Russia Oil Improvement Investing

Brian Hicks

Written By Brian Hicks

Posted May 30, 2013

The Russian oil and gas sector is expanding significantly, and the repercussions could be widespread.

One of the main areas of growth and investment in Russia is the modernization of the country’s aging oil and gas infrastructure. Bloomberg notes that more than half of Russia’s 1,835 rigs are over 20 years old. That’s just not adequate for companies like OAO Rosneft (MM: ROSN) and OAO Gazprom (MM: GAZP) to successfully pursue shale operations in Siberia.

oil 11%2F11%2F11This represents a great opportunity for manufacturing companies like National Oilwell Varco Inc. (NYSE: NOV) and Honghua Group of China, which are now vying to build new oil rigs in Russia.

The Bazhenov shale in Siberia – estimated to be nearly as big as the entire nation of France – is presently being jointly explored by Rosneft and Exxon Mobil Corp. (NYSE: XOM). Allegedly, there is more than enough oil in the Bazhenov shale to increase Russia’s reserves by more than double.

And under Putin, the desired level of production is just over 10 million barrels per day – something that’s not possible right now. Hence the necessity for newer infrastructure.

This year, Russia will receive up to 105 new rig units – a five-year high. Yet older rigs are being decommissioned at the rate of 400 or more per year, creating a significant supply gap.

VTB Capital, whose research Bloomberg quotes, indicates that National Oilwell could provide 5 rigs to companies operating in Russia over 2013, thereby competing with Russia’s domestic OAO OMZ. And Russia already ranks second in terms of sales for China’s Honghua Group, so it is clearly very interested in Russia as well.

Despite the apparent lack of adequate infrastructure, Russian production remains quite high; back in March, average production was 10.47 million barrels per day. So far, evidently, the balance between older rig retirements and newer rig development has been maintained successfully. However, if Russia is to seriously grow its oil and gas sector, that balance may prove more difficult to sustain.

To wit, companies like Rosneft and Gazprom are seeking to emulate American-style fracking practices in order to get at tougher shale reserves. And that requires machinery that’s a little more advanced.

Rosneft, Gazprom, and International Ambitions

That Russia is seeking to become even more of a major player in the international oil and gas sector is fairly evident. The Chicago Tribune notes that Rosneft just recently made moves to acquire another local gas company, Itera, in a proposed $3 billion deal. Itera is already partially owned by Rosneft (51 percent, to be exact).

Itera used to be the biggest gas supplier in the former USSR, but Gazprom came along and established its monopoly over Russian gas exports back in 2006. Gazprom’s fortunes have entered somewhat questionable territory of late. Right now, Gazprom is in the paradoxical situation of being quite powerful when it comes to exporting gas across Europe, but being rather vulnerable at home due to increased competition.

In 2008, Gazprom commanded 80 percent of the domestic gas market. In 2012, that was down to 73 percent. Meanwhile, Rosneft has been collaborating internationally – notably with Exxon Mobil – to seriously boost its oil and gas infrastructure. Just this March, Rosneft bought out TNK-BP, the Anglo-Russian oil firm, in a massive $55 billion acquisition. That move made Rosneft the world’s biggest crude oil producer based on volume.

And now Rosneft is targeting gas production on hitherto-unprecedented levels, which is what has Gazprom concerned. Last year, the company paired up with Itera to produce 13 billion cubic meters of gas over 2013. Certainly, that is dwarfed by Gazprom’s 2012 output of 479 billion cubic meters, but Rosneft has also made some other moves, such as collaborating with local company Novatek to lobby for exporting liquefied natural gas to Asian nations.

As well, Rosneft is aiming to boost domestic gas shares to nearly 20 percent by 2020. Currently, it hovers around 9 percent.

The Itera deal did come under some criticism, with some analysts suggesting Rosneft is overpaying. Bloomberg indicates that VTB Capital believes Rosneft is paying too high at nearly $78 per barrel of oil equivalent.

In sum, the markets are likely to respond somewhat unfavorably to the deal, assuming it materializes as planned.


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