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. Last Updated: 07/27/2016

Flaring the Gas That Could Fix Supplies Gap

Itar-TassA gas flare at Rosneft's Priobskoye field lighting up the sky near Nefteyugansk. Gazprom will pay only $11 per 1,000 cubic meters for the gas, Rosneft says.
NEFTEYUGANSK, Khanty-Mansiisk Autonomous District -- Two huge flares that burn around the clock mark Rosneft's sprawling Priobskoye oil field outside Nefteyugansk. Spewing 2 billion cubic meters of precious gas into the crisp Siberian air every year, they stand testament to the absurdity of the country's looming gas crisis.

Without access to Gazprom's infrastructure, namely processing plants and pipelines, Rosneft and other potential producers are being shut out of the gas game even as the country veers toward a shortage that could keep it from fulfilling contracts at home and abroad.

Gazprom buys 1.5 billion cubic meters of gas per year from Yuganskneftegaz, the former Yukos unit that Rosneft scooped up at a forced state auction in December 2004. Yet Yugansk burns well over that amount, poisoning the environment and losing out on substantial revenue because there is currently nowhere for the gas to go.

"In Siberia and beyond, almost all gas goes through Gazprom infrastructure," Rosneft vice president Sergei Kudryashov said on the sidelines of a news conference in Moscow last week. "There is no point seeking out the domestic market, which is dominated by Gazprom.

"Who chooses the price? The buyers do -- that is, Gazprom. They have to get us interested, and all that interests us is price."

Gazprom pays just 280 rubles, or just under $11, per 1,000 cubic meters of gas from Yugansk, the production unit's general director, Vladimir Bulba, said on a recent Rosneft-sponsored tour of the Priobskoye field. In marked contrast, Belarus recently agreed to pay Gazprom $100 per 1,000 cubic meters, while customers in Europe pay an average of $230.

With demand for gas surging at home and abroad and the yields from many of Gazprom's most lucrative fields in west Siberia falling, the gas giant may well soon face a crisis of supply as it stalls on its exploration of new fields.

In a bid to make the domestic market more attractive to Gazprom and the independent gas producers allowed to function under the near-monopoly, the Cabinet in December approved a gradual rise in domestic gas prices, which will reach market levels by 2011. Yet Gazprom is locked into long-term supply contracts with many of its largest buyers, and last year renewed the terms of its deals with German, French, Italian and Austrian customers, which oblige it to maintain supplies for up to 25 years.

If Gazprom fails to develop the fields that it has been sitting on for decades, such as Yamal and Shtokman, while continuing to squeeze out independent gas producers, the government will eventually have to choose between turning down the taps to either Europe or customers at home, analysts said.

"There is plenty of gas in the ground in Russia and identifiable projects that haven't been developed because of politics," said Chris Weafer, chief strategist at Alfa Bank. "Oil companies could produce significantly more gas if only they could pump through Gazprom's pipelines. At some point in the not-too-distant future, the state is going to have to step in, but this will be complicated by the fact that the respective heads of Rosneft and Gazprom sit at opposite ends of the Cabinet table."

Those complications appear to be deepening as the country moves closer to next year's election that will decide President Vladimir Putin's successor.

Sergei Karpukhin / Reuters
Officials at Yugansk say average wages at the unit have risen by 35 percent since Rosneft took over two years ago.
The recent promotions of Sergei Ivanov to first deputy prime minister and Sergei Naryshkin to deputy prime minister appear to have strengthened the hand of the siloviki, the Kremlin faction that represents the country's security services. Naryshkin has, since 2004, been a member of the Rosneft board, which is chaired by Igor Sechin, Putin's powerful deputy chief of staff who is widely viewed as the informal leader of the siloviki faction. Sechin is also the man whom former Yukos chief Mikhail Khodorkovsky accused of orchestrating the legal onslaught against him.

Gazprom's interests, meanwhile, are represented by the man expected to be Ivanov's rival for Putin's blessing in the upcoming election, First Deputy Prime Minister Dmitry Medvedev, who heads Gazprom's board of directors.

The war over Yugansk marked a low point in relations between the two state energy giants. Gazprom pulled out of the auction for Yugansk, formerly Yukos' main oil production unit, after an injunction from a U.S. court. The unit went instead for just $9.34 billion to an unknown shell firm, Baikal Finance Group, which was acquired by Rosneft a few days later. A planned merger between Rosneft and Gazprom fell apart in the wake of the struggle.

That sale transferred about 11 percent of the country's oil output into state hands. The state's share rose even further in September 2005, when Gazprom bought Sibneft from Roman Abramovich for $13.1 billion.

Despite widespread criticism of creeping state control over the country's energy sector, officials at Yugansk hailed the change in ownership here.

"It's much more stable now," said Yelena Shulgina, who heads a treatment center at the Priobskoye field and has been with Yugansk since 1981. "It's better to work for a state company."

Since acquiring Yugansk at the expense of Yukos, Rosneft has gone from a mid-tier company to the country's favored oil champion, with nearly 15 billion barrels in proven oil reserves, putting it just behind privately held LUKoil.

Rosneft hopes to raise output to 2 million barrels per day by 2010 and to 2.8 million bpd by 2015, up from the current 1.75 million bpd.

Walking reporters through a tightly managed tour of the Priobskoye site, Bulba passed buildings that, more than two years later, remain painted in the yellow and green colors of Yukos.

"I wouldn't say that it's right everywhere," Bulba said, when asked what he thought of state control over the energy sector. "As long as the companies pay taxes and develop the fields -- if that doesn't happen, then the state should step in."

Yukos was dismantled amid state claims that it had failed to pay over $33 billion in back taxes. Khodorkovsky was jailed for eight years on charges of fraud and tax evasion, and faces a further 15 years in prison if found guilty of new charges of embezzlement and money laundering. He has called the campaign against him politically motivated, coming as it did during the run-up to the 2003 State Duma elections and amid speculation that he was getting ready to sell a stake in Yukos to a U.S. oil major.

"Stability" was the word of the day in meetings with officials from Rosneft, Yugansk and the Nefteyugansk city administration.

Sergei Karaganov, Rosneft's vice president for social affairs, said: "People are quite confident in their future now. There are no longer problems with hiring, without even regard to salaries -- people are looking for stability."

Rosneft's vice president Kudryashov agreed: "This is a step forward."

Karaganov said wages at Yugansk, the highest in Rosneft's empire, had increased by 35 percent since 2004, averaging 48,700 rubles ($1,850) per month.

The yellow and green buildings stand as the only reminder of the days when Yugansk was in Khodorkovsky's realm.

In a presentation of the company's history and future plans, Bulba left out the entire period of Yukos ownership, skipping straight from the formation of a joint stock company in 1993 to Rosneft's acquisition of the unit in 2004.

Khodorkovsky and his lawyers have likened Rosneft's purchase of Yugansk to expropriation.

Rosneft is expected to snatch up a large part of the remaining Yukos assets that are due for auction this year. The cycle of sales will begin March 27, when the 9.44 percent stake that bankrupt Yukos still owns in Rosneft goes up for auction. The state is widely expected eventually to dilute further its 75 percent stake in Rosneft to a controlling 51 percent. The company raised $10.6 billion last July in the country's biggest initial public offering to date.

Rosneft officials have said they hope to get their hands on five refineries up for sale, and the company is expected to go head-to-head with Gazprom in the auctions for Yukos' two remaining large oil production units, Tomskneft and Samaraneftegaz.

"The original model of Gazprom in gas and Rosneft in oil has certainly broken down," Alfa Bank's Weafer said.

Recent partnership deals between the two companies prompted speculation that the Kremlin hoped to set aside differences ahead of the presidential vote. In December, the two firms signed a strategic-partnership agreement to make joint bids for licenses and join forces in the production and delivery of oil, gas and electricity. Last month, Putin approved a decision to split all new offshore oil and gas fields equally between the two companies.

Part of the deal saw Gazprom pledging to buy associated gas from Yugansk, but the amount is less than half of the gas that the unit is required to produce under its license, Bulba said.

If it does not produce the gas, the production unit could be fined by the Natural Resources Ministry and theoretically find itself in the same position as TNK-BP, which faces an investigation into breaching the terms of its contract. At its Kovykta field in east Siberia, TNK-BP subsidiary Rusia Petroleum is producing just 1.5 bcm of gas per year, instead of the 9 bcm stipulated in its contract. Gazprom is refusing TNK-BP access to export pipelines, limiting it to filling weak local demand.

"We are not producing more precisely because we don't want to flare the gas," said TNK-BP spokeswoman Marina Dracheva. "We don't want to meet the terms of the license just to flare it."

Environmental groups and international organizations say gas flaring causes untold damage, emitting vast amounts of carbon dioxide into the atmosphere and adding to the greenhouse gases that are slowly eating away at the ozone layer.

Both the International Energy Agency and the World Bank, which estimates that Russia accounts for about 11 percent of more than 100 bcm of gas flared worldwide into the atmosphere every year, have called on the country to cut down on the practice.

For now, Bulba said Yugansk was planning on converting the gas into electricity, with plans to commission two compression stations by 2008 and a gas-fired power plant by 2009 with a capacity of 300 megawatts.

"By 2010, we expect this problem will be fully addressed," Bulba said.

Yet Jonathan Stern, director of gas research at the Oxford Institute for Energy Studies, said that method of dealing with associate gas, a natural byproduct of oil production, was an improvement on flaring but still "a terrible waste."