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Fares Kilzie: “Curse of Oil” will yet work for Russia

Fares Kilzie

The current fall in the global price of oil is a long-term process. Within the coming four-five years, oil prices will range between $40 a barrel and $45 a barrel, says Dr. Fares Kilzie, Chairman at Creon Energy Board of Directors. However, Russia can adapt to such situation much more successfully than such countries as Venezuela and Algeria that almost fully depend on oil. Besides, the “hydrocarbon model” of growth has not been exhausted yet – the current situation makes demand for development of such highly profitable sectors as petrochemical industry and chemical utilization of natural gas. In addition, Fares Kilzie says, Russia should not refuse from the development of alternative energy either, even under pressure of the market circumstances. The expert believes that in the visible future, these circumstances will lead to serious changes in the Russian fuel and energy sector and in such pending issue as reforms in Gazprom.

$40-$45 - “it has come to stay”

The current situation in the world’s oil market reminds the “oil shock” of 1973, though then the oil prices skyrocketed and then fell again in few years, which had a far-reaching negative effect on oil producing countries: debt crisis, political convulsion etc. Both then and now, there have been enough conspiracy theories in the explanations of what is happening. Will history repeat in this or another form?

I see no parallels with 1973, but there is an exception. When Saudi King Faisal decided to stop the inflow of hydrocarbons to Europe to press the West over the Palestinian issue, the world started thinking of alternative sources of energy. I’d like to recall that then Russia was not ready to supply large volumes of oil to the world market – it became possible only in 1978-1979 and the Persian Gulf states actually had a monopoly position on it. Now the situation is quite different: then there was shortage of oil, now there is oversupply situation. That is why one should not explain the current situation in the market with a conspiracy theory. I do not really believe in the talks that Saudi Arabia decided to make oil prices fall to stop the shale oil industry – of course, there is a shale oil factor which upsets Saudis, but it is not the major one. The major factor that caused landslide of oil prices is the need of the developing countries, and China first, is an adequate oil price. The current average oil price is $40-$45 per barrel +/- $5, which I have repeatedly mentioned, and it makes sense for everyone, even Saudis. Stemming from this forecast, Saudi Arabia has set up its development plan for 2020-2021 and acts in accordance with it along with all the other countries of the Persian Gulf. This is a weighted policy of a competent supplier that understands that concessions now will bring healthy consumers in five years. Furthermore, there are all signs that developing countries receive low oil price dividends. That’s all. All the other talks are connected with the general geopolitical situation, but market factors are essential. Yet, there is a new trend in the market: formerly, various local conflicts pushed oil prices up, but now the zone of these local conflicts has expanded dramatically and the prices no longer react to it.

Saudis are acting in accordance with their plan. What about Russia? Did our economy prove ready for the current price in the market?

This plan is not exactly what we need, but we too started adapting to the new prices. To fill the budget, Russia started using mechanisms that imply more customs duties, taxes, more independence to the regions in financial decision-making.

Do you think it is a spontaneous reaction or was it planned yet in the period of high oil prices?

Well, the drop of oil prices did not catch us by surprise. Furthermore, we have much more positions to play back the current situation in the oil market than other oil producing countries do. The resources we have – raw materials for production of mineral fertilizers, gold and others – will help us anyway. We will not die due to poverty, exactly. But, not it is necessary to speed up the sectors of economy that may bring us any additional profits. This is not tourism and not investments in bridges, indeed. It is necessary to invest in new sectors, and we have such sectors and they show quite good results, just need some more stimuli, for instance, the petrochemical industry and chemical utilization of natural gas I have mentioned above. These are those unique segments that can bring us as much income as oil and gas did yet not so long ago, if we support and develop them. So, we are not in the same situation with such countries as Venezuela and Algeria that highly depend on oil and gas and will sure experience not just shocks. The situation in such countries will grow into domestic political conflicts and even collapse. However, it is their problems, since they needed to think of adapting to possible shocks beforehand. Such scenario does not threaten us – Russia has a range of other segments of industry that can be supported and developed rapidly to be recompressed for losses from sliding oil prices.

Reformatting the “hydrocarbon model”

Can we argue that in the middle of the last decade, the country’s leadership adopted a strategically right decision by binding oil companies to modernize their refining capacities? Do they receive the anticipated dividends now?

Yes, look at Surgutneftegaz and LUKOIL that have implemented their investment projects by almost 100 percent and now receive the results they anticipated. LUKOIL’s own refining capacities saved it yet during the crisis of 2008 – but for its fuel filling stations, it would suffer greatly.

What about Rosneft?

No, unfortunately. Their tactics was very simple unlike the companies that invested in their own capacities, which requires a competent management, first of all. Rosneft’s development strategy was unique, as it could afford amalgamating any rival relatively reasonably. Why does Rosneft seek to buy Bashneft? Everything is simple: these are additional capacities in refining and logistics, though it can build such capacities on its own funds. However, if you have administrative resources that let you amalgamate any rival, you do not need to write an investment program to develop refinery – you can simply amalgamate the company that has such capacities. However, those opportunities remained in the past because of a range of reasons. First of all, there is no company to amalgamate. Those that can be still amalgamated are not appropriate for a growth.

Has the “hydrocarbon model” of economic growth been exhausted, as known experts say, or can it be reformatted with a focus on refining?

Today, it is very hard to make any long-term forecasts. Gas energy which I qualify as alternative energy develops very rapidly and no one knows where it will end. There was a similar situation twenty years ago when Internet emerged. No one could imagine then that it will become not just a new phenomenon in our life, but a great part of it, and an integral element of our existence. Alternative energy is like Internet – no one knows how, for instance, cars will look in 2025. I can bring just one example: the International Maritime Organization consistently restricts the use of diesel oil in maritime traffic, and many companies shift to methanol. There are a range of laws stimulating the use of compressed gas in motor traffic.

So far, all these initiatives are developing so chaotically that it is not clear what this all may lead to. There is an established fact – there will be two worlds: hydrocarbon and an alternative to it. There may be even division into various regions by that criterion. For instance, it is well known that France depends on nuclear power by 78% despite the opinion of the entire Europe. Therefore, in the future there will be countries that will depend on alternative sources of energy significantly, but there will be also the ones that will rely on traditional sources of energy. It is obvious that we will be belonging to the second group, and it’s no crime. Russia will remain a country exporting hydrocarbons, but it is hard to say now how much the demand will fall and how Russia will be adapting to the situation in 10-15 years. Now, we can speak only about the 5-year outlook where we anticipate the oil price at $40 a barrel in average – maximum $50, coupled with chaotic field of shale gas.

Do we need to develop the shale gas?

No, we don’t have to do it. It is not expedient. We need to increase the natural gas output, which, I repeat, is an alternative type of fuel too. It is very economical and environment-friendly.

The West has not left us, but it does not wait for us either

How did the West’s sanctions affect the Russian fuel and energy sector? Have our companies learnt to circumvent them?

Although the sanctions have covered a long list of equipment for the fuel and energy sector, they proved quite targeted. First, the sanctions stopped offshore recovery, but the contracts on Amur Gas Processing Plant and Power of Siberia gas pipeline are progressing; Gazpromneft and a number of oil refineries are being modernized. Many other projects that were feared to be affected by sanctions are now being implemented and without any maneuvers. The sanctions proved targeted and their impact can be assessed only by the lost incomes and postponement of some projects involving the West.

Do we need the shelf, considering that the current oil prices make most of the offshore projects unprofitable?

The shelf is no longer profitable. Why does Rosneft develop its fields on the shelf and invest so big funds in it? This question should be addressed to the authors of the relevant projects, not to me. I can just remind that the key operator of Rosneft’s offshore projects is Exxon, which, in principle, should have got out of the way, but it hasn’t done it.

Speaking about the failed international projects outside Russia, for instance, the plans of Summa Group to build an oil terminal in Rotterdam: did the sanctions affect them or was the project ill-conceived?

Any international project of Russian investors must be backed by the state – this is a common principle for every country, not only for Russia. And it can be either support, not just financial one. Yet, Summa’s project not only did not receive any government support but also fell victim to intrigues of the clans inside the Russian government. I cannot say that the project was ill-conceived, I did not see the figures, but the project was inherently interesting.

Is our fuel and energy sector ready for such projects? Do we have what to offer to the world?

So far, our portfolio is entirely based on raw materials. Look, for instance, at Vietnam that is interested in cooperation with Russia in the oil and gas sector. All the projects are offshore and complicated there, and we have nothing to offer them - I am speaking about new equipment.

Does the world expect any complicated gas projects from us?

All the international sentiments are against us now, at least when it comes to the projects that are profitable. Imagine that you have quarreled with your neighbor on a number of occasions and then you go and tell him: let’s invest in something together. To make such projects possible, it is necessary to correct the geopolitical situation, first. However, I see no such signs yet. They will start expecting something from us when we show that we are ready to live in peace and not exacerbate conflicts.

Anyway, we have the situation with the Turkish Stream more and less clarified…

So far, things here do not go beyond handshaking and an agreement to work on the fronts that Turkey is concerned about, namely Syria and its surroundings. It is early to say if that political truce will bring any economic results too.

If you punish Gazprom, you punish Putin

You have qualified gas as an alternative energy source. Do they in Gazprom understand that?

No, in its current state Gazprom is a colossal problem for Russia. Therefore, it must be reorganized. At least five companies created on the regional principle should come to replace it. It is an absolutely different format as compared to the current one.

It has long been said that Gazprom needs to be reorganized. Who should trigger that process?

The market will push Gazprom towards reforms whether it wants to or not. No political decisions are needed here. Here is a telling example: huge investments are being made in the Power of Siberia gas pipeline and the Amur Gas Processing Plant now, but it is not clear enough what is that to Gazprom? Why don’t they put the Chayadinskoye field, the Yakutsk and Irkutsk gas production centers on the balance sheet of a new company with a capitalization of at least $300-$400 billion and get a conditional Gazprom Vostok that could enter the world’s financial market and receive any loans for development of the Power of Siberia? This is evidently an issue that needs a political decision; it is not just an issue of economic viability.

Political decisions depend on how the policy is “served.” Gazprom’s team presents its every project as political one. I cannot say how this all goes up, but Gazprom keeps fighting for the participation in Russia’s international political decisions. As soon as we get rid of it, Gazprom will start recovering, and this is extremely necessary, since, I repeat, Gazprom has become a problem for Russia, though it was a progressive company yet about 15 years ago. By the way, Rosneft is not involved in the international political decision-making as much as Gazprom does. Nevertheless, Rosneft is perhaps of higher importance for the Russian economy.

We regularly learn that the cost value of the energy from non-traditional sources has come close to the one from traditional sources, but crude-oil production does not decrease in the world. What is behind that paradox?

Did you forget about TV when you got access to Internet? Did you throw away your corded phone? When a new product emerges, it does not mean that the old one disappears immediately. Emergence of new types of energy does not rule out the traditional ones. And we have to live with this without denying alternative sources of energy, not saying that they are unprofitable or “bad.” Quite the contrary, it is necessary to adapt your traditional hydrocarbon resources to the emerging alternative ones. Yet, so far we follow the path of least resistance: rise taxes, freeze pensions, reform customs etc. This is an easy path: to search where “to squeeze money out” from. When this ends, we will start thinking of other scenarios.

When will this end?

Very soon.

Is there a “think tank” ready to promote such doctrine in Russia?

There are many talented people in Russia, but so far I do not see them to participate in decision-making or they are perceived just as experts. In Russia the word “expert” has a specific sense. Recall what Putin said concerning Kudrin: Who does not want to control, must become an expert. The attitude to experts in Russia, especially in the energy sector, is so negligible that no think-tanks in any sector have any serious levers for decision-making. In Russia they used to consider right what the master says. I cannot name a public politician at the level of deputies or sectors who advocates for the alternative energy. Everything develops in line with such big companies as Gazprom and Rosneft. The rest is nothing but simple expert views that have little influence.

Nevertheless, you are confident that Gazprom will have to step on the path of reorganization. What is your opinion based on?

Unfortunately, Gazprom has reached the point of no return and it is no longer able to reform itself. Moreover, a very long period has passed since that moment – it was the end of the last decade: emergence of serious projects in the field of liquefied natural gas, the shifting of the motor transport to the use of compressed gas and a range of other factors. Then it was necessary to adopt certain decisions and implement them, but nothing of the kind has happened. The market will get Gazprom down, because the situation there is worse than ever now: extraction is falling, there are nearly no gas processing projects, Europe has limited Gazprom’s share in its gas import to 30% and will not exceed it. All our efforts to increase that limit will be facing resistance like Poland has done recently – inside Europe, the increase of Gazprom’s share is not perceived as something desirable. Actually, a 30% limit is unchangeable - we have to get along with it.

The prospects of our oil refineries in the European market are probably better, aren’t they?

Refineries are independent and if your oil products are demanded at the price you want, you just pour them into a tanker and send it to any destination. The situation with gas is different: we have no such privileges as private business in that field. In Europe there is an indisputable fact – if you punish Gazprom, you punish Putin.

By Nikolay Protsenko

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23.09.2016

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