Novatek Shifts Focus to Liquids as Russian Gas Revamp Stalls

OAO Novatek, Russia’s second-biggest natural-gas producer, is switching its focus to production of liquid fuels after adding crude oil reserves as a planned overhaul of the domestic gas market stalls.

“Our main profitability in the next several years will come from increasing liquids production,” Novatek Chief Executive Officer and billionaire shareholder Leonid Mikhelson said in Davos, Switzerland.

Novatek has more than doubled its output in the past seven years, eating away at state-run OAO Gazprom’s dominance in the domestic gas market. Natural gas expansion is constrained by Gazprom’s monopoly on export pipelines, while Novatek, controlled by Mikhelson and Gennady Timchenko, an ally of President Vladimir Putin, profits from shipments of liquids and products abroad.

Output of crude and gas condensate, which is similar to light oil, is set to jump a record 40 percent to 50 percent this year, Mikhelson said. That compares with an 11 percent increase last year to 4.77 million metric tons.

“This year, liquids will account for 12 percent of output, up from 9 percent, while contributing 50 percent of earnings, up from 40 percent,” Mikhelson said.

Gas production growth will remain little changed in 2014, the executive said. Output increased 8.5 percent last year to 62.2 billion cubic meters, enough to supply Italy for a year, according to the company.

Rosneft Swap

Novatek added crude and condensate reserves after agreeing last year to gain control of the SeverEnergia venture with Gazprom’s OAO Gazprom Neft unit, while ceding a stake in a natural gas venture, Sibneftegas.

SeverEnergia’s reserves are 24 percent liquids, compared with 2 percent at Sibneftegas, Maxim Moshkov, an energy analyst at UBS AG in Moscow, said by phone.

The new strategy will be approved by the end of the year, Mikhelson said. Novatek estimated capital expenditures of about $28 billion to 2020 in the plan it presented in December 2011.

Novatek exports crude, stable gas condensate, liquefied petroleum gas and gas condensate products, benefiting from higher prices overseas. The company won the right to export liquefied natural gas last month and plans to start production in 2017. It is barred from exporting gas though Gazprom’s pipelines under a 2006 law.

European Prices

To make the domestic market more attractive, the government needs to decrease transportation and storage costs and resume plans to increase Gazprom’s regulated gas prices, according to Mikhelson. In 2006, Russia said that within five years, local gas prices would be raised to European netback levels, equalizing the profitability of domestic supplies and exports, taking into account transportation costs and duties. The target year has been changed several times since then.

Novatek and oil producers will continue to expand their presence in Russian gas sales, Mikhelson said, declining to elaborate. Novatek may increase its market share to 21 percent in 2015 from 16 percent in 2012 and 8 percent in 2006, according to a Sberbank CIB report this month.

To take advantage of Russia’s long winter, Novatek proposes diversified increases in local gas prices, raising them more in the cold months when gas consumption is higher, Mikhelson said. “Hopefully in the next two to three months, the government will form its position,” he said.

Such a move, which would pass costs either to consumers or regional budgets, is unlikely to come to fruition in the near future, Mikhail Rasstrigin, an analyst at VTB Capital said by phone from Moscow.

“The idea is logical but only if power utilities get lower prices in summer,” Rasstrigin said. “That’s the kind of a market that Russia aims to create in the coming decade but in reality the decisions won’t be approved in the near future.”

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