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BEYOND THE HORIZON
It is now more than three years since the West imposed sanctions
on Russia, due to its activities in Ukraine. Most recently, the Trump
administration has taken additional steps to punish Russia for its alleged interference in the US presidential election in 2016.
The sanctions have not impeded Russia’s ability to supply the
international oil market. In fact, the country’s oil production has
reached record post-Soviet levels. Rather, the intent has been to limit
Russia’s ability to develop new production in the 2020s by targeting
equipment and technologies and services that would be necessary
for deepwater oil exploration and production, Arctic oil exploration,
and shale oil projects. Another goal has been to exclude Russian oil
companies from capital markets.
This September’s 21st Sakhalin Oil and Gas Conference in Yuzhno-
Sakhalinsk afforded the opportunity to reflect on the impact of the
sanctions on Russia’s offshore programs. Given the maturity of the
existing Sakhalin projects and their focus on expanding LNG expor ts,
these were not an initial target of the sanctions. However, in the
summer of 2015 the US State Department added the undeveloped
Yuzhno-Kirinskoye field (part of the Sakhalin- 3 license block) to the
list in the belief that it contained significant oil reserves. And this is
one instance where the sanctions are having an impact.
Sakhalin- 3 operator Gazprom has identified a subsea development
of Yuzhno-Kirinskoye as providing the feed gas for expansion of
the Sakhalin Energy-operated Sakhalin- 2 onshore LNG plant. It is
probably not coincidental that the field was added to US sanctions
soon after Gazprom announced a strategic alliance with Shell at the
St Petersburg Economic Forum. It leaves Gazprom and its partners
in Sakhalin Energy with a problem: the construction of a third LNG
train is clearly needed, but they currently lack access to the necessary gas resources.
However, the ExxonMobil/Rosneft Sakhalin- 1 project has significant gas that it is seeking to monetize, potentially through building
its own single-train LNG plant on the site of its oil export terminal at
De Kastri on the Russian mainland. But the Sakhalin- 1 partners have
also discussed selling Sakhalin- 2 the gas it needs. This would solve
the immediate problem and would limit the impact of sanctions on
Yuzhno-Kiriniskoye. It also appears to be the best outcome for the
Russian state because the cost of the Sakhalin- 1 LNG plant would have
been covered by the production-sharing agreement and the investors
would first have had to recoup their costs.
The sanctions against Russia need to be considered in light of two
other significant developments. First, the fall in the price of oil post-
2014, and second, the decision by the Russian government to allow
the rouble to devalue. These two factors are clearly inter-related and
have served to isolate the Russian oil and gas industry, and to some
extent, the Russian government, from the impact of the falling oil
price. Each dollar earned now equates to a lot more roubles to be
spent domestically, and by international standards Russian production
costs are low. Even if the sanctions were not in place, the partners
in all Russia’s oil and gas projects—both foreign and domestically
operated—would be obliged to maximize their reliance on domestic
suppliers, some of which would be joint ventures or foreign-owned
subsidiaries with a cost base in roubles.
Of course, this also assumes there are sufficient technically compe-
tent domestic companies to service the needs of the various projects.
On Sakhalin, this process was embedded in the island’s economy
through the ‘Russian Content’ requirements of the various Sakhalin
license block production-sharing agreements, and this did much to
raise the competence of the domestic supply chain to the offshore
industry. However, the sanctions have halted access to the supply of
equipment and services that are not currently available from Russian
companies. The intent is to inhibit exploration and development.
One response, where possible, has been to source these needs from
countries and companies not under sanctions, such as Chinese oilfield
service contractors. But, the deepwater offshore, Arctic, and shale
oil are specifically areas of Western competence. Another response
has been for the Russian state to encourage ‘import substitution’ by
promoting and subsidizing the development of Russian competencies.
But this is a costly and long-term process and it remains to be seen
how much progress is being made.
So, on the face of it sanctions have stopped Russia from exploring
and developing its deepwater offshore, Arctic and shale oil potential.
This is a problem because Russia’s traditional fields are well past their
peak and new production needs to be developed, while at the same
time, the cost base of Russian oil and gas is increasing. However, the
sanctions are proving to be positive for Russia in that they are forcing a greater cost-consciousness—because capital is hard to come
by—and they are stimulating localization and import-substitution that
will increase the amount of value added captured by Russian industr y.
Over the longer term, they may reduce Russia’s reliance on Western
equipment, technologies, and services.
Professor of Global Energy
Warwick Business School
Russian sanctions slowing
progress offshore Sakhalin