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GLOBAL TRENDS IN OIL & GAS
MARKETS TO 2025
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TABLE OF CONTENTS
Global oil market outlook 3
Global trends in refining 22Global natural gas market outlook 30
Challenges for Russian oil and gas industry 42
Conclusion 59
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TRENDS IN GLOBAL OIL &
GAS MARKETS TO 2025
The present outlook reects LUKOIL’s position regardingthe global hdrocarbon market’s long-term prospects. Theoutlook’s objective is to analze trends that will - in our
view - determine the future of global oil and gas markets.
Such analses are prepared b the Compan on a regularbasis in order to keep strateg up to date and to form aninvestment program. However, this is the rst time that weare making such analses public.
B publishing such an outlook we hope that it will help toclarif the current situation in the oil and gas market andwill draw attention to the challenges that face the globaloil and gas industr.
An analsis of the current problems of Russia’s oil andgas industr in the context of the main trends of global oiland gas market development is an especiall importantpart of this outlook.
Ke conclusions of this outlook:
• Global demand for liquid hdrocarbons will continue togrow. The growth of population and the consumer class in
Asia will support oil demand increase. The main increasein consumption will come from transportation sectors in
developing countries.
• Increase of oil production in North America won’t lead toa global oil price collapse. Modern methods of evaluationof shale oil reserves allow considerable uncertainttherefore we are cautious in our estimates of the USproduction potential. A number of factors
including the growing cost of reserve replacement, thebalancing role of OPEC and the depreciation of the USdollar will help to support the current levels of oil prices in
the long term.
• The European oil rening industr is experiencing asstemic crisis. Ongoing trends such as the decrease inUS gasoline imports and the commissioning of new highleffective oil reneries in the Middle East and Asia willcontinue to have a long- term negative effect on Europeanproducers.
• Gas consumption will grow faster than oil consumption.The greatest potential for gas consumption growth is inChina, while the European markets - Russia’s traditionalclients - will continue to remain stagnant.
• Maintaining oil production in Russia requires large-scale use of new technologies. Projects currentl plannedare unable to compensate the production decline ofbrownelds. Without large-scale use of new technologies,oil production in Russia will begin to fall in 2016-2017.
• The Russian oil rening industr will undergo signicantmodernization but risks of gasoline decits remain.Measures taken b the Russian government will promote
modernization of domestic oil reneries but the situationconcerning the automotive gasoline market will remainquite tense until 2016-2017.
• The main challenge for the Russian gas industr isaccessing new markets. Competition for the global gasmarkets will continue to rise. To develop gas productionin Russia, Russian companies have to gain access togrowing markets.
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GLOBAL OIL MARKET OUTLOOK
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GROWTH FACTORS AND CHALLENGES
FOR THE OIL MARKETGlobal oil price dnamics are subject to man factors,principall the balance of suppl and demand, themacroeconomic and geopolitical situation, the dnamicsof the US dollar exchange rate and conditions of theglobal nancial markets.
Technological breakthroughs make it possible to develophuge resources. The increase in unconventional oil andgas production in the US serves as a good example.Taking into account the US oil production progressman analtical agencies lower their long-term oil priceforecasts.
At the same time a number of trends will support oil pricesin the medium term.
In this outlook we would like to specif these trends andcriticall analze a number of challenges that the oilindustr face nowadas.
Growth factors:
Principal challenges:
• Population growth, urbanization• Motorization in Asia
• Growing costs of exploration and production• OPEC polic• Dollar depreciation
• Increase of unconventional oil production in North America• Increase of oil production in Iraq• Deepwater shelf production• Biofuels production growth• Gas to liquids (GTL) expansion
US Dollar exchangerate
Macroeconomicsituation
Financial markets Geopolitics
Supply and demand
Oil price
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DEMOGRAPHIC FACTORS
Our planet’s population will continue to grow rapidl.Between 2010 and 2025 global population will grow bmore than 1.1 bln people.
The greatest population growth will be registered indeveloping countries, while in the developed countriespopulation will remain relativel stable.
High rates of population growth are expected, rst of all,in India, which will become the world’s most populouscountr b 2020. Explosive population growth is alsoforecasted for the African countries where it will be theresult of improvement in socio- economic conditions andqualit of medical services.
Along with population growth, developing countries willexperience the movement of the rural population to thecities, known as urbanization. According to the estimatesof Mckinse Global Institute, b 2025 440 cities indeveloping countries will contribute up to half of the globalGDP growth.
At the same time the levels of consumption will grow. Itis expected that b 2025 the size of the urban consumerclass will grow b 1 bln people and the overall middleclass will amount to more than 50% of the total globalpopulation. The main growth will come from developing
Asian countries.
Urbanization and growth of the consumer class indeveloping countries will, in turn, promote demand for realestate, infrastructure, cars, hi-tech goods and, as a result,energ resources.
Source: UN, IHS CERA, Mckinse Global Institute
Developed countries Developing countries
Global population, bln Share of consumer class in global population, %
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OIL DEMAND
Demand for liquid hdrocarbons will continue to grow.Global demand for liquid hdrocarbons will continueto grow annuall b 1.2% on average and will, in ourestimate, reach 105 mb/d b 2025.
The greatest surge in oil demand will come from thetransportation sector, for which oil is the principal energsource (over 90%).
Consumption of liquid hdrocarbons will increase indeveloping countries where the transportation industris undergoing rapid growth. Analsts expect to seesignicant growth in the number of cars as well as thedevelopment of sea, air and railwa transportation.
In addition to this, growth in demand for oil in developingcountries will be further encouraged b the industrialsector, in particular, the petrochemical industr.
At the same time, consumption of liquid hdrocarbons indeveloped countries will remain relativel stable due tolow rates of economic growth and further improvementsin fuel econom.
Despite stable growth rates, oil’s share in the globalconsumption of energ resources will graduall decrease,because of substitution for other energ sources in suchsectors as power generation and housing.
Sources: IEA, IHS CERA, LUKOIL estimates
Forecast for consumption of liquid hdrocarbons, mb/dPattern of energ resource consumption in the transportation
sector, %
Transportation sector of OECD countries
Electricity Gas Other Oil
Transportation sector of developing countries
Other industries
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MOTORIZATION IN ASIAN COUNTRIES
The motorization of the population in developing countriesis one of the principal factors behind the future growth indemand for oil. Toda developing countries are severellagging behind developed nations in terms of the numberof cars per 1,000 people, thus creating conditions forsignicant growth in the size of global car ownership.
In the forecast period, the most noticeable increase incar ownership will take place in China, whose car markethas alread entered an intensive growth stage. In toda’sChina the number of cars per 1,000 people is 40. B2025 this gure will be close to 200, which will mean anincrease of 220 million cars for the period of 2010-2025.
Signicant growth in car ownership will also be registeredin India and other developing Asian countries. B 2025large-scale growth of car ownership will begin in Africa.
Freight cars and trucks will make a strong contributionto the growth in consumption of motor fuels. The totalnumber of such cars is expected to grow b 140 mln b2025.
According to our estimates, the aggregate global car eetwill grow b 670 mln during the period 2010-2025. Thiswill lead to an increase in fuel consumption of 9 mb/d.
Sources: IEA, OPEC, World Bank, PFC Energ, LUKOIL estimates
Motorization curves Car eet growth in certain regions, 2010-2025,mln of cars
Passenger cars/1000 people
Boom stage
China2025
Europe
NorthAmerica
Europe China India LatinAmerica
- LDVS 2010
- TRUCKS 2010
- GROWTH
NorthAmerica
Asia
GDP per capita, $2011China2010
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FUEL ECONOMY IMPROVEMENT
We are currentl observing a sustained trend towardsdecrease of fuel consumption in passenger cars. This ishappening for a number of reasons: the designs of carbodies and engines are improving, the qualit of enginefuel is getting better and hbrid technologies are beingimplemented more often.
Growth in the size of the car eet will be accompanied bchanges in its structure. However, over the course of thewhole forecast, internal combustion engines will preservetheir dominant position. Their share in the total car eetwill amount to more than 80%. At the same time the shareof cars with diesel engines will slightl increase.
The decreased rate in fuel consumption over the last 20ears was due to the improvement in its qualit. Enginesthat consume RON-95 gasoline became an industrstandard. The further decrease in fuel consumption ratewill be evolutionar, not revolutionar.
Promising trends in car improvement, such as thehbrid engines, reduced rolling resistance tires, decreasedweight and improved aerodnamics, will help to reduce theconsumption of fuel in passenger cars b 30% b 2025.
Sources: IEA, PFC Energ, LUKOIL estimates
Consumption of fuel b new cars, l/100 km Structure of car eet,%
*Flexible fuel vehicle - cars with exible choice of fue l (the car can use either gasoline or a
mixture of gasoline and ethanol in exible proportions)
- gasoline
- FFV*
- electric cars
- gas
EU USA China
- diesel
- hybrid
- LPG
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UPSTREAM COSTS INCREASE
The last decade was characterized b unprecedentedgrowth in exploration and production costs. Accordingto current estimates, oil companies’ expenditure ongeological exploration, development and production havemore than tripled since the beginning of the centur.
In man was the increase in costs is tied to the depletionof the conventional oil resource base. The growingdemand for hdrocarbons forces companies to developunconventional and highl costl reserves. The companiesare producing oil from deepwater shelves, operating highviscosit oil elds and extracting oil from tight reservoirs.
In toda’s market about 15 mb/d have commercialproduction costs above $70/bbl. for example, shale oil
projects in the US on average are protable at $80/bblcost of oil.
Therefore, even if demand for oil falls signicantl, itsequilibrium price is unlikel to sta below $70-80/bbl forlong.
Future growth in production will primaril come from thedevelopment and operation of unconventional reserves.From 2010-2025 over 70% of the increase in the supplof liquid hdrocarbons will come from the use of hi-techproduction methods and alternative fuels such as naturalgas liquids (NGL), GTL/CTL and biofuel.
The greatest increase in production will come from thedeepwater shelf, tight oil reservoirs in the US and heavcrude from Canada and Venezuela. We also expect anincrease in the production of NGL, primaril in the Middle
East and in the US.
Sources: IEA, IHS CERA, IHS Herold, LUKOIL estimates
OPEX (left axis)
capex (left axis)
Brent price (right axis)
$/boe $/bbl
Conventionalregions
Development of newconventional reserves(Iraq, Saudi Arabia, CIS)
Deepwater shelf
Tight oil reservoirs andshale oil in the US
Heavy Venezuelanoil, Canadian sands
NGL
BiofuelsCTL/GTL
Dnamics of capital and operating costs inexploration and production
Forecast for changes in suppl of liquid hdrocarbons in2010-2025, b sources, mb/d
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10Sources: IEA, IHS CERA, IHS Herold, LUKOIL estimates
* For counties in North Dakota
US SHALE OIL PRODUCTION OUTLOOK
The development of horizontal drilling and hdraulicfracturing technologies have made protable a signicantamount of unconventional hdrocarbon reserves in theUnited States. This began with the active production ofshale gas which led to the collapse of spot gas prices.
High oil prices in 2011-2012 forced man companies tostart active drilling in unconventional reservoirs containingliquid hdrocarbons. In 2011 the number of drilling oil rigsin the US exceeded the number of gas rigs.
The growth in shale oil production in 2011-2012 was verimpressive. Oil production at the Bakken formation in NorthDakota increased more than 7.5 times and amounted to589,000 b/d in 2012.
Eagle ford pla in Texas also became a site of explosivegrowth in liquid hdrocarbon production.
In 2012 the aggregate volume of oil production fromunconventional reservoirs in the US is estimated to haveequaled 1.2 mb/d.
The transportation and rening infrastructure wasunprepared for such production growth and that led to adecrease in US oil prices. The average spread betweenBrent and WTI oil amounted to $17/bbl in 2011-2012, whileseveral ears before WTI sold at a premium in comparisonto Brent.
Average oil production at Bakken*, kb/d Hdrocarbon output at Eagle Ford, kboe/d
condensategas oil
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US SHALE OIL PRODUCTION OUTLOOK
UNCERTAINTY IN RESERVE ESTIMATIONShale oil reserves are characterized b low permeabilit.Hdraulic fracturing technolog is used to improvethe oil inow. Well ow rates in shale formations arecharacterized b high decline rates in the rst ear ofproduction - generall the amount to 60-70% of themaximum ow rate.
Shale oil reserves in the US have undergone severalrevisions in the last few ears. In 2008 the US Geologicalsurve (USGS) estimated recoverable oil reserves at theBakken formation at 3,65 bln. In 2013 the USGS increasedthe reserves estimate to 7,4 bln bbl. In 2011 ContinentalResources valued recoverable reserves at 20 bln bbl.
The principal instrument of reserve estimation is production
curve analsis, where production curves are derived fromthe actual data of approximate well ow rates. When theperiod of a well’s operation is small, forecasts for differentproduction curves ma var signicantl.
The majorit of wells in the Bakken formation currentlonl have data for 3-4 ears of actual operations, leadingto signicant discrepancies in existing estimates.
The value of the estimated ultimate recover (EUR)depends on the chosen method of calculation and dataavailable. Estimates ma signicantl var for differentgroups of wells, depending on the qualit of formation,hdraulic fracturing technolog and other factors.Hence, an overestimation of shale formation reserves ispossible.
HISTORICAL AVERAGE
HyPERBOLIC
EXPONENTIAL
STRETCHED EXPONENTIAL CURVE
Months
k b / m o n t h
Average Bakken well production curve
EUR estimates for Bakken formation, kb/d
LUKOIL estimates for wells of 2004-2007
LUKOIL estimates for wells of 2008-2010
Estimates of Mason J. (2012), Oil & Gas Journal for wells of 2011
A - Hyperbolic, B - Duong, C - Extended exponential, D - Hyperbolic+Dmin, E- Exponential
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US SHALE OIL PRODUCTION OUTLOOKPOTENTIAL FOR WELL DRILLINGWhen forecasting shale oil production, it is necessarto take into account the potential for well drilling. Themaximum number of wells will depend on the productivearea of land suitable for drilling and on well spacing.
According to the current estimates, the maximum numberof wells that can be drilled at the Bakken formation inNorth Dakota is 33,000-39,000.
As the densit of well spacing grows, EUR decreases, andthis should also be taken into account when forecastingfuture production.
Intensifing shale oil production b increasing rates ofdrilling will lead to fast reserve depletion.
According to our estimates, dail oil production of 2 mbat the Bakken formation is unlikel to be sustainable,because in this case the drilling potential will be depletedb 2022-2025. The most likel scenario of Bakkenformation development is that it reaches a productionlevel not higher than 1.5 mb/d b 2020.
To support consistentl high levels of productioncompanies will have to continue increasing the number ofactive drilling rigs, leading to the need to hire more drillingcrews. According to the 2012 poll conducted b NationalOilwell Varco, the availabilit of qualied drilling crews isone of the principal challenges for US drilling companies.It is possible that another substantial constraint to thegrowth in shale oil production in the US will be a shortage
of hdraulic fracturing crews.
Sources: Mason J. (2012), Oil & Gas Journal, LUKOIL estimates
Forecast for number of wells in Bakken formation*Inuence of well spacing on recoverable
reserves per well
* For counties in North Dakota
MAXIMUM NUMBER OF WELLS
Production - 1,5 mln bbl/day
Well spacing, acres per well
E U R
p e r w e l l ,
k b
Production - 2 mln bbl/day
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OTHER CONSTRAINTS
Shale oil production requires the use of large quantities ofwater. Hdraulic fracturing requires 5-19 mln liters of water.This ma become an impediment in certain productionregions.
There are also certain concerns regarding theenvironmental safet of shale oil production. Whenhdraulic fracturing is underwa at a shallow depth,companies ma inject chemical reagents into the groundwaters. There ma also be problems with the disposal ofused chemical solutions.
In addition, experts note that shale oil production isassociated with the emission of methane and otherdangerous compounds into the atmosphere.
Some experts express concern that the use of hdraulicfracturing ma lead to rock movement and deformation,and this, in turn, can provoke landslides and restrictconstruction.
Considering this list of constraints, we forecast that shaleoil production in the US will amount to 3.9 mb/d b 2025. Shale oil production growth is expected primaril at themost developed formations in Bakken and Eagle ford.
Taking into account well ow rates, the pace of drilling andthe productive area, the most intensive growth in shale oilproduction in the US will take place in the next 5-10 ears.
After that production will stabilize.
Sources: EIA, LUKOIL estimates
Forecast for shale oil production in the US, mb/d
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NORTH AMERICA BECOMES THE LEADERIN PRODUCTION GROWTHFor the next decade North America will remain the leaderin terms of growth of production of liquid hdrocarbons.B 2025 the aggregate volume of liquid hdrocarbon andbiofuel production in the US and Canada will amount to 19mb/d, thus signicantl reducing the region’s dependencon oil imports.
Just several ears ago few believed that such growthwould be possible in a region with consistentl decliningproduction at brownelds. But large-scale deploment ofinnovative technologies has forced man to review theirevaluations.
The United States will continue to increase liquidhdrocarbon production with the help of shale oil, thedevelopment of deepwater shelf and growth in NGLproduction
In Canada production growth will primaril depend onthe oil sands. B 2025 production of high-viscosit oilin Canada will reach 3.6 mb/d, which is 1.7 mb/d morethan this ear. Production growth in Canada ma besignicantl constrained b logistics and environmentalconcerns.
Sources: EIA, IHS CERA, LUKOIL estimates
Forecast for production of liquid hdrocarbons in North America*, mb/d
*Excluding Mexico
Conventional
Deep water
Shale oil
Oil Sands
LPG
Biofuel
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BIOFUELS
According to our estimates, the rapid growth in biofuelconsumption that the world has been experiencing sincethe mid-2000s is unlikel to be repeated.
European biofuels have high production the cost anduntil recentl have been developed with the help ofsubsidies. In German, for example, the cost of biodieselproduction is almost two times higher than the cost ofproduction of regular diesel fuel. The crisis, however, isforcing the European governments to cut biofuel subsidprograms and, as a result, man European producers areexperiencing losses.
In addition to this, the European Commission hasproposed to lower the target level of 1st generation biofuel
consumption to 5% of the total volume of motor fuelconsumption, while the current target level is 10%. If thissuggestion is passed, it will have a negative effect on theconsumption of biofuels in Europe.
The United States is the world’s largest biofuel producer,but the situation there is also far from optimistic. It wasbelieved earlier that the development of biofuels is astrategic necessit capable of decreasing Americandependenc on imported oil. But the growth in productionof unconventional hdrocarbons has reduced the role thatbiofuels were meant to pla in the provision of Americanenerg securit.
Man experts doubt whether biofuel production is justiable from an environmental point of view, since, asa rule, production of fuel from crops requires fossil fuels.
Taking the stated circumstances into account, we have arather conservative view of future biofuel prospects.
Source: International Institute for Sustainable Development
DIESEL BIODIESEL
Self cost of fuel production in 2010*, euros/l Forecast for global biofuel production, mln bbl/da
* German case ** As of the end of 2012
** EXPERTFORECASTS:
LUKOILFORECAST
Cuts in subsidies*, euros/l
Subsidies
Excise tax on biodiesel
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DEEPWATER PRODUCTION
As traditional onshore reserves are depleted, offshoreresources are plaing a greater role in suppling thegrowing demand. The growing interest in shelf resourcesis illustrated b the fact that over the last 20 ears thenumber of large shelf discoveries has been greater thanthe number of big onshore discoveries.
Toda, proven offshore reserves are valued at 280 blnbbl, while shelf production amounts to 30% of the globalproduction.
Technological development helps oil companies toincrease the depth of offshore elds. About 27% of shelfproduction is currentl at a depth of 300 m and more andwith time this share is set to grow. Toda, technolog allows
producers to drill at depths that exceed 3,000 m. However,development of such reserves requires multimillion-dollarinvestments.
The accident at the Deep Water Horizon drilling platform inthe Gulf of Mexico has forced man companies to reviewtheir approach to safet measures during shelf drilling.This will lead to growing operating costs for offshoreprojects.
The high tax burden in certain countries, such as Angolaand Nigeria, will also lead to growth in production costs.
We estimate the oil price for protable development ofdeep water reserves should be at the level of $50-90/bbldepending on the region of production and water depth.
Despite the high cost of production and operating risks,deepwater production will continue to grow. After 2015,
when a number of new large elds will be put in operation,we expect to see signicant production growth.
Sources: IHS CERA, Statoil presentation to the IEF, LUKOIL estimates
Number of large discoveries Deepwater production forecast, mb/d
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
OFFSHORE
ONSHORE
% OFFSHORE
Angola
Latin America
Other countries
Nigeria
North America
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IRAQI PRODUCTION GROWTH PROSPECTS
Iraq remains the most promising region in terms ofconventional oil production growth. Despite the countr’simpressive proven reserves that amount to 143 bln bbl,production levels remain relativel low - and in 2012amounted to 3.1 mb/d.
In the process of distributing licenses in 2009 thegovernment of Iraq announced its goal of achieving dailproduction levels of 12 mb b 2020. Later the target levelof production was lowered to 9-10 mb/d, but toda eventhis level seems overl optimistic.
Existing oil pipeline infrastructure is barel managing thevolume of oil exports and development plans show that thehopes for resolution of the existing logistical bottlenecks in
the near future are futile.
In addition to the decit of export capacities, operatingcompanies have to deal with a shortage of drillingrigs, decit of water resources for the maintenance ofreservoir pressure and lack of developed transportationinfrastructure for the deliver of goods and equipment.
To reach at 9 mb/d production level b 2020 Iraq has toincrease production at the rate that Saudi Arabia did atthe end of 1960s-beginning of 1970s, or twice as fast asRussia in 2000s. Taking existing limitations into account,such growth rates are unlikel.
We forecast that b 2020 oil production in Iraq will reach6 mb/d.
Sources: IEA, LUKOIL estimates
Dnamics of oil production growth, mb/d Forecast for oil production in Iraq, mb/d
Production of 12mb/d (+1,13)
Production of 9mb/d(+0,75)
Saudi Arabia(+0,75)1966-1974
Iran (+0,35)1967-1975
LUKOIL forecast2012-2020 (+0,38)
Iraq (+0,15)1972-1980
Russia (+0,41)2000-2008
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OPEC’S BALANCING ROLE
Toda OPEC countries control about 42% of global oilproduction. Thanks to their coordinated actions, cartelmembers are capable of rapidl reacting to changes in themarket situation b introducing production quotas. Suchactions helped to stabilize oil prices rather quickl duringthe global nancial crisis of 2008.
Oil prices act as a decisive factor for the budget revenueplanning of OPEC countries. As a result of the Arab Spring,the budgetar obligations of certain cartel members havegrown signicantl. According to existing estimates, thebreakeven price that allows Saudi Arabia to balance itsbudget was about $78/bbl in 2012.
The probabilit of further budget expenditure neededto stimulate the econom and implement infrastructureprojects is quite high for the next 2-3 ears. For example,Saudi Arabia’s budget for 2013 envisions an increase of19%. Therefore it should come as no surprise that Saudirepresentatives regularl voice a price of $100/bbl as thetarget level.
In the medium term, as production b independentproducers, especiall the US and Canada, grows, OPECmembers will limit the growth of their own production, thussupporting the global oil prices at necessar levels.
Sources: Deutsche Bank, PIRA, LUKOIL estimates
Price of oil necessar to balance Saudi Arabian budget, USD/bbl Dnamics of OPEC share in global production, mb/d
Saudi Arabia threshold price
Brent price
If budget expenses growb 12% each ear (mean for 10 ears)
OPEC Independent OPEC share
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GTL – CHALLENGE FOR THE OIL MARKET AFTER 2020
One of the most promising alternatives to oil fuels is GTLtechnolog. This technolog, based on the snthesis ofliquid fuels from coal or methane, had been used back inthe 1940s in German, which experienced a shortage ofoil during World War II.
GTL technolog makes it possible to rene methane fromnatural gas into a wide spectrum of products, the mostimportant of which are diesel fuel and kerosene withimproved environmental credentials.
Toda, revival of interest in this technolog is a result bothof the stricter environmental requirements for motor fuelsand of the possibilit of operating gas elds in regionslacking gas transportation infrastructure.
The largest active GTL project toda is Pearl GTL. Сurrentmarket prices make it protable.
The onl project currentl under construction is theEscravos GTL in Nigeria. The relativel small number ofactive and planned projects is a result of the high costs ofbuilding GTL reneries.
Over the next few ears GTL technolog won’t presenta serious challenge to the oil industr. But beond thistime the situation ma radicall change due to furtherdevelopment of methane conversion methods. Among thepromising methods is the micro channel technolog thatmakes it possible to substantiall reduce the phsical sizeof reactors, leading to a reduction in capital investmentsin construction.
We believe that development of GTL technolog ma
have a signicant inuence on the oil market after 2020.Should GTL technolog gain large-scale circulation, it’spossible we’ll see the spread between oil and gas pricesnarrowing.
Histor of GTL process
Microchannel technolog (Compact GTL) Modular reactors
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INFLUENCE OF THE DOLLAR EXCHANGE RATE
Since oil prices are denominated in USD, the dnamicsof the American currenc’s exchange rate will inuenceglobal oil prices. As a rule dollar depreciation leads togrowth in oil prices, while dollar appreciation does theopposite.
The inuence of the dollar exchange rate on oil pricescan be illustrated b comparing the dnamics of oil pricesin USD with oil prices, denominated in Swiss francsand gold. Over the period of 2000-2012, the price of oildenominated in USD increased 3.9 times, while the priceof barrel denominated in Swiss francs onl grew 2.2 times,while the price of oil denominated in gold actuall fell.
If the dollar was tightl tied to the gold standard, the price
of oil over the last decade would be practicall unchanged.
Over the last decade we have been seeing a trend towardsdollar depreciation against other global currencies. Inman was this is a result of US monetar polic.
Depreciation of the dollar stimulates the US economb having a positive inuence on exports. Along witheconomic growth, the currencies of developing countries,especiall the ones from the Asia Pacic region, areappreciating.
Most likel this trend will continue in the medium term,encouraging growth in oil prices.
Sources: Platts, LUKOIL estimates
Dnamics of Brent oil prices in USD, Swiss francs and gold, %
XAU/bbl USD/bbl CHF/bbl
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OIL PRICES FORECAST
Population growth and high rates of automotive growthin Asia will encourage an increase in oil consumption in themedium term. Growing demand and the natural declineof production from conventional oil elds will require thedevelopment of new reserves.
Recentl there has been a stead trend towards anescalation in E&P costs which can be explained bthe depletion of conventional elds. As the increasein production will be from high cost sources such asdeepwater elds, high-viscosit oil and oil from tightreservoirs, the production costs will continue to grow.
Taking into account the high cost and technologicalachievements in oil production, biofuels will not have
serious stimulus for growth in production.
The increase in oil production in North America will begradual which will allow market plaers to adjust tochanges. Medium-paced increase in oil production isexpected in Iraq where the planned production probablwon’t be reached due to technological and infrastructuralshortage.
OPEC will strive to keep prices above $100/bbl to meetits budget commitments as the independent producersincrease their production.
Above all, the trend towards US dollar depreciation is oneof the important factors that inuence oil price increases.
According to our estimates, it’s unlikel that the price of oil
will fall below $100/bbl in the medium term.
Sources: Platts, LUKOIL estimates
Brent price forecast, USD/bbl
Historical data
LUKOIL forecast
Forecast range by analysts
Range of base scenariosby analytical agencies
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GLOBAL TRENDS IN REFINING
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Global oil product consumption, mb/d
Gasoline Diesel fuel Fuel oil Others
Source: Purvin & Gertz, LUKOIL estimates
STRUCTURE OF DEMAND FOR OIL PRODUCTS
Over the course of 2012-2025, global oil productconsumption will grow b an average annual rate of1.2%. In the medium term, the transportation sector indeveloping countries will remain the main driver of oilproduct demand growth. China is alread the world’slargest market for new passenger cars. Analsts expecthigh growth rates in Chinese car ownership and forecastthat b 2025 the total number of cars in China will reach266 mln. The growth of the Asian car eet will spur growthin demand for gasoline, while the commercial transportsector will contribute to the growth in demand for distilledproducts.
An increase in consumption both in light and fuel oilproducts will be registered in Middle East countries that
have traditionall been big consumers of fuel oil. PersianGulf countries use fuel oil in electricit generation,industrial production, water desalination and as a fuel forreneries.
Developed countries have reached their peak in oilproduct consumption. Both Europe and North America areat the stage where their car market is nearing saturation.Improvements in fuel econom will limit growth in oilproduct consumption.
Consumption of gasoline in developed countries willcontinue to fall, while demand for distillates will increasedue to stricter environmental requirements for bunker fueland an increase in demand from the commercial transportsector.
Global demand for diesel fuel will grow fastest amongall the oil products. B 2025 the share of diesel fuel inthe global oil product consumption will increase from
the current 32% to 37%. This will require changes in theconguration of existing reneries.
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AMERICAN MARKET TRENDS
Over the last several ears we’ve been observingsignicant changes taking place in the US oil productmarket. Growth in production of light shale oil has led toincrease in throughput at US oil reneries and growth inproduction of oil products.
This has primaril led to protabilit in continental oilreneries that use light oil from the Bakken province astheir crude. Infrastructure limitations created a situationwhere signicant oil volumes began accumulating in theoil storage terminals in the town of Cushing, Oklahoma.This has signicantl reduced the price of crude oil in theregion. After the implementation of such infrastructureprojects as the Seawa Pipeline expansion and KestoneXL, the advantage that continental oil reneries currentl
have in terms of crude costs will be signicantl reduced.
Simultaneousl the US oil rening industr is undergoinga process of rationalization. Smaller oil reneries aregraduall exiting the market. In the period 2009-2012 7oil reneries with an output capacit of less than 100,000b/d were closed on the US East coast and along the Gulfof Mexico.
Low demand for oil products in the Atlantic basin hasled to the closure of some offshore giants. Hovensa oilrener located in the Virgin Islands with a capacit of350,000 b/d was closed in 2012. That same ear theValero compan transformed its 235 kb/d oil rener in
Aruba into a terminal.
Sources: EIA, IHS Purvin & Gertz
Dnamics of oil rener capacit utilization in the US and Europe, %
Europe
PADD 1 (East Coast)
PADD 3 (Gulf of Mexico coast)
PADD 4 (Midwest)
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The US government is activel pursuing a polic towardsa reduction in the consumption of motor fuels. TheCAFE (Corporate Average Fuel Econom) sstem hasbeen active since 1975. The sstem sets limits on fuelconsumption rates for the producers of passenger cars.
Nowadas, the standard of fuel consumption dependson car tpe and size. According to existing standards theaverage fuel consumption for cars produced in 2016 willbe 31.1 miles/gallon (equivalent to 6,9 l/100 km). Underthose standards the fuel consumption b new cars willdecrease b 20% b 2016. Besides, measures taken in theUSA to boost the consumption of biofuels will encouragea decrease in oil demand.
Until the mid-2000s the United States was the world’slargest gasoline importer, but toda the countr’sdependenc on import is falling. At the same time theexport of diesel fuel is growing.
The United States are becoming a net exporter of oilproducts. Excess diesel fuel will be sent to Europe, whilegasoline will be exported to the Latin American countries.
Changes on the US oil products market will have along-term negative effect on the European oil reneries.Man European oil reneries were designed for arbitrageoperations and the deliver of car gasoline to North
America. The trend towards reduction in gasoline importsin the US is making the economic model of such arbitrageoil reneries no longer feasible.
Source: IHS Purvin & Gertz, LUKOIL estimates
Net import of gasoline in the US, kb/d Net import of diesel fuel in the US, thousands kb/d
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EUROPEAN OIL REFINING ISEXPERIENCING SYSTEMIC CRISISThe period of 2004-2008 was the “golden age” ofEuropean oil reneries. Stable demand for oil productsand the decit in conversion capacities made the oilreneries highl protable. But after the global nancialcrisis of 2008 the situation in the European oil reningindustr changed signicantl.
The decrease in demand for oil products that hit Europe in2009 led to a reduction in the throughput of European oilreneries. This coincided with the construction of severalconversion projects, which meant that the spread betweendark and light oil products narrowed further. Moreover, thelargest gasoline consumer - the United States - reducedimport volumes. All of these events had a negative effecton the economics of the European producers. As a result,
the European oil processing industr is undergoing adeep crisis.
Since 2009 producers have shut down a number of oilreneries with an aggregate output capacit of 3.7 mb/din the Atlantic Basin region. However, this seems to beinsufcient as man European oil reneries have lowprotabilit, while their utilization remains rather low.
Quite a few low-efcienc oil reneries continue to function.Oil companies are unable to radicall cut operations dueto the pressure from local authorities and labor unions. Ahigh risk of shutdown is especiall imminent for small oilreneries with low level of complexit because such oilreneries have high per unit operating costs.
To overcome the European oil rening crisis, thecompanies have to shut down an additional 1-1.5 mb/d of
rening capacities.
Sources: Wood Mackenzie, LUKOIL estimates
Comparison of European oil reneries in capacit and complexit
Working
Closed
High riskof closure
C D U
c a p a c i t y ,
t h o u s a n d s b b l / d a y
Nelson Complexity Index
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GLOBAL OIL REFINING CAPACITIES
It’s expected that in 2012-2020 the annual net increase inglobal oil rening capacities will amount to 1 mb/d.
The greatest increase in rening capacities is forecastedfor the Middle East and the Asia Pacic region, wheredemand for oil products will grow the fastest.
Scheduled projects have high capacit and complexit,challenging the European oil reners. Moreover, the oilreneries under construction have advantages in terms oflogistics, providing them with an opportunit to make protfrom arbitrage.
China, the largest oil product consumer in the AsiaPacic region, is forced to import part of its fuel. In orderto reduce its dependenc on oil product imports, thecountr plans to increase its own oil rening capacities b2.4 mb/d b 2018.
One of the world’s leading reners - Sinopec - plans tobuild several new oil reneries. In particular, Sinopec isbuilding an oil rener with a capacit of 300,000 b/d inthe southern province of Guandun in partnership withKPC (Kuwait Petroleum Compan). Together with PdVSA,CNPC is implementing the Jieang project with an outputcapacit of a 400,000 b/d. In addition to this CNPC isbuilding 400,000 b/d oil rener in the Zhejiang (Taizhou)province.
Sources: IHS Purvin & Gertz, LUKOIL estimates
Dinamics in changes of oil rening capacities (ear on ear), kb/d
China Latin America Middle East Europe Asia North America Others
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The Middle Eastern countries are also planning signicantinvestments in the construction of additional reneries inorder to satisf the growing domestic and global demand.Saudi Arabia plans to build three new oil reneries withan output capacit of 400,000 b/d each and an aggregatecapacit of 1.2 mb/d. The Al-Jubail facilit located on thePersian Gulf coast will be put into operation in 2013, whiletwo others - yanbu and Jizan - will be built on the Red Seacoast b 2016-2017.
Commissioning new capacities in Asia and the MiddleEast will lead to the reallocation of oil product ows. Theexport of gasoline from Europe to the Middle East willdecrease, while competition within the European dieselfuel market will grow.
Growth of global primar crude oil processing will beaccompanied b the construction of new conversionfacilities. New oil reneries in the Middle East and Chinahave high Nelson complexit Indices and this implies thatthe have extensive conversion capacities. For Europeanoil reneries the average Nelson Index equals 7 units, butfor the new capacities in the Middle East and Asia thisgure amounts on average to 10 units.
Construction of new conversion capacities will continueto take place in developing countries. The most popularproduction processes will include hdro cracking unitsused for production of diesel fuel and high qualit motoroils, cataltic cracking units used for production of highoctane gasoline and the coking unit that allows heav
residues to be rened into petroleum coke with productionof additional light oil products.
Sources: D-maps, Global data, Purvin & Gertz, LUKOIL estimates
Largest new oil rener projects in the Middle East, South Asia and Asia Pacic
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STRICTER STANDARDS FOR BUNKER FUEL
Authorities of coastal states have become concerned withthe worsening environmental situation and have set newlimits on the maximum allowed sulphur content in bunkerfuels.
Starting in Januar 2010, the territor of the EmissionControl Area (ECA, the water zones of Northern Europe,the US and Canada) is closed off to usage of an tpes ofbunker fuels with a sulphur content above 1%.
Even stricter regulations will come in force in the ECAzone after 2015. Sulphur content in fuels will have tobe below 0.1%. According to existing estimates, this willincrease distillate consumption b 450,000 b/d.
The global trend towards the restriction of sulphur contentin bunker fuels is not so tough. Starting in Januar 2012bunker fuels are supposed to contain no more than 3.5%sulphur.
After 2020, usage of fuels containing more than 0.5%of sulphur in international bunkering will be prohibitedHowever, man experts sa that this deadline ma bemoved to 2025.
The industr ma respond to this challenge b usingscrubber lters on tankers to purif exhaust gases withoutchanging the tpe of bunker fuel. Such approach can beused on large vessels that consume 80% of all bunkerfuel.
Another method of meeting environmental requirementsis to change the vessels’ fueling sstem to use liqueednatural gas (LNG).
Taking into account the trend towards less production ofdark oil products and further technological progress, weexpect that the industr will be able to graduall adapt tothe introduction of new standards.
Source: Purvin & Gertz
Dnamics of changes in sulphur content in bunker, %
WORLD POSSIBLE DELAY OF DEADLINES ECA
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GLOBAL NATURAL GAS MARKET OUTLOOK
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GLOBAL GAS MARKET SHIFTS TO A BUYER’S MARKET
In the beginning of the centur, the three principal markets(United States, South-East Asia and Europe) facedstagnating domestic production alongside growth in localdemand for gas.
Growing demand for imports favored suppliers allowingthem to set their terms. The main pricing principle waslong-term indexed contracts where the price of gaswas set based on the cost of alternative fuel, such asoil products. The long-term contracts and take-or-paobligations were explained b the need to make largeinvestments upstream.
The gas supplies were mainl delivered via pipelines asLNG capacities were limited.
But b the end of the 2000s the situation has changed.Technological breakthroughs in the US added to thereserves available for the production of large depositsof shale gas. Intensied exploration around the worldled to discoveries of new prospective regions with largereserves.
Over a 10 ear period, LNG-liquefaction capacitiesmore than doubled. Falling demand, as a result of theglobal economic downturn and increasing suppl, madeEuropean gas hubs modeled after the US Henr Hubmuch more liquid.
As a result, customers started to set terms on theinternational gas market.
2000s
Long-term indexed contracts -
dominant pricing principle
Spread of technologies of unconventional
f ields development
Growth of spot trading of natural gas
2010s
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GAS DEMAND GROWS FASTER THAN OIL DEMAND
Ke growth factors in the demand for gas, which initiallwas considered a b-product of oil production, were itsenvironmental credentials and low costs in comparisonwith other tpes of fossil fuels.
To address the threat of global warming the are to reduceCO
2 emissions into the atmosphere. Natural gas has lower
emissions of CO2, as well as other dangerous substances
(sulphur and nitrogen compounds).
In Asia and the Middle East gas-red electricit generationwill replace coal and oil-powered plants respectivel. Gasconsumption will also continue to grow in North America.
Another growth driver for gas-red generation is the
worldwide concern about the safet and reliabilit of thenuclear power.
In addition to power generation, population growth willalso contribute to the growth in gas consumption in theresidential and industrial sectors.
China will be the major region for gas consumptiongrowth and b 2020 will become one of the world’s largestconsumers and importers of gas.
We estimate, that until 2025 global gas consumption willcontinue to grow at an annual rate of 2.2%. Therefore gasconsumption will have the highest rate of growth amongother tpes of fossil fuels.
Sources: IHS CERA, LUKOIL estimates
Gas consumption b regions, bcm Gas consumption b sectors, bcm
China
Other non-OECD
Other OECD
North America
Other Population, utilities, housingIndustryPower generation
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SHALE GAS WILL ALLOW THE US TO BECOME A GAS EXPORTER
For decades the North American oil and gas industrwas tring to master the production of unconventionalgas resources. The price surge of the mid-2000s aptlcoincided with technological breakthroughs in the areasof hdraulic fracturing and directional drilling.
In addition to the experience that the industr had alreadaccumulated, an important contribution in the overallsuccess was the low population densit in productionregions and availabilit of water resources.
The growth in production of unconventional gas will allowthe US to start exporting gas b the middle of the currentdecade, and, according to various estimates, to become anet exporter of gas b 2020.
A major advantage of American LNG projects is therelativel low level of capital expenditure due to asignicant number of existing LNG import facilities thatcan be quickl converted for LNG exports.
As of toda, onl Sabine Pass terminal has acquired thepermission of the US authorities to export 16 mln t of LNGa ear (about 22 bcm). The start of exports is scheduledfor the end of 2015. The total export capacit of theproposed projects is 200 mmpta, but there is an inuentiallobb inside the countr that seeks to limit exports due toconcerns over domestic gas price growth.
Source: EIA
Forecast for production and consumption of gas in the US, bcm
Conventional gas Unconventional gas Consumption
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GLOBAL PROSPECTS OF UNCONVENTIONAL GAS
Taking into account the amount of time required to developthe necessar expertise, as well as to upgrade the rig eetand master the required technologies, shale gas will startto pla a serious role outside of North America after 2020.
There are considerable reserves of unconventional gasboth in Asia and Latin America. China has the mostfavorable conditions to establish shale gas production andhas alread begun to import the relevant technologies.
It should be noted that the lack of gas infrastructure andstrictl limited water resources won’t allow China, in short-term, to make the cost of unconventional gas productionas low and production growth as fast as in the US.
To increase shale gas production, one needs a largenumber of modern drilling rigs. At present the appropriateeet is available onl in North America, where it is fullutilized. Global capacit to manufacture such drilling rigsis estimated at 300 rigs per ear.
Lack of qualied personnel, as well as a lack of capacitfor the water injection necessar for hdraulic fracturingwill also constrain unconventional gas production aroundthe world.
Sources: IEA, EIA, LUKOIL estimates
Recoverable reserves of unconventional gas, tcm Unconventional gas* production forecast, bcm
*shale gas, tight gas reservoir reserves, coal -bed methane
Shale gasTigth gas reservoirsCoal-bed methane
Others
Europe
China
Canada and Mexico
USA
Middle East
Europe
Africa
CIS
Latin America
North America
Asia
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NEW REGIONS OF CONVENTIONAL GAS
Along with the progress in development of unconventionalresources, new, large conventional gas reserves are beingdiscovered in new regions of the world. Ver soon South-East Africa and the Eastern Mediterranean will becomeglobal sources of gas suppl.
B the end of the current decade appreciableliquefing capacities (around 20 mmpta) will havebeen commissioned to suppl the recentl discoveredsignicant gas reserves of Mozambique and Tanzania.Total annual export capabilit of the region is estimatedaround 70 mmpta, putting the region’s export potential onpar with the US.
South-East Africa has a good location for LNG deliveriesto the Asia Pacic region. Taking into account growinginterdependence between markets, competition in Europewill improve. To minimize costs, Chinese and Indian oiland gas companies are acquiring stakes in productionprojects around the region.
In Europe, the shelf of the Eastern Mediterranean mabecome a new global source of LNG b the beginning of thenext decade. According to various estimates, aggregaterecoverable offshore reserves of Israel, Cprus, Lebanonand Egpt amount to several tcm of gas. Considering theclouded international relations in the region as well as lowdomestic consumption, these countries will choose LNGas a wa of exporting their gas surplus. The rst liquefing
capacities are scheduled to become operational b 2020.
Sources: IHS CERA, EIA, Ernst&young
Largest natural gas eld discoveries in 2010-2012, bcm Forecast of commisioned LNG capacities, mmpta
Mozambique
Tanzania
Norway
Malaysia
Azerbaijan
Australia
Brazil
EasternMediterranean
Iran
Eastern Africa
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LNG MARKET OUTLOOK
The large-scale commissioning of new LNG capacitiescreates a good footing for the development of the globalnatural gas market.
The previous decade was characterized b the growth inLNG trading volumes and construction of LNG facilitiesall around the world - aggregate liquefing capacitincreased b 2.5 times and reached 270 mmpta (over360 bcm). In particular, Qatar commissioned a numberof large-scale LNG projects (QatarGas, RasGas) with anaggregate capacit of 61 mmpta.
Regasication capacities were mostl constructed inEurope and North America. LNG suppl contracts werebased on oil- indexation.
In the course of the current decade we expectimplementation of even greater-scale plans, primaril in
Australia. B 2020 new LNG facilities are planned in North America, Africa and Russia.
As LNG suppl grows, price differentials betweenmajor gas markets will narrow to the costs of LNGtransportation. It’s possible that signicant part of LNGdeliveries will be supplied under spot pricing. Therefore,development of LNG will make the global gas marketsmore interdependent.
Sources: PFC Energ, LUKOIL estimates
Global liquefing capacitites development forecast, mmpta
Russia
East Africa
Qatar
Australia
North America
Others
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EUROPEAN GAS MARKET
Despite the forecasted high growth rate of global gasconsumption, demand for gas in Europe is unlikel togrow signicantl in the next 5-10 ears.
The shale gas revolution resulted in a decline of coalconsumption in power generation in the US. ThereforeEuropean coal market prices have fallen due to the glut.
As a result, coal became more economicall efcient thannatural gas for power generation in Europe. The low costof co2 emission quotas also promotes replacement gaswith coal.
Low rates of economic growth do not favor growth inEuropean gas consumption unlike the fast-growing gasmarkets of Asia and the Middle East.
At the same time EU authorities are seeking everopportunit to stimulate development of LNG infrastructureand to diversif gas suppl to Europe.
Under the Third Energ Package gas transmission andstorage is separated from commercial activities. Intensivedevelopment of midstream infrastructure will allow theestablishment of a single trading hub for the whole ofEurope and eliminate signicant differences in gas pricesacross Europe.
Considering signicant rates of decline in domestic gasproduction, import of gas to Europe will continue to grow,even if overall gas demand stagnates. But forecasts showthat after 2015 there will be a sharp increase in the number
of potential global sources of gas suppl.
Sources: IEA, SKOLKOVO Energ Center, LUKOIL estimates
Comparison of European power generation’s cost, $/MWhNon-contracted demand for gas in 2020 and
volumes of suppl*, bcm
* Contractually unassured gas with European costof delivery lower 320$/1000 cm
Gas is more proftable
Gas price, $/1000 cm
SupplyDemand for gas
C o a l i s m o r e p r o f t a b l e
C o a l a n d r e s i d u a l o i l a r
e
m o r e p r o f t a b l e
C o a l , r e s i d u a l o i l a n d w i n d
a r e
m o r e p r o f t a b l e
Russia (new projects)
Pipeline gas (exceptfor Russia)
LNG others
LNG USA
LNG Australia
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Suppl will primaril grow thanks to large-scalecommissioning of new LNG facilities. Export from Australiawill grow after 2015, and b 2025 the United States, East
Africa and Russia ma become large LNG suppliers.
Asia remains the most attractive market for LNG, but inthe second half of the decade due to the growth of globalLNG suppl, gas prices in Asia will graduall decline.
In addition to LNG, there is some potential for increasingpipeline gas deliveries to Europe.
B the end of the decade, when man long-term importcontracts will graduall expire, there will be a signicantvolume of demand to be satised under new contracts.
Nonetheless, the volume of potential suppl will be muchhigher than contractuall unassured demand, leading toimprovement of competition in Europe. B 2020, Europe’sdemand for gas above the existing contracts will amountto 50 bcm, while Russia’s competitors will be capable ofsuppling the market with additional 250 bcm. Competitionwill force suppliers to lower long-term contract prices inorder to maintain their market share.
In the long run, the rise of share of hub pricing willconsiderabl challenge Russian gas in Europe. Growingcosts of production and depletion of the traditional resourcebase in West Siberia will undermine the competitivenessof Russia on the European market.
Sources: PFC Energ, SKOLKOVO Energ Center, Argus
Comparison of costs of gas deliveries to Europe, $(2012)/1000 cm
Pipeline gas
LNG
Average price of Russian gas at the borderwith Germany, 2012
Shtokman USA Yamalvia SouthStream
Yamal Lybia Russiaold
Algiers Australia Norway Nigeria Qatar
Forecast of gas prices in Europe, 2025
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GAS POTENTIAL OF CHINA
Gas consumption in China is set to grow signicantl. Around 3% of power suppl is produced from gas. This iswa below both the OECD countries and the developing
Asian states.
The skrocketing industrial-production growth of2000s quickl made China the world leader in terms ofCO
2 emissions. Environmental concerns will promote
substitution of coal with gas. The Chinese government setambitious goals for gas consumption growth in their 12thve-ear plan. Should the all be realized, Chinese gasconsumption ma reach 200-250 bcm as earl as 2015.
The growth of gas consumption in China will considerablexceed domestic production, thus creating opportunities
for export to this countr.
Sources: IEA, EIA, PFC Energ, CreditSuisse, IHS CERA, LUKOIL estimates
Chinese gas production and consumption forecast, bcm Dnamics of CO2 emissions, mln t
Range of forecasts of gas consumption
Range of forecasts of gas production
Consensus forecast of gas consumption
Consensus forecast of gas production
India China EU-27 USA
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Nowadas the main sources of import are Сentral Asiangas (in western parts of the countr) and LNG (in theEast). In the near future a gas pipeline from Manmar willbe commissioned.
Gas pipelines “Сentral Asia-Сhina” and “West-East”deliver the gas to China’s eastern provinces wheredemand is concentrated. B 2020 the pipeline sstem’saggregate throughput capacit ma reach 100 bcm,which corresponds to the aggregate export capacit ofTurkmenistan, Kazakhstan and Uzbekistan.
The Chinese are also activel building regasication LNGfacilities that will be capable of receiving over 60 mmptaof LNG b 2020. Toda up to 80% of supplies are coming
from Australia, Qatar, Indonesia and Malasia. Russia’sshare amounts to approximatel 2% under spot sales ofSakhalin gas.
Negotiations for deliveries of pipeline gas from Russiahave been taking place for a long time. Dialogue iscomplicated b the fact that the two sides have differentviews both on the price of fuel and on the direction ofsuppl. Two principal alternatives are the Alta project,with a capacit of 30 bcm, going to China’s Westernprovinces, where Russian gas will compete with deliveriesfrom Central Asia, and a branch of the “Power of Siberia”pipeline with throughput capacit of 38 bcm in the farEast, where Russian gas will mainl compete with LNG.
Capacities to import gas to China, bcm
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COMPETITIVE PRICE OF RUSSIAN GAS IN CHINA
Russia ma secure a large share on the Asia Pacic gasmarkets, especiall in China.
Domestic gas prices in China are regulated and kept lowb authorities. At the same time prices of imported gasare much higher.
Implementation of the Alta project would mean that themain competitor of Russian gas will be the Central Asianone. In the far East Russian gas will compete against LNGfrom Qatar and Australia.
Using the principle of equal protabilit levels with gasdeliveries to Europe, Russian gas seems relativel
expensive, both via either Eastern or Western routes.However, should the gas prices in Europe go down, thesituation will change.
On the whole, gas deliveries via the Eastern route seempreferable, both in terms of price competition, and in termsof infrastructure constraints that exist for the transportationof gas from China’s western provinces to the East coast.
The Russian side still has some unresolved issues withthe pricing. If the current approach to pricing persists, thecompetitiveness of Russian gas on China’s market seemsdoubtful.
Sources: The Oxford Institute for Energ Studies, LUKOIL estimates
Comparison of netback prices on Shanghai basis*, $/1000 cm
Turkmenistan
West Siberia (alternative to deliveries to Europe)
East Siberia (alternative to deliveries to Europe)
LNG (weighted mean)
LNG (Qatar and Australia, new contracts)
Western markets
Eastern markets
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CHALLENGES FOR RUSSIAN OIL AND GAS INDUSTRY
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RUSSIA HAS CONSIDERABLE RESOURCE POTENTIAL
Russia is one of the global oil production leaders and hasthe world’s eighth largest proven reserves.
The data on the size of Russian reserves is still condential.This is a legac of the Soviet period. But the situation isgraduall changing. Government ofcials are beginning toreveal reserve data in their speeches.
According to the Russian Ministr of Energ, the countr’soil in place amounts to 74.3 bln t, while resources equalto 157.1 bln t. In light of technical production capabilities,Russia’s recoverable reserves are valued at 22 bln t.
Evaluation of oil reserves using international classicationis approximatel twice as low as the Russian one. Thishappens, because the sstem of reserve evaluation usedin Russia is primaril based on geological and technicalattributes, while the economics of new elds’ developmentare almost disregarded.
Russia has signicant potential to increase its reservesaccording to international classication if it createseconomic stimuli to develop elds that are currentlunviable.
Sources: Oil & Gas Journal, Ministr of Energ of the Russian Federation
Geologicalreserves and
resources(Russian
classifcation)
Recoverablereserves
Resources
Reserves
Proven reserves(internationalclassifcation)
Proven oil reserves, bln t Reserves and resources of oil in Russia, bln t
Nigeria
Lbia
Russia
UAE
Kuwait
Iraq
Iran
Canada
Saudi Arabia
Venezuela
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MAJOR APPROACHES TO THE EVALUATION OF HYDROCARBON RESERVES
Estimation of reserves is used to determine the quantit of hdrocarbons that can be extracted from subsoils, takinginto account current technological, economic and other restrictions. In addition to reserves, such estimations alsoearmark resources with ver little available geological information.
There are man methods to calculate reserves that are based on various criteria of classication. Below are briefdescriptions of several of these methods.
RUSSIAN SySTEM OF RESERVE CLASSIFICATION
Russia currentl uses a temporar sstem of reserve classication that was introduced in 2001. This sstem inheritedapproaches that were proposed back in Soviet times and the primar classication criteria that it uses takes intoaccount geological and technical features of reserves. At the same time this method pas almost no attention to theeconomics of developing the elds.
According to the Russian sstem of classication, reserves are divided into categories according to available information:
• A, B, C1 – proven reserves• С2 – preliminar estimated reserves• СЗ – potential reserves• D1, D2 – forecasted resources
categories А, B, C1, C2 are considered reserves, while C3, D1, D2 – resources.
SEC REQUIREMENTS
SEC standards were suggested b the US Securities Exchange Commission for the companies that have a stockexchange listing. These standards have their own particular characteristics: the standards take into consideration onlproven reserves and take into account the duration of licenses for eld exploitation and the plans for their development.
The classication of resources utilizes such criteria as achievement of commercial signicance and probabilit ofgeological conrmation of reserves.
SPE-PRMS
The most widel used PRMS classication of reserveswas developed b the Societ of Petroleum Engineers
(SPE).
According to this classication, reserves are dividedinto three principal categories:• Proven - probabilit of extraction no less than 90%• Probable - probabilit of extraction no less than 50%• Possible - probabilit of extraction no less than 10%
Proven reserves in turn subdivide into the followingcategories:• Proved, developed, producing (PDP) - reserves thatare currentl being extracted from active wells• Proved, developed, non-producing (PDNP) - reservesthat can be extracted with negligible capital expenditures• Proven undeveloped reserves (PUD) - reserves thatdemand capital expenditures, e.g. for drilling wells, tostart production.
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TREND TOWARDS OIL PRODUCTION GROWTH
RESUMED AFTER 2008 CRISISOil production in Russia was steadil and dnamicallgrowing throughout 2000s thanks to the intensicationof production at existing elds and implementation oftechnologies to enhance oil recover rate. The hdraulicfracturing technolog was particularl popular, andcompanies implemented other new technologies andequipment.
Over the period of 2000-2010 production grew more than1.5 times, exceeding 500 mln t a ear.
During the crisis of 2008-2009 there was a trend towardsproduction decline, but timel tax cuts b the governmenthelped to stabilize production and even promote itsgrowth.
The greater part of Russian oil production is based ondiscoveries that were made in the time of the SovietUnion. 90% of oil production in Russia is done at oil eldsthat were discovered before 1988, and onl remaining10% is extracted from the elds that were discovered inthe 1990s and 2000s.
Such a situation has resulted from the fact that newldiscovered elds are mainl located in farawa regionswith difcult climates or lack of infrastructure. Theirdevelopment requires considerable investment.
Future production dnamics will depend on the companies’abilit to speedil commission new elds and the ratesof implementation of modern technologies necessar to
maintain production at existing elds.
Sources: Central Control Administration of the Fuel and Energ Complex, Ministr of Energ of the Russian Federation, LUKOIL estimates
Oil production in Russia, mln t Pattern of oil production in Russia, mln t
Production at felds
discovered after 1988
Production atfelds discovered
before 1988
Production atfelds discovered
before 1988
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HIGH DECLINE RATES - A CHALLENGEFOR THE RUSSIAN OIL INDUSTRY
A distinguishing feature of the majorit of Russian oil eldsis the natural decline rate in production due to depletion ofreserves. The greater part of production takes place at theelds of West Siberia, where rst large discoveries weremade in 1960s.
In the 2000s the rates of production decline in currentdeclining well stock increased considerabl, reaching theannual level of 11%.
An increase in the number of production enhancementoperations, which began in 2009, helped to stabilizedecline rates, but the remain high and present a realchallenge for the Russian oil industr.
Positive production dnamics that we have been observingsince 2010 are primaril a result of commissioning ofnew large elds. The greatest increase in productionwas registered in East Siberia, where oil companiesbegan production at such elds as Vankor, Talakan andVerkhechonsk.
To overcome the production decline rate, Russia hasto annuall commission 3-4 oil elds comparable withVankor.
Sources: Central Control Administration of the Fuel and Energ Complex, LUKOIL estimates
Production decline rates at current declining well stock in Russia, %
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At the end of 2012 the government issued licenses forthe development of the last remaining large lots on thebooks of the Federal Agenc for Subsoil Use (Rosnedra).The elds are Lodochnoe in Krasnoarsk region andShpielman and Imilor in Khant-Mans region. Therefore,in the mid-term the opportunities for commissioning ofnew large elds will be limited.
According to the oil companies’ plans, b 2020 thewill put in operation such elds as yurubcheno-
Tokhomskoe, Russkoe, Vostochno-Messoakhskoe,Novoportovskoe, Kuumbinskoe and Imilorskoe.
As a result, b 2025, the increase in annual productionfrom commissioning of new large elds will amount to 100mln t.
The majorit of new elds will be commissioned after2015, and until then maintaining production at stablelevels will remain a ver difcult task.
Forecasted production volumes for the new projects areunlikel to compensate the natural decline rate at old
elds.
Sources: Central Control Administration of the Fuel and Energ Complex, LUKOIL estimates
Production of oil at elds commissioned in 2003-2012, mln t
*yuzhno-Khlchuuskoe, Korchagin, Baandskoe, Pashshorskoe, Kravtsovskoe elds
East Siberia others
Vankor (Rosneft)
- LUKOIL
- Rosneft+TNK-BP
- Joint ventures
- Gazpromneft
- Slavneft
- Surgutneftegas
Uvat (TNK-BP)
LUKOIL*
Priobskoye (Gazprom Neft)
Salym (JV Shell-Gazprom Neft)
Sakhalin PSA (Rosneft-Exxon Mobil)
Forecast of oil production at large elds, mln t
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OIL PRODUCTION FORECASTS
Under current conditions, oil production in Russia can bemaintained through development of the following areas:
• enhanced oil recover at existing elds• development of unconventional reserves• development of Arctic shelf reserves
But to develop these areas, the government has to createfavorable conditions. Tertiar stimulation methods havehigh costs and their use under the current tax regime iseconomicall inefcient. The same can be said for thedevelopment of the so- called unconventional oil reserves,whose extraction requires use of expensive technologies.
The government’s measures to lower export duties
and provide companies with targeted incentives thatwere taken in 2010-2011, have proven their efcienc -production has stabilized and there has even been somegrowth.
The government lowered the export dut, gave tax breakson the mineral resources extraction tax, introducedpreferential rates of export dut for the oil elds of EastSiberia and North Caspian shelf. The authorities alsointroduced 10-10-10 concession sstem to stimulateproduction of super viscous oil.
Nonetheless, in order to maintain stable production in thelong term the government needs to take additional stepsto reform the tax regime for the oil industr. Otherwisedecline in production is likel to begin as earl as 2016-2017.
Sources: Central Control Administration of the Fuel and Energ Complex, LUKOIL estimates
Forecast for liquid hdrocarbon production in Russia, mln t
IF THE TAX BURDEN IS LOWERED
CondensateRunning wells’ production
Viscosity > 10000 cPPotential production with tax reduction
New wells’ productionNew top projects
Exploration projects’ potential production
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ENHANCING OIL RECOVERY AT
EXISTING FIELDSOne of the important steps towards maintaining futurelevels of production is to increase the oil recover factor(ORF) at existing elds b using methods of enhancedoil recover. Toda Russia seriousl lags behind suchcountries as the US and Norwa in terms of oil recoverfactor.
Increasing the oil recover factor on Russian elds to 43%will help to engage an additional 4 bln t of reserves indevelopment.
One of the advantages of using methods of enhancedoil recover at old elds is the opportunit to use theexisting infrastructure, thus foregoing additional capitalexpenditures.
At the same time, the majority of tertiary recoverymethods have higher costs in comparison with traditionalmethods of extraction, and this prevents their mass implementation by Russian companies.
Basically, their use often turns out to be economicallyinefficient. Therefore, in order to stimulate the use ofenhanced oil recovery methods, the government has toadjust the existing tax regime. Source: “Drilling and Oil” magazine, Februar 2011
Sources: compan materials, LUKOIL estimates, JSC “VNIIneft”
Potential for increasing ORF Comparison of expenditures in traditional productionand using EOR, $/bbl
CО2injection
target ORF37%
achievedORF
achievedORF
achievedORF 20%
Russia USA Norway Traditional methods EOR
~4 bln t of recoverable conventional oil reserves
Thermal methods
-Thermal steam reservoir stumulation-Fire ooding-Hot water/steam displacement-Cclic steam soaking
Gas methods-Hdrocarbon gas injection-Carbon dioxide injection-Nitrogen injection-Furnace gas injectjion-Water-alternated-gas injection
Physical and chemical methods-Solvent ooding-Polmer solvent ooding-Foam oil displacement-Alkaline oil displacement-Acids oil displacement-Change of ltration ows technologies
Microbiological and other methods
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DEVELOPMENT OF UNCONVENTIONAL RESERVES
Russia has high resource potential for the developmentof unconventional oil. The Bazhenov rock formation inEast Siberia has similar geological characteristics tothe Bakken formation. The variance of appraisals ofrecoverable reserves is also comparable to Bakken.
Toda the Bazhenov formation produces about 1 mln t ofoil a ear, while the oil recover factor amounts to 2-3%.Implementation of existing technologies can increase theoil recover factor to 35- 40%. According to Rosnedra, b2025, oil production at Bazhenov ma amount to 52 mlnt a ear.
Successful development of unconventional hdrocarbonsin the US is a result of several simultaneous factors such
as a favorable tax regime, state backing of researchprograms, existence of a drilling rig eet and qualiedpersonnel.
According to existing estimates, American companiesinvested more than $100 bln into the developmentof unconventional reserves. The development ofunconventional oil reserves in Russia ma requirecomparable expenditure.
The dnamics of unconventional oil production in Russiawill depend on the state’s abilit to create effective stimulifor the implementation of innovative technologies in oilproduction.
Sources: Sberbank Investment Research, Oil & Gas Journal, СERA, LUKOIL estimates
Comparison of Bazhenov rock and Bakken formation Recoverable oil reserves, bln bbl
Index
Area, mln km2
Formationthickness, m
Porosity, %
Average occurrencedepth, m
Bazhenov rock Bakken formation
Bazhenov rock Bakken
Max
Max
Min Min
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DEVELOPMENT OF ARCTIC RESOURCES
Development of the Arctic shelf ma become a signicantsource for long term production growth.
Ver little is actuall known about the Arctic shelf at themoment. Explorator drilling has onl been done on theshelf of the Barents and Kara Seas.
Toda the aggregate hdrocarbon resources of Russia’s Arctic shelf are estimated at 76.3 bln toe, while recoverablereserves are valued at 9.6 bln toe. The greater part ofpositive reserves is made up of natural gas.
Severe Arctic conditions - the difcult ice situation, lowtemperatures and lack of infrastructure - demand theexercise of unique expertise and technologies.
Existing legislation restricts the private companies’ abilitto develop of shelf elds. Removing this restriction couldstimulate geological exploration in the region, promotethe distribution of new technologies and allocate the risksamong a large group of participants.
If the current restrictions on private companies’ access to Arctic shelf are not lifted, b 2025 production at the Arcticshelf will amount to 12 mln t a ear.
Sources: Ministr of Natural Resources of the Russian Federation, LUKOIL estimates
Resource potential of Russia’s Arctic shelf, bln toe* Arctic production volumes forecast, mln t
*1 ton of oil equivalent = 1 ton of oil = 1,000 m3 of natural gas
Resources with conrmation АBC1+C2 reserves
Exploration
Dolginskoe (Gazprom Neft)
Medn Sea (Arcticshelfneftegaz)
Prirazlomnoe (Gazprom)
Oil Condensate Gas
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PREREQUISITES FOR EXCESS PROFIT TAX
The existing sstem of oil production taxation in Russia is based primaril on such scal instruments as mineralextraction the tax and export duties. The greater part of the tax burden falls on the oil production companies and thetaxes are levied on these companies’ sales of oil. Such a sstem fails to take into account individual features of oilproduction projects (geolog, geographical location, expenditure on development) and limits implementation of newtechnologies. The concept of the excess prot tax envisions using the nancial results of the compan’s activities asthe principal subject of taxation. This will create new economic stimuli for implementation of oil production projects.
MAIN PRINCIPLES OF EXCESS PROFIT TAX
The rst excess prot tax concept was submitted to the State Duma back in 1997, but the relevant law was neverapproved and no methodolog for calculation of excess prot tax was conrmed. According to new open-source
information, a method for the calculation of excess prot tax ma be developed b the end of 2013.
The following principles of the excess prot tax can be stipulated toda:
1) Tax base - the project’s nancial result. It’s expected that the tax base for excess prot tax calculation will be theproject’s operational prot minus capital expenditures.
2) Redistribution of tax burden. If the excess prot tax is implemented, tax burden on revenues will fall.
3) Separate accounting. For the goals of calculating excess prot tax, accounting has to be done separatel for eachlicensing plot.
If the excess prot tax is levied, the level of tax burden will depend on the stage of the oil/gas eld’s development.During initial development stages, when capital expenditures are the highest, the tax burden will be considerabllower than under the current tax regime. As production grows, the tax burden will increase. The tax burden willfall once again during later stages of eld development, allowing the subsoil users to activel use the methods forincreasing the oil recover factor.
PROSPECTS FOR INTRODUCTION OF EXCESS PROFIT TAX
In order to introduce the excess prot tax the state has to resolve a number issues, in particular the creation,implementation and management of a clear and transparent sstem of separate accounting for each project. Thereare currentl plans for the introduction of an excess prot tax in trial mode.
LUKOIL and Surgutneftegas proposed an initiative to implement the pilot excess prot tax project at Shpilman andImilor elds. A decision on this request is expected in 2014.
EXCESS PROFIT TAX
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CURRENT STATE OF RUSSIA’S OIL REFINING INDUSTRY
The modern-da shape of the Russian oil rening industrwas formed in the Soviet times. The existence of largeoil reserves, the necessit of using considerable amountsof fuel oil for heating and the Soviet Arm’s demand fordiesel fuel determined the conguration of Russian oilreneries. As a result, the Russian oil reneries producean excessive amount of residual oil and diesel fuel, whilegasoline production is barel enough to cover nationalconsumption.
The average conversion rate of Russian oil reneries ismuch smaller than the similar rate of their European and
American counterparts because the methods of residueconversion are used ver insufcientl. This being said,
the tax sstem that was in place until recentl created thewrong stimuli for oil reneries and prevented an inow ofinvestments.
However, situation is graduall changing. In 2011 theRussian government took a number of steps to stimulateinvestments into the modernization of oil reneries.
First of all, it changed the tax regime for the oil reningindustr, introducing the 60-66-90-100 polic. This sstemenvisions signicant growth of export duties on heavpetroleum products - starting in 2015 export dut on theseproducts will be equal to the export dut on oil, creatingstimuli for investment in the construction of conversioncapacities.
That same ear the federal Anti-Monopol service,Rostekhnadzor, Rosstandart and the Russian oilcompanies signed a four-wa agreement documentingthe companies’ plans to modernize their reneries.
Thanks to these measures we expect that in the coming
decade the Russian oil rening industr will undergolarge-scale modernization.
Sources: Central Control Administration of the Fuel and Energ Complex, LUKOIL estimates
Average conversion rate in 2012, % Production and consumption of oil products in Russia in2012, mln t/r
Russia Europe USA
Production
Consumption
Gasoline Diesel fuel Residue oil
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GASOLINE MARKET TRENDS
Demand for gasoline in Russia will continue to grow alongwith growth in the number of cars. The average annualincrease will amount to 1.5-2 mln cars, while consumptionof gasoline will amount to 43-47 mln t a ear b 2025.
As the car eet is undergoing modernization, there will bestructural changes in gasoline demand towards a growingshare of high-qualit Euro-5 gasoline. This will present aserious challenge to the gasoline producers.
Until 2016, when several large FCC units will becommissioned, the situation with the Russian gasolinemarket will remain ver tense. At the same time there is arisk that not all of the companies will fulll their obligationsunder the four-wa agreement in time. As a result,
problems with gasoline suppl ma extend for a longerperiod of time.
The government has taken a number of measures toincrease fuel qualit. In particular it has implemented aset of technical rules that specif that fuels below Euro-5will be banned starting from 2016.
Chart: engine fuel technical requirements:
Moreover, the government has introduced differentiatedexcise rates, activel stimulating producers to make aswitch to production of Euro-5 gasoline. In this respect theGovernment’s initiative to increase excise tax on Euro-4and 5 gasoline to the level of excise on Euro-3 gasolineseems inconsistent. Increasing excise tax will lower thequalit of gasoline and increase domestic prices.
2013
CLASS 3CLASS 4
CLASS 5
2014 2015 2016
Sources: Petromarket, LUKOIL estimates
Motorization in Russia forecast Forecast for production and consumption of gasoline, mln t/r
Production of RON-95, grade 5
Production of others
Consumption
Cars/1000 people
European trend
Russia 2025 г.
Russia 2012 г.
GDP per capita, thousands USD
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THE END OF THE FUEL OIL ERA
Toda, production of fuel oil amounts to about 28% ofRussian oil reneries‘ total output or 68 mln t a ear.Over the next 10-15 ears we expect considerablechanges in the ield structure of oil reneries. Fuel oil willgraduall leave the market. The execution of oil renermodernization plans, announced b the companies,will reduce fuel oil production volumes b three times,simultaneousl increasing production of light fractions.
As production of commercial fuel oil declines, theconversion rate will increase b 2025 to 92%, exceedingthe average European ratio.
Cuts in fuel oil production will primaril inuence theEuropean market where this product is activel used for
further rening and as bunker fuel.
Since fuel oil is an export product, its price on thedomestic market is heavi