil from Yukos’ assets.
Russia’s natural gas in 2007
Production: 654 billion m3 (-0.3%)
Reserves: 47,800 billion m3*
* According to Russian measuring standards
Source: Gazprom
Gazprom 2007
Natural gas production: 549 billion m³ (-1.3%)
Natural gas sales: 576 billion m³ (-0.4%)*
Natural gas reserves: 29,785 billion m³ (-0.2%)*
Production of crude oil and gas condensate: 45 million tons (±0)
Reserves of crude oil and gas condensate: 2,722 million tons (+5%)*
Turnover: 2 390 billion roubles (€65 billion, +11%)**
Profit after tax: RUB 695 billion (€19 billion, +9%)**
Number of employees: 436,100 (+1%)
* According to Russian measuring standards
** According to IFRS
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