28 Jul 2020

Gazprom Neft Deputy CEO Vadim Yakovlev: Growth in share of Gazprom Neft's gas output result of expansion in Arctic, not end in itself

MOSCOW. July 28 (Interfax) - Gazprom Neft is the oil subsidiary of Russian gas giant Gazprom, but recently the share of gas in the company's new projects has been growing. This is primarily due to the company's expansion in the Arctic, where new projects enjoy preferences from the government as of the summer of 2020.

Gazprom Neft's deputy CEO for exploration and production, Vadim Yakovlev spoke to Interfax about how the company is looking for new points of growth in the gas segment and is gradually transforming from an oil company into an oil and gas company, as well as about the prospects of its Arctic cluster, oil companies' talks with the Finance Ministry about the excess profit tax (EPT), and his opinion on actions within the context of OPEC+.

Question: Gazprom Neft is the operator at Messoyakhaneftegaz, a joint project with Rosneft and the northernmost project in continental Russia. In difficult Arctic conditions, you decided to inject associated petroleum gas (APG) from one field into undeveloped gas formations of another field. This is an unconventional move. What was this decision based on?

Anwer: The goal has been to bring the salvaging of APG at the Vostochno-Messoyakhskoye field to 95%. For this, a 47-kilometer pipeline from Eastern Messoyakha has been laid to an underground gas storage facility that will be located in the undeveloped gas reservoirs of neighboring Western Messoyakha. This could be called an unusual and unique decision for the oil industry, because APG from one field is being salvaged into the undeveloped gas reservoirs of another area for the first time domestically.

Messoyakhskoye is a remote field. The volume of APG produced there is about 1.5 billion cubic meters per year, and it is not enough to establish a profitable project with gas delivery to the unified gas supply system. Therefore, it was sensible to consider the option of re-injection; however, Eastern Messoyakha could not provide a suitable reservoir for this purpose. Consequently, we evaluated the neighboring field and found a required reservoir with high seal tightness and a large volume at Eastern Messoyakha.

Underground gas storage facilities are usually created in depleted fields, where the pressure has already decreased; however, we are injecting gas into initial reservoir conditions, which requires careful engineering calculations. During the injection process, we were assured and our assumptions were confirmed.

Q.: How will the gas issue at Messoykha be resolved in future, when do you plan to feed the gas into the pipeline?

A.: Pumping gas into underground storage facilities is a self-sufficient solution, but not a permanent one, even if we understand that we would be able to utilize 1.5 billion cubic meters annually for a period of 11 years. At the same time, we are continuing to evaluate the nearby resource base, and we are working to generate the volume of gas required in order to construct the infrastructure to the UGSS.

There are several assets of our parent company nearby, as well as plots of other industry players, and licenses still remain in the unallocated fund. In any case, the 47-kilometer transport section that we have built is already located in the target corridor and brings Messoyakha closer to the existing Russian gas pipelines.

Q.: The share of Arctic projects in Gazprom Neft's production is growing. What might it be in the medium term, and to what extent will the contribution of traditional regions of production decrease?

A.: Production from Arctic projects in Gazprom Neft's total portfolio in the next three years will amount to about 30%. In the future, this share will grow consistently and significantly. The Arctic, and in particular the Yamalo-Nenets Autonomous District, is indeed the main source of production growth for Gazprom Neft - Novy Port, Messoyakha and Prirazlomnoye will remain such drivers for a long time. The company is also actively working on the oil rims of the Yen-Yakhinskoye and Pestsovoye fields, which are becoming new growth points for liquid hydrocarbon production.

Speaking of the long-term prospects, production at the new projects depends on the elimination of geological uncertainty and the resolution of technical challenges. But we're not betting on the Arctic at the expense of other regions, we're looking for opportunities everywhere to boost and maintain profitable production.

Q.: New exploration projects on the Gydan and Taimyr peninsulas might be postponed due to the crisis?

A.: We're continuing to work there. Near-term plans involve the Leskinsky block. This is Gydan, the left bank of the mouth of the Yenisei, where we plan to start drilling by the end of the year.

Taimyr blocks are located on the opposite bank, and the information that we get at Leskinsky in terms of geology will be important for assessing the prospects of this region. We have not formed long-term plans for Taimyr yet. The near-term plan includes doing aerial surveys, ground reconnaissance, determining the necessary list of field work. When the geology on the left bank of the Yenisei becomes clear, we'll think about what to do on the right bank.

Q.: According to tenders, Gazprom Neft is continuing to work through issues related to the construction of new ports in the Arctic to export hydrocarbons along the Northern Sea Route (NSR)...

A.: A priority now is choosing the optimum means of delivering liquid hydrocarbons to target markets from Bovanenkovo and Kharasavey. A decision should be made in 2021. We're considering three possible options: a new sea terminal at the Gulf of Ob, and also supplies by rail either southward via the existing Bovanenkovo-Ob line or northward as part of construction of the additional Northern Latitudinal Pass-2 section.

The decision will depend on the prospects of developing Bovanenkovo and Kharasavey. The objective of the pilot work being done is to form production profile forecasts: how much condensate we expect, how much broad fraction of light hydrocarbons. As a result, we will be able to understand the economics of the three options and choose the optimal one. If the decision is made to create a new channel for shipping liquid hydrocarbons in Yamal, this infrastructure can be used for the resource base of the entire region.

As regards other transportation facilities that could be located in the bodies of water of the Yamal-Nenets Autonomous District, these decisions will depend on the results of the stage of preparing reserves. There are reserves in Yamburg, but there is the issue of selecting technology and the economics of development. We need to get an idea of the reserves at the mouth of the Yenisei River, and this is still a very long way off.

Q.: Gazprom Neft is increasingly talking about gas. The company is gradually transforming from an oil into an oil and gas company. To what extent might the share of gas in production increase?

A.: Growth of the gas component was never an independent goal for us. That this is happening now is the result of the company's development in the Arctic. This is unavoidably linked to the change in geological reserves and increase of the gas factor at oil fields. In addition, we often see that infrastructure solutions become more effective if they are planned for preparation and transportation of all types of hydrocarbons.

At the same time, we are naturally expanding our expertise in working with multi-component reserves. For instance, on the basis of a joint venture with Novatek-Arcticgas - we have been developing gas condensate deposits for a long time, and now we have received similar assets from our parent company - I mean the Bovanenkovo and Kharasavey projects. Moreover, all decisions are taken in close cooperation with Gazprom and as part of forming a long-term gas balance.

The share of gas in Gazprom Neft's overall production will indeed continue to grow. In the coming three years the share of investment in gas projects will total around 30%. With the launch of new projects - the Urengoy Achimov deposits, Bovanenkovo and Kharasavey in 2024-2026, the share of gas in our production will be up to 45%.

We are developing in the general logic of the fuel and energy sector, where the gas component is starting to dominate in new projects, and this makes Gazprom Neft more resilient to the situation on the oil market: under the OPEC+ deal companies have to lower oil production, so growth of gas production becomes an additional opportunity for us to increase the scale of our business.

Q.: The base project right now is Yamal Gas. How is it progressing?

A.: Literally at an accelerated pace. We are creating powerful gas infrastructure, which will ensure economically efficient and comprehensive development of hydrocarbon reserves in the south of Yamal. Right now, two main facilities are under construction - the external transport gas pipeline across the Gulf of Ob and the expansion of the Novoportovskoye field gas treatment unit (GTU).

The Yamal Gas project team exceeded the plan during the winter season, with more than 36 out of 56 km of the onshore pipeline being laid, and the onshore facilities being constructed. In early July, the project team began laying the gas pipeline in the waters of the Gulf of Ob from the side of the Yamal Peninsula. This is a very large-scale operation that will involve a total of 55 vessels offshore. We are now starting to lay the pipeline from the side of the Taz Peninsula. We plan to complete laying the pipe along the seafloor of the Gulf of Ob during the summer and partly into the autumn until October, and next winter finish work onshore, where we have completed two thirds of the plan. Concurrently, we will begin laying the gas pipeline to the village of Novy Port in order to supply gas to the settlement.

The active construction season is also underway at the site of the expansion of the Novoportovskoye field GTU. Piles for process equipment and racks were positioned in the winter. Concrete foundations for the equipment of the booster compressor station and gas pumping units (GPU) were poured in difficult climatic conditions. Work is continuing on the assembly of metal structures at the process racks to the raw GPU and for feeding gas into the external transport gas pipeline.

We plan to begin start-up and commissioning operations at the expanded GTU in mid-2021, and we will be ready to supply gas to the unified gas supply system by 2022. By this time, we plan to boost the output capacity of the GTU to 17.5 billion cubic meters per year.

The implementation of the Yamal Gas project has coincided with the pandemic, but we are strictly adhering to all quarantine measures. We are trying to transfer operations to autonomous mode as much as possible, especially in the most significant areas, and we are constantly testing all personnel and employees of contractors.

Q.: How promising does the company believe gas-chemical projects are in the Arctic?

A.: It is already necessary to think about the target base for the gas-chemical sector at the stage of reserves preparation, when projects are put together in order to find the most efficient ways to monetize resources.

Changes in the share of gas in reserves with the advance to the North form a potential raw material base and preconditions for the implementation of gas-chemical projects. There are also regional particulars - in the north of Yamal there is more 'wet' gas than 'dry' gas. These are millions of tonnes of ethane, propane, and butane that are traditionally used as feedstock for the gas-chemical industry. Yamal's reserves are huge, and in terms of raw materials they are comparable to the needs of the whole gas-chemical industry of Western Siberia. Moreover, these are world class resources in terms of scale and quality, and the gas-chemical markets are growing faster than the oil or gas markets.

Therefore, it is clear to everyone that these resources at least need to be analyzed and studied. We are doing such work, making our assessments, and consulting with companies that specialize in this area. We must set up an expert dialogue of all the interested parties, and then a solution will be developed that will become a driver for the development of not only our, but also related industries, and make it possible to monetize new reserves as efficiently as possible.

Q.: Further into the Arctic is the shelf of Arctic seas. Gazprom Neft has said that it is reconsidering the pace and timing of the implementation of offshore projects due to the macroeconomic situation. Has the company asked the Natural Resources Ministry to postpone deadlines for work on offshore projects?

A.: We have already carried out a very large amount of work at our licensed blocks ahead of schedule: around 20,000 linear meters of seismic surveying and 7,000 square kilometers of 3D seismic work. The company has drilled three wells on the shelf of the Sea of Okhotsk in the past three years.

As a result, a large amount of geological information was collected that must be analyzed carefully, and the present market conditions allow us not to rush, particularly since we're only supposed to drill the next well at the Dolginskoye field in 2023.

Therefore, we have fulfilled all license obligations and can calmly work on data processing in order to create a solid foundation for launching these projects.

Q.: Gazprom Neft's most promising offshore exploration projects are in Sakhalin Region, the Neptune and Triton fields. Will you have to forget about a potential partnership at these fields due to the crisis?

A.: Not at all. We have conducted a large amount of geological exploration work on the Sakhalin shelf. Furthermore, the classification of the Sea of Okhotsk shelf as a Category 4 area of difficulty has improved the economics of these projects.

The most important thing is that we started to assess the options for asset development. We believe that using the existing infrastructure of Sakhalin-2 can be optimal, especially from the position of our parent company. This configuration provides a basis for making a decision on asset development. However, it is appropriate to implement projects of this scale with partners. Therefore, there will be a two-stage movement: first we need to agree on the infrastructure, and this conversation has already begun, and then we will move on to the formation of the partner structure.

Q.: Are you continuing talks with Shell on joining the Sakhalin projects?

A.: This conversation is being had with Shell and with other potential partners.

Q.: At what stage is the formation of a joint venture in the Arctic with Novatek, the first asset of which is supposed to be the offshore Severo-Vrangelevsky block in the Chukchi Sea?

A.: We are in the process of preparing legally binding documents. We plan to set up the JV at the start of 2021. All the agreements are in force; we are progressing in line with our joint plans.

Q.: In recent years, Gazprom Neft's new major assets have been projects handed over from Gazprom under long-term risk-based operatorship contracts. Will Gazprom Neft acquire more such contracts on Gazprom fields?

A.: This is a universal mechanism for structuring relations between Gazprom and Gazprom Neft. It is also suitable for work on other blocks, but at the moment we have a sufficient portfolio of assets. Under long-term risk-based operatorship contracts we received a significant additional investment burden, we're carrying substantial liability to the parent company. Therefore, we are now focussed on precisely fulfilling all the obligations that we assumed. Of course, we're constantly updating our strategy, looking for new sources of growth, but the priority is the implementation of projects we've already begun.

Q.: How has the new reality with Covid-19 and the drop in oil prices affected the company's management?

A.: Right now one can probably say that is was more that the new circumstances accelerated the corporate management processes chosen earlier than that the crisis and the coronavirus pushed Gazprom Neft toward some kind of decisions. They come down to moving along the path of comprehensive transformation, creating integrated business processes, introducing digital solutions.

Our employees are increasingly working in the format of cross-functional teams, developing new products, supporting these projects throughout their lifecycle, from the birth of an idea to full-scale rollout. And what's happening now in terms of management differs considerably from traditional models built on the principle of hierarchical, top-down interaction.

We're teaching our managers to work in a new format, creating a distributed system of knowledge preservation, platforms for joint remote work. The work of cross-functional teams is simultaneously a risk and an opportunity. We never know ahead of time what idea will take off and find its legs and which one won't pay off. But in this way we're building an internal culture of initiative. This is a kind of system of motivation aimed at getting employees ready to find new opportunities for improvement, initiate projects and get involved in subsequent work.

The upper management team does not seek to make the final decision on every matter. Such a distributed model of authority and business structure sets the stage for a constant, dynamic, self-sustaining work process. This is particularly important for companies whose assets are geographically distributed and require completely different products and solutions.

Q.: Is this something akin to the management system adopted by IT companies?

A.: Probably, a specific of IT companies is exactly that they are constantly creating new solutions. In this there is indeed a certain similarity between us. We also know how to experiment and take justified risks, know how to launch new projects and work with a great deal of uncertainty. After all, when geological exploration starts, by industry standards the chance of success is estimated at just 20-30%. Therefore, the Fail Fast principle, which is aimed at sifting out all unviable options as quickly as possible at the earliest stages, is also applied broadly in the oil industry. Like at IT companies - fast verification of hypothesis, rejection of inefficient options and concentration on the most promising ones. When beginning exploration, we also, foremost, set the goal of determining specifically what further studies will make it possible to obtain the maximum needed information and narrow the scope of uncertainty. In other words, we consider various options and find the best one. By the algorithm of actions, this is similar to the work of a company that develops digital products.

Q.: Oil production has been reduced due to the OPEC+ deal, perhaps for a long time. Accordingly, the same number of employees will no longer be needed as when production was growing. Will the change in oil production volumes have an impact on the number of employees at Gazprom Neft?

A.: We're not planning measures such as mass layoffs or transfer to part-time work. However, labor productivity, as an indicator, is important to us, we control and manage it. We structure our operations based on this. Yes, some of our employees have been freed up due to the decrease in production volumes. We're thinking about how to employ them. First of all we cut external hiring and we're trying to fill all vacancies with the internal talent pool. For example, we're moving employees between enterprises, transferring them to growing assets and to promising projects. We are now using our own staff to carry out some services that were previously provided to us by outside organizations, among other things, we can retrain them.

Q.: The introduction of the excess profit tax (EPT) remains a sensitive issue for Russia's oil industry. The Finance Ministry has talked about a budget revenue shortfall in the hundreds of billions of rubles and seriously questions the need to expand EPT pilot projects to new fields. Have oil companies managed to defend their position on the need to continue the experiment?

A.: Of course, this is a very important issue for the whole oil sector that requires consistent and careful approaches. It's important to understand that we're all working together on a common cause, creating additional value, both for the nation and the sector. In order to find a solution to a complex problem, as a rule one needs to successively ask three questions: Why? What? and How?

The first question is why have we turned to the EPT? The answer is in order to harmonize the tax system, which, as everyone understands, is becoming ever more complex, unwieldy and patchy due to the constant appearance of some sort of targeted decisions. Why did this happen? Because the underlying tax system was established quite a long time ago and remains fairly schematic. Specifically, it does not take into account production conditions in different geographical, geological and climatic conditions.

The answer to the question of what needs to be done in order to establish a harmonized system is simple - introduce the EPT. After all, no one is proposing realistic alternatives to this system. Therefore, we will have to establish this mechanism one way or another, fine-tune it, meaning try to answer the third question: How?

We need to understand that we are at the pilot stage. The experiment is being conducted at assets that account for just 10% of oil production in the country. The Energy Ministry has already positively assessed the first results of the sector's operations under the EPT. The objective of any pilot project is to confirm hypotheses, eliminate uncertainty, help in the further fine-tuning of the mechanism.

Among other things, the pilot project has identified what issues will certainly need additional attention. It showed that the EPT needs to be set up for a broad price range. We all see how dramatic changes in the market situation can be on a horizon of three to four years. The second important element is the correlation of such elements as rent and taxation of profit in the new tax regime.

Since we're at the stage of testing the new system, we need a calm and balanced expert assessment of the results and solutions for how to improve this mechanism. The criteria, of course, need further discussion, because right now calculations are being made fairly linearly - tax revenues before and after the changes are taken, but by default the level of production is considered a constant. This is incorrect. If we could get this oil under the usual tax regime, then we wouldn't need to change anything. But we are moving together with the government toward changing the system exactly in order to create incentives to produce additional oil that no one would otherwise produce, so there wouldn't be anything to tax.

In addition, assessments need to be made not only looking back at a very short period of one to two years, but taking into account longer periods. After all, there is the investment stage and the stage of earning income. We need to look at all sources of revenue, not only the EPT and the mineral extraction tax. There are also the tax on profit and dividends from state companies. This way we can form a comprehensive assessment.

Our objective is to show the effectiveness of this system for everyone, both for companies and for the state. Therefore, I would like to note again that we don't see alternatives to the EPT either way. It is necessary to correctly analyze the obtained results, grasp and convert into the fine-tuning of the mechanism. And now it is very important to join forces and move further in order to create additional value - new oil and new revenue for the state.

Q.: And a few questions on the subject of OPEC+. Do you agree with the assertion that there will already be a shortage on the oil market in July?

A.: There is a certain lag between what is really happening in the market and objective information about indicators, such as the balance of supply and demand, the volume of stocks. There is an opinion that the market already reached a point of balance in June. We cannot see this yet from the mentioned indicators. But factors affecting the markets generally confirm this trend.

The parties to the deal are fulfilling their obligations with discipline. Production volumes in North America have fallen, and so far we don't see signs of recovery. The depth of the market slump and scale of stocks were not as dramatic after all as it sounded in the scariest forecasts. We're seeing steady demand for Russian oil and even a shortage that is reflected in, among other things, price quotes, in premiums on Urals crude compared to other blends.

Indicators do indeed show that the market has stabilized. The assumptions factored into the design of the OPEC+ deal are generally proving true. Perhaps, the situation will develop even more optimistically. Of course, there is uncertainty regarding a possible second wave of the pandemic, but in any case neither we, nor experts expect that the depth of the correction in this second wave, if it happens, will be as deep as in the first stage. Right now we're seeing a recovery trend and we believe it will continue.

Q.: In August, OPEC+ countries will start to increase oil production. Has the Energy Ministry already discussed this with Russian oil companies?

A.: We're in regular consultations, there is constant comparison of opinions, we have long ago established working relations. Increasing production will not require some special, radical decision, everything will happen within the context of previously agreed plans. There are quantity parameters that we expect to reach in August and we're intent on using this possibility.

Q.: How sustainable do you think the current oil price of about $40 per barrel is, and what is your forecast to the end of the year?

A.: We believe that today's price reflects the current state of the market. We prefer not to give forecasts, and in any case we try not to guess some price level. The company makes multi-scenario forecasts for itself and prepares an action plan in a certain price horizon. Right now there is no reason to seriously expect that current price levels might change much.

Q.: Gazprom Neft head Alexander Dyukov proposed earlier to switch from targeting inventories to targeting OPEC+ market share. How might this work where there are producers with different cost levels and financial capabilities? Might not we and other OPEC+ countries end up giving up our competitive advantage?

A.: This refers to the participants in the OPEC+ deal being able to target their share amid growth in global demand for oil.

If we're talking about long-term trends, we expect demand to grow, and participants in the deal must think about what is the fair share of OPEC+ in this increase. This makes it possible to plan our capacity, assess long-term projects and investment programs.

The idea is being well received in industry discussions. But, of course, today everyone is more worried about the development of the short-term situation. I think that it will be right to return to the issue of targeting the market share of OPEC+ a little later. The mechanism should have two elements: the ability to achieve short-term stabilization of the market if necessary, and to target the fair share of the participants in the long term.