- Rosneft will face difficulty as Moscow prioritizes the government's financial and political needs over those of the oil firm.
- Gazprom's piped natural gas export monopoly will eventually end, spurring competition between the Russian energy firms for customers at home and abroad.
- Russian President Vladimir Putin will try to disperse power within the energy sector among numerous players, including Novatek and LUKoil, while keeping the industry strong.
- In the long term, Russia will reopen its energy sector to partnerships with foreign firms to gain access to capital and technology — something it has avoided during the standoff over Ukraine.
For more than a decade, the Russian energy giants Rosneft and Gazprom have traveled an easy road: both were relatively strong and stable, the darlings of the Kremlin. This was rooted in Moscow's heavy reliance on energy revenues, which make up half of the government budget. Now, however, obstacles are piling up for Russia's two largest firms. Energy prices seem set to stay low, Russian businesses face sanctions over Ukraine and domestic competition for resources is rising. These changing circumstances are forcing Rosneft and Gazprom to adapt in order to maintain their political positions and their status within the industry.
Russia's oil giant, Rosneft, has experienced a year of uncertainty after more than a decade of growth and high revenues. The continued low oil prices have cut into Rosneft's profits; the company's revenues declined 19 and 22 percent in the first and second quarters of 2015 compared to the previous year. With revenues sliding, Rosneft has been struggling with an enormous debt burden. Currently, the company has $39.9 billion in debt — down from $57.4 billion in 2014 after a series of payments. Western sanctions over Russia's actions in Ukraine have only compounded the pressure on Rosneft. These sanctions prevent Rosneft from taking out loans of more than 30 days from U.S. and EU institutions. They also limit the company's ability to partner with foreign firms — partnerships that themselves could provide much-needed capital.
In 2014, Rosneft petitioned the Kremlin for $40 billion in assistance, but Finance Minister Anton Siluanov and Deputy Prime Minister Arkady Dvorkovich have stood against a bailout. Siluanov and Dvorkovich, members of the fiscally liberal Kremlin camp, believe the Russian state needs to divest from large firms and that companies such as Rosneft need to privatize shares instead. This is a move that Rosneft head Igor Sechin vehemently opposes. This was only one of many battles between Sechin and the team of Siluanov and Dvorkovich in recent years.
Rosneft has been creative in finding ways to service its debt payments. In December, the company issued a series of bonds just before the Russian ruble collapsed, securing $10.9 billion. The timing of the issuance was seen as a backroom deal between Sechin and Central Bank Governor Elvira Nabiullina, but they deny the accusation. Rosneft raised another $7.2 billion in a series of oil trading deals with Switzerland's Trafigura, a firm that has long been friendly with Russia. Over the past year, Rosneft has also been in talks with Western lenders to refinance $16 billion of its debt.
But in July, Rosneft grew concerned that it would not be able to pay the $15 billion in debt payments it owed in the second half of 2015 and once again petitioned the government for cash. When Siluanov and Dvorkovich again blocked financial assistance, Sechin reportedly sent a letter to Dvorkovich's office threatening to cut oil production. A staffer in Dvorkovich's office called the letter "blackmail." In August, Rosneft officially rescinded its request for government assistance — but notably did not follow through on Sechin's threat.
Sechin's change of heart could have come about when Russian President Vladimir Putin fired Russian state railways head Vladimir Yakunin in August, reportedly for refusing to change how the large firm operates during these lean financial times. Yakunin reportedly also demanded a bailout from the government. At the time, Yakunin was considered too elite, too wealthy and too close to Putin to ever be fired. Many Russian commentators have speculated that in firing Yakunin, Putin wanted to send Sechin a message about how to behave at a time when resources are restricted.
Rosneft now has another $10.9 billion in debt payments due before the end of the year, and the company is selling assets to cover some of the costs — an option it previously opposed. For example, in recent months Rosneft sold a 20 percent stake in the Taas-Yuryakh field to BP and shares in one of its refineries in the Russian Far East to China National Chemical Corp., also known as ChemChina. Sechin has stated that between the company's current cash flows, the money it is raising in the asset sales and other means, Rosneft will be able to handle its debt payments this quarter.
However, Rosneft's stability in 2016 is in question. Oil prices are likely to remain low, the United States has given no indication that it will ease sanctions without significant changes in Ukraine and Rosneft has another $15.1 billion due in loan payments.
Adding to Rosneft's concerns is a series of proposals by Siluanov to raise taxes on oil company export duties and mineral extraction. According to Siluanov, Russian oil firms are benefiting from selling their oil in dollars while paying their workers and expenses at home in rubles — a currency that weakened more than 40 percent over the past year. A working paper that Sechin prepared for Putin shows that Rosneft will pay $33.9 billion in taxes this year — a 27 percent decrease from last year — because of lower revenues, a weaker ruble and low oil prices. This means the government budget will have an unforeseen $12 billion shortfall, according to the Ministry of Finance. Thus, Siluanov is suggesting a change in taxation mechanisms in 2016 to reduce Moscow's vulnerability to outside fluctuations. The Ministry of Finance estimates that changing the mechanisms for the oil export duty and mineral extraction tax would bring in another $10 billion for the 2016 budget.
Sechin has long argued that Rosneft already pays too much in taxes. In 2014, 55 percent of the company's revenues went to export and excise duties as well as other taxes. This was tolerable when oil revenues were high, but Rosneft is drawing a line and dividing Moscow's liberal financial circles over the issue. Russian Minister of Economic Development Alexei Ulyukayev has put forth a compromise proposal that would increase the mineral extraction tax on both oil and natural gas companies but not the export duties. Sechin said Oct. 13 that the tax increase in 2016 could force Rosneft to decrease its production by 600,000 barrels per day — 5 percent of Russia's oil production — over the next three years. The proposed tax increases are still under debate in the government and the Duma is not set to vote on the Russian budget until Oct. 25.
It will be crucial to see whether Sechin can push back on the Kremlin for financial relief. For the last 10 years, Rosneft and Sechin have had strong influence over the Kremlin's policies on taxes and financial assistance. However, Sechin's recent struggles show that his company's influence is waning as the Kremlin prioritizes its own needs over those of the oil giant.
Amid all of these conflicts, Rosneft does see one battle tipping in its favor in the years ahead: the end of its primary competitor's energy monopoly.
Gazprom's behavior has changed in recent years. Whereas the company used to be aggressive in using cutoffs and high natural gas prices as part of Russia's foreign policy, the natural gas firm has been forced to cut back on the use of these political tools. This is particularly true in Europe, where it has to contend with diversification efforts, low global energy prices and the EU Third Energy Package legislation. Gazprom supplies one-third of the European Union's natural gas, and its supplies to Europe even rose 23 percent in the third quarter of 2015. But in order to maintain its position as a key European natural gas supplier, Gazprom has had to step back from the mechanisms that allowed the company to allocate its supplies according to Moscow's wishes. These mechanisms included long-term contracts and indexing natural gas to oil.
Now Gazprom is up against another challenge that could change its behavior and Russia's overall energy environment. Russia's Federal Antimonopoly Service said Oct. 2 that Gazprom should create a separate subsidiary for natural gas transportation as the first step to end the company's monopoly on exporting natural gas. Energy Minister Alexander Novak reiterated this idea, stating that the Russian government could rewrite the state's energy strategy to give other firms access to the natural gas exporting network, though he did not give a timeframe. Novak joined Gazprom's board in June. At the time, his joining was seen as a political boost for the firm, but since his appointment he has been rather aggressive about making sure Gazprom meets the Kremlin's needs.
Russian energy firms such as Rosneft and Novatek have long petitioned the government to end Gazprom's monopoly on natural gas exporting, but as long as Gazprom served as a powerful foreign policy tool, the Kremlin had no need to bend to Gazprom's competitors. However, as the Russian energy landscape changes, the Kremlin sees more benefits in diversifying its natural gas exporters. First, Gazprom will have to compete with other natural gas producers in Russia (including Rosneft and Novatek), and the competition for contracts will motivate the firm to operate more efficiently. Second, Russia's customer base — particularly Europe — has long pressed for a diversification of Russian natural gas suppliers. Should Gazprom's export monopoly end, the Europeans can then play the Russian firms against one another to garner more favorable supply contracts. This could lead the Europeans to look more favorably on Russian supplies, because there would be a competitive market and the Kremlin's ability to politicize natural gas supplies would weaken. Moscow knows its ability to use its natural gas as a political tool is already declining, so it would rather maintain its position as a dominant supplier in Europe, because that translates into crucial revenue.
Evolution in Energy Sector Influence
Both Rosneft and Gazprom are facing challenges to their dominance in their respective sectors. Their vulnerability to low energy prices and obligations to the federal government — both political and financial — are forcing both companies to alter their behavior. Their ability to dictate energy strategy in their respective sectors is on the wane, and now they must respond to market and financial changes like most energy firms instead of centralized state tools.
Those members of the Kremlin elite who used Gazprom and Rosneft as the foundations of their influence are also losing political clout. Gazprom's previous political backer, Prime Minister Dmitri Medvedev, supported the increased taxes on the company and the possibility of export liberalization. And Rosneft's Sechin, who once drove Russia's energy policies, has encountered significant reluctance from the Kremlin as the government prioritizes its own financial needs over Rosneft's.
In the long term, Russia will have to make changes in its energy sector again as the need for investment and technology becomes urgent. Theoretically, this could mean increased foreign involvement in the energy sector. Currently, Russia's energy laws prevent any foreign firm from holding more than a 30 percent stake in an energy project in the country. But as Russia's traditional oil and natural gas fields begin to decline, Moscow will need foreign technology to tap unconventional reserves and prolong the usefulness of current fields. With the Russian energy firms and government strapped for cash, the need for foreign investment will also grow. But the big foreign firms — particularly Western companies — will want a greater return and stake in Russian energy projects, and that will be difficult for Russia to accept during its tense standoff with the West.
In the short term, Russia's protectionist policies will remain intact as Moscow prioritizes its fear of foreign influence in the country over developing its energy sector. In addition, U.S. and EU sanctions remain in place. But the one thing Russia has learned over the decades is that its energy policies cannot remain stagnant. Because energy is still the largest part of the Russian economy, Moscow must continue to shift and react to the continued changes in the markets and the world.
Lead Analyst: Lauren Goodrich
Production Editor: Robin Blackburn