Short-Term Global Oil Service October 26, Key Issue: Has Russia missed the chance to replace Iran s lost market share in Europe?

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1 FSU Monthly Short-Term Global Oil Service October 26, 218 Highlights Key Issue: Has Russia missed the chance to replace Iran s lost market share in Europe? Crude Production & Trade: Russia s September crude output surge confirmed; 13 kb/d above precut levels Crude Production Russian production at record-high, while Kazakh production temporarily rose on lower maintenance activities in September Products Demand: FSU main products demand +75 kb/d y-o-y in Jan-Aug 218, driven by Russian diesel Refinery Runs & Investment: FSU crude runs + 36 kb/d y-o-y in September Products S/D & Trade: FSU Net Export Balances down by 14 kb/d y-o-y in Jan-Aug Main Revisions from Last Month We have revised up Russian refinery runs by 17 kb/d for October 218 in light of preliminary data suggesting continued light refinery maintenance. 1. Key Issue: Has Russia missed the chance to replace Iran s lost market share in Europe? By now Europe has largely wound down crude imports from Iran; but Russian exports not higher? With the re-imposition of US sanctions on Iran, Russia s Urals blend was widely touted as an alternative for Iranian crude because of its similarity to Iranian blends. However, recent data suggest, that contrary to expectations, Russia has missed out on the chance to replace Iran s market share in Europe. Fig 1: Iran s Crude/Condensate Loadings in Sep/Oct Page 1 of 16

2 kb/d FGE - FSU Monthly October 26, 218 By now, Europe has largely wound down crude imports from Iran in response to the imminent US sanctions threat, with crude/condensate loadings averaging only 7 kb/d in the first half of this month (see Fig 1). We expect the monthly average at around kb/d (see FGE Flash Alert 17 th October). Meanwhile, Russia s crude production reached a new record high of 11.3 mmb/d in September; some 38 kb/d higher than in May; but in contrast with market expectations, its crude exports to Europe have not increased. We have written previously about downside risks to Transneft s increased 3Q 218 export schedules to Europe, underlying that the expected light refinery maintenance season in autumn could limit the availability of Urals for exports (see FGE Flash Alert 3 rd July 218). This possibility has in fact materialised, and to an even greater degree than we thought. Throughout 3Q 218, Russia s increased crude runs took some 3 kb/d of the additionally-available crude following the relaxation of the production cuts. Domestic crude runs have been at near-record levels for months now, on the back of much-improved margins (see Section 5), which have led to particularly-light refinery maintenance in September. Furthermore, preliminary data suggest that only about 6 kb/d more CDU capacity was brought offline throughout October, compared with September. This implies that Russian crude runs remain high, continuing to limit the availability of crude for export. For this reason, we believe that Transneft s 4Q crude export schedules to Europe again look optimistic. Instead of returning to normal levels, as implied by the schedules, we now anticipate that Russia s crude exports to Europe could remain lower y-o-y even throughout 4Q 218. Fig 2: Transneft Actual & Scheduled Crude Exports, Y-o-Y Q schedule looks optimistic Q 217 2Q 217 3Q 217 4Q 217 1Q 218 2Q 218 3Q 218 4Q 218 Asia Europe Total Page 2 of 16

3 mmb/d FGE - FSU Monthly October 26, Crude Production & Trade: Russia s September crude output surge confirmed; 13 kb/d above pre-cut levels Crude Production Russian production at record-high, while Kazakh production temporarily rose on lower maintenance activities in September Russia s September crude output was a record-high 11.3 mmb/d, up some 15 kb/d from August, as was confirmed by official data released by Russia s Ministry of Energy (see Fig 3). This level is ~15 kb/d higher than the reference output of October 216 used in the cutback deal with OPEC. It was also 45 kb/d higher y-o-y, as we highlighted a couple of weeks ago based on preliminary data for the first half of September (see FGE Flash Alert 17 th September 218). We expect Russia s crude production to hover around mmb/d for the remainder of the year, as we see Russia as having no more spare capacity to substantially increase output any further in the short term. Supporting our view, comments from Russian governmental officials imply that production throughout October has been little changed, potentially increasing by about 4 kb/d m-o-m. FGE forecasts that crude & condensate production could increase further next year to average 11.4 mmb/d. Fig 3: Russia Crude & Condensate Output Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Production-cuts reference output Kazakhstan s September crude & condensate production averaged 1.85 mmb/d, up 13 kb/d m-o-m as maintenance at the 6 kb/d Tengiz field ended. However, we expect production to fall again throughout October, due to maintenance at the Karachaganak field. We estimate the impact of this to be about 6 kb/d for the month on average. Also, Kazakh officials have announced that the Kashagan field will be stopped for 45 days starting in April 219, the first large-scale maintenance since the field s 216 restart. Works will be aimed at upgrading the existing compressors, so that the field can reach production levels of 37 kb/d. This will be an improvement of 2-25 kb/d on the current output capacity of the field. We see that in order to increase production beyond that level and reach Phase I s design capacity of 45 kb/d, additional compressor capacity will need to be added and/or new wells drilled. Page 3 of 16

4 kb/d kb/d FGE - FSU Monthly October 26, 218 Fig 4: Kazakhstan Production at Kashagan field year-end target lowered to 25 kb/d from 37 kb/d Maintenance at Boleshek onshore processing complex Start of gas re-injection Power outage Partial stoppage to allow analysis of technical difficulties with gas re-injection Planned field maintenance Azerbaijan s crude production averaged 796 kb/d in September, up 2 kb/d m-o-m and up 2 kb/d y-o-y for the first 9 months of the year as a whole. This modest increase has come almost entirely from the Central Azeri platform of the ACG field, which we see as being the result of lower maintenance activity y-o-y. Also, the start-up of the Shah Deniz 2 gas condensate field in 2Q 218 has added some further output. Crude Trade FSU crude exports focus still on Asia We assess that FSU crude exports averaged about 7.2 mmb/d in September (see Fig 5), largely unchanged from August. Eastbound deliveries continue to increase y-o-y, boosted by the 2 kb/d ESPO expansion this January, as well as reported higher exports from Sakhalin-I in September (likely due to the restart of Odoptu stage 2). Fig 5: Russia Crude Exports to Asia by Route, Y-o-Y Change* ESPO pipeline expansion Higher Sakhalin-I exports Kozmino Skovorodino via Kazakhstan Sakhalin Total *September 218 data partly estimated Page 4 of 16

5 kb/d FGE - FSU Monthly October 26, 218 FSU crude deliveries to Europe have been growing y-o-y for two consecutive months now; however, this growth comes mostly from higher Kazakh exports via the CPC pipeline. Russia s crude exports to Europe still remain below last year s levels, despite rapidly-increasing production (see Section 1). Looking ahead, we think the crucial question is whether Russian refiners will head for hard maintenance in October. If so, crude exports will have substantial room (~3 kb/d) to increase in 4Q, potentially allowing the Transneft crude schedules to Europe to be met in that period (see FGE Flash Alert 28 th September 218). However, preliminary data suggest that refineries are continuing with light maintenance. We therefore expect limited room for increasing Urals exports to Europe in the short-term. Fig 6: Russia Crude Exports to Europe by Route, Y-o-Y Primorsk Ust Luga Druzhba Pipeline Novorossiisk Arctic Total Azerbaijan s crude exports via the BTC pipeline to the Med averaged 77 kb/d in January-September, 7 kb/d higher y-o-y, helped by higher Azeri production and possibly by higher Turkmen throughput volumes. Fig 7: FSU Monthly Crude Exports (kb/d) Main routes Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Baltic* 1,558 1,642 1,398 1,325 1,322 1,33 1,291 1,41 1,317 1,215 1,246 1,269 1,221 Druzhba pipeline 1,131 1, ,15 1, , ,19 1,55 Black Sea & Med** 2,349 2,586 2,92 2,632 2,35 2,824 2,716 2,765 2,758 2,764 2,624 2,677 2,76 Far East*** 1,364 1,536 1,641 1,559 1,843 1,698 1,73 1,86 1,75 1,716 1,82 1,84 1,747 Arctic Rail TOTAL 6,777 7,362 7,421 6,994 6,953 7,346 7,185 7,458 7,318 7,28 7,122 7,276 7,24 Main streams Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Urals 3,265 3,445 3,227 2,918 2,857 2,949 2,923 3,8 2,864 2,846 2,85 2,931 2,928 ESPO 893 1,37 1, ,227 1,87 1,126 1,227 1,18 1,127 1,226 1,24 1,164 Sakhalin-I (Vityaz) Sakhalin-II (Sokol) CPC 1,79 1,187 1,321 1,326 1,239 1,3 1,47 1,337 1,351 1,323 1,315 1,23 1,228 BTC Other TOTAL 6,777 7,362 7,421 6,994 6,953 7,346 7,185 7,458 7,318 7,28 7,122 7,276 7,24 *Includes Primorsk, Ust-Luga and Kaliningrad **Includes CPC, BTC, Georgian ports and Transneft (Novorossiysk) *** Includes Kozmino, Skovorodino-Mohe and Sakhalin **** Includes Varandey, Novy Port, Prirazlomnaya September 218 data partly estimated Page 5 of 16

6 FGE - FSU Monthly October 26, Products Demand: FSU main products demand +75 kb/d y-o-y in Jan-Aug 218, driven by Russian diesel The trend in FSU main products demand remains largely unchanged from previous months. Middle distillate is driving overall growth, which averaged 7 kb/d or 2.7% y-o-y throughout January-August. This compares with a much more modest growth of.6% last year (due to a large reduction in Russian fuel oil use). We expect annual demand growth at about 1.5% this year, due to a projected slowdown in Russian naphtha and diesel demand in 2H 218 on the back of slower economic activity. Fig 8: FSU Main Products Demand Change (kb/d) Y-o-Y 12 MMA Naphtha Gasoline Gasoil/diesel Fuel Oil Naphtha Gasoline Gasoil/diesel Fuel Oil Naphtha FSU naphtha demand on average grew by 18 kb/d or 15% y-o-y throughout January-August. Demand from Russia s petchem sector was at a record-high throughout 1H 218, averaging 133 kb/d. Demand since has returned to levels similar to last year, with lower sales in Siberia and the Volga region. We expect petchem demand to remain near last year s levels throughout the remainder of the year. Gasoline FSU gasoline demand has been essentially unchanged YTD, with a slight decline. In general gasoline sales have been weak in the region, in particular in Ukraine where drivers increasingly prefer LPG-fuelled cars. In Russia, pump prices passed the psychological limit of RUB 4/litre (~$.7/litre) in late March; in October they are nearing RUB43/litre, a 13% y-o-y increase. We are currently keeping our outlook for gasoline demand unchanged, forecasting a small 1 kb/d growth throughout 2H 218 driven by continued high car sales in the main FSU economies. However, official data available so far has remained mostly below our projections; thus we see downside risks further down the line due to pump prices growing at a higher rate than incomes. Page 6 of 16

7 FGE - FSU Monthly October 26, 218 Gasoil/diesel Middle distillate as in previous months is the driver of demand growth in the FSU. This almost entirely comes from Russia due to positive underlying macroeconomic fundamentals. For instance, Russia s retail sales grew by 2.2% y-o-y in January-September, while industrial output grew by 2.1% in the same period. Moreover, it seems that, if it were not for weaker performance in the agricultural sector due to bad weather, diesel demand could be even stronger. As of mid-october, Russia has harvested about 11 mmt of grain, 15% lower than last year s bumper harvest. Middle distillate demand was also boosted in 2Q by the FIFA World Cup; with its impact phasing out, we expect the growth in diesel sales to slow down and potentially even turn into a decline in 4Q 218. Russia s GDP growth appears to have slowed down recently, having averaged 1.3% in 3Q 218 and only 1.1% in September. Fuel Oil FSU fuel oil demand averaged 38 kb/d in January-August, up 15 kb/d or 4% y-o-y. Russia s fuel oil use grew by 25 kb/d in the same period despite increasing prices, but this was partly offset by lower demand in Azerbaijan and Ukraine. Russian media reports that in certain regions consumer heating oil prices increased by as much as 3%. This could prompt the government to increase subsidies to these regions to shield end-users as the heating season sets in. Nevertheless, the main point for FSU fuel oil is that its production is rapidly reducing due to refinery upgrades in Russia. This trend, coupled with relatively strong domestic demand, significantly reduces fuel oil availability for exports. We expect domestic fuel oil demand to largely track last year s levels, but with a 1-2 kb/d upside depending on bunker sales and demand from the power generation sector for heating. Page 7 of 16

8 FGE - FSU Monthly October 26, 218 Fig 9: FSU Main Products Demand (mmb/d) Naphtha Gasoline Range Range Gasoil/Diesel Fuel Oil Range Range Page 8 of 16

9 mmb/d FGE - FSU Monthly October 26, Refinery Runs & Investment: FSU crude runs + 36 kb/d y-o-y in September FSU refinery runs in September remained essentially flat m-o-m at 6.9 mmb/d, a 4-year high for this time of the year. Despite 1 mmb/d of CDU capacity being previously scheduled to go offline in Russia for seasonal maintenance, runs there were actually 3 kb/d higher y-o-y. This essentially implies that maintenance work last month was much less than previously indicated. Based on preliminary data, Russia s crude runs are expected to be only slightly lower in October, with only 6 kb/d more CDU capacity planned to be brought offline m-o-m. This could mean that runs remain over 2 kb/d higher y-o-y in October, continuing to limit crude Urals availability for export. Fig 1: Russia Refinery Runs Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec We assess that refinery margins in Russia fell by about $2/bbl m-o-m in September. Fig 11: Russia Export Refinery Margins ($/bbl) Complex Simple Page 9 of 16

10 FGE - FSU Monthly October 26, 218 Our Urals and products price forecast indicates that complex refiners can expect their margins to remain near the current levels for the remainder of the year. However, simple refiners margins are expected to dip below last year s levels due to a forecast larger increase in crude prices than in atmospheric residue prices. (Please note our model assumes a refinery located at either the Baltic or Black Sea shore. Real margins will be lower than the modelled levels depending on distance from these shores due to higher transport costs.) FSU Downstream Investment in October ForteInvest s 12 kb/d Orsk refinery commissioned its new 35 kb/d hydrocracker in late September. Gazprom s 23 kb/d Salavat refinery began the construction of a sulphur-producing unit in mid- October. The unit will have a capacity of 6 ktpa, to allow the utilisation of additional hydrogen sulphide following the modernisation of the FCC and hydrotreater. Lukoil has awarded an EPC contract reportedly worth $25-5mn to McDermott International for the planned delayed coker at its 315 kb/d Kstovo/Norsi refinery. 5. Products S/D & Trade: FSU Net Export Balances down by 14 kb/d y-o-y in Jan-Aug We assess that the net export balance of FSU main products shrank by 14 kb/d to 2.1 mmb/d in the first eight months of the year. This reduction is almost entirely due to falling fuel oil exports. To a lesser degree, relatively strong diesel demand in Russia is also contributing to lower export availability. Fig 12: FSU Main Products Balance Changes (kb/d) Y-o-Y 12 MMA Naphtha Gasoline Gasoil/diesel Fuel oil Naphtha Gasoline Gasoil/diesel Fuel oil Page 1 of 16

11 FGE - FSU Monthly October 26, 218 Naphtha The FSU net naphtha export balance averaged 53 kb/d in Jan-Aug, slightly down y-o-y, due to higher domestic demand in Russia from the petchem sector as well as higher gasoline production that required a yield shift away from naphtha. Gasoline The FSU s net gasoline export balance averaged 15 kb/d higher y-o-y in January-August, driven by higher refinery supply in Russia; this is also mirrored in higher actual exports from the region. At the same time, Kazakhstan has maintained its ban on imports of Russian gasoline. Kazakhstan has now become self-sufficient in gasoline, but the existing import contract with Russia prevents the re-export of Russian gasoline. Therefore, we see it likely that Kazakhstan will not resume buying gasoline from Russia until the new year, when it will be allowed to re-export, in order to avoid oversupply in the domestic market (see FGE Flash Alert 1 th October 218). Due to high refinery runs in Russia, we expect the country s net export balance for gasoline to have increased by up to 7 kb/d y-o-y in September. We project higher export availability y-o-y throughout 4Q 218, though to a lesser degree than in September. Gasoil/diesel The FSU gasoil/diesel net export balance averaged +85 kb/d in January-August, 25 kb/d lower y-o-y, due to higher domestic demand in Russia. However, exports in recent months have picked up, helped by higher refinery runs y-o-y due to lower downstream maintenance activity. Similarly to gasoline, we expect higher diesel sales on the back of increased crude runs and refinery upgrades. We project this increase to average about 5 kb/d throughout 219. Fuel Oil Russia s fuel oil exports have registered new record lows almost every month this year; in August, they slipped below 5 kb/d for the first time (excluding bunker sales). We see no reversal in this trend, due to the ongoing sharp decreases in refinery output of fuel oil; Russia s fuel oil exports will continue to reduce and 4-5 kb/d will be the new norm in the next 6-12 months. Kazakhstan s fuel oil exports increased on average by 1 kb/d y-o-y in January-August, but not enough to offset the large declines from Russia. Page 11 of 16

12 FGE - FSU Monthly October 26, 218 Fig 13: FSU Main Products S/D Balances (mmb/d) Naphtha Gasoline Range Range Gasoil/Diesel Fuel Oil Range Range Page 12 of 16

13 FGE - FSU Monthly October 26, 218 Russia Main Product Exports by Region (kb/d) Gasoline Naphtha 1,2 1, Gasoil/Diesel Siberia Urals Northwest Volga Central Far East Siberia Urals Northwest Volga Central Southwest Mini-refineries Far East Siberia Urals Northwest Volga Central Southwest Mini-refineries Fuel Oil Siberia Urals Northwest Volga Central Southwest Mini-refineries Page 13 of 16

14 FGE - FSU Monthly October 26, 218 FSU Crude Exports by Main Route (kb/d) NW Europe Primorsk Ust-Luga Druzhba Arctic Mediterranean Novorossiysk (Transneft) Asia CPC BTC Georgian ports Sakhalin Kozmino Skovorodino-Mohe Alashankou Page 14 of 16

15 FGE - FSU Monthly October 26, 218 kb/d Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Apr-19 May-19 Jun-19 Jul-19 Aug-19 Sep-19 Crude throughput 6,491 7,9 7,23 6,894 6,96 6,894 6,546 6,99 7,73 7,285 6,972 6,96 6,867 7,77 7,126 6,886 6,978 6,773 6,634 6,737 7,79 7,134 7,216 6,838 year-on-year change Naphtha* year-on-year change Gasoline 1,155 1,263 1,323 1,288 1,269 1,241 1,135 1,184 1,322 1,349 1,294 1,324 1,257 1,319 1,365 1,324 1,347 1,293 1,253 1,39 1,387 1,38 1,47 1,34 year-on-year change Jet/Kerosene year-on-year change Gas Oil/Diesel 1,827 2,91 2,36 1,998 2,51 1,981 1,847 2,36 2,75 2,15 2,33 2,5 1,994 2,97 2,123 2,72 2,138 2,54 1,983 2,13 2,125 2,158 2,174 2,21 year-on-year change Fuel Oil 1,62 1,187 1,238 1,188 1,123 1,11 1, , ,3 1,4 1,157 1,128 1,71 1,79 1, ,7 1,31 1,25 1,2 year-on-year change Total of above 4,936 5,717 5,695 5,466 5,775 5,444 4,935 5,41 5,638 5,429 5,268 5,64 5,519 5,451 5,662 5,461 5,445 5,296 5,332 5,194 5,382 5,65 5,89 5,184 year-on-year change Naphtha year-on-year change Gasoline 1,146 1,135 1,234 1,121 1,125 1,147 1,123 1,12 1,244 1,282 1,281 1,221 1,172 1,163 1,262 1,172 1,168 1,124 1,126 1,167 1,234 1,318 1,33 1,212 year-on-year change Jet/Kerosene year-on-year change Gas Oil/Diesel 1,243 1,176 1, ,63 1,151 1,196 1,129 1,18 1,294 1,262 1,214 1,29 1,155 1,129 1, ,11 1,197 1,175 1,194 1,231 1,272 1,271 year-on-year change Fuel Oil year-on-year change Total of above 3,155 3,12 3,21 2,897 2,974 3,88 3,93 3,16 3,24 3,342 3,347 3,173 3,144 3,96 3,166 2,97 2,939 2,977 3,95 3,11 3,198 3,37 3,372 3,257 year-on-year change Naphtha month-on-month change year-on-year change Gasoline month-on-month change year-on-year change Jet/Kerosene month-on-month change year-on-year change Gas Oil/Diesel , ,51 1, month-on-month change year-on-year change Fuel Oil month-on-month change year-on-year change *: Naphtha supply figures include estimate on non-refinery production Balance (Refining - Demand) Demand Refining FSU Product Balance Outlook Page 15 of 16

16 $/bbl FGE - FSU Monthly October 26, 218 Russia Key Upstream Financial Metrics (US$/bbl) Russia Excise Tax (US$/bbl) Assumed USD/RUB rate In effect from Jan-17 Jan-18 Jul-18 Jan-19 Jan-2 RON 92 gasoline RON 95 gasoline Naphtha Jet/kero Diesel/gasoil OPEX CAPEX MET Export duty Urals price Russia Export Duty (US$/bbl) 218 FGE For queries, please FGE@fgenergy.com The dissemination, distribution, or copying by any means whatsoever without FGE s prior written consent is strictly prohibited. Page 16 of 16