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FSU/CEE Insight: Russia Special

Issue 17 | 2-May-19 Weekly Report

Editorial Nightmare Supply Scenario for FSU/CEE Refiners

 A full halt on Druzhba flows has refiners along the line scrambling to find alternative crude supplies  Outage to affect Poland and Germany much less than Belarus  A prolonged Druzhba outage would put an estimated 600,000 b/d of refining capacity at risk

s we write this, flows along crude imported via the Druzhba have also been affected. However, it one of the oldest, longest, and pipeline always remained the also means that flows to Russia’s A most important pieces of oil baseload crude in these refineries. biggest export terminal, the Baltic pipeline infrastructure in the world Hence the current outage is an port of Primorsk, have not been are severely disrupted. We are of extremely significant event, contaminated. course referring to Russia’s Druzhba particularly as it may take months (Friendship) pipeline, which remains rather than weeks for the pipeline to A note on the contamination. We the lifeline to several Eastern return to normal operations. understand that the strategy being European and FSU refineries. The employed by the Russians is to northern leg of the pipe supplies Flows stopped after it became blend the crude down to levels Belarus, Poland, and eastern evident that the crude flowing along where the organic chlorides are no Germany, while the southern leg the pipeline was contaminated by longer high enough to cause serves refineries in Hungary, organic chloride in concentrations of problems. This is however a massive Slovakia and the Czech Republic. up to 30 times the maximum logistical undertaking because it These countries have always been accepted standard. It was reported requires all of the contaminated aware of their dependence on that the contamination occurred crude still in the system—estimated Russian crude and many have somewhere along the pipeline leg by Transneft and reports from the successfully found new routes of between Samara and Unecha (see Belarussian state news agency, to be supply over the years. However, map). This is significant because it around 5 million tonnes (36.5 even when new supply routes means that flows along the BPS-2 million barrels)—to be pumped out became available, Russian Urals pipeline from Unecha to Ust Luga and transported to storage facilities Russian Crude Exports via the Druzhba and BPS Systems to Europe in Q1 2019 [b/d]

Primorsk Legend: 800,000 b/d Schwedt Refinery and its Ust Luga 230,000 b/d capacity 600,000 b/d Russia

Germany Delivery point and 460,000 b/d volumes Yaroslavl

Schwedt 230,000 b/d NovoPolotsk Unecha 170,000 b/d Belarus Gdansk Samara Germany Poland 210,000 b/d Belarus 350,000 b/d 460,000 290,000 b/d Mozyr Source of contamination Leuna 330,000 b/d somewhere between 230,000 b/d Plock Samara and Unecha 330,000 b/d

Czech Rep. Ukraine 70,000 b/d

Litvinov Kralupy Slovakia 110,000 b/d 68,000 b/d 115,000 b/d

Slovnaft 115,000 b/d Pipeline Legend: Hungary Pipeline - not contaminated 85,000 b/d Duna Pipeline - offline/contaminated 161,000 b/d

1 [email protected], www.jbcenergy.com FSU/CEE Insight: Russia Special Issue 17 | 2-May-19

European Imports of Russian Crude via the Druzhba Pipeline ['000 b/d] 2000 Ust Luga Germany Poland Czech Republic Slovakia Hungary 1800

1600

1400

1200

1000

800

600

400

200 Ust Luga volumes are seaborne and occasionally get arbed out of the NWE region Source: Argus Media 0 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 where it can be blended down. month but with the possibility of a access to seaborne crude can of Thereafter clean crude will 6-month extension (Interfax) — course tap the wider international presumably need to be inputted into something that hints at the scale of crude market. However, this may not the affected Druzhba system to the operation. even need to be the case as the blend down the remaining volumes capacity of Primorsk is actually 1.5 sticking to the pipes. This is why In the meantime the big question on million b/d, significantly higher than Transneft is already in talks with the everybody’s mind is how to deal recent exports. This indicates that, if Russian state owned railway with the sudden lack of Druzhba necessary, up to an additional operator, RZD, for the use of up to crude. Here each refinery has its 700,000 b/d of Russian crude could 5,000 rail cars, initially for one own supply dynamics. Those with potentially be exported out of

Sources of Crude Imports in Selected CEE Countries [%]

Poland Czech Republic Hungary

1 1 1

0.9 0.9 0.9

0.8 0.8 0.8

0.7 0.7 0.7

0.6 0.6 0.6

0.5 0.5 0.5 Other 0.4 North Sea 0.4 0.4 Kazakhstan 0.3 0.3 0.3 Iraq Saudi Arabia Other (primarily Algeria Other 0.2 0.2 0.2 Russia Caspian (KZ, AZ) Caspian (KZ, AZ) Russia 0.1 0.1 0.1 Iraq

Source: Based on IEA data from MODs © OECD/IEA, www.iea.org/statistics, Licence: www.iea.org/t&c; as modified by JBC Energy Russia 0 0 0 2015 2016 2017 2018 2015 2016 2017 2018 2015 2016 2017 2018

2 [email protected], www.jbcenergy.com FSU/CEE Insight: Russia Special Issue 17 | 2-May-19

Primorsk, thereby more than making especially gasoline, react to this up for the loss of Ust Luga. situation as neighbouring countries might have to compensate for lower Moreover, both Polish refineries processing for a certain while. could shift more of their imports of Likewise, the Urals differential at Russian crude to seaborne Urals out Primorsk has reached the highest of Primorsk. Obviously the Gdansk level in at least 10 years at a 90 cent refinery could run fully on Russian premium to North Sea Dated (Argus seaborne crude while the 330,000 Media), highlighting ongoing supply b/d Plock refinery could receive its diversification efforts. crude via the 650,000 b/d southbound pipeline link between A longer-lasting impact could be Gdansk and Plock, leaving another that the Druzhba outage underlines 320,000 b/d for onward delivery to the importance of the JANAF the affected German refineries of pipeline network as a means of Schwedt and Leuna. The remaining supply diversification for the Czech 140,000 b/d required by the German Republic, Slovakia, and Hungary. refineries could come from the The system of pipelines runs from 140,000 b/d Rostock to Schwedt the port of Omisalj on the Adriatic pipeline. From this perspective, up through Croatia, and Hungary Germany and Poland could reroute and in theory onwards to Bratislava their supplies without too much of a and into the Czech Republic, where headache. For neighbouring Belarus, it could be used to supply both the however, there are few options, all Litvinov and Kralupy refineries. In of which rely on very high freight fact, Unipetrol already reached an costs. We therefore expect agreement this year with Janaf to Belarussian run rates, which had enhance business opportunities, but averaged around 340,000 b/d in flows are only due to start once 2018, to decline substantially for as transportation agreements with long as the outage persists. Hungary and Slovakia are signed. ¤

Refiners along the Southern Druzhba leg are also highly dependent on Russian crude, particularly Slovakia which relies on the Druzhba for over 95% of its supplies. Hungary is a little more diversified with Druzhba imports amounting to around 70% of crude input. For the Czech Republic, the 70,000 b/d of Russian crude that it runs will be very hard to replace as it has already largely maxed out supplies via the fully-subscribed Transalpine (TAL) pipeline route. This means that the refinery could be forced to run at substantially lower levels. The same goes for the 115,000 b/d Slovakian refinery, while Hungary could replace some of the missing barrels from the Adriatic (JANAF) route as it already imports around 50,000 b/d of Iraqi crude. This would put the volumes at risk from the outage of the Southern leg at a maximum of 270,000 b/d.

To conclude, if the Druzhba outage persists, we could be looking at reduced runs for refineries along the northern route by up to 340,000 b/d (i.e. Belarus), as well as another 270,000 b/d from the south, bringing total volumes at risk to just over 600,000 b/d. Such an outage would tighten refined product markets in the affected areas, i.e. Belarus and Russia (which has tolling agreements with Belarus) as well as CEE. We have seen product prices,

3 [email protected], www.jbcenergy.com FSU/CEE Insight: Russia Special Issue 17 | 2-May-19 Feature Article Russia Turns to the Arctic Ocean

 The NSR to play an increasingly bigger role in Russia’s energy strategy

 Gazprom Neft is negotiating with Novatek on Arctic cooperation

 Rosneft is yet to find a way to ramp up Arctic supply

t the beginning of last month Although under current Russian Neptune fields. The two latter fields a UN subcommittee officially legislation only Gazprom and are currently being developed and A recognised that a part of the Rosneft are allowed to hold licences are scheduled to commence subsea area beneath the Arctic for offshore field developments in commercial production by the Ocean is a geological continuation the country’s Arctic, so far only middle of the next decade (company of Russia’s continental shelf. With Gazprom seems to have managed to information). In addition, Gazprom this decision, the UN will probably take advantage of this arrangement. Neft also plans to bring online the put an end to some of the ongoing Gazprom Neft, Gazprom’s liquids Dolginskoye field, located close to territorial disputes in the area and arm, is currently the only Russian the Prirazlomnoye field in the respect Russia’s claims for around Arctic offshore field operator with Pechora Sea, by 2021-2022, utilising 1.2 million square kilometres, in the its offshore 70,000 b/d the existing infrastructure in the Arctic Ocean. While this area is set Prirazlomnoye field. Meanwhile, area. Moreover, by the time the field to increasingly play a bigger role Gazprom Neft and Novatek have comes online, production costs at the going forwards, in the context of been actively negotiating on Prirazlomnoye field could fall to as melting ice caps and the effective prospective cooperation in Russia’s low as $10/bbl, as the field is opening of the Northern Sea Route Far North, Gazprom Neft’s CEO scheduled to reach plateau early in (NSR) for potential year-round announced recently. Currently, the next decade (company journeys from Europe to East Asia, Gazprom Neft holds licenses for information as cited by Argus it is also the last major region on the exploration and development of the Media). Therefore, if prospective planet which may hold substantial 1.7 billion-barrel Dolginskoye field projects prove viable, Novatek will unexplored oil and gas reserves. in the Pechora Sea, as well as the 1 likely opt to participate, especially However, while Russia will likely be billion-barrel Kheisovsky block in given the company’s ambitions to granted exclusive access to the area the Barents Sea and the largely scale up condensate exports from its for exploration and exploitation of unexplored Severo-Vrangelovsky Yamal project and its future Arctic its natural resources, the country is block in the Chukchi Sea. In LNG plans. Moreover, the two still facing difficulties in utilising its addition, last year it made two major companies are already working existing geological reserves in its discoveries off the island of together in two joint ventures, Far North provinces, due to lack of Sakhalin, namely the 1 billion-barrel namely Arktikgaz and Northgaz, infrastructure and technologies. Triton and the 3 billion-barrel where they focus predominantly on

Russia: Arctic Crude and Condensate Production Outlook ['000 b/d] 200 500 Prirazlomnoye Prirazlomnoye (high output scenario) 180 Dolginskoye 450 Dolginskoye (high output scenario) Triton 160 Triton (high output scenario) 400 Neptune 140 Neptune (high output scenario) 350 Rosneft Arcitc offshore fields Rosneft Arcitc offshore fields (high output scenario) 120 Total Russian Arctic output-r.s. 300 Total Russian Arctic output (high output scenario)-r.s. 100 250

80 200

60 150

40 100

20 50 SuDeP 0 0 2018 2019 2020 2021 2022 2023 2024 2025

4 [email protected], www.jbcenergy.com FSU/CEE Insight: Russia Special Issue 17 | 2-May-19 natural gas and condensate fields such as the Vankor, Suzun, still see Russia’s Arctic output production, so further cooperation Tagul, Lodochnoye, and others. In averaging some 420,000 b/d by seems like a logical choice for both order to take advantage of 2025, but the risk to production is parties. potentially more favourable transit rather skewed to the upside. costs, Rosneft has decided to build a Moreover, if reserves in traditional While the future seems bright for 600-kilometer pipeline to the coast production regions, such as West Gazprom Neft’s future Arctic of Taymyr, connecting fields in the Siberia, continue to decline, Russian development plans, the same cannot Vankor cluster to the Arctic Ocean producers will likely turn to be said for Rosneft. After Russia’s and the NSR. developing hard-to-recover reserves, biggest crude producer was granted such as the ones in the Arctic. ¤ most of its licenses in 2014, the Late last month President Putin company did not manage to bring further reiterated his commitment to online any of its offshore Arctic the development of the NSR and fields so far. Rosneft has been Russia’s Arctic as a prospective new working on developing Arctic fields production province, at the together with the US major International Arctic Forum in St ExxonMobil, but the latter Petersburg. However, achieving this eventually decided to withdraw from might prove difficult, as shown so Arctic joint ventures in Russia in Q1 far by the production record of -2018, following a round of US Gazprom Neft and Rosneft. As sanctions against Russia. This has Rosneft’s CEO has been advocating eventually led to a halt of further state support and tax development works at Rosneft’s concessions to companies investing Arctic fields, as the Russian in the region, negotiations might not company still lacks technologies to have gone as planned, judging by proceed on its own. However, it Rosneft’s absence at the Forum. In a seems that Rosneft is turning its scenario where Russia decides to attention back to the Arctic. The move ahead with its plans to scale company’s CEO Igor Sechin, said at up Arctic production, we might see a meeting with President Putin that total output from Russian Arctic his company is currently working on fields rising to 460,000 b/d by the setting up an Arctic cluster. middle of the next decade. However, According to Mr Sechin, total crude to do so, the country will have to exports by his company via the NSR invest extensively in supporting could reach some 80 million tonnes Rosneft and Gazprom via tax (1.6 million b/d), but some flows concessions and in research in should be redirected from onshore development. In our base case, we Northern Sea Route vs. NorthernSuez Canal Sea and Route Russian vs. SuezOffshoreCanal Arctic Exploration Areas

Kamchatka 15 days Severo- KamchatkaTriton, Vrangelovsky Neptune block East Siberian Sakhalin LNG block Severo-Karsky block Boryeong Kheisovsky Boryeong block Arctic LNG Prirazlomnoye, Arctic LNG Dolginskoye Yamal LNG Yamal LNG

Zeebrugge Zeebrugge

Northern Sea Route Suez Canal Route Existing LNG terminal Planned LNG Terminal 30 days Source: Total,JBC Energy JBC Energy information based on Rosneft and Gazprom Neft information

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Downstream Highlights Product exports out of Russia in March saw gasoil/diesel and fuel oil outflows contract strongly m-o-m and y-o-y, whilst gasoline was Russia: Gasoline Exports & Domestic Deliveries ['000 b/d] the only product to enjoy a slight uptick over the 175 1,000 same period (Ministry of Energy as reported by Exports Domestic Deliveries Reuters). Last month’s data rounds off what has 150 950 been a disappointing first quarter for refined product exports, which have averaged in total 125 900 some 85,000 b/d lower than Q1-2018. Of course, this comes on the back of some promising 100 850 transport fuel demand signals over January- February in particular. Additionally, it is

75 800 understandable to some degree over the first few months of the year, when we saw refiners

50 750 seemingly purposefully keeping the domestic 2019 2018 2017 2016 5-Year Avg market well supplied – despite atrocious margins

Source: Russian Ministry of Energy quoted by Reuters 25 700 – to allay government fears of another retail Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec price surge.

Russia: Product Exports, Domestics Deliveries & Crude Intake, Y-o-Y Change ['000 b/d] In fact, the Q1-2019 downtick in total product 600 400 flows out of Russia is part of a broader downtrend in export growth. We have seen, 400 despite some significant y-o-y gains in

200 throughput over the past number of months 200 (March excluded), the majority of this higher

0 processing filtering through into product supply

0 delivered to the domestic market (see chart). -200 Moving forward, our projections suggest that Russian demand for key export products should -400 Fuel Oil Gasoline -200 remain relatively robust through Q2, capping Gasoil/Diesel volumes available for export (see FSU/CEE Total -600 Crude Intake (Y-o-Y) Insight – Issue 16). At the same time the Source: JBC Energy calculations based on Ministry of Energy data as quoted by Reuters government has given no indication of shifting -800 -400 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 its focus away from encouraging refiners to keep the local market amply supplied and margins Russia: Estimated Refinery Margins with Subsidy by Refinery Type [$/bbl] have even shown some signs of improvement. Yield Assumptions 20.00 Naphtha Gasoline 92 RON Medium/complex Other gasoline ULSD Simple As part of ongoing negotiations regarding an Other gas oil VGO 15.00 Gasoline-focused Fuel oil Other products adjustment to the dampening or “top-up” 100% 10.00 component of the tax manoeuvre, the

80% 5.00 government released a preliminary statement last week suggesting the necessary funds for 60% 0.00 increasing the subsidy could be met by

-5.00 introducing an excise tax on VGO and fuel oil, 40% amongst proposed adjustments to the MET. -10.00 20% Refinery margins are estimated based on export revenues vs Curiously, this amendment includes a rebate revenues from crude exports and the implied subsidy.The -15.00 implied subsidy is the result of the difference between the mechanism in which the duty will be deducted 0% crude export duty and product export duties. for those volumes used in bunkering, secondary Medium / Simple -20.00 Complex Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 refinery processing, and for power generation. Source: JBC Energy Estimates based on official legal information, Argus Media As a result, we would expect downstream players to receive a sizeable portion of the duty back, whilst the burden of bolstering the state budget would likely fall more to the upstream Our projections for Russian fuel oil exports in sector. We need to stress however that the 2020, some 40,000 b/d (-6%) lower y-o-y provisional agreement can in no way be under the assumption of an uptick in demand 670 considered final just yet as we are still expecting as HSFO prices competitively enough to 000 b/d additional deliberations in the forthcoming support increased buying interest. days.¤

6 [email protected], www.jbcenergy.com FSU/CEE Insight: Russia Special Issue 17 | 2-May-19

Data Table

Russia - JBC Energy Statistics ['000 b/d]

2016 2017 2018 2019 2020 Demand 476.6 485.9 485.9 491.3 486.6 LPG Supply 646.1 632.8 652.5 635.9 638.3 Net Exports 169.6 146.9 166.6 144.5 151.7 Demand 150.8 151.9 151.8 146.8 143.8 Naphtha Supply 636.1 655.4 683.9 666.1 665.4 Net Exports 485.3 503.5 532.1 519.3 521.7 Demand 816.4 821.8 830.6 841.8 844.4 Gasoline Supply 928.5 914.1 922.2 944.9 960.9 Net Exports 112.1 92.3 91.6 103.1 116.5 Demand 239.9 269.9 285.2 297.2 303.2 Jet/kero Supply 305.1 321.1 365.9 370.8 380.5 Net Exports 65.2 51.3 80.8 73.7 77.3 Demand 729.5 743.8 802.8 826.8 837.2 Gas oil/diesel Supply 1,681.6 1,730.8 1,769.3 1,760.4 1,731.6 Net Exports 952.1 987.0 966.5 933.6 894.4 Demand 227.2 179.4 213.4 217.1 265.0 Fuel oil Supply 1063.0 978.8 929.0 892.5 898.9 Net Exports 835.8 799.4 715.6 675.4 633.9 Demand 623.7 650.3 649.6 658.7 687.0 Other products Supply 722.2 746.5 789.4 799.3 825.6 Net Exports 98.5 96.2 139.7 140.6 138.6 Demand 3264.1 3303.0 3419.2 3479.7 3567.1 Total products Supply 5982.6 5979.5 6112.2 6070.0 6101.2 Net Exports 2718.5 2676.5 2693.0 2590.2 2534.1 Refinery Capacity 6,214 6,241 6,290 6,381 6,425 Desulphurisation Capacity 2,762 2,793 2,833 2,855 2,869 Conversion Capacity 1,748 1,845 1,918 2,026 2,098 of which: Catalytic Cracking 553 574 595 595 595 of which: Calalytic Hydrocracking 438 469 503 611 663 Refining of which: Coking 229 256 256 256 276 Crude Runs 5,573 5,587 5,720 5,672 5,678 Domestic NGLs Use 412 386 379 378 399 Biofuels 4 5 6 7 7 Other Feedstocks 133 132 131 130 129 Refinery Utilisation [%] 89.7% 89.5% 90.9% 88.9% 88.4% So urce: JB C Energy SuD eP

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