1. OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme Russian gas in Europe: how competitive and how secure? James Henderson JUNE 2016 OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme

2. Supply and demand for Russian gas is only balanced because of decline in Gazprom production Domestic demand is declining and independents are gaining market share Demand from CIS countries continues to decline as Ukraine continues to diversify imports European demand stable despite EU desire to diversify away from Russian gas Emergence of Asia is currently based on one LNG plant on Sakhalin; future growth relies on pipelines to China The Russian Gas Matrix – Gazprom decline reflects commercial reality

3. OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme Eastern Gas Programme only offers long term diversity 3 Power of Siberia to proceed, but first gas may be beyond 2020 Altai pipeline remains under discussion, but realistically no exports before 2025. Far East pipeline could even be preferred LNG plans have taken a step back. Yamal LNG now likely to make Novatek main LNG exporter by 2020

4. OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme Russia’s LNG prospects have been undermined by economic reality Breakeven prices for Russian LNG projects suggest they are all too expensive at current gas price Assuming a rebound in the oil price before 2020, Yamal LNG can cover its cash costs and Sakhalin 2 will continue to produce Expansion of Russia’s LNG plans will depend upon cost control and partnership Sakhalin 2 expansion and Baltic LNG the most likely to progress, but not before 2021 at the earliest Breakeven economics of Russian LNG projects compared to gas prices US LNG SRMC Asia price Europe price Outlook for Russian LNG projects

5. OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme Gazprom has a surplus of cheap gas, mainly targeting Europe Russia’s total supply capacity to western markets is c.800bcm Demand for Russian gas currently stands at 640bcm (2015) Gazprom in particular has a large surplus available for the export market, which could be priced down to SRMC Expectations for European gas imports are static in the short-term, but expanding in the 2020s Power of Siberia S-K-V 5 Altai Pipeline Core Supply Capacity Gazprom – 550-600bcm Independents – 200bcm East Siberia Capacity Gazprom – 60bcm Independents – 30bcm? Sakhalin Capacity Gazprom – 15-22bcm Independents – 15bcm? Europe Demand Gazprom – 160bcm CIS Gazprom – 45bcm Domestic Demand - 460bcm Gazprom – 270bcm Independents – 190bcm Chinese Demand Gazprom – 0-100bcm? Independents – 0-??? Asian Demand Gazprom – 15-???bcm Independents – 0-??? Existing Pipeline Planned Pipeline Existing LNG LNG under construction Possible LNG Central Asia Imports – 25bcm Gazprom – 100bcm+ of extra capacity

6. OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme Focus on European market will remain core Gazprom strategy for many years Gazprom deliveries to Europe have rebounded in 2015, to reach 163bcm (and sales reached 185bcm) Data for Q1 2016 is also up year-on-year, increasing by 28.6% over 2015 FSU sales continue to fall, based on Ukraine sales decline Not surprising that Gazprom is focused on maintaining European market share at 30%+; it remains key revenue generator Uncertainty over political dimension is main doubt 6 Gazprom sales to Europe and FSU Gazprom market share in Europe

7. OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme Gazprom believes, not surprisingly, that its place in the European gas market is relatively secure –European import set to rise –Indigenous production in long-term decline –Alternative sources of competitive gas are not abundant Target is to at least maintain market share, which implies some small growth in volumes What will be the reaction to increased availability of LNG in short-to- medium term? Gazprom export strategy to Europe based on growing import requirement Source: Gazprom Investor Day, 2015Source: Gazprom Investor Day, 2016

8. OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme Gazprom prepared to compete but will there be a price war? Gazprom has demonstrated that it is prepared to shift towards market prices Price formation in long-term contracts may still be nominally linked to oil prices, but reality shows that actual prices are close to NBP In fact any oil-linked prices are set to move lower over the next few months, potentially below the SRMC of US LNG Gazprom can compete for market share, and appears to be prepared to do so, but is unlikely to willingly create a price war 8 Gazprom export price to Europe versus NBP Oil-linked price set to fall further US LNG SRMC

9. OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme Cost of Russian gas supply very competitive Surplus gas can be priced at short run marginal cost if competitive pressure increases and Gazprom prioritises market share Devaluation of rouble has reduced costs in US$ terms Export cost via Nord Stream is particularly competitive Relative position of Russian exports versus US LNG depends on variation in rouble exchange rate and price of gas at Henry Hub Who can survive longest pricing at SRMC? 9 At current FX Rate of US$1=RR66 SRMC of Gazprom gas exports to Europe Cost of Russian gas versus US LNG Current Russia Current US LNG

10. OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme Russia has adopted a rather opportunistic export pipeline strategy over the past 12-18 months Focus now appears to be on Nord Stream 2, indicating a focus on market in NW Europe Black Sea pipeline could materialise, although destination remains unclear – politics a major stumbling block EU not keen on Nord Stream 2, insistent on maintaining transit through Ukraine A compromise solution is likely – some Ukraine plus one new pipeline Pipeline uncertainty underlines evolving nature of strategy and political uncertainty South Stream and Turkish Stream Nord Stream, Lines 1-4

11. OXFORD INSTITUTE FOR ENERGY STUDIES Natural Gas Research Programme Russia has a significant gas bubble which is available to western markets at low cost Russia’s pivot to Asia, and switch to LNG, are happening more slowly than hoped, leaving Europe as Gazprom’s key market Gazprom does not want a price war, but is apparently willing to fight for market share in the short term Gazprom has certainly shown a willingness to be competitive on price where necessary The short-run marginal cost of Russian exports and US LNG is very similar at present In the longer term, European gas market fundamentals may allow for a balance to be found between Russian gas and LNG Politics is clearly playing a major role in pipeline decisions – a compromise is the most likely outcome ConclusionsConclusions