What Is Russian Gas Insight?

1
What Is Russian Gas Insight?

• RGI is a multi-client report that analyzes
  volumes, costs and benefits of all operations
  with natural gas that gets into the pipeline
  system of Russian gas monopoly Gazprom.
• At this stage, we consider only projects that are
  or will be connected to the gas pipeline system
  of Gazprom.
• Isolated LNG projects, like Shtokman before the
  link to Volkhov is built, are out of the scope of
  RGI.
• RGI is launched to give answers to the most
  important questions concerning supplies of
  Russian gas to domestic and European markets

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Answers to Key Questions

• Where and at what cost is Gazprom going to get
  the gas volumes in 2015-2025 to meet its supply
  obligations and to implement its ambitious
  expansion plans?
• Would Gazproms negotiating position be stronger
  or weaker after the expiration of existing gas
  export contracts to Europe?
• What is the real future cost of gas delivered to
  Europe?
• What is the difference between a rational
  investment plan and the investment plan of
  Gazprom?
• Rational investment assumes Max utilization of
  existing capacities
• Governmental agencies tend to focus on maximum
  spending
• What are the major threats to security of supply
  of Russian gas to Europe?
• Can Gazprom survive a drop in oil price?

3
The Contents of RGI

• Executive Summary
• Part 1. Russian Gas Business Environment
• Taxes, wages, prices and tariffs
• Part 2. Gas Balance and Volumetric Analysis
• Historic and projected sales
• Production and import
• Gas flows and pipeline bottlenecks
• Part 3. Cost Benefit Analysis
• Production costs of Gazprom
• Transmission costs
• Cost of gas delivered to different markets
• Profits and net cash flow
• Part 4. Comments to Financial Reports of Gazprom
• Part 5. RGI Focus Russian-Ukrainian Gas Dispute

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Part 1. Russian Gas Business Environment

• In this section, we publish updates on relevant
  external factors affecting Russian gas sector
• Taxation, regulated domestic price of gas,
  regulated transmission tariffs
• Cost of labor, materials and supplies
• Gazproms relations with independent gas
  producers
• In RGI 2006-1, we comment on the following issues
• Cost of Russian labor continues to grow at a very
  high rate of over 30 a year (in USD terms)
• Huge difference in labor cost by region and
  industrial sector a 17-times difference between
  regions of Tyumen province, West Siberia
• Weak ruble in Gazprom projections
• Gazprom is strengthening control over the FSU
  market (the way of Standard Oil of the 1880s)

Price of gas in different markets, /mcm
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Part 2. Gas Balance and Volumetric Analysis

• Gas consumption is addressed by region and by
  consumer sector
• We assume a moderate growth of gas consumption in
  the service area of Gazprom in Russia
• In 2003-2005, annual growth rate of industrial
  production exceeded 6, while consumption of
  pipeline gas in Russia was growing 1.6 a year
• High energy price will affect gas consumption in
  Russia
• High share of gas in the fuel balance of power
  plants in European Russia does not give much
  space for growth of gas use
• Efficiency improvement is a more likely way of
  power sector development
• Gazprom plans its domestic gas sales in 2006 at
  the same level as in 2005

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Export Projections

• RGI considers only exports via Gazprom pipelines,
  including transit of Central Asian gas
• LNG projects that are not connected to the
  existing pipeline system of Gazprom are out of
  the scope of RGI
• High energy price is likely to affect gas
  consumption in the FSU
• European exports are broken down by country and
  by terminal
• Velke Kapusany
• Drozdowichi
• Beregovoe
• Satu Mare
• Izmail
• Vyborg Finland
• Brest
• Kondratki
• Blue Stream
• Vyborg NEGP
• Primorsk LNG

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Sample Production Forecast of Gazprom, bcm
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Gazprom Production Breakdown

• All reservoirs are broken down by cost category
• Cenomanian-1 old low-cost giant and super-giant
  fields of W. Siberia
• Cenomanian-2 medium-cost West Siberian
  reservoirs commissioned after 2000 or to be
  commissioned in the future
• Cenomanian-3 high-cost fields of Yamal and
  Gydan peninsula
• Deep small Neocomian, Valanginian, Achimov
  and other deep reservoirs of West Siberia and all
  fields of Severgazprom and Gazpromdobycha-Kuban
• High sulfur Orenburg (1.5 of H2S) and
  Astrakhan (25.7 of H2S)
• Shtokman
• In regional breakdown, net input into gas
  pipelines is shown by field and by company for
  regions of Russia

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Gazprom Production Seasonal Swing

• RGI addresses seasonal swing of producing
  branches of Gazprom
• Urengoygazprom and Yamburggazdobycha have high
  winter peaks
• West Siberian gas producers have 30 of
  production capacity dedicated for winter peaks
• In European Russia, winter peaks of production
  are very small
• Low well flow and high cost
• Independent gas producers do not have winter
  peaks
• The record high daily production of 1700 mmcmd,
  reached on January 22, 2006, discloses actual
  capacity of pipelines in West Siberia
• We will address this issue in RGI 2006-2

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Independent Gas Production Forecast
Production investment requires incentives
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Import and Transit from Central Asia

• Imports and transit are broken down by country
  and by terminal
• Turkmenistan
• Uzbekistan
• Kazakhstan
• Aleksandrov Gai
• Karachaganak-Orenburg
• Makat-Northern Caucasus
• About 2 bcmy (6 mmcmd) of Central Asian gas is
  delivered via the old Bukhara-Urals pipeline
  (commissioned in 1963)
• This small volume is added to the volumes
  delivered to Aleksandrov Gai
• We expect the Bukhara-Urals pipeline to be
  decommissioned soon

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Cross-Regional Gas Flows

• We calculate regional balances for regions of
  Russia and the FSU states
• Annual balance
• Daily balance (winter)
• Based on historic daily flow data, we calculate
  daily flows across the state and regional borders
  from Europe to West Siberia
• Spare capacity or capacity deficit is calculated
  for all pipeline sections by year

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Daily Flows and Consumption
14
Sample Scenario New Pipelines in 2006-2025
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Part 3. Cost Benefit Analysis

• Detailed analysis of production costs by
  different reservoir category
• Labor Depreciation
• Taxes Interest
• Other costs
• Production investment requirements by reservoir
  category by year
• Detailed analysis of transmission costs of
  Gazprom
• Labor Depreciation
• Fuel gas Taxes
• Interest Social cost
• Other costs
• Pipeline investment requirements by project and
  by pipe diameter, including replacement pipe
• Cost of transit out of Russia
• Cost of sales and cost of gas delivered to
  different markets
• Gazproms profit by market segment and net cash
  flow from gas operations

Anything can fly at 70/bbl
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Sample Cash Flow Projections

• Growth of internal costs of Gazprom is more
  dangerous than a drop in oil price
• Base Case assumes that internal costs grow 25 in
  2006 and 10 in 2007-2008
• High Cost Case (red line) assumes that in
  2006-2008 cost growth rate is 10 higher
• In 2009-2025, cost growth rate is the same for
  both cases
• We believe that Base Case assumptions are too
  optimistic
• Cost of Gazprom are more likely to follow the
  High Cost scenario
• NPV of net cash flow from gas operations under
  Base Case is 71 billion versus 45 billion of
  the High Cost Case (at 10 discount rate)

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Part 4. Comments to Financial Reports

• Financial reports of Gazprom are transparent
  enough to reveal some serious discrepancies
• Expenses of production and transmission segments
  of Gazprom are reported inaccurately
• Very often quarterly and accrual numbers do not
  add up with the difference reaching 200 million
• Current negligence in financial reporting is
  unacceptable
• Since January 2004, Gazprom is effectively
  overpaying export duties by over 0.7 billion a
  year
• Recent deal with RosUkrEnergo shows that Gazprom
  could legally cut payments of export duties
• Reports indicate that Gazprom gives unfair
  advantages to RosUkrEnergo
• The risk of successful lawsuits from Western
  shareholders of Gazprom is extremely high

Gazprom reported the growth of tax payment as one
of its major achievements in 2004 (Gazprom
Annual Report 2004, page 9) Source www.gazprom.ru
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Part 5. Russian-Ukrainian Gas Dispute

• Shareholders of Gazprom benefited from giving
  Ukrainian exports to Itera in 1998
• Many analysts believe the opposite
• Sales of transit services to Itera were a way
  more profitable for Gazprom than deliveries of
  gas to Ukraine without being paid
• Eural Trans Gas was and RosUkrEnergo is a loss
  for Gazprom
• A fully-owned foreign subsidiary of Gazprom, like
  ZMB, could have been a better intermediary for
  all shareholders of Gazprom, including the state
• Gazprom gives RUE a huge profit margin
• In Jan-Sep-2005, RUE made a profit of 500
  million with half of it transferred to private
  accounts in Switzerland
• Apparently, the most profitable business
  exports of Kazakh gas to Europe formerly run by
  ZMB, is now given to RUE
• Now RUE is making a daily profit of 6 million
• Russian and Gazprom officials insist on RUE
  staying in business
• The new transit agreement causes Gazprom a loss
  of about 1 billion a year.

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Dominating Political Factors Increase Uncertainty
of Supplies of Russian Gas

• For the first time in the history of gas exports,
  Russia deliberately stopped the gas flow
• The gas transit conflict with Ukraine has caused
  an economic loss to Gazprom
• The conflict is far from being solved
• Russias vision of the future of European gas
  markets is absolutely different from European
  views
• Gazprom would like to have a Standard Gas Company
  of Europe (like Standard Oil) controlled by
  Gazprom
• President Putins vision of European gas market
  is explained in his letter (Energy egotism
  road to nowhere)
• Competition is counterproductive
• Gas price should be regulated
• Lack of competition leads to inefficiency
• Are European consumers supposed to pay for
  Gazproms inefficiency?

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RGI keeps our clients on top of important
events in Russian gas business