Novatek (MCX: NVTK) - the second company in Russia in terms of production and sales of natural gas and one of the world leaders in terms of proven reserves. The main part of the company's natural gas is sold through the Unified Gas Supply System in the Russian market, and a smaller part is processed at own and joint plants and sold abroad in the form of liquefied natural gas - LNG.
13 In January, the company published preliminary operating results for 2021, that look ambiguous. Despite rising natural gas prices in Europe to record levels amid increased demand, LNG export volumes fell by the end of the year by 11% from the low base of 2020. At the same time, the total volume of hydrocarbon production was a record for the business.
In this review, we will assess the dynamics of the main production indicators, to draw a conclusion about, what awaits investors in the upcoming financial statements for 2021. But first, I propose to understand, what happened on the global gas market last year and why prices at gas hubs reached unprecedented levels.
Disclaimer: if we write, that something went up or down by X%, then by default we mean a comparison with the report data for the same period last year, unless otherwise stated.
Position in the industry
In my opinion, in 2021, there was not just a crisis in the gas industry, a real revolution: literally before our eyes a new independent market has appeared. Decades before that., since the 60s of the last century, world gas prices were tied to the price of the oil basket. However, in recent years, the price of long-term gas supply contracts has become increasingly dependent on short-term exchange prices at European gas hubs due to changes in the calculation formula..
To a large extent, this is due to the development of LNG projects and the desire of European consumers to benefit from market pricing against the backdrop of growing competition from gas producers.. The turning point has come in 2020, when Gazprom lost the court in Stockholm and renegotiated the terms of the contract in favor of a greater peg to spot prices.
In 2021, a "perfect storm" occurred in the gas market, when several negative factors led to a shortage of gas in European markets and an unprecedented increase in prices at the largest gas hubs. At the moment, the price of contracts reached 2200 $ for 1000 m2, however, it was then adjusted more than two and a half times and by 17 January 2022 traded in the area 900 $ for 1000 m2.
The Russian gas market was on the sidelines. The fact, that gas prices in the domestic market are strictly regulated by the state, therefore less volatile, and the price tag for Russian consumers is several times lower, than for European.
Mining
Hydrocarbons.
Based on the results of 12 in the months of 2021, the volume of hydrocarbon production, taking into account the share in joint ventures, reached a record 626 million barrels of oil equivalent. At the same time, the growth of production year-on-year amounted to only 3%. Average daily production amounted to about 1.72 million BOE per day.
The dynamics are not impressive, however, it is worth noting, that Novatek even in the crisis year of 2020 increased, and did not reduce the volume of hydrocarbon production and demonstrated the amazing resistance of production to crisis phenomena.
Natural gas.
Production increased by the same 3% and reached a historic high of 79.89 billion cubic meters. The growth in production is associated with the gradual reach of the design capacity of the Severo-Russkoye field, which was launched at the end of 2019.
Production growth at the North-Russian field compensated for the reduction in the production of liquid hydrocarbons in mature fields, as a result, total production remained almost at the level of 2020 and amounted to 12.3 million tons.
Production dynamics at the end of the period
| 2017 | 2018 | 2019 | 2020 | 2021 | |
|---|---|---|---|---|---|
| Hydrocarbons, million boe | 513,3 | 549,1 | 589,9 | 608,2 | 626,0 |
| Average daily production, million boe per day | 1,41 | 1,5 | 1,62 | 1,66 | 1,72 |
| Natural gas, billion cubic meters | 63,4 | 68,81 | 74,7 | 77,37 | 79,89 |
| Liquid hydrocarbons, million tons | 11,77 | 11,8 | 12,15 | 12,24 | 12,3 |
Sales
Despite Novatek's leadership in LNG development in Russia, liquefied natural gas sales still represent a small share of total sales. The main volume of natural gas produced is piped to Russian consumers.
In total, in 2021, the company sold 75.81 billion cubic meters of gas, of which 67.87 billion cubic meters accounted for Russia. At the same time, export supplies collapsed on 11% — up to 7.94 billion cubic meters.
Such an outcome seems illogical given the increased demand for LNG from Asia and Europe in 2021 and favorable export prices..
The fact, that for the sale of LNG for export, the company acquires the required volumes from its own joint ventures Yamal LNG and Cryogas-Vysotsk. At the same time, Novatek seeks to switch to direct sales of LNG by its joint ventures under long-term contracts.. Such a scheme allows you to be less dependent on short-term market conditions..
The availability of long-term supply contracts allows management to predict future volumes and prices of supplies abroad, which increases business resilience and reduces the risks of high volatility in the market.
As a result, in 2021, Novatek began to buy less LNG for resale and increased the share of sales through the Joint Venture Yamal LNG.. This will negatively affect sales revenue in the financial statements for the year, but will have a positive impact on the share of profits of joint ventures, taking into account current gas prices in Europe.
Dynamics of natural gas sales for the year by markets, billion cubic meters
| Russia | International | General | |
|---|---|---|---|
| 2017 | 64,9 | 0,1 | 65 |
| 2018 | 66,07 | 6,06 | 72,13 |
| 2019 | 65,65 | 12,8 | 78,45 |
| 2020 | 66,69 | 8,89 | 75,62 |
| 2021 | 67,87 | 7,94 | 75,81 |
What's the bottom line?
For four years in a row, Novatek has been updating historical highs in hydrocarbon production. However, growth this year was modest against the background of the depletion of a number of mature fields and restrictions on oil production by OPEC+. On the other hand, high hydrocarbon prices guarantee record revenue by the end of 2021.
Fall in gas export sales, in my opinion, do not be afraid. Gradual transition to direct deliveries through joint ventures under long-term contracts seems to be the right strategy. The last two years have shown, how volatile the spot gas market can be and how dangerous is the dependence of producers and consumers on the current market conditions, when it is impossible to reliably predict the volumes and prices of future supplies.
In my opinion, current high prices at gas hubs are an anomaly, related to several factors, about which I wrote above. In the future, prices will stabilize at lower levels as the balance in the world market is restored.
In May last year, Novatek launched the fourth stage of the Yamal LNG plant and increased its design capacity by another 0.9 million tons of LNG per year., up to 17.4 million tonnes. Besides, the company signed an agreement to attract additional financing for the construction of the Arctic LNG-2 LNG plant in the amount of up to 5.7 billion euros. The design capacity of the enterprise will be 19.8 million tons of LNG per year, and the launch of the first line is scheduled for 2023.
After reaching the design capacity, the plant will become one of the largest in the world and the largest in Russia, which will strengthen Novatek's position in the international LNG market.
I will also note, that Novatek has significant hydrocarbon reserves, which reached by the end of 2021 16.4 billion barrels of oil equivalent according to SEC standards, including 2.26 trillion cubic meters of gas and 189 million tons of liquid hydrocarbons.
