[NGW Magazine] Novatek Plans for New LNG World

This article is featured in NGW Magazine Volume 2, Issue 20

By William Powell

Russia's next gas exporter is about to launch itself on world markets with Yamal LNG; its second is waiting in the wings. Success will entail cutting costs while improving customer service, says Novatek's boss.

With the first train of its – now – 17.5mn mt/year Yamal LNG project more or less finished, the operator Novatek is looking at how make its next export project, the confusingly-termed Arctic LNG 2, even cheaper. So far, by opting for a gravity-based solution instead of mounting it on piles sunk deep into the frozen sand and ice, it believes it has knocked about a third off the capital cost per ton of output compared with Yamal LNG. He said this will allow it to compete anywhere in the world.

But further cost savings could be achieved by using modular liquefaction equipment, made at its planned Kola facility – “the plant to makes plants,” as CEO Leonid Mikhelson called it, at a press briefing mid-October. “It will be very important to build the Kola yard,” he said, as each platform it makes will be cheaper than the one before.

It has also taken the final investment decision to build a 1mn mt/year liquefaction train at Yamal LNG, using its own technology, although it also has a co-operation agreement in place with Germany’s Linde and Russian Nipigaz to develop LNG technology for Arctic LNG 2. He said this new, small project was a “critical, pilot plant.”

He expects that this alone will have the effect of cutting the capital cost per ton of output from what will now be a 17.5mn mt/yr plant by 4%-5% compared with what it would have been at 16.5mn mt/yr.

Train 1 of Yamal LNG is going to start up this year – he was not more specific than that – and the second train will be ready to go earlier than planned, in Q3 next year not Q4; and the third train will be ready go in Q1 2019, not Q4 2019. The pilot train will start up at some point in 2019, he said.

This accelerated path is despite EU and US sanctions that were imposed in early 2014 after Russia's seizure of Crimea which limited access to long-term financing. But it was doable and financing the second project will be even more straightforward, he expects.

Sanctions too have not been all bad for Russia: it has forced its domestic technology companies to be more resourceful while producing world-class equipment; and the government has made clear its views on the importance of economising without sacrificing quality. Accordingly Novatek has instructed Linde and Nipigaz to contact potential manufacturers of equipment for Kola, and to be very careful in their selection.

Financiers of Yamal LNG might have been cautious initially given that there had been no gas liquefaction projects in Yamal and that Novatek was a newish player in the LNG world. “The biggest difficulty with Yamal LNG was that nobody believed in the project,” he said. “We were very grateful to our partner and shareholder Total,” he said, saying that when it invested in the project – despite the changes on the political front, which the then CEO Christophe de Margerie took in his stride, the perception of risk fell and other banks felt confident enough to lend to it.

These were initially Russian and Chinese state institutions but also late last year it signed a memorandum of understanding with the Japan Bank for International Co-operation and also a loan agreement with Italian banking giant Intesa Sanpaolo which bought into some of the debt. With insurance coverage provided by the Italian export credit agency Sace and the French export credit agency Coface, this loan helped lower the cost of external debt, Mikhelson said at the time.

So one way or another, Novatek achieved its budget and timescale when it took the final investment decision on Yamal LNG in the closing weeks of 2013, just four years before the first cargo is due to leave; and 95% of the output has already already been sold to partners or investors. He said he saw good economics for the project even with the most pessimistic view of the oil price, and that compared with Yamal, financing Arctic LNG would be very straightforward. So confident is he about this that the first steps have been taken to build a yard to build the platforms, at Kola, with the first plant due to roll off the assembly line by 2019.

But Novatek will not start talks with partners or financial institutions before then: it wants to show them the designs and talk the project up as a reality. Among them is likely to be JBIC, which with other finance institutions in Japan announced a $10bn public-private initiative to build LNG import and gas-to-power infrastructure in Asia. Mikhelson said he had signed a confidentiality agreement with Japanese entities limiting his freedom to comment, but that it was his intention to share information about equity and financing opportunities. “Japan is the biggest LNG market for today and tomorrow,” he said.

He expects external financing to account for a lower percentage of Arctic LNG 2 than it accounts for at Yamal LNG, perhaps because it will be able to attract LNG buyers into the equity.

Flexibility on both sides

A different strategy will dictate the sales of LNG from Arctic LNG 2, assuming it decides to proceed, he said. The emphasis will be on flexibility: both pricing and contract terms, with seasonality allowed. So Dutch Title Transfer Facility and other gas price indices will be allowed as spot markets develop in Asia. But while this involves taking more risk, Mikhelson believes that this is the way forward. “It is a buyer’s market,” he said. “Everyone understands that, which is a good thing…. We are ready to be more flexible with the [shorter] length of contracts, seasonality and the diversions,” he said. “We want to have a bit of everything in our portfolio: long-term, short-term and spot.”

Flexibility provision comes at a cost: mirroring its Zeebrugge LNG terminal deal, where winterized vessels can offload cargoes in a dedicated tank for collection by a conventional tanker, the company is planning something similar off Kamchatka in Russia’s far northeast – a region prone to earthquakes – perhaps using a series of floating storage units. This would allow conventional tankers to deliver the LNG to the final destination. He said there had been a lot of interest from potential partners in this idea of a terminal including gas buyer Jera and Korean Kogas, as it could solve a number of objectives.

With only the project partners’ LNG so far planned to be held in the tanks, it would not be a natural choice for a trading hub; but with third-party storage it would have potential. But anyway it would be a hedge against a low market, saving Novatek from forced sales at low prices, giving it a storage point of last resort. He plans to commission conventional tankers to service the transhipment terminal from Russian (Sovcomflot), Japanese (MOL) and Chinese builders.

While the northern sea route eastwards is only navigable for eight months of the year, he expects it to be just a question of time before it becomes a year-round service.

Simpler financing

He hopes too that the cumbersome financing arrangements will not be necessary when it comes to Arctic LNG. Nobody needs to show they have buyers lined up for an oil production project, he said, expecting the banking sector to become more flexible. “It is just a matter of time before the banking system adapts to this,” he said. Admittedly it will take some time for the existing oil price indexation clauses to work their way out of the system, but buyers want every possible indexation formula as a protection against high gas prices, or high oil prices. If banks want a slice of this growth market, they might need to take more risk, observers say.

He was unconcerned about competition from US and Australian projects, first because they would all be taking market share from other fuels, according to the decarbonising agenda of the Paris Agreement; but also because he believes his project is the cheapest. Others have higher lifting costs, involving fees to the liquefaction operator and Henry Hub gas, as well as the 15% that is lost in the liquefaction process.

Novatek has access to 2.5 trillion m³ of reserves under the Yamal and Gydan peninsulas and expects to double this in the next five years. This will give it the credibility it needs to negotiate terms with buyers of all sizes, but the company is not blind to relatively minor opportunities too.

Among the items for discussion in his in-tray is a 2.4-GW state-run gas-to-power project in Morocco – this will become the object of urgent talks he believes, once the gas purchase contract with Algeria expires in a couple of years. “This could give the impetus for a decision,” he said. Since its formation in March the new government has not announced the tender and Novatek is not holding direct talks with it, he said.

As well as gas supply for a power project, Novatek could also carve out a business offering bunkering services and he said he expected to include that in any tender from Morocco. He said Novatek was also interested in bunkering in Europe, partnering the Zeebrugge terminal operator Fluxys.

The two agreed in June to join forces in developing LNG marketing in Europe and Latin America, optimising LNG logistics, as well as other projects involving LNG. Fluxys CEO Pascal De Buck said that small-scale LNG “ticks all the boxes to curb the carbon and health impact of heavy duty road transport, shipping and remote industry.”

William Powell