Pipeline changes
Since ABN Amro opened its office in Moscow in 1972 the bank has
been actively pursuing project financing and financial advisory
deals in the oil and gas sector in which it has built up
considerable experience world-wide. This drive culminated last year
with the conclusion of two major deals, which provided fresh
financing to this important sector and enabled two large projects
to move forward.
The first was the divestment of half of the combined 40% share of Rosneft and Rosneft-Sakhalinmorneftegaz in the ExxonMobil operated Sakhalin-1 PSA to the Indian state oil company ONGC whereby ABN Amro was financial advisor to the seller. The second was the closure of the financing deal for the Blue Stream Transport Company BV, a 50-50 joint venture between Gazprom and ENI/Snam, in which ABN Amro was the financial advisor to ENI/Snam, one of the two project sponsors.
Sakhalin-I
ABN Amro's relationship with Rosneft and Sakhalinmorneftegaz started in 1993 when the bank was selected as financial advisor for the company's D6 oil development project. Thereafter ABN Amro assisted Rosneft with several pre-export financing credits and became financial advisor to the company for the Sakhalin-1 project. The Sakhalin-1 Production Sharing Agreement was signed on 30 September 1995 and initially the shareholders were ExxonMobil, operator, 30%, SODECO, Sakhalin Oil Development Co-operation Company (a consortium of Japanese companies) 30%, Rosneft 17% and Rosneft-Sakhalinmorneftegas 23%. The PSA covers three oil and gas fields, Odoptu, Chayvo and Arkutun-Dagi, which have now a combined estimated recoverable reserves of c. 2 billion bbl oil/condensate and c. 17 Tcf gas.
In 1998 Rosneft decided to divest half of its combined 40% interest in the project, but at that moment market conditions detoriated and no buyer came forward. In 2000 several buyers showed interest again and eventually Rosneft agreed the conditions for the sale with ONGC in December 2000. ONGC paid a cash amount covering premium and past costs and has agreed to carry Rosneft's and Rosneft-Sakhalinmorneftegas's remaining 20% share in the project through the development phase.
The deal was closed in august 2001 when all conditions precedent were met. ExxonMobil recently declared that the Sakhalin-1 project economic and investments will eventually total around $12 billion.
In the project's first phase the consortium will develop the oil rims of Chayvo and Odoptu reservoirs with first oil production scheduled for 2005. This oil production will be treated onshore and then transported by pipeline to the export harbour De Kastri, located on the mainland. Gas production is the objective of the next phase and the operator ExxonMobil is developing a gas export pipeline into Japan. The structure of the deal provided Rosneft with cash to invest further in new field developments while the carry arrangement ensures that the project can go ahead without further cash calls to Rosneft. The carry loan, which has an attractive interest rate, is being repaid out of the production proceeds.
Blue Stream
In 1999 there were several pipeline projects competing to supply the next large volume of gas to Turkey, i.e. the Trans Caspian Gas pipeline project proposed by PSG, which aimed to supply Turkmen gas to Turkey via a pipeline crossing the Caspian Sea, Azerbaijan and Georgia, and the Blue Stream Pipeline project proposed by Gazprom and ENI/Snam, which aimed at supplying Russian gas through a pipeline crossing the Black Sea.
The Trans Caspian gas pipeline was based on an intergovernmental agreement between Turkmenistan, Iran and Turkey to supply c. 30 BCM/yr of Turkmen gas via Iran to Turkey. Due to US sanctions the transportation route was changed to cross the Caspian Sea instead.
At the end of 1997 an Intergovernmental Agreement was signed between the Russian Federation and the Republic of Turkey for the sale of 16 bcm/yr gas starting in 2001. As a result, Gazexport Ltd., a fully owned subsidiary of Gazprom, and the Turkish state gas transportation company Botas entered into a gas supply agreement. Thereafter, Gazprom began the planning process to construct a new gas pipeline from the Russian Federation to Turkey, running under the Black Sea area with a transportation capacity of 16 bcm per year. This project proved technically challenging, being the longest (c. 375 km) and deepest gas pipeline (c. 2150 m subsea) in the world and also financially unattainable without third party support.
In November 1998 Gazprom and ENI S.p.A. entered into a memorandum of understanding to participate on an equal basis in a joint venture, later called the ?Blue Stream Pipeline Company BV? (?BSPC?) for the development and implementation of a gas transportation system from Dzubga in Russia to Samsun in Turkey. Blue Stream Pipeline Company will own the offshore section of the pipeline and the Beregovaya compressor station up to the two onshore sections and is responsible for their construction and operation. Gazprom is responsible for the Russian onshore part from the gas production facilities up to the Beregovaya station, while Botas is responsible for the transport from Samsung onwards. An inter-governmental tax treaty ensures a stable and preferential tax regime for the entire project lifetime.
In 1999 the managing board of ABN Amro decided to act as financial advisor to ENI/Snam on the Blue Stream Pipeline Project in a move designed to support ENI, with which the bank has worked for over 40 years. Furthermore, although the Blue Stream pipeline would have to be laid in much deeper waters than the Trans-Caspian pipeline it was judged to be a more viable project: no other transit countries would be involved and the legal status of the Caspian Sea was under dispute, making laying of subsea pipelines impossible to finance.
ENI chose ABN Amro because of the depth of experience, which the Bank has in financing large oil & gas related projects globally, and because of ABN Amro's knowledge and experience in the former Soviet Union, and specifically in working with Gazprom. This experience has been built up over the last decade and is an area where the bank's expertise is widely recognised. ABN Amro has regularly been ranked as a top 5 player in providing financial services in Europe and the Former Soviet Union.
The decision to back the Blue Stream project was further influenced by a number of other factors including the importance of Italy as a strategic market to ABN Amro and the likelihood of the project's success. And it became clear during the initial discussions with ENI that a critical mass of support for the project was emerging, both from a variety of Italian companies, and the Italian Export Credit Agency, SACE.
The possibility that a project can be completed within a reasonable time frame is a necessary prerequisite for ABN Amro to dedicate resources to a project. With the bank's focus on generating a 25% return on equity, a project needs to have a reasonable chance of generating a success fee to justify its attention. There is also the element of assisting clients on projects which are strategically important to them. For ENI, this project was important as a way to develop its foothold in Turkey and relationship with Gazprom.
In 21 months the sponsors and ABN Amro managed to organise all the necessary elements of the project and its financing, including the co-ordination of diverse elements such as contractors, export credit agencies, suppliers from Italy, Japan, Russia, Turkey, France, and the UK.
The Blue Stream financial advisory focussed on mitigating Snam's risk position and optimising its rewards through the project and financing documents, in the negotiations with Gazprom in relation to the Joint Venture Agreement and related documents, in relation to the construction companies during the EPC negotiation and in relation to the Joint Arrangers in respect of the loans to be procured by BSPC. The solutions are mostly commercially sensitive, but one general example is the introduction of two trust waterfalls for BSPC, whereby Snam will be isolated from any cross defaults of the BSPC Gazprom guaranteed loans.
The outcome is history ? the Trans-Caspian gas pipeline project was abandoned in mid-2001 (at least for the time being), because another large gas find in Azerbaijan (Shakh Deniz) gave this country the potential to export large volumes of gas. A smaller export scheme to supply Turkey with Azeri gas is now being developed as well with a gas line planned in the same corridor as the Baku-Tblisi-Cheyhan oil export line. Furthermore Turkmenistan and Azerbaijan could not agree on how to share the export volume into Turkey. Moreover the legal status of the Caspian Sea remains unresolved. Bluestream financing was closed at end 2001 and offshore pipe laying for the twin 16 inch gas lines has now started by the Saipem-7000 lay barge. The onshore pipeline sections in Russia and Turkey are almost completed. The offshore part of this export scheme and its associated compressor station requires an investment of $1.9 billion. Gas exports to Turkey are expected to start late 2002.
Russo-Turkish relations
From the Russian point of view, Turkey is also a potential competitor. Turkey is potentially a strategic artery for oil and gas flowing from the Caspian, Central Asia, and the Middle East. Part of this vision calls for the eventual transit of gas from Iran, Iraq, Azerbaijan, Turkmenistan, and Kazakhstan through Turkey and on to markets in Western Europe.
But an East-West gas highway through Turkey would be disastrous for Russia's position and plans. It would take away much of the Turkish gas market. It would provide Central Asian producers with an alternative export outlet, enabling them to bypass the Russian Federation. It would also add another supplier to the crowded European gas market, weakening Russia's competitive position in its prime export market.
The Blue Stream Project will create a North-South flow of gas to Turkey. This will encourage a strong community of economic interest between two countries, which traditionally had competing interests and were largely cut off from each other during the Soviet era. The emerging economic axis between Russia and Turkey is a new fact in the geopolitics of the Black Sea and Caspian Sea regions. It has already begun to have political consequences, gradually warming the traditionally cool relations between the two countries.
Turkey views Russia with a mixture of respect and fear. While many Turks look for opportunity and promise in relations with Russia today, it is hard to forget the number of wars which were fought between the two countries as the balance of power has shifted to and fro across the Black Sea over the centuries. Turks also feel resentful of the dominating role Russia has played in Central Asia and the Caucasus, which the Turks regard as their traditional homeland and an area of strategic interest. In these areas and the Balkans, there is an undercurrent of Russian-Turkish conflict. The situation is somewhat sensitive and the potential would exist for a larger conflict between the sides to emerge, if the relationship were not as carefully managed as it has been.
Developing positive relations with Russia is becoming a greater priority for Turkey as the country has felt left out of the European integration process. In 1998, after exclusion from the short list of countries to join in the next round of EU expansion, Turkey conducted a strategic reassessment of its foreign policy priorities. As a result, improving relations with Russia became part of the new strategy. While there are political elements in Turkey, which view Russia with great suspicion, their views have not been the dominant voice over the last decade. The implementation of the Blue Stream Project and its uninterrupted supply to Turkey may do much to improve and strengthen Turkey's perception of Russia. Development of the Blue Stream Project will increase mutual interdependence between the two countries and decrease the risk of any conflicts in the future.
The oil and gas sector was and increasingly is again Russia's lifeblood. Russia was, with c. 11 million b/d, the largest producer in the world, but this production dropped to c. 6 million b/d in 1995. In 2000, Russia's production was up again to c. 6.8 million b/d and currently Russia is with c. 2.8 million b/d the second largest oil exporter after Saudi Arabia.
With 584 Bcm (yr 2000) Russia is also the largest gas producer and with c. 217 Bcm (yr 2000) the largest exporter of gas in the world. Its economy, which has shrunk considerably in the past decade, is very dependent on the income generated by these exports. Export revenues from oil and gas sectors constituted 25% and 15% respectively of Russia's yr 2000 budget. This clearly demonstrates Russia's vulnerability to the oil and the index linked gas price levels The state's 2002 budget is based on an average oil price of $23/bbl and a minimum price of $18.5/bbl. The Russian treasury is expected to loose $0.9 billion in tax revenues for every dollar price drop. So Russia's economic well being is, just as OPEC, very dependent on an oil price between $22-28/bbl, which it needs to develop its economy and pay back its huge loans.
Future production
Over the next five years, Russian oil production is expected to grow at 4-5%, while gas production is expected to decline. Russia's current oil and gas production is coming from fields which were discovered some 20-30 years ago and most of them have reached maturity. In a number of cases production has started to decline and this effect is more clearly visible in the gas than in the oil sector. In the gas sector Gazprom has the commitments to supply large volumes under existing and several new long-term take-or-pay contracts and Gazprom wants to maintain and preferably increase its share of the growing West European import market. In addition thereto Gazprom has the commitment specified in the Russian Gas Law of 1999 to supply the domestic market, regardless of profitability, at regulated prices (currently $15/1000 cum). Gazprom, Itera and the Russian oil companies have more than enough undeveloped gas reserves in their portfolio to ensure future supplies. However, Gazprom's domestic supply obligation at regulated prices and its hold over Russia's trunk-line system preventing other producers to sell their gas directly and allowing Gazprom to buy that gas on its terms, with Itera being the only exception, have prevented timely investments in new gas developments.
The only investment in new gas production made by Gazprom recently is the development of Zapolyarnoye, the last of the easy-to-develop giant fields. The output of this field, which has been brought on stream in October, will offset the decline in Gazprom's production and it is also required to supply Blue Stream. For the longer term other large fields need to be developed to ensure that Gazprom can fullfill its domestic and export obligations. Therefore Gazprom has recently signed a Joint Venture with Rosneft, which aims to develop together and possibly with other partners several large projects. The two JV partners have agreed to pursue a re-issuance of licences on a project-by-project basis of the following fields, which are currently held by themselves or their subsidiairies: Kharampurskoye (reserves 154 million ton oil, 751 Bcm gas), Prirazlomnoye (reserves 76 million ton oil), Stokhmanskoye (reserves: 31 million ton condensate, 3.2 Tcm gas), Vyngayakhinskoye (reserves 93 million ton oil, 107 Bcm gas), Yety-Purovskoye (reserves 32 million ton oil, 300 Bcm gas). Furthermore Gazprom holds licences for the many smaller, but still sizeable gas fields already discovered on the Yamal peninsula and the deeper gas reservoirs below the currently producing older giants like Urengoy, Medveshue and Yamburg.
On the oil side there are many discoveries awaiting appraisal and development as well, but here more exploration may be required. Therefore the Russian oil and gas industry will require in the coming years very large amounts of capital to develop new oil and gas fields, which are mostly all located in the more difficult regions and/or aim at developing deeper reservoirs, requiring much higher investments, if Russia wants in the future to maintain/ increase its export levels and supply increasing volumes of oil and gas to its growing economy.
Even if the oil price returns to OPEC's preferred band width of $22-28/bbl it is likely that the Russian oil and gas industry will need extra capital to finance all the required developments. Developments like Prirazlomnoye and Stokhmanskoye are provisionally budgeted to cost $1 and $15-20 billion respectively. Development of the smaller gas fields in the Yamburg and Yamal areas will require a lot of capital. Most of Russia's production licences are working under the royalty/tax system, while Russia has signed only three PSA's with foreign partners, Sakhalin I, II and Kharyaga. Under the royalty/tax regime in force until now a venture is subject to pay 9 different taxes, some of which change quite frequently. Such an unstable tax regime is unfavourable to attracting large amounts of capital for projects, which have a long lifetime. Due to this unstable tax regime foreign oil companies prefer to invest only if their project is covered by a PSA and have therefore until now refrained from investing in projects whose licences operate under the royalty/tax regime. Starting 1st of January 2002 Russia will introduce a new tax code which lowers the overall profit tax to 24% (from 35%) with expanded deductions and abolishes a number of taxes payable by the oil industry. On the other side, investors will loose the ?50% investment exemption? for re-invested capital. The Russian Government clearly prefers the royalty/tax regime above the PSA. Project financing is possible for PSA as well as royalty/tax projects, but the new tax regime must show that it is stable.
While the former Soviet Union has been a very risky area over the last several years, it is necessary to take a long-term view on the region and its potential. This is one area where ABN Amro has surpassed other financial institutions. For example, in Russia in 1998 after the financial crisis, many foreign financial institutions withdrew or reduced their activities in the country. ABN Amro stayed on and continued to service a wide variety of international and domestic clients. Furthermore one also has to keep an eye as to where future growth will come from. Over the next 20 years world energy consumption is forecast to grow by c. 50%. As oil & gas fields in the North Sea and other parts of the world mature, new sources of energy will have to be developed. For Europe and East Asia, a viable source of hydrocarbons is likely to be the former Soviet Union, meaning Russia and the countries of the Caspian basin/Central Asia. While the area is marked by political instability, our experience has been that in the long-term hydrocarbons tend to make their way to the markets, regardless of interim instability or political upheavals. The terrorist attacks on the United States have caused much improved relations between Russia and the United States and the fact that Russia/CIS is after Saudi Arabia the largest exporter of oil and gas could become even more important in the future, with a large part of the production in the hands of private companies.
The first was the divestment of half of the combined 40% share of Rosneft and Rosneft-Sakhalinmorneftegaz in the ExxonMobil operated Sakhalin-1 PSA to the Indian state oil company ONGC whereby ABN Amro was financial advisor to the seller. The second was the closure of the financing deal for the Blue Stream Transport Company BV, a 50-50 joint venture between Gazprom and ENI/Snam, in which ABN Amro was the financial advisor to ENI/Snam, one of the two project sponsors.
Sakhalin-I
ABN Amro's relationship with Rosneft and Sakhalinmorneftegaz started in 1993 when the bank was selected as financial advisor for the company's D6 oil development project. Thereafter ABN Amro assisted Rosneft with several pre-export financing credits and became financial advisor to the company for the Sakhalin-1 project. The Sakhalin-1 Production Sharing Agreement was signed on 30 September 1995 and initially the shareholders were ExxonMobil, operator, 30%, SODECO, Sakhalin Oil Development Co-operation Company (a consortium of Japanese companies) 30%, Rosneft 17% and Rosneft-Sakhalinmorneftegas 23%. The PSA covers three oil and gas fields, Odoptu, Chayvo and Arkutun-Dagi, which have now a combined estimated recoverable reserves of c. 2 billion bbl oil/condensate and c. 17 Tcf gas.
In 1998 Rosneft decided to divest half of its combined 40% interest in the project, but at that moment market conditions detoriated and no buyer came forward. In 2000 several buyers showed interest again and eventually Rosneft agreed the conditions for the sale with ONGC in December 2000. ONGC paid a cash amount covering premium and past costs and has agreed to carry Rosneft's and Rosneft-Sakhalinmorneftegas's remaining 20% share in the project through the development phase.
The deal was closed in august 2001 when all conditions precedent were met. ExxonMobil recently declared that the Sakhalin-1 project economic and investments will eventually total around $12 billion.
In the project's first phase the consortium will develop the oil rims of Chayvo and Odoptu reservoirs with first oil production scheduled for 2005. This oil production will be treated onshore and then transported by pipeline to the export harbour De Kastri, located on the mainland. Gas production is the objective of the next phase and the operator ExxonMobil is developing a gas export pipeline into Japan. The structure of the deal provided Rosneft with cash to invest further in new field developments while the carry arrangement ensures that the project can go ahead without further cash calls to Rosneft. The carry loan, which has an attractive interest rate, is being repaid out of the production proceeds.
Blue Stream
In 1999 there were several pipeline projects competing to supply the next large volume of gas to Turkey, i.e. the Trans Caspian Gas pipeline project proposed by PSG, which aimed to supply Turkmen gas to Turkey via a pipeline crossing the Caspian Sea, Azerbaijan and Georgia, and the Blue Stream Pipeline project proposed by Gazprom and ENI/Snam, which aimed at supplying Russian gas through a pipeline crossing the Black Sea.
The Trans Caspian gas pipeline was based on an intergovernmental agreement between Turkmenistan, Iran and Turkey to supply c. 30 BCM/yr of Turkmen gas via Iran to Turkey. Due to US sanctions the transportation route was changed to cross the Caspian Sea instead.
At the end of 1997 an Intergovernmental Agreement was signed between the Russian Federation and the Republic of Turkey for the sale of 16 bcm/yr gas starting in 2001. As a result, Gazexport Ltd., a fully owned subsidiary of Gazprom, and the Turkish state gas transportation company Botas entered into a gas supply agreement. Thereafter, Gazprom began the planning process to construct a new gas pipeline from the Russian Federation to Turkey, running under the Black Sea area with a transportation capacity of 16 bcm per year. This project proved technically challenging, being the longest (c. 375 km) and deepest gas pipeline (c. 2150 m subsea) in the world and also financially unattainable without third party support.
In November 1998 Gazprom and ENI S.p.A. entered into a memorandum of understanding to participate on an equal basis in a joint venture, later called the ?Blue Stream Pipeline Company BV? (?BSPC?) for the development and implementation of a gas transportation system from Dzubga in Russia to Samsun in Turkey. Blue Stream Pipeline Company will own the offshore section of the pipeline and the Beregovaya compressor station up to the two onshore sections and is responsible for their construction and operation. Gazprom is responsible for the Russian onshore part from the gas production facilities up to the Beregovaya station, while Botas is responsible for the transport from Samsung onwards. An inter-governmental tax treaty ensures a stable and preferential tax regime for the entire project lifetime.
In 1999 the managing board of ABN Amro decided to act as financial advisor to ENI/Snam on the Blue Stream Pipeline Project in a move designed to support ENI, with which the bank has worked for over 40 years. Furthermore, although the Blue Stream pipeline would have to be laid in much deeper waters than the Trans-Caspian pipeline it was judged to be a more viable project: no other transit countries would be involved and the legal status of the Caspian Sea was under dispute, making laying of subsea pipelines impossible to finance.
ENI chose ABN Amro because of the depth of experience, which the Bank has in financing large oil & gas related projects globally, and because of ABN Amro's knowledge and experience in the former Soviet Union, and specifically in working with Gazprom. This experience has been built up over the last decade and is an area where the bank's expertise is widely recognised. ABN Amro has regularly been ranked as a top 5 player in providing financial services in Europe and the Former Soviet Union.
The decision to back the Blue Stream project was further influenced by a number of other factors including the importance of Italy as a strategic market to ABN Amro and the likelihood of the project's success. And it became clear during the initial discussions with ENI that a critical mass of support for the project was emerging, both from a variety of Italian companies, and the Italian Export Credit Agency, SACE.
The possibility that a project can be completed within a reasonable time frame is a necessary prerequisite for ABN Amro to dedicate resources to a project. With the bank's focus on generating a 25% return on equity, a project needs to have a reasonable chance of generating a success fee to justify its attention. There is also the element of assisting clients on projects which are strategically important to them. For ENI, this project was important as a way to develop its foothold in Turkey and relationship with Gazprom.
In 21 months the sponsors and ABN Amro managed to organise all the necessary elements of the project and its financing, including the co-ordination of diverse elements such as contractors, export credit agencies, suppliers from Italy, Japan, Russia, Turkey, France, and the UK.
The Blue Stream financial advisory focussed on mitigating Snam's risk position and optimising its rewards through the project and financing documents, in the negotiations with Gazprom in relation to the Joint Venture Agreement and related documents, in relation to the construction companies during the EPC negotiation and in relation to the Joint Arrangers in respect of the loans to be procured by BSPC. The solutions are mostly commercially sensitive, but one general example is the introduction of two trust waterfalls for BSPC, whereby Snam will be isolated from any cross defaults of the BSPC Gazprom guaranteed loans.
The outcome is history ? the Trans-Caspian gas pipeline project was abandoned in mid-2001 (at least for the time being), because another large gas find in Azerbaijan (Shakh Deniz) gave this country the potential to export large volumes of gas. A smaller export scheme to supply Turkey with Azeri gas is now being developed as well with a gas line planned in the same corridor as the Baku-Tblisi-Cheyhan oil export line. Furthermore Turkmenistan and Azerbaijan could not agree on how to share the export volume into Turkey. Moreover the legal status of the Caspian Sea remains unresolved. Bluestream financing was closed at end 2001 and offshore pipe laying for the twin 16 inch gas lines has now started by the Saipem-7000 lay barge. The onshore pipeline sections in Russia and Turkey are almost completed. The offshore part of this export scheme and its associated compressor station requires an investment of $1.9 billion. Gas exports to Turkey are expected to start late 2002.
Russo-Turkish relations
From the Russian point of view, Turkey is also a potential competitor. Turkey is potentially a strategic artery for oil and gas flowing from the Caspian, Central Asia, and the Middle East. Part of this vision calls for the eventual transit of gas from Iran, Iraq, Azerbaijan, Turkmenistan, and Kazakhstan through Turkey and on to markets in Western Europe.
But an East-West gas highway through Turkey would be disastrous for Russia's position and plans. It would take away much of the Turkish gas market. It would provide Central Asian producers with an alternative export outlet, enabling them to bypass the Russian Federation. It would also add another supplier to the crowded European gas market, weakening Russia's competitive position in its prime export market.
The Blue Stream Project will create a North-South flow of gas to Turkey. This will encourage a strong community of economic interest between two countries, which traditionally had competing interests and were largely cut off from each other during the Soviet era. The emerging economic axis between Russia and Turkey is a new fact in the geopolitics of the Black Sea and Caspian Sea regions. It has already begun to have political consequences, gradually warming the traditionally cool relations between the two countries.
Turkey views Russia with a mixture of respect and fear. While many Turks look for opportunity and promise in relations with Russia today, it is hard to forget the number of wars which were fought between the two countries as the balance of power has shifted to and fro across the Black Sea over the centuries. Turks also feel resentful of the dominating role Russia has played in Central Asia and the Caucasus, which the Turks regard as their traditional homeland and an area of strategic interest. In these areas and the Balkans, there is an undercurrent of Russian-Turkish conflict. The situation is somewhat sensitive and the potential would exist for a larger conflict between the sides to emerge, if the relationship were not as carefully managed as it has been.
Developing positive relations with Russia is becoming a greater priority for Turkey as the country has felt left out of the European integration process. In 1998, after exclusion from the short list of countries to join in the next round of EU expansion, Turkey conducted a strategic reassessment of its foreign policy priorities. As a result, improving relations with Russia became part of the new strategy. While there are political elements in Turkey, which view Russia with great suspicion, their views have not been the dominant voice over the last decade. The implementation of the Blue Stream Project and its uninterrupted supply to Turkey may do much to improve and strengthen Turkey's perception of Russia. Development of the Blue Stream Project will increase mutual interdependence between the two countries and decrease the risk of any conflicts in the future.
The oil and gas sector was and increasingly is again Russia's lifeblood. Russia was, with c. 11 million b/d, the largest producer in the world, but this production dropped to c. 6 million b/d in 1995. In 2000, Russia's production was up again to c. 6.8 million b/d and currently Russia is with c. 2.8 million b/d the second largest oil exporter after Saudi Arabia.
With 584 Bcm (yr 2000) Russia is also the largest gas producer and with c. 217 Bcm (yr 2000) the largest exporter of gas in the world. Its economy, which has shrunk considerably in the past decade, is very dependent on the income generated by these exports. Export revenues from oil and gas sectors constituted 25% and 15% respectively of Russia's yr 2000 budget. This clearly demonstrates Russia's vulnerability to the oil and the index linked gas price levels The state's 2002 budget is based on an average oil price of $23/bbl and a minimum price of $18.5/bbl. The Russian treasury is expected to loose $0.9 billion in tax revenues for every dollar price drop. So Russia's economic well being is, just as OPEC, very dependent on an oil price between $22-28/bbl, which it needs to develop its economy and pay back its huge loans.
Future production
Over the next five years, Russian oil production is expected to grow at 4-5%, while gas production is expected to decline. Russia's current oil and gas production is coming from fields which were discovered some 20-30 years ago and most of them have reached maturity. In a number of cases production has started to decline and this effect is more clearly visible in the gas than in the oil sector. In the gas sector Gazprom has the commitments to supply large volumes under existing and several new long-term take-or-pay contracts and Gazprom wants to maintain and preferably increase its share of the growing West European import market. In addition thereto Gazprom has the commitment specified in the Russian Gas Law of 1999 to supply the domestic market, regardless of profitability, at regulated prices (currently $15/1000 cum). Gazprom, Itera and the Russian oil companies have more than enough undeveloped gas reserves in their portfolio to ensure future supplies. However, Gazprom's domestic supply obligation at regulated prices and its hold over Russia's trunk-line system preventing other producers to sell their gas directly and allowing Gazprom to buy that gas on its terms, with Itera being the only exception, have prevented timely investments in new gas developments.
The only investment in new gas production made by Gazprom recently is the development of Zapolyarnoye, the last of the easy-to-develop giant fields. The output of this field, which has been brought on stream in October, will offset the decline in Gazprom's production and it is also required to supply Blue Stream. For the longer term other large fields need to be developed to ensure that Gazprom can fullfill its domestic and export obligations. Therefore Gazprom has recently signed a Joint Venture with Rosneft, which aims to develop together and possibly with other partners several large projects. The two JV partners have agreed to pursue a re-issuance of licences on a project-by-project basis of the following fields, which are currently held by themselves or their subsidiairies: Kharampurskoye (reserves 154 million ton oil, 751 Bcm gas), Prirazlomnoye (reserves 76 million ton oil), Stokhmanskoye (reserves: 31 million ton condensate, 3.2 Tcm gas), Vyngayakhinskoye (reserves 93 million ton oil, 107 Bcm gas), Yety-Purovskoye (reserves 32 million ton oil, 300 Bcm gas). Furthermore Gazprom holds licences for the many smaller, but still sizeable gas fields already discovered on the Yamal peninsula and the deeper gas reservoirs below the currently producing older giants like Urengoy, Medveshue and Yamburg.
On the oil side there are many discoveries awaiting appraisal and development as well, but here more exploration may be required. Therefore the Russian oil and gas industry will require in the coming years very large amounts of capital to develop new oil and gas fields, which are mostly all located in the more difficult regions and/or aim at developing deeper reservoirs, requiring much higher investments, if Russia wants in the future to maintain/ increase its export levels and supply increasing volumes of oil and gas to its growing economy.
Even if the oil price returns to OPEC's preferred band width of $22-28/bbl it is likely that the Russian oil and gas industry will need extra capital to finance all the required developments. Developments like Prirazlomnoye and Stokhmanskoye are provisionally budgeted to cost $1 and $15-20 billion respectively. Development of the smaller gas fields in the Yamburg and Yamal areas will require a lot of capital. Most of Russia's production licences are working under the royalty/tax system, while Russia has signed only three PSA's with foreign partners, Sakhalin I, II and Kharyaga. Under the royalty/tax regime in force until now a venture is subject to pay 9 different taxes, some of which change quite frequently. Such an unstable tax regime is unfavourable to attracting large amounts of capital for projects, which have a long lifetime. Due to this unstable tax regime foreign oil companies prefer to invest only if their project is covered by a PSA and have therefore until now refrained from investing in projects whose licences operate under the royalty/tax regime. Starting 1st of January 2002 Russia will introduce a new tax code which lowers the overall profit tax to 24% (from 35%) with expanded deductions and abolishes a number of taxes payable by the oil industry. On the other side, investors will loose the ?50% investment exemption? for re-invested capital. The Russian Government clearly prefers the royalty/tax regime above the PSA. Project financing is possible for PSA as well as royalty/tax projects, but the new tax regime must show that it is stable.
While the former Soviet Union has been a very risky area over the last several years, it is necessary to take a long-term view on the region and its potential. This is one area where ABN Amro has surpassed other financial institutions. For example, in Russia in 1998 after the financial crisis, many foreign financial institutions withdrew or reduced their activities in the country. ABN Amro stayed on and continued to service a wide variety of international and domestic clients. Furthermore one also has to keep an eye as to where future growth will come from. Over the next 20 years world energy consumption is forecast to grow by c. 50%. As oil & gas fields in the North Sea and other parts of the world mature, new sources of energy will have to be developed. For Europe and East Asia, a viable source of hydrocarbons is likely to be the former Soviet Union, meaning Russia and the countries of the Caspian basin/Central Asia. While the area is marked by political instability, our experience has been that in the long-term hydrocarbons tend to make their way to the markets, regardless of interim instability or political upheavals. The terrorist attacks on the United States have caused much improved relations between Russia and the United States and the fact that Russia/CIS is after Saudi Arabia the largest exporter of oil and gas could become even more important in the future, with a large part of the production in the hands of private companies.
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