The Shifting Energy Dynamics and Geopolitical Implications of the U.S. Shale Revolution for Asia: `s Perspective How the U.S. shale revolution has impacted Russian energy relations/ approach/ strategy towards Asia, mainly Japan and

Dr. Tatiana Mitrova Head of Oil and Gas Department Energy Research Institute of the Russian Academy of Sciences

Washington 15 October, 2014 1 IMMEDIATE IMPLICATIONS

2 MEDIUM-TERM IMPLICATIONS

3 LONG-TERM IMPLICATIONS

1 In the short-term US shale gas boom has already strongly affected global energy markets - 1

 Unprecedented drop in the North American gas prices and their decoupling from the European and Asian price trends: gas markets are now more regionalized than ever (despite globalization theory).

 US domestic gas consumption increased, gas squeezed partially coal from the power

generation, leading to CO2 emissions reduction in North America.  Significant LNG volumes were redirected to the other markets – Europe and Asia. In Europe they lead to spot price drop, in Asia helped to dampen the consequences of Fukushima (otherwise prices could go even higher).

 European gas pricing model changed dramatically in just 5 years with the share of spot- indexed gas supplies increasing from 20% in 2007 up to 50% in 2012. `s contracts are renegotiated under extreme consumers pressure, oil linkage is already regarded by the European Commission as market power abuse.

 Coal exports from the US undermined gas competitiveness in the European power sector and lead to stagnant gas demand for electricity generation (which means actually stagnant total demand for gas), low utilization rates and even closure of gas-fired power plants in Europe. 2 In the short-term US shale gas boom has already strongly affected global energy markets - 2

 Several large-scale projects, targeted initially at the US gas market, had to look urgently for the other buyers, others were postponed for unclear period of time (for example, Shtokman).

 The US targets Japan, Korea, Taiwan and new small Asian LNG consumers. US producers have already portfolio of about 40 mln. tonnes contracts targeted at Asian buyers (during just 1,5 years!), so the US is already conquering the market niche in Asia. It has already impacted (not physically, but more psychologically) price negotiating position for all its new contracts not only in Europe, but also in Asia - now any proposal is compared to the Sabine Pass contracts.

 Shale boom has strong impact on the industries: it is reducing both Europe’s competitiveness vis-à-vis the US and China’s overall manufacturing competitiveness.

 Generally, there was a huge reassessment of the national energy policies in many countries (like Poland, Ukraine, Argenita, China, etc.) – they got a “new hope”.

 It is also bringing shifts in global politics – changing America’s role in the EU-Russia gas relationship, as well as in the Middle East.

3 Under the "shale pressure" Russia started its historical shift Eastwards

 Now there is clear urgent need for Russia to diversify its energy export markets:

. There is no room for increase of Russian exports to Europe

. Increasing competition (North American shale gas and oil, potential Iran, Iraq, Australia, Brazil entrance to the global markets)

. For geopolitical reasons Europe is targeting to decrease dependence on Russian energy supplies

. The sanctions target the finance and energy sectors, restricting some state firms' and banks' ability to raise financing  North-East Asia seems to be the most attractive new energy market

. Asian markets are demonstrating the highest growth rates even during the crises, and according to all projections, they will drive future global hydrocarbon demand growth

. Lack of own energy resources (and problems with nuclear in Japan) make North-East Asian countries ideal, complimentary partners for Russia in the energy trade.  Asian partners are regarded by Russia not only as a market, but also as a source of financing, technologies, equipment and even labor force. Russia is now promoting switching to roubles and RMB payments, which could mark a new stage in the whole Asian energy trade development.  Creation of the new energy infrastructure in the Russian Eastern and the Far East is regarded as a tool to accelerate country`s economic growth, helping to form new industrial clusters based on the development of energy resource production and processing. 4 Negotiations with China, which have been going on for more than a decade, finally resulted in the mega-deal

 MoU on gas exports via two potential routes (Altai and East Siberia) signed in 2004  Gazprom purchase of Kovykta in 2011 allowed negotiations to focus on eastern route  Major parameters agreed by 2013, apart from the vital element of price  In 2013 CNPC-Novatek deal was structured on 20% of Yamal LNG and 2,2 mln tonnes of Yamal LNG supples.  May 21, 2014 – Putin`s to visit Beijing – new geopolitical environment catalysed final decision - Gazprom and CNPC signed the 30-year contract for 38 bcma of Russian pipeline gas supply to China.  On August 2014 Gazprom started negotiations with CNPC on the “Western route” (6700 km long “Altai pipeline” with 30 bcma capacity from the Western Siberia, diverting supplies targeted to the European market). Gazprom says that the pipeline could be built very fast and its capacity might be expanded up to 100 bcma. Russian energy ministry expects the contract to be signed before the end of 2014.  In October 2014 Gazprom for the first time announced that it is ready to refuse from LNG and to send all the feed-gas to China via pipelines.  On October 13, 2014 Russia finally signed 40 year long intergovernmental agreement for the Eastern gas supplies. The Western route was not agreed. Rosneft started negotiations with Chinese on Skhalin-1 LNG sales. 5 “Secret mega-deal”

 The contract is linked to oil prices and has 'take-or-pay' clause.

 Contract price is not officially disclosed (Russian trade representative in China announced, that it it slightly higher than Central Asian gas price for China).

 With total amount of the 30 year long deal of $400 bln., average price is estimated at 370-380 $/mcm (average Gazprom`s export price to Europe in 2013 was 380 $/mcm).

 It seems that there is strong price review clause in the contract.

 $25 bln. were expected as a down payment from the Chinese side, but the deal failed. Now Gazprom plans to attract loans from the Chinese banks by the end of 2014-early 2015 (most likely at Libor + 3-5%).

New LNG projects coming on stream in the next years in Australia and the US will not only have to compete between each other for demand, but also against the price set by pipeline imports deals such as the one between Russia and China, which has an estimated price of around $11-12/MMBtu. 6 1 IMMEDIATE IMPLICATIONS

2 MEDIUM-TERM IMPLICATIONS

3 LONG-TERM IMPLICATIONS

7 In the medium-term global LNG supply is expected to boom, partially due to the shale gas revolution, but this growth is associated with great uncertainties

Global liquefaction capacities (existing and planed) Mln. tonnes 600

500 Other

400 East Africa

300 US

200 Canada

Australia 100

Existing

0

2008 2017 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2009 2010 2011 2012 2013 2014 2015 2016 2018 2019 2020

Source: ERI RAS 8 For North American LNG Asia seems to be much more attractive market, US and Canada are already actively signing contracts for their LNG

Cost comparison for the US LNG sales Signed contracts for LNG supply from North $/MBtu to Europe and Asia America 16 60

14 2.55 Margin 50 12 Europe

0.55 40 10 Regasification Asia 8 30 Transportation 6 20 Portfolio buyers 4 Liquifaction 10 2 Henry Hub price 0 0 Europe Asia 2015 2017 2019 2021 -2 Source: ERI RAS 9 World gas war: US will compete with Russia in all its export markets

10 US might become “swing LNG producer” on the global gas market, creating downward pressure on the gas prices

 All traditional suppliers feel the urgency to develop new export projects ahead of the competition from US LNG.

 US will have very flexible LNG production volumes (first of all due to the flexibility of shale gas production) and completely new contractual system

 US might become a swing supplier, reacting on a short notice, while the other producers will operate on higher capacity utilization rates. Such “swing gas producer” position is something completely new for the gas market and more reminds of the Saudi Arabia position in the global oil market. As a result US LNG will set the floor price both in Atlantic and in Pacific basins.

 Global LNG market oversupply will lead to increasing pressure on prices. We witnessed already the change of the pricing system in Europe (due partially to the impact of the re- divertion of the LNG, targeted initially to the US). Henry Hub indexed contracts in Asia (despite their small volumes) started the new era of the "hybrid pricing system" in Pacific. Negotiations to sell new gas are becoming tough now that the buyers are refusing full oil- indexation due to the expectations of the US Henry Hub based LNG. First Henry Hub indexed contracts in Asia (despite their small volumes) started the new era of the "hybrid pricing system" in Pacific. 11 Pipeline and LNG export options in the Russian East Siberia and Far East

Source: Russian Gas Matrix, OIES 2014. 12 “The Empire Strikes Back”: Altai, Korean and Japanese pipeline negotiations

 The whole Russia’s Eastern strategy is closely related to Chinese deal and “Power of Siberia” pipeline construction

 The 61 bcm Yakutia – – Vladivostok (some 3,200 km) gas pipeline will be constructed at the first stage by 2018. This will make it possible to initiate direct gas supplies to China 2019 (though there were some statements, which Gazprom later refused, that the first Russian gas will reach China in 2020 and that by 2024 there would be only 25 bcma supplies). Pipeline infrastructure is the key to opening up Russia’s vast Eastern resource base; Additional leg to South Korea through Bohai Bay is possible.

 Sakhalin has the option of increased LNG exports or the S-K-V pipeline to Vladivostok and possibly into NE China.

 On August 2014 Gazprom started negotiations with CNPC on the “Western route” (6700 km long “Altai pipeline” with 30 bcma capacity from the Western Siberia, diverting supplies targeted to the European market). Gazprom says that the pipeline could be built very fast and its capacity might be expanded up to 100 bcma. Russian energy ministry expects the contract to be signed before the end of 2014.

 In October 2014 Gazprom started negotiations with CNOOC on LNG supplies.

 In October 2014 Gazprom for the first time announced that it is ready to refuse from Vladivostok LNG and to send all the feed-gas to China via pipelines.

13 Global competition is increasing, but Russian Eastern gas export options are looking competitive

Eastern gas export options costs and margins comparison, $/MBtu

Source: ERI RAS 14 Gas production potential in the Russian Eastern Siberia and Far East

Eastern Siberian Russian Far East gas production potential, bcm gas production potential, bcm 90 80 Yurubcheno- 70 TokhomskoyeКрасноярский and центр 60 Kuyumbinskoye Fields 50 50 40 40 Якутский центр 30 Sakhalin - 3 30 Chayandinskoye 20 20 10 10 Sakhalin - 2 0 0

Kovyktinskoye

2014 2011 2012 2013 2015 2016 2017 2018 2019 2020 2025 2030

2027 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2028 2029 2030 2016 Иркутский центр Yurubcheno-Tokhomskoye and other Rosneft Marketable gas Sakhalin-1Sakhalin - 1 Small gas field (IOC) Marketable gas Sakhalin-2 Kovystinskoe Marketable gas Sakhalin-3 Chayandinskoe

Source: ERI RAS 15 1 IMMEDIATE IMPLICATIONS

2 MEDIUM-TERM IMPLICATIONS

3 LONG-TERM IMPLICATIONS

16 In the long-term unconventional gas might reach nearly 15% of total gas production

Gas Production by Source, Baseline Scenario

Source: ERI RAS Unconventional gas by 2040 will make 15% of the world gas production (11% - shale gas, 3% - coal-bed methane and 1% - biogas). North America will show the largest increase of unconventional production. In the baseline scenario aside from the North America shale gas production will not exceed 70 bcm in total by 2040. 17 Shale gas expands global gas supply curve, making more gas available to the world at lower prices

Gas supply curve (cost of production)

Source: Global and Russian Energy Outlook up to 2040. ERI RAS-AC. 2013. 18 Due to the gas oversupply, its prices in Europe and Asia will not exceed the current levels even by 2040, while North American prices will remain far below

Forecasted average weighted price* of gas by regional markets, Baseline Scenario

$ 2010/ mcm

600

500 Europe (average weighted)

400 China(average weighted) 300 Japan (average weighted) 200 USA (Henry Hub) 100

0 2000 2005 2010 2015 2020 2025 2030 2035 2040

Source: Global and Russian Energy Outlook up to 2040. ERI RAS-AC. 2014.

* Weighted average price between the prices of long-term contracts linked to alternative fuels, and spot prices.

The significant difference of regional gas prices, which took place in 2006-2012, will remain, prices will overcome current levels only by the end of the period. 19 Even in the long-term Russian energy exports to Asia do not even come close to the levels that have already been reached on the European markets

Total Russian pipeline and LNG export Russian energy export forecast potential from East Siberia and Far East by markets mtoe 120 700

100 600

East Siberia Pipe 500 80 Sakhalin 1 400 60 Yamal LNG bcma Vladivostok LNG 300 40 Sakhalin Expansion 200 Sakhalin Current 20 100

0 0 2010 2015 2020 2025 2030 2010 2015 2020 2025 2030 2035 2040

Sources: ERI RAS, Russian Gas Matrix, OIES 2014. CIS Europe Asia 20 Contacts

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