7m THE OXFORD INSTITUTE FOR ENERGY STUDIES A fiECOGNIIED INDEPEhOEnT CENTRE OF tME UNlYEPtSlTY Of OlfOfiC UNIVERSITY OF Russian oil in a global arid domestic context James Henderson NOVEMBER 2018 World oil reserves by country 350.0 300.0 250.0 in Russia stands in 6th position in terms of proved oil reserves, and is the largest non-OPEC holder of conventional (low cost) oil Three countries dominate a diversified supply mix Global oil output by region Growth in oil production by region (2007-2017) 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ■US ^^"Saudi Arabia ^^"Russian Federation ■Iran ^^"Canada ^^™lraq The US, Russia and Saudi Arabia produce more than 10mmbpd each and account for one third of total global oil supply Other supply is spread across the world, although the Middle East again accounts for roughly one third of output The OPEC cartel produced 38mmbpd in 2015, or 40% of total oil supply, but it is increasingly dominated by Saudi Arabia The oil price and the Russian economy Oil price and Russian Rouble tc no/ Zj.UAi in not _ 1 ^ n°/> ±D.\J/0 10 0% 5.0% n no/ A ^r^^. f lu-i V ^ D *~~m 1 n no/ ~1 ^ "1 Apr- •HI oil fl a 1 u| ff < ^ O" I <™- o i < - -lU.U/o Vft 1 1 ^ n°/ ■ A j. J.U/o •in no/ ZU.U/d I i-vn/ Z.J.U/0 ^^"Decline in Rouble ^^"Decline in Oil Price Tight correlation between oil price, rouble exchange rate and Russian budget deficit Russia running a large budget deficit at lower oil price 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ^■Revenue Expenditure ^^™Surplus/(Deficit) Non-Oil Deficit Russian Reserve Fund collapsed 2014-17 Russia GIR: Sovereign Reserve Fund and National Welfare Fund $bn ■ National Welfare Fund Sbn ■ Sovereign Reserve Fund $bn 200 100 sf ^* / * # / / / f $ 4 4 i $ * 4 4 4 4 i * source: CBR Importance of oil and gas to the Russian Economy Split of Russia's export revenues Correlation between oil price and Russia's GDP 600 500 400 n 300 200 100 o o U3r--oocriO*HrNm^-Lnu3r^ oooooooooo*h*htHth*h*htHth oooooooooooooooooo rNrNrsirNrNrNrsirNrNrNrNrNrNrNrNrNrNrN Source: Central Bank of Russia • Oil is vital to the Russian economy, contributing much more than gas to exports and budget revenues • Oil price and GDP are very tightly correlated. Oil makes a direct contribution of 15-20% of GDP. • Oil and gas are both political symbols of Russia's strength and importance to the global economy Russia's ail reserves are spread across various types of field Reserves by age of field 60.0 50.0 40.0 S 30.0 c 20.0 10.0 0.0 I Ural Federal District I Far East Federal District l North West Federal District I Offshore Greenfields Plateau Decline ■ Siberian Federal District ■ Volga Federal District I South & North Caucasus Federal Districts Russian estimate of total reserves base is approximately 125 billion barrels The majority are located in the Urals federal district (which includes part of West Siberia) Importantly 85 billion barrels are in fields that are not yet in decline Russian ail infrastructure • Focussed on the West, with a new pivot to the East • West Siberia remains the heartland, but East Siberia is a major growth area and increasingly important from a political perspective History of Russian oil production °- 6000 4000 2000 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Following the collapse in oil output from 1991, a period of low level stability in the late 1990s also saw the creation of the major VIOCs Partnership with foreign service companies saw a dramatic rebound in early 2000s Increase in state control of sector from 2005 coincided with slowdown in output recovery There has been only one year of decline since 2000 (2008) despite constant complaints about the tax system The Key Russian Oil Companies The Major Russian Oil Producers 2016 2017 9M 2018 Rosneft 3799 3778 3866 2% LUKOIL 1662 1637 1642 0% SurgutNG 1239 1213 1219 1% GazpromNeft 757 791 797 1% Tatneft 575 580 585 1% Slavneft 300 286 275 -4% Bashneft 428 413 381 -8% Russneft 140 140 142 1% Gazprom 348 356 392 10% Novatek 161 194 161 -17% PSAs 320 331 364 10% Other 1236 1231 1281 4% Russia Total 10965 10951 11105 1% Production is dominated by eight major oil companies and two gas companies which produce condensate Three companies account for more than 60% of total production There are around 150 smaller companies who are growing strongly but make little in the way of overall contribution Russian) oil production by ownership State control of Russian oil production 12000 -r-.....---------------------------- 10000 ■ ■o £ 8000 £ *j 6000 3 ■o o ^ 4000 6 2000 ■ Private State-Influenced State-Owned 2000 2015 Rosneft dominates Russian oil output, following takeover of TNK-BP in 2013, with a 37% share When the sector had been fully privatised in 2000 the State's equity share of total oil production was only around 300kbpd (Rosneft) The share of state ownership roseto 50% on an equity basis by 2015 and almost 70% on a "control" basis §£ Russian oil production history by company Liquids production by company Share of total Russian liquids production • Production growth has been seen across most companies • Organic growth a feature of the early 2000s • Subsequently M&A has played an increasing role • Consolidation under state control has been a major theme • Rosneft, GazpromNeft, Bashneft, Slavneft now all under clear state control (with Gazprom also an important liquids producer) • Surgutneftegas, Tatneft and Novatek are heavily influenced by regional or federal authorities • Rosneft now accounts for 40% of production, while the Russian government has control over 51% and significant influence over a further 19% NATURAL GAS PROGRAMME Russian oil production has been robust Production has continued to increase in 2016 and 2017, in line with the trend set in 2015 No month has seen a decline year-on-year since July 2014, despite Govt, concerns Companies have been put under pressure to focus on core production, re-directing investment towards enhanced oil recovery at existing fields - stability seen as the minimum requirement New fields that were under development pre-2014 have also made a significant impact on short-term production Total Russian Oil Production 11,600.0 11,400.0 11,200.0 11,000.0 ^ 10,800.0 Q. 10,000.0 9,800.0 9,600.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec ^—2012 ^—2013 ^—2014 ^—2015 ^—2016 ^—2017 ^—2018 Impact of tax changes, sanctions and rouble exchange rate will be key to outlook Future of Russian oil production - key drivers 14 12 -a 10 Q_ I 8 ■° 6 4-1 N> N> >i> \> & & r& n\/ r?> r> f> ■ Brownfield ■ Greenfield Source: Ministry of Energy, General Scheme of Development of Oil industry to 2020, EIA International Energy Outlook 2013 Maintaining oil production growth is certainly a challenge Slow growth from 2014 levels (10.6mmbpd) had been expected The impact of new fields could have seen total output at 11.5mmbpd by 2020, and this level could have been sustained with Arctic output Challenge now is to optimise capital expenditure and prioritise key developments Brownfield decline has been actively managed Output from 10 largest production companies 6000 5000 I I I I ■ 1 1 ! ! 2008 2009 2010 2011 2012 ■ Yuganskneftegaz ■ Surgutneftegaz ■ Noyabrskneftegaz ■ Orenburgneft I I Samaraneftegaz ■ Purneftegaz 2013 2014 2015 2016 Lukoil West Siberia ■ Samotlorneftegaz Megionneftegaz ■Tomskneft 2017 Russian companies have been relatively successful at restricting brownfield decline Expected natural decline at a West Siberian field would be 10-15% per annum, but the average decline at the top 10 producing companies has been less than 2% Relatively simple secondary recovery techniques have been used to date, in tandem with enhanced computer technology to monitor reservoir performance NATURAL GAS PROGRAMME Potential decline In brownfield output Decline rate scenarios from Russian brownfields 12000 - 10000 Brownfield (estimate) — — — Brownfield (5% decline) — — Brownfield (10% decline) Average decline rate with sustained investment is 2.0% per annum Natural decline rate from fields is 10%+ without any remedial action Decline in early 1990s averaged 8.6% per annum (1990-1996) Mid case assumed at 5% per annum to reflect possible reduction in spending and increasing maturity of fields Production, especially at brownfields, is driven by drilling Levels of drilling and oil production 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 •Capex ■Russian oil prod (kbpd) 11200 11000 10800 10600 — 10400 j$ 10200 c o 10000 "+= 9800 9600 9400 9200 9000 o Horizontal drilling in Russia " rOpMlOKTUIkHM SypSHMO, MflM m Horizontal drifting, million motors —BcefO, wnii m Total, mWon metera -flo/m ropMMMTuibMoro 6yp*HMn n xccnnyitiumohmom npoxoaxt, % Horizontal dritling ■ •tharn of production driHing. H Ha«t^OHMO-HanpanneMMO«+o«pTMi(anbHoo 6yp«HM», m/ih m , i ., - , i ,n. roflOBOH npMpocr 061.CM3 ropMMHTisibMOro 6yp«MMH, % Annual growth rate tor horizontal dnUtng. % Hctomhkk: URV T3K aMariW3 RPI / Source: CDU TEK. RPt a flii3rpaMM3 6. fluHaMwo o6bewa ropn30HTanbHoro w Haroxx-tHO-HanpaanenHoro 6ypenMfl b Pocchw b 0n3n^ecKOM Bbipawenuw e 2006-2017 roftax, mjih m Histogram 6. Trend in horizontal and directional drilling in Russia in physical terms from 2006 to 2017, million meters • Not surprising that there is a strong correlation between production drilling and oil output • R squared of 0.92 suggests imperative to keep drilling in order to maintain production • Drilling, both conventional and horizontal, continues to increase • However, companies need to be encouraged to invest - costs need to be controlled and the Russian tax system needs to provide incentives Increased use of directional and horizontal drilling has improved well performance 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 TpacbHK 3: flMHaMHKa očbeMOB 3BC b Pocenu b 2006-2016 ro^ax n ppm Brc n BHHC b 2016 roAy. onepauwži n % Chart 3: Sidetracking Progress (operations) in 2006-2016 and Horizontal / Directional Sidetrack Wells (%) Mctovhmk: aaHHbie kompbhhizi; ananrnvNecKviH orvér •Poccmmckhm pb/HOK 3SC: rexymee cocropnue n nporH03 AO 2027 rqfla-. RPf. 20 i 7 Source: Company dala. Analytical Report Russian Sidetracking Market: Today and 2027 Forecast. RPi. 2017 Sanctions have had an impact on availability of new technology, but Russian service companies can still provide significant input to improving production Increase in horizontal drilling has been dramatic over the past 3-4 years GazpromNeft in particular has tripled the amount of horizontal drilling, especially at its Salym subsidiary in West Siberia 1175 I - ll 1503 Impact of Rouble Devaluation Oil price versus rouble exchange rate i—i-1—i-1—i-1—i—i-1-1-1-1-1-1-1-1—i-1—r ro^-^-^-^-LnLnLnLnu3U3U3U3r~-r~-r~-r~-oooooo rHrHrHrHrHrHrHrHrHrHrHrHrHrHrHrHrHrHrHrH ui-CQ.<->i-CQ.<->i-CQ.<->i-CQ.<->i-CQ. Q5—ioo ■Oil Price (US$) ■RR=US$1 120 100 80 60 40 20 Oil price in roubles and dollars 6000 5000 4000 3000 2000 1000 X2 DC ro^-^-^-^-LnLnLnLnu3U3U3U3r~-r~-r~-r~-cxDcx)cx3 rHrHrHrHrHrHrHrHrHrHrHrHrHrHrHrHrHrHrHrH u^cQ.tJii-cQ.tJ^-CQ.tJii-cQ.tJii-cQ. O 5 —> on O 5 —> on O 5 —>loQ5—>ooQ5—>oo I Oil Price (US$) •Oil Price (RR) 80-90% of capex is in roubles, so investment costs in US$ have fallen sharply Around two thirds of operating costs are in roubles Correlation between oil and price and exchange rate was very strong but has been broken as oil price has risen in 2017/18 Central Bank of Russia has intervened to keep rouble weak, providing a major benefit to exporters 8047 §£ Russian oil company cost base is very low Russian oil production costs 6.00 5.00 o vv 4.00 o 3.00 £ 2.00 ■n o 1.00 0.00 Devaluation impact 2011 2012 2013 2014 2015 80% of operating costs and around two thirds of capital costs are rouble-based As a result, post-devaluation Russian costs are among the lowest in the global oil economy Obviously, a rise in the oil price will be offset by an increase in US$ costs Russian costs versus global peers (US$/boe, 2016) NATURAL GAS PROGRAMME Russian breakeven ail price is below $20 per barrel Brownf ield cash costs, $/bbl, 2016E* g.z Despite tax adjustments Russian oil production is very economically robust Cash costs are below $10 per barrel Including taxes and transport, Russian oil production from brownfields breaks even at below $20 per barrel Key parameter is initial flow rate of wells, to allow early recovery of costs I Brownf ield capex □ Upstream opex Total brownfield costs at a Urals price of $20/bbl, in $/bbl 25.0 20.0 15.0 10.0 5.0 0.0 On paper, even the pure oil exporter does well at $20/bbl; well-integrated companies with refining capabilities do even better, as product prices (for nowj have deciinedless than oil prices. 3.7 16.4 0.9 2.2 3.3 3.3 3.6 20.0 Capex Lifting Transportation MET Export duty SG&A Profit tax Total Free Revenues cost cash costs cashflow Note: Average cost across Russian oil majors, assuming USD/RUB of 75. METs and export duties provided per 2016 schedule. tax burden constrains cashflow but also provides a buffer against low oil prices Breakdown of oil company upstream cashflow 80 70 60 50 11.08 10.02 ■COLO 40 30 20 10 10 20 30 Export tax ■ MET Transport and Other ■ Profit Tax 40 50 60 70 I Operating Costs I Post-tax cashflow Russia's high level of revenue taxes (export tax and MET royalty) has limited cashflow throughout post-Soviet era However, sliding scale of taxes means that government bears most of the burden in a falling oil price environment In 2015, for every $10 decline in the oil price Russian oil companies only lost $1.44 per barrel of post-tax cashflow Percentage decline was still significant, but high tax rates acted as something of a buffer Taxation remains a major area of debate Russian tax grab in 2016 and 2017 20.00 18.00 16.00 14.00 o 12.00 _Q vv 10.00 LT) ZD 8.00 6.00 4.00 2.00 0.00 I 2013 2014 2015 2016 2017 Export Tax MET Governments are always changing the rules - Russia is no exception Companies hate uncertainty, and won't invest if they think the playing field is being changed constantly Profit tax for old and new fields now being discussed 12 fields for onshore trial Profit / Return-based system used in Russian offshore Group Location IRR target Royalty rate 1 Baltic/Azov Seas 16.6% 30% 2 Shallow waters of the Black Sea. Pechora and White Sea. southern part of the Okhotsk Sea. offshore Sakhalin 18.6% 16% 3 □eepwaters of the Black Sea, the northern part of the Okhotsk Sea, southern part of the Barents Sea 20.6% 10% 4 Offshore projects in the Arctic (includes Kara Sea), the northern part of the Barents Sea. the Eastern Arctic 22% 5% Company Fields Lukoil Lazarevskoye Krasnoleninskoye Nivagalskoye Las-Yeganskoye Imilorskoye-lstochnoye Rosneft Khasyreiskoye Nadeiyuskoye Bakhilovskoye Verkhne-Kolik-Yeganskoye GazpromNeft Vyngayakhinskoye Yety-Purovskoye Vokyntoiskoye Profit-based tax system introduced for offshore, to appease ExxonMobil in Arctic Easy to implement and no immediate impact on government revenues New scheme to be trialled for onshore fields under development 12 fields selected, but no details as yet of tax scheme to be used Key element is cost recovery, which allows companies to make a better rate of return and reduce risk Russian budget Eras been put under pressure by lower oil price but lias now improved Budget deficit c.3% at an oil price of $50 per barrel 18000 0.0% 2014 2015 2016 2017 ^■Revenue ^^■Expenditure Deficit (% GDP) However, Russian fiscal policy remains a critical issue, as the fall in oil and gas revenues reated a significant budget deficit At the 2016 budgeted oil price of $40 per barrel Russia would run a budget deficit of almost 4% However, the improvement in 2017 led to a fall in the deficit to 1.5% of GDP as oil contributed 40% of budget revenues Russia's relationship with OPEC - finally ^ cooperation_ The history of Russian discussions with OPEC • Until 2016, Russia's relationship with OPEC had featured a series of unfulfilled promises • The Doha meeting in April 2016 marked something of a turning point, although Russia again failed to deliver an agreement • Necessity proved to be the mother of invention in November 2016, however, and Russia played a leading role in the OPEC/Non-OPEC production cut NATURAL GAS PROGRAMME i| Company production relative to OPEC targets kbpd Oct-16 Jan-17 Aug-17 Mar-18 Sep-18 Jan 17- Aug 17 - Mar 18- Sept 18 - Aug 17 Sept 18 Oct 16 Oct 16 Oct 16 Oct 16 Change (%) Change (%) Rosneft 3876 3802 3758 3816 3968 -74 -118 -60 92 -3.1% 2.4% Lukoil 1678 1671 1624 1631 1667 -7 -54 -47 -11 -3.2% -0.7% SurgutNG 1241 1241 1201 1206 1255 0 -40 -35 14 -3.2% 1.2% GazpromNeft 816 784 796 783 795 -32 -20 -33 -21 -2.5% -2.6% Tatneft 596 593 576 578 602 -3 -20 -18 6 -3.3% 1.1% Bashneft 431 442 403 383 382 11 -28 -48 -49 -6.5% -11.4% Slavneft 298 293 300 267 282 -4 2 -31 -16 0.8% -5.3% Russneft 144 143 140 143 144 -2 -4 -1 0 -3.0% -0.2% NNK 45 44 44 39 33 -1 -1 -6 -12 -1.8% -26.3% Novatek 178 177 164 163 158 -1 -14 -15 -20 -7.9% -11.2% PSAs 349 344 324 359 394 -5 -25 10 45 -7.2% 12.8% Others 1588 1614 r 1538 r 1670 r 1757 26 -50 82 169 -3.1% 10.7% Total 11240 11147 10868 11038 11437 -93 -372 -202 197 -3.3% 1.7% • OPEC target was reached by mid-2017 (versus April 2017 target) • Production cut of 300,000bpd maintained through the majority of H2 2017 • Weakening of production restraint began towards the end of Ql 2018 • Production rebound since the end of official agreement has been strong - output is up by almost 600,000bpd since the Aug 2017 lowb NATURAL GAS PROGRAMME 7IR Company financial positions are robust Free Cashflow after Total Investment 40000 30000 20000 10000 0 ^^^B Rosneft ^^^H Lukoil ^^^H GazpromNeft ^^^H Tatneft -----Total SurgutNG Bash neft • Russian oil companies have, on average, generated sufficient cashflow to cover all capex • The exceptions have been major acquisitions, mainly by Rosneft • Since 2014, though, the sector as a whole has been consistently free cashflow positive, and has easily covered operational capex NATURAL GAS PROGRAMME w Offshore regions contain the majority of Russia's future resources, although shale and East Siberia have significant potential Russia's Prospective Oil & Gas Resources South Kara Sea ■ 136bnboe Yenisey Khatanga ■ 31bnboe South Barents Sea - 38bnboe Other Arctic -85bnboe A new tax regime has been introduced for Russian offshore, where two thirds of Russia's future resources are located offshore, with more than half in Arctic waters Gas also makes up two thirds of the resource base, but oil resources remain significant Exploitation of existing regions will be a priority, but a shift towards the frontiers appears inevitable International investment will be a necessitv. for finance and technoloav Greenfield potential close to existing infrastructure 20 new fields planned for development NOCs dominate spending 2 SC 2 CO 1 50 ICC 50 12,000 9,000 - £ cn 2 2015 ■ Rosneft 2016 2017 2018 2019 2020 iGazpromNeft ~_uci cSeuerEnergia * □ All other * from own ash flow Russia has as many as 20 new fields set for development, many of them close to existing infrastructure However, c.$40 billion will need to be spent to ensure timely development A key issue is that NOCs dominate the development plans, with Rosneft and GazpromNeft needing to spend $11 bn in the next two years alone Russia's "pivot to Asia" has been spearheaded by Rosneft and the oil industry The ESPO pipeline has provided a vital infrastructure catalyst The production potential of the Russian Far East is very significant tea of Okhotsk 2.50 ■ 2.00 0 miles 240 400 £aurai US- GwrnmT: 1.50 1.00 0.50 0.00 2008 2015 Low 2022 Low 2030 Low 2015 High 2022 High 2030 High Russian government projections East Siberian oil resources are estimated in a wide range of 70-160 billion barrels, and major tax breaks have been offered for their development Realistic production estimates suggest that 2mmbpd could be produced from the region by the end of the next decade Oil is also being redirected from West Siberia to fill the ESPO pipeline, which will have an ultimate capacity of 1.6mmbpd to China and the Pacific coast Rosneft is the main player in the region, and has dominated the relationship with China Foreign companies are becoming increasingly involved, with a focus on Asian players Development of Russian Arctic a possible long term option but now in serious doubt Russia has largest share of Arctic resources Partnership with Exxon has been key focus ROSNEFT-EXXONMOBIL STRATEGIC COOPERATION AGREEMENT AREAS • Arctic development a prestige political project for Russia as well as a long-term production solution • Opportunity to develop world-leading technology in partnership with lOCs and establish important presence in emerging new region • Rosneft will not be able to move forward with plans without IOC support, both financial and technical | For Russia the Arctic is geo-political as well as commercial The Northern Sea Route set to become the "Cold Silk Road" to Asia Finland Si WROS -ARCTIC Marim Shiitiv. Asslssmisi 2(X)S» kikwi, ArctK" CtxJMJL. Amu 2009 -\l<; t \USAI". DMSP (AS, AVI 1RR. and RADAR SAT UCK3NU Ui Zotm 2012 Djuiv 1(1 Anaiims Products SUlUND, Mawiasd USA NADONU ki , punxi mm. The Russian Arctic holds vast hydrocarbon potential (240 billion boe), which could sustain the country's oil output beyond 2030 and form the basis of an LNG hub The Russian government is keen to develop the economic potential of its Northern regions, and plans to use the oil and gas industry as a foundation for this — New tax regime based on sliding royalty to incentivise investment The Kremlin has clear geo-political ambition in the region, which goes beyond commercial logic -control of the northern sea route is a core strategy and Soviet military bases are being re-opened Oil production has started (2 fields), the Yamal LNG project is set to come online in 2017 and a major discovery has been made in the South Kara Sea Outlook for shale oil in Russia limited by sanctions Estimated production potential of Russian shale oil Location of Bazhenov in West Siberia 1800 1600 1400 1200 1000 800 600 400 200 2015 ■I 2020 I Rosnedra 2025 2030 IRF MoE Russian shale oil in Bazhenov had been identified as a key source of med i urn-term production Original expectations of l-1.5mmbpd of production by mid-2020s SElf-Snurced Bazhenov Fractured Reservoirs. A55es5mEnl Unit 1174D102 J West Siberian Basin Geologic Province 1174 • Joint ventures involving Shell, BP, ExxonMobil, Statoil and Total were undermined by sanctions, which specify no transfer of technology for use specifically in shale reservoirs Key technology issues appear to concern multi-stage hydro-fracking and logging while drilling, where Russian companies lack proprietary technology • Major long-term concerns likely to be infrastructure and governance - can Russia build enough rigs and are state companies the ideal players Tax manoeuvre cam benefit "hard-to-recover" reserves Comparison of cashflow breakdowns Increasing share of hard to recover reserves in Russia j3 ■i/v ZJ 120 100 80 60 40 20 0 14.55 10.95 9.75 20.90 2014 @ $100 2016 Planned at 2016 Actual at $50 2106 Actual @$50 $50 with Tax Discounts I Export tax ■ MET I Transport and Other ■ Profit Tax l Operating Costs l Post-tax cashflow 100* 80« 60* 40* 20* Reserves 2-j'-. IOC* Production 4^ 16* am 35* 60S 3* 20* 2000 2011 2000 2011 Easily recoverable reserves Heavy a nd viscous oi Is Tight reservoirs Deposits below the aas rap Source: Ernst & Young Cashflow for hard-to-recover oil with 50% discount to MET and export tax is greater at $50 per barrel oil price as 2014 total cashflow at $100 per barrel without discount MET discount can range up to 100% of specific reservoirs and types of crude oil, while export tax and also be reduced to zero However, these benefits have been partially offset by an adjustment to the 2016 tax arrangements A planned reduction in the export tax rate was postponed in order to generate an extra $3 billion for the federal budget Economics of a Bazhenov well Assumed flow rate of Bazhenov well NPV sensitivity to oil price for Bazhenov well 400 350 300 T3 Ja 250 c ■° 200 "1 150 o 100 50 Year Year Year Year Year Year Year Year Year Year Year Year Year Year Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 "Production (bpd) CD 2 c o on in > Q. A standard Bazhenov well close to existing infrastructure in West Siberia would appear to breakeven at an oil price of around $55-60 per barrel Companies such as GazpromNeft and Rosneft are currently maintaining a watching brief on Russian shale, without making any major financial commitments BP has signed a JV with Rosneft to explore the Domanik tight oil formation, committing $300mm of exploration funds Bazhenov economics based on data from 2014, adjusted for devaluation of rouble - Original cost of Bazhenov horizontal well with multi-stage fracking was estimated at up to $9mm - rouble devaluation would imply that this has fallen to around $5mm - Initial flow rate assumed to be 50 tonnes per day (370bpd), declining to 15 tonnes per day (llObpd) in year 2 - Zero MET assumed, in accordance with current tax rules - 50% of crude oil exported, 50% sold on domestic market Sanctions have forced a strategic re-think Transneft Gazprom South Kirinskoye field (Sakhalin 3 - Gazprom) GazpromNeft Lukoil N ovate k Rosneft Surgutneftegas US Treasury EO 13662 Directive 2 (Financing) US Treasury EO 13662 Directive 4 (Technology) US Commerce Dept. Export Controls EU Finance Restrictions EU Technology Restrictions Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Technology bans in the Arctic and shale oil have had little impact on short-term production but have changed investment priorities Arctic investment acknowledged as irrational at current oil price; tight oil desirable but unachievable until sanctions lifted Key concerns with regard to sanctions concern financing: - Specific limits on finance-raising for certain companies - The downgrade of Russian sovereign debt to junk status, with a consequent impact on state companies' financing ability Re-focus on core assets and enhanced recovery International oil company activity in Russia - increasing 7iK Asian presence Arctic partnership Barents Sea Exploration South Kara Sea Exploration E^on Mobil Statoil ^ l||l||l CMPC NOVATEK ewe total J-(J r YamalLNG I \ Z>) IV^b J) ^@ 6"«» Tight Oil EAZPRDM Baltic LNG? Udmurtneft l||l||l »"* E^onMcbil E^on Mobil v .|A|> Statoil * H Tight Oil Ö * Equity stakes bp 0 19.75% ....... GLENCORE 19.75% ■n ■ qia! 19% \* Total MOVATEK Laptev and Chukchi Sea Exploration ailEöi^MI oriQC Vankor East Siberia JV VCNG ■W statoil Sea of Okhotsk Taas-Yuriakh |1||,L E^on Mobil A< ÖCMPP.DM 3 Bon« FEPCO Petrochem Plant Sakhalin E&P NATURAL GAS PROGRAMME A Base Case Production Outlook 14000 12000 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 ■ Brownfield ■ Greenfield Assumes 2% brownfield decline curve No delay at green-fields already on production or set to commence in the next year 2 year delay for all new fields that can realistically be delayed Result is a steady increase in output to 11mmbpd in 2020 No production from tight oil or Arctic Downside scenarios underline the risks of getting) the balance wrong T3 Q. 13000 12000 11000 10000 9000 8000 7000 6000 5000 \> n> n> & O ^ ^ ^ ^ ^ ^ n*3 2015 Outlook 6% Brownfield decline 6% Brownfield + 2yr delay 4% Brownfield decline 4% Brownfield + 2-yr delay Russian government has a good track record in the post-Soviet era, though Oil trade is becoming more competitive in a low price environment Crude Exports in 2015 and Growth in 2009-15 for Key Trade Routes* {milion barrets per day) _ * Excludes Into-Regional Trade i| Russian Crude Oil Exports Oil exports by month Change in oil exports by month (YoY) • Oil exports flattened out from Q2 2017, as production restraint kicked in • The share of non-Transneft routes has increased as some companies have tried to circumvent the system • From September 2017 exports went into decline on a Y-o-Y basis • However, this trend reversed dramatically from June 2018, as production controls ended NATURAL GAS PROGRAMME w Russia's oil export system - still focussed on the West Russia crude oil exports by destination total 4.75 million barrels per day South Korea United States other eia1 More Russian crude oil exports are heading East Oil exports by direction 6000 5000 4000 3000 2000 1000 -■ o ^ ■ West De Kastri o ^ £ China via Kaz Sakhalin 2 - o < -■ o ^ Skovorodino I Kozmino Bay -----% East Q. < • There has been a noticeable shift in Russian oil exports in 2018 • The share of exports heading East has risen from an average of 31% in 2017 to 36% in 2018 • This continues the longer term trend seen since the opening of ESPO, but also underlines Russia's growing energy relationship with China NATURAL GAS PROGRAMME i| Oil export outlook shifting further East Russian oil exports 300 250 200 150 100 50 0 — Export to CIS Export to Europe Export to Asia 2000 2005 2010 2015 2020 2025 There has been a clear trend towards Asia for oil exports, and this is expected to continue Expansion of the ESPO system will be at the heart of this strategy Exports via Kazakhstan are also playing an important role as Rosneft fulfils its commitments to CNPC's pre-payment deal NATURAL GAS PROGRAMME Russia's mew oil link to Asia The East Siberia - Pacific Ocean (ESPO) Pipeline ESPO was completed in 2010 and will eventually export 1.6mmbpd to China and the Pacific Coast Russia's increasing role in the Chinese market Figure 2. Chinese crude oil imports by source Russia became largest supplier in 2016 and 2017 million barrels per day • China has been keen to diversify away from Middle Eastern crude • It has also been concerned about receiving too much oil by sea via the Malacca Straits • Russian oil provides a pipeline and seaborne option, plus high quality crude • Russia has become China's largest supplier of crude oil in 2016 Conclusions • Pre-2014 Russian oil production looked set to reach 11.5mmbpd by 2020s • Impact of lower oil price and sanctions was initially significant • Rouble devaluation has helped to offset impact for up to 3 years • Russian oil companies have been forced to re-prioritise, and tax changes have helped to catalyse focus on brownfields • Oil price recovery has helped enormously, and following the end of the NOPEC production agreements output has surged again • The main problem is in downstream, where tax changes have hit simple refineries and created need for investment • Shut down of some refineries and lower demand will free up crude oil for export • Outlook for production beyond 2017 is more difficult if oil price stays low and benefits of devaluation unwind, but upside still exists • Crude exports likely to remain flat at worst, and to be focussed more on Asian markets