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   Experts note that NOVATEK’s share at the domestic market is growing on the account of reducing the share of Gazprom.

   NOVATEK, which began its rapid growth in the early 2000s, managed to become the largest independent gas producer in Russia within only a few years. In 2004, the company produced about 20 billion cubic meters of gas per annum, and seven years later – 53 billion cubic meters of gas per annum.

   Prior to its Initial Public Offering at the London Stock Exchange in 2005, NOVATEK promised its investors to increase the production rate to 45 billion cubic meters of gas per annum by 2010. However, despite the claims of NOVATEK’s management of keeping their promises, the later were fulfilled only thanks to the acquisition of 51 percent of Sibneftegaz, which was in Gazprom’s sphere of interest, at the close of 2010. In fact, in 2010, NOVATEK produced 37 billion cubic meters of gas, and in 2011, taking the “shopping” into account, – 53 billion cubic meters.

   Since the beginning of trading session on the London Stock Exchange, NOVATEK’s GDR quotes increased seven-fold and amounted to $140 per GDR.

Successful “Shopping”

   By the beginning of the new decade, NOVATEK has accumulated a substantial amount of reserves – its proven reserves have doubled since 2004 and amounted to 8.1 billion barrels of oil equivalent according to SEC standards, while the organic growth of reserves amounted to only half of the respective incremental value.

   Over the past two years, NOVATEK spent about $2.7 billion to conduct four major acquisitions: the company acquired South Tambeyskoye Gas Condensate Field containing C1 + C2 natural gas reserves in the amount of 1.3 trillion cubic meters from a businessman Gennady Timchenko and his partner Peter Kolbin and Gazprombank at the price of $1.6 billion, 51 percent of Sibneftegaz along with 400 billion cubic meters of ABC1 + C2 natural gas reserves at the price of 27 billion rubles (almost $1 billion) from Gazprombank, 25 percent of Severenergia along with 1.3 trillion cubic meters of natural gas and 722 million tons of ABC1 + C2 liquid hydrocarbons from Gazprom at the price of 56.3 billion rubles (NOVATEK’s share was approximately $0.9 billion), and virtually without any competition received from the state four natural gas fields containing 1 trillion cubic meters of C1 + C2 gas reserves at the price of only 6.7 billion  rubles (approximately $200 million).

   Thanks to this strategy, NOVATEK today is the sixth largest company in the world in terms of natural gas’ proven reserves, coming next after such giants as Gazprom, Exxon Mobil, Petrochina, BP, Shell – and hard on the last two’s heels.

Capturing the Domestic Market

   NOVATEK’s forecast stated in the previous development strategy through 2015 in terms of gas production increased slightly – from 65 to 68 billion cubic meters of natural gas. The development of new reserves after this milestone will allow NOVATEK to double the production of natural gas and to triple the production of liquid hydrocarbons, which currently account for about 40 percent of the company’s revenues, even in nine years. Having ensured the availability of such volumes of natural gas, NOVATEK expects to double its share at the Russian natural gas market by 2020 – from present-day 8 percent to 14 percent – along with the increase of gas production in Russia from 665 to 825 billion cubic meters.

   According to figures provided by NOVATEK, by 2020, Gazprom’s share in the supply of natural gas to the domestic market will drop from present-day 74 percent to 61 percent along with the increase of the volumes in the domestic market from 700 to 880 billion cubic meters. As this takes place, the market share of NOVATEK shall increase from present-day 8 percent to13 percent, and the market share of other independent producers shall increase from 13 percent to 21 percent, the share of the Central Asian market shall remain the same – 5 percent (i.e., the actual volumes shall increase).

   NOVATEK’s CEO Leonid Mikhelson believes that it is better to let the Russian independent producers increase their production rate than to sponsor other economies. However, purchasing natural gas from Central Asia is rather a part of Gazprom’s “Great Game” aimed at preventing competition with this gas at export markets, and a part of the big-time politics.

   Over the past year, Gazprom has already given a substantial sales area to NOVATEK – the Chelyabinsk region – with large industrial customers located relatively close to the gas production areas. Previously, NOVATEK, “stole” a major customer in the name of Inter RAO UES from Gazprom. Now, NOVATEK also aims at the promising Moscow region. During the presentation, NOVATEK’s CEO made it clear that the company was not averse to participating in the privatization of Mosoblgaz, and the presentation designated the Moscow market as the sales area of approximately 15 billion cubic meters of NOVATEK’s natural gas by 2020. The Moscow region consumes approximately 20 billion cubic meters of natural gas, and the Moscow city consumes approximately 30 billion cubic meters.

   The company declares that it is ready to carry the social burden in terms of supplying natural gas to the population at regulated prices, but admits that it has no doubts regarding the increase of price for natural gas in Russia, the only question is the rate of such increase. According to the company’s estimates, the average prices in Russia shall increase by 42 percent – up to 4,000 rubles per 1,000 cubic meters by 2014, and, taking into account the expected liberalization, the company expects that the prices shall rise to 5,700 rubles by 2017. The only thing that embarrasses NOVATEK’s leadership is the tendency to save energy during the growth of prices and the need to ensure the competitiveness of Russian companies in connection with Russia’s accession to the WTO.

World-Scale Ambitions

   In addition to increasing its domestic market share by 2020, NOVATEK intends to win a name for itself in the world market not only in terms of liquefied natural gas (LNG), but also – judging by management’s passing statements – in terms of pipeline gas and petroleum products.

   The company confirmed its previously announced plans concerning the start of LNG production on the Yamal Peninsula by the end of 2016. However, it plans to build only gas mining facilities in cooperation with foreign partners – all port facilities and transport infrastructure, including icebreakers and icebreaking gas tankers, shall be financed and constructed by the state. Despite the prompt granting of tax incentives for the Yamal LNG Project, one must not rule out the possibility that the construction of transport infrastructure can be delayed, however, as with any project of this scale. Russian Prime Minister Vladimir Putin promised that the state will take over the construction of port infrastructure. In addition, the state promised to build three new next generation nuclear icebreakers by 2020, since the operating life of older Russian icebreakers is coming to an end. The project will cost approximately 1 trillion rubles taking into account only the construction of port infrastructure.

   NOVATEK plans to take over the funding of only $2.5 billion out of the preliminary cost of Yamal LNG Project amounting to $18-20 billion. It is assumed that $7-8 billion shall be attracted subject to the conditions of project financing, $2 billion shall be generated by the execution of the first phase of the project, and the rest shall be financed by the foreign participants. As this takes place, while selecting foreign partners, besides Total, which has already been selected, NOVATEK intends to focus on marketing, and not financial or technological opportunities of potential partners.

   Market participants were mostly concerned with NOVATEK’s vision of perspectives for exporting LNG from this hard-to-reach region. Currently the company is considering four options for transportation of LNG from the Yamal Peninsula – exporting to the European market, the nearest one (the prices per 1 million Btu amounted to $9 in the third quarter of 2011), exporting to the Asia-Pacific market ($12 per 1 million Btu) through the Northern Sea Route, exporting to the Asia-Pacific market through the Suez Canal and exporting to the South American market ($12 per 1 million Btu).

   Although NOVATEK makes statements concerning the growth prospects at the Asian market, the company itself seems to be still looking for a place in the European market, which is closer than the Asia-Pacific market. This is also confirmed by the words of Total CEO Christophe de Margerie, who expressed confidence in the fact that the gas produced by the Yamal LNG Project shall gain access “not only to the European Market.” “I think it would be possible to export gas to Asia-Pacific countries, even if not in physical volumes, then by means of the swap system,” said Christophe de Margerie. To do this, Total believes it necessary engage Qatari companies in project development, since Qatar is the world’s top producer of LNG.

   Meanwhile, Leonid Mikhelson, strenuously dodging the investors’ questions concerning the company’s expectations in terms of abolishing the monopoly of gas exports in Russia, mentioned that NOVATEK is investigating the possibility of acquisition of a certain gas consumer company beyond the borders of the Russian Federation. It is worth recalling that just six months ago, while listening to Gazprom’s plans on building another export pipeline to Europe – South Stream – EU Energy Commissioner Guenther Oettinger expressed himself in favour of the abolition of the monopoly on gas exports in Russia, and noted that Europe would like to see companies such as NOVATEK in its market. A little later, the European media rumored that NOVATEK was carrying on negotiations concerning the acquisition of Verbundnetz Gas (VNG) company – the third company in Germany in terms of volume of gas sales. Later, Prime Minister Vladimir Putin mentioned that one must not rule out the possibility of abolition of monopoly on gas exports in Russia.

   Additionally, one shall not forget that Gazprom is exporting natural gas produced at the Shtokman Gas Condensate Field primarily not to Europe, but rather to Asia. Thus, last year, Gazprom Marketing has signed memoranda of 25-year supply of 10 million tons of LNG to Indian companies.

   NOVATEK is confident in the profitability of its LNG project in distinction from the Stockman project, the decision on which has once again been postponed for three months, and this was apparently conditioned by the price issues. According to Mikhelson, in spite of complications concerning forecasting the costs of transporting LNG, even if the current Asian-Pacific market price ($12 per 1 million Btu) decreases by almost a half, the export operations shall still remain profitable.

Gazprom’s Under Pressure

   Yuzhno-Tambeyskoye field which has not been developed yet, is to serve as a resource base for the Yamal LNG Project. However, according to NOVATEK’s Chief Financial Officer Mark Gyetvay, the deposit will reach the 16-years mark of 25.2 billion cubic meters of gas per annum by 2020. Given this, NOVATEK also received from the RF Government four prospective gas fields located at the Gydan peninsula (containing C1+C2 natural gas reserves in the amount of almost 1 trillion cubic meters) at the price of only 6.7 billion rubles to “expand the LNG production resource base at the Yamal Peninsula.” Formally, there were other contenders – Itera and Summa Group’s subsidiary, but their bids were dismissed as non-conforming to the tender’s terms. Itera bridled up, but did not file an appeal.

   At the same time, according to Leonid Mikhelson, there is a possibility that gas from the first gas producing fields – Utrenny and Geofizicheskoye, which are to yield  30.6 billion cubic meters of gas by 2020 – will be partially fed into pipelines integrated into UGSS’ network.

   Leonid Mikhelson’s last meeting with Gazprom CEO Alexei Miller in January 2012 indirectly confirmed the fact that gas from Geofizicheskoye and Utrenny fields would be fed into the pipe.

   According to press release, the parties discussed a possibility to jointly build the facilities to produce LNG on Yamal. They also considered a strategy for joint development and commissioning of new fields based on the Gydan Peninsula’s resource base to orderly replace the falling production from the Nadym-Pur-Taz Region.

   In the region there are three major fields owned by Gazprom, namely the Yamburg,  Urengoy and Medvezhje. The said fields’ reserves are dwindling, thus making available a pipe in the vicinity of Yamburg Compressor Station.
To connect the pipe with Geofyzicheskoye field, additional 125 kilometers of pipeline should be laid, and to reach Utrenny field, a longer pipeline – 260 kilometers – is required. Next to Geofyzicheskoye, Gazprom’s Antipayutinskoye field is located, and the companies could share the cost of constructing a pipeline to the Yamburg CS.

   With this in mind, it may be suggested that NOVATEK will continue pressurizing Gazprom in the domestic market given that Gazprom only compensates for the falling production in the corridor, while Novatek intends to supply new gas.
In late November, Gazprom Deputy Chairman Valery Golubev announced some very telling figures at the annual forum “Gas of Russia – 2011”: in the pre-crisis 2008, Russia produced 665 billion cubic meters of gas, while Gazprom produced 550 billion cubic meters (82.7 percent of the total amount). Independent companies produced 110 billion cubic meters, with NOVATEK’s share amounting to 30 billion cubic meters (or 5.5 percent). In 2011, as Russia’s gas consumption recovered, the total amount of produced gas approximated to 670 billion cubic meters, with Gazprom’s share amounting to 510 billion cubic meters (76 percent) and NOVATEK’s – to 53.3 billion cubic meters (almost 8 percent). Thus, Gazprom’s production capacity decreased by 40 billion cubic meters of gas only over the last four years.

   Valery Golubev noted that independent producers sold gas to Gazprom as well – directly or through joint ventures. Meanwhile, the effectiveness of Gazprom’s sales, is “very small” – about 5 percent, according to Gazprom’s top manager.
In general, as Golubev said, gas supplies in the UGSS-covered area amounted to 353 billion cubic meters in 2008, with independent producers’ share accounting for 20.7 percent. According to forecasts made in 2011, in case the supply volume approximated 370 billion cubic meters of gas, the share of independent producers would reach 26.8 percent, thus showing an increase by over 6 percent. “With this share, we may hope that an actual competitive market is evolving in the country,” Gazprom’s top manager noted. At the same time, Golubev expressed his concern over preferential treatment given to independent producers: while offered an opportunity to supply gas to big industrial consumers in the redions located in the vicinity of production areas, they pay lower MRT (Mineral Replacement Tax) – e.g., in 2012 Gazprom would have to pay MRT which is twice the amount set for independent producers. That is why Gazprom spoke against independent companies receiving a statutory declarative access to the gas “pipe”.

   UBS analysts mention that the resource base may enable NOVATEK to produce  the declared amount of gas. They also believe, however, that given consideration to other independent producers’ aggressive plans, in the mid-term perspective Russian market may be oversupplied with gas.  

   The experts thus predict that NOVATEK will contunue squeezing Gazprom out of its traditional markets. Also, some of UBS analysts are of the opinion that gas import from Central Asia may stop due to independent producers growth.

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