What does not kill us makes us stronger: Russian business has proven this adage to be true many times. Sometimes it seems, however, that there’s no room for growing stronger, since it can’t be worse. Could Transneft that survived an emergency with the “contamination” of Druzhba, the largest oil export route to Europe, imagine it would have to face another terrifying threat this year? Yet nobody in the oil industry has been able to come off unscathed from the pandemic storm this year, given that COVID-19 has literally dried budgets and crude oil flows.
The coronavirus epidemic which grew into a pandemic knocked down the demand for crude oil and petroleum products to the very “bottom” in spring. And even in spite of unprecedentedly low mineral prices, all the global producers faced the problem of overproduction and a shortage of storage space. Naturally, the eyes of Russian oilers turned to Transneft that transports 83% of all crude produced in Russia, operates more than 67,000 km of pipelines and over 24 million cubic metres of storage tank capacity.
Thus, as estimated by the Russian Gas Society (RGS) which has assessed the outlook for creating a system of storage tanks to accumulate the strategic national oil reserve, it is Transneft (MOEX: TRNF) that keeps the main storage tank volumes. “This capacity stands at about 20-30 million tonnes. Of this amount 85% is used to store crude oil and the rest - to store petroleum products,” explained Executive Director of RGS Roman Samsonov for Interfax, having specified that about 50 million tonnes is needed (at least 10% of the yearly output).
Yet Transneft stated that the monopoly lacks capacity for commercial storage of crude oil, so it can store crude only for process purposes. “Maximum storage time was limited to one month. The system is not meant for storage and we do not store crude oil for a long time,” says Press Secretary and Advisor to President of Transneft Igor Demin. “There is a certain amount of undistributed crude oil stored in our tank farms. This is part of our technology. The stored amount cannot exceed a certain ceiling, enabling oil producers to sell crude in the oil market more effectively. This volume cannot be unlimited, since there are norms which oil producers cannot ignore,” he clarified. If the limits of undistributed crude are markedly exceeded, we may resort to the extreme measure of halting the reception of crude oil from the oilfields of the culprit company,” our interviewee specified.
Furthermore, only in early December 2020 did First Vice President of Transneft Maksim Grishanin informed that there’s no more contaminated oil in the monopoly’s system in the territory of Russia after the incident that had taken place at the Druzhba oil pipeline in spring 2019. However, the Company never mentioned any precise volumes of crude oil with an excessive content of chlorinated organics, which Transneft had to suck in and store in its tanks for subsequent disposal by way of mixing it with “clean” crude. The Belarussian side alone reported on more than 1.3 million tonnes of contaminated Russian crude transported over the oil pipelines or stored in storage tanks in the territory of Belarus, of which about 900 thou tonnes were forced out to the territory of Russia.
But it is the limited crude oil storage capacity that was one of the reasons why Russia too signed a new OPEC+ agreement about the reduction of crude oil production.
NO TO TARIFF GROWTH!
Under the ongoing oil crisis caused by the pandemic lockdowns, CEO of the biggest national petroleum company Rosneft (MOEX: ROSN) Igor Sechin raised the question of bringing the tariffs of transport monopolies in conformity with the current market prices at his May meeting with Russian President Vladimir Putin. “We do not ask for any preferential treatment, but dovetailing their prices with actual oil prices would of course be important for us. Right now, oil transportation charges account for 32% of the crude oil cost,” Mr. Sechin clarified. President Putin instructed the government to work out the issue of advisability of setting special tariffs for the services of Transneft and Russian Railways during the entire term of the OPEC+ agreement on crude oil production cuts.
Already in mid-July, the Ministry for Economic Development suggested a long-term change in the mechanisms of Transneft tariff indexation by dovetailing them with net profit margin which should be reduced from 22.6% to 5%. For its part, Transneft believed that the reduction of tariffs would bring about a sharp rise in the revenues of private shareholders of oil companies at the government’s expense, whereas the approach proposed by the Ministry for Economic Development would drastically slash capital investments and, accordingly, would accelerate the wear-out of fixed assets. In the meantime, the monopoly pointed out that the rise of tariffs to the market level would enable the Company to pay out dividends to the state in the amount of up to 75% of net profits by IFRS instead of 51% of the normalised parameter.
Concurrently the Federal Antimonopoly Service (FAS) entered a draft directive to the government regarding the long-term tariffs for oil transportation services rendered by Transneft with preservation of the current “inflation minus” principle, stemming from the annual tariff growth by 99.9% of the expected consumer price index. This issue had lost its relevance already by the end of the summer as the oil market started recovering after lockdowns have been lifted across the world. And in October the Russian government approved the “inflation minus 0.1%” principle behind the annual rise of Transneft tariffs that has been at play in 2018-2020. As per the FAS decision, the tariffs for Transneft services would be indexed by 3.596% in 2021.
Transneft, confronted with sinking turnover because of lower demand on the petroleum market as well as the OPEC+ agreement on reducing crude oil production, asked the government in April to grant a deferral of dividend payout for 2019. “We believe this is a more open and honest stance: we realise that many Russian companies will most likely reduce dividend payouts against the forecast amount (accruals rather than payments, to be more exact); we also understand that the financial sector will feel more like building the capital instead of paying out dividends. I can say that we believe the dividends are to be accrued and paid out in full, but a certain installment plan is needed. Our proposed solution is most friendly towards our shareholders, given the current situation in the world energy sector,” said First Vice President of Transneft Maksim Grishanin.
Thus, the management of Transneft proposed to pay out 50% of the adjusted net profits by IFRS as dividends for 2019, which amounts to RUB 81 billion (or 11,200 rubles per share), but asked to pay out this amount by installments: about half of the sum straight away and the rest during three years. However, in accordance with the decision made by the monopoly’s main shareholder, i.e. the state, Transneft had to pay RUB 84.18 billion, or 8.5% more than for 2018, and without any installment plan in place.
In the lack of any dividend payout deferral Transneft was forced to correct its investment programme for 2020-2021: this year, the level of investments will decline by more than RUB 45 billion (about 20% of the entire investment programme) to RUB 191.4 billion, and in 2021 it will be reduced by RUB 30 billion (about 12%) to RUB 207.8 billion. The Company plans to make up for these missing investments in 2022-2025 after the situation in the oil market stabilises. Given the completion in 2019 of key investment projects, the main funds will be used to upgrade and revamp the existing infrastructure.
NO MORE FRIENDSHIP AFTER “DRUZHBA”?
The aftermaths of the force majeure that occurred at the Druzhba OTP in spring 2019 will backfire on Transneft in 2021 as well. It was obvious from the very beginning that the issue of paying compensations for contaminated oil would drag on for quite some time, though last year the monopoly hoped to have settled it by mid-2020.
To set off the damage of consignors from interrupted supplies, Transneft formed a compensation reserve last year in the amount of RUB 26.1 billion, of which RUB 3.3 billion was paid out in Q4 2019. During six months, another RUB 5.2 billion was transferred to the accounts of consignors, whereas the reserve has been refilled by RUB 5.4 billion during nine months because of the exchange rate fluctuations. Therefore, RUB 22.9 billion was reserved for these purposes by the end of September.
LUKOIL (MOEX: LKOH) and Hungarian MOL, Kazakh consignors, Surgutneftegas (MOEX: SNGS) and Total (SPB: TOT) as well as Gazprom Neft (MOEX: SIBN) have already signed compensation agreements with Transneft. In April, the monopoly informed that it had agreed on the amount to be paid to the Mozyr Refinery as well, but nobody knows if the funds have been disbursed for the Belarussian Refinery. In October, Transneft, Rosneft and French Total had also completed settling their dispute in relation to the volumes supplied to the Leuna Refinery in Germany.
At present, Transneft hopes that all settlements will have been completed by mid-2021. “As of the present date, we’ve already paid USD 143.6 million and this work continues. In our estimation, this is more than half of the amount,” said Mr. Grishanin. “We hope to settle one more issue with one of our consignors by the end of the year. The work must be completed by the middle of next year, but this is our estimate,” he added.
CRUDE IS STILL AVAILABLE
Transneft that has been building new pipes for the past 15 years to pump the burgeoning volumes of extracted crude, has faced the problem of filling the system this year. At the beginning of the year, even before the world was in the midst of the coronavirus pandemic and due to the lack of agreements between Russian producers and Belorussian consumers, there were almost no supplies of hydrocarbons to this market in Q1 2020. The resumption of oil deliveries to Belarus almost concurred with the new OPEC+ agreement which implies the reduction of crude production in Russia in 2020 from the initially planned 560 million tonnes to the level of about 500 million tonnes. As a result, in relation to the original plan, the reduction of oil freight turnover over the Transneft system as well as the reduction of its tariff revenues could decline by around 10% at the year’s end. After 9 months, net profits by IFRS have already gone down by 24%, to RUB 110 billion.
Based on conservative plans, Transneft expects to keep oil pumping in 2021 at 2020 levels and to transport 440-450 million tonnes of crude oil. However, the monopoly admits that for now there’s no clarity about the OPEC+ deal parameters for the Q2. While the demand for crude has been rebounding in recent months, it has not reached the pre-crisis level yet. If earlier its recovery had been anticipated in Q2 2021 and later in 2H of the year, now experts feel the demand will be back only in 2-3 years from now.
At the present moment, the plan of crude oil export from Russia for Q1 2021 implies the reduction by 10% year-on-year, although the agreements about supplies to Belarus have already been signed. Under the current circumstances, despite the “green” energy trend, Transneft can only hope that hydrocarbon energy will still be in demand for many years to come, and crude oil will remain a significant part of the energy mix.