We sat down Monday with Mark Gyetvay, CFO of PSJC Novatek (NOVKY) , for a candid conversation about the power that Russia has on the global energy landscape, on the back of the Moscow Exchange conference in New York. Novatek is Russia's largest independent natural gas producer, and the seventh largest publicly traded company globally by natural gas production volume. We came out of the meeting with various premises that we think are not fully priced in the market:
The Nord Stream 2 project is not going away. The unspoken agenda of the Trump Administration has been to undermine the efforts of the Nord Stream consortium for two purposes: 1) weaken Russian foothold in the European natural gas market and using sanctions to effect this, 2) position U.S. LNG market for European consumption at a moment when Russia is strengthening its global footprint. However, Novatek thinks these efforts are futile given that Nord Stream 2 will bring the diversification away from Ukrainian pipelines, and U.S. will need to compete, not only with Russian gas but also, other international providers.
Novatek is poised to be the largest LNG producer by 2030, and this is predicated on 2 drivers: 1) Novatek is implementing technological innovation to lower their production costs allowing them to be more competitive than peers, 2) the development of liquid pricing hubs for spot trading, through investments like the transshipment terminal on Kamchatka Peninsula in the Russian Far East.
Novatek is in the process of implementing "gravity-based structures," meaning, efficient technologies to streamline LNG production by delivering solutions in one vessel or barge. This would allow to significant capex reductions. It is Novatek's target to decrease LNG production prices, to a level below $10/MMBtu, to be competitive versus alternative sources of power like solar and wind.
The Kamchatka facility on the East coast of Russia is meant to be the main trading hub for Asian countries, given the liquidity that this hub is expected to bring. As new liquefaction and regasification capacity comes online, over time, The LNG market is meant to evolve to a very liquid spot market, just like the U.S. gas market is today, where liquidity trading hubs provide near-term trading and delivery versus long-term bilateral agreements.
Japan is already at the forefront of this development with the JKM pricing market set to be the most active in settling gas-on-gas transactions, versus oil-linked ones. This allows for more accurate hedging of LNG commodity risk exposure versus baskets linked to crude oil prices.
Another wave of natural gas is expected to come from the Permian Basin in West Texas where there is a lot of natural gas associated with crude oil production. Today, around 2 billion cubic feet of gas is extracted for every 1 million barrels produced, or roughly, 34% of every oil barrel produced. This is an enormous amount of gas that will not find its way into the export markets until enough pipeline infrastructure comes on line after 2020. This creates negative value for producers today, which must find a way to deal with it, either by flaring it into the air, using it to power rigs or re-injecting it back into the ground to stimulate production.
Aside from natural gas, the U.S. has other bottleneck problems that other countries, like Russia, don't have. Ethane is one example. Ethane, a hydrocarbon used in industrial production, has also its own set of infrastructure challenges accessing the export or consumer markets. Russia, in contrast, according to Novatek, is blessed with access to a unique passage through the Arctic Circle that allows them to deliver commodities to Europe and China, cutting travel and cost expenses by 50%.
Finally, the cheap ruble over the last 12 months has propelled oil revenue for major Russian producers like Rosneft (OJSCY) , Gazprom (OGZPY) and Lukoil (LUKOY) . For Novatek, revenues are up 50% year on year and as they invest in production and development costs will continue to decrease to a point that will allow them to control margins despite volatile commodity markets.
For now, our top Russian oil stock is Rosneft given their leverage to crude oil production, however, Novatek has been the outperformer of those two over the last twelve months, 56% versus 78%, on the back strong production, margins and a bull thesis on global LNG export.
