Russia Downstream Oil & Gas

Russia refines onby Dmitry Grushevenko, Research Fellow,and Nikita Kapustin, Engineer, Energy Research Instituteof the Russian Academy of Sciences (ERIRAS)

Tatneft’s TANECO refinery will utilise KBR’s (Kellogg Brown and Root) Veba Combi Cracker technology. (Photo: Tatneft)

Despite sanctions, Russia is still attracting investors; however, the country’s downstream modernisation programme is being affected by the political and economic turmoil. What should Western companies expect?

ussian crude oil and condensate refining capacity in 2015 was estimated at around six million barrels per day (Mbbl/d). This

makes Russia the world’s third largest refining country, behind only the US and China. Over half of crude oil produced in Russia is refined domestically and a large share of the products is exported to the EU, Asia, the US and CIS (Commonwealth of Independent States) countries1.

Industry consolidationRussia’s downstream sector is characterised by a high level of government control, as over 60% of refining capacity is under the control of the vertically integrated state oil companies. Government companies are the main driving force behind the sector’s development, providing over 70% of overall downstream investments. Independent refineries have low complexity factors, and are constantly facing feedstock procurement

difficulties as most of the crude oil production is controlled by vertically integrated companies as well. Consequently, independent refineries are mostly involved in processing - that is, providing oil refining services for third parties - along with low-quality product exports, thus having quite a low impact on overall Russian downstream activities.

Such an arrangement is far from accidental. Since the dissolution of the USSR (Union of Soviet Socialist Republics), most of the country’s largest industrial assets, including the downstream sector, have undergone privatisation in an effort to convert from the centrally planned economy towards one with a market basis, to improve management, and to attract private investment.

However, new private owners are focused solely on the most profitable exports of middle distillates and fuel oil, ignoring technological development and domestic market needs.

Downstream investments were erratic and deemed secondary to the upstream.

During 2004-2007, the situation began to change dramatically. The largest government companies: Rosneft, Gazprom and Gazprom Neft began a series of acquisitions of major refining assets, including Angarsk, Achinsk, Kuibyshev, Syzran and Novokuibyshevsk oil refineries, previously owned by Yukos.Later, as part of the acquisition, TNK-BP’s assets, Ryazan and Saratov refineries as well as a share in the Yaroslavl refinery (50% stake in Slavneft), also came under Rosneft’s control. Gazprom Neft acquired the entirety of the shares in the Moscow oil refinery and the remaining 50% stake in Slavneft. As part of the deprivatisation of Bashneft’s assets, the Ufa group of oil refineries came under state control, which eventually led to over 60% of downstream capacities being concentrated in the hands of state-owned companies (Figure 1). ►

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Oil & Gas Russia Downstream

►

Figure 1. Russian refining capacity structure by company, 2004-2015

■ Others TAIF-NK

■ TNK-BP■ Tatneft■ Surgutneftegas■ Yukos■ LUKOIL■ Bashneft■ Slavneft■ Gazprom Neft■ Gazprom■ Rosneft

*Shaded areas denote state control

Figure 1. Source: Companies’ data, KORTESThe consolidation of the downstream sector spearheaded by the government, however, was not due to the high marginality of the sector, or a desire to absorb refining assets into a national monopoly. It was down to social needs to ensure steady supply of fuels to all the branches of the national economy in the midst of a tight supply and demand balance of certain petroleum products.

Balance of supply and demandSince 2001, volumes of crude oil refining have been outgrowing demand for motor fuels and other oil products (Figure 2).

Figure 2. Changing demand patterns for the key petroleum fuels, 2001-2014

information centre ERIRAS

Yet, Russia still faced instances of high- octane gasoline shortage. In late August/early September 1997, Moscow virtually remained without regular and premium gasoline supply. Excessive demand was also observed in Belgorod, Briansk, Orel, Lipetsk, Penza, Samara, Tambov, Ulyanovsk, and Chelyabinsk.

In April 1999 in St. Petersburg, fuel prices spiked two and a halftimes their initial level in just a matter of days. From May to June the same year, the cost of gasoline rose dramatically in Moscow, Novgorod, Pskov, Vologda and other regions of Russia. From January to November 2004, gasoline prices in

Russia increased by 34%. A sharp rise in the prices of motor fuel, up to 10%, was observed in the summer and autumn of 20072.

Shortage of gasoline also occurred in Altai, Voronezh and Kaliningrad in 2011, and in the Central Federal District after the fire at the Moscow oil refinery in 2012, as well as in the Urals and Siberia in 2014 after the Achinsk refinery accident3. To cover the high-octane gasoline deficit, Russia regularly had to resort to imports from Belarus.

Despite significant crude processing capability, the Russian downstream sector is poorly equipped and short of high-technology conversion units. This is reflected in the production structure of Russian refineries, where up to 60% of output is taken up by low-margin heavy and straight-run oil products, which eventually leads to disruptions in the fuel supply of the domestic market.

Maintaining the existing balance of supply and demand on the oil products market formed the key priority for Russian energy policy in regards to the downstream sector: that is, securing a stable supply of the domestic market with high-quality motor fuels, while simultaneously increasing high-margin exports, primarily that of low-sulphur diesel fuel4.

In 2011, with a view to achieve the aforementioned priorities, a modernisation programme to be completed by 2020 was developed by oil companies in conjunction with state officials. It was expressed in Quadripartite Agreements between the major oil companies: FAS (Federal Antimonopoly Service), Rosstandart (Federal Agency on Technical Regulating and Metrology) and Rostechnadzor (Federal Environmental, Industrial and Nuclear Supervision Service).

In these agreements, the companies formally confirmed their downstream development plans, designed with due consideration to

Figure 2. Source: ERIRAS

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Russia Downstream Oil & Gas

"During 2009-2014 more than US$35 billion had been invested in refineries to stimulate the development of the downstream sector.”

the recommendations made by the state, while public authorities undertook the task of monitoring performance. The result should have been a significant upgrade of the Russian refineries’ technological development, and a breakthrough in the quality of processing and products. At the same time, tax measures were implemented to discourage straight-run processing.

Up to 2014 growth in export-oriented straight- run refining had been due to extremely low export duties for fuel oil and other heavy products, which was only 66% of the crude oil duty - making crude distillation quite profitable even without further processing. From 2014 onwards, as part of a tax reform, a policy of diversification with regard to oil products export duties, known as the “60-66-90” system5, has been in force. Export duties on light oil products of high quality are set at a rate of 60% of the crude oil duty, while fuel oil and heavy products duties are to be gradually increased to 90% or 100% of the crude oil duty.

The implementation of this policy is expected to cause a reduction in low-tech, inefficient refining, as well as low-margin oil products exports and an increase in crude oil exports. According to the Energy Strategy of Russia, for the period up to 20 356, compared to 2014, crude processing volume will decrease by 10% by 2035, while crude oil production will remain relatively stable with export growth projected at 11 %.

Up until recently, there was little doubt in the overall effectiveness of government policy. During 2009-2014 more than US$35 billion had been invested in refineries to stimulate the development of the downstream sector. Active reconstruction and modernisation of domestic refineries was conducted with the active participation of foreign companies and contractors, and in close cooperation with major multinational corporations including Honeywell UOP,Axens, Haldor Topsoe, Shell and KBS.

Role of W estern com paniesDespite the fact that foreign companies are not represented as direct owners or operators

of the refineries, their participation plays a vital role in Russian downstream activities.The 25-year period since the dissolution of the Soviet Union brought a comprehensive expansion and deepening in the collaboration between Russian refiners and Western engineering and service companies.

Companies holding licences of advanced refining technologies are key to the sector’s modernisation. A number of secondary processing construction projects have been carried out with the involvement of Western companies and professionals including:

■ Construction of hydrocracking units at Rosneft’s Tuapse refinery7,Novokujbysevsk refinery8, and Gazprom Neft’s Omsk refinery9 under Chevron Lummus Global licence

■ Hydrotreatment units under Shell, Axens and Honeywell UOP licences10 and Veba Combi Cracking unit by KBR (Kellogg Brown & Root) at TANECO refinery (Tatneft group)

■ Fluid catalytic cracking (FCC) unit at Rosneft Syzran refinery under Honeywell UOP licence11

■ Axens’ hydrotreatment units at Rosneft’s Kuibyshev and Syzran refineries

■ Biturox process by Porner at TAIF-NK refinery

■ Vacuum gasoil hydrocracking complex at Surgutneftegas Kirishi refinery. Licensors: hydrocracking - Chevron Lummus; visbreaking - Shell; sulphur production- Worley Parsons

Foreign companies are important in the catalyst market, where over 70% is fulfilled through imports. In addition, a number of catalysts, e.g. for hydrotreating processes, hydrocracking and hydrodeparaffinisation, are either not produced in Russia or their characteristics do not allow fuel production according to environmental standard Class 5. The share of imports in the Russian catalysts market is presented in Table 1.

Table 1. Share of foreign com panies in Russian cata lysts for oil refining marketUNIT DESIGNATION IMPORTS SHARE

Isomerisation 50%

Catalytic Reforming 60%

Catalytic Cracking 65%

Hydrotreating 97%

Hydrocracking 100%Source: Ministry o f Energy o f The Russian Federation No. 210,31 March 2015

In 2014, the rapid deterioration of relations between Russia and the West, and the consequent imposition of economic and technological sanctions, coupled with a sharp drop in oil prices and the devaluation of the national currency, rendered the prospects of full downstream modernisation questionable. Despite the impressive investments made over the last five years, ERIRAS estimates that at least as much capital again will be required to complete the upgrade programme. More importantly, further modernisation will not be possible without the participation of Western companies as suppliers of technologies and consumables.

"Companies holding licenses of advanced refining technologies are key to the sector’s modernisation.”

Sanctions impactCurrently, there are no Western-imposed technological sanctions on downstream activities. However, economic constraints have affected the largest Russian oil companies, such as Rosneft, Gazprom, Gazprom Neft and Lukoil, which control the majority of the downstream sector. Sanctions have significantly limited the companies’ investment capabilities in foreign currency, thereby impairing their ability to purchase technology and equipment abroad.

The sector’s high degree of dependence on imports is a source for concern when considering development prospects, and the idea of import-replacement is gaining popularity and support.

Import-replacement is a series of measures which could be undertaken by the government to support Russian developers and manufacturers of technologies and equipment for downstream activities, with a view to expanding their market share. The proposed actions vary greatly in severity, ranging from the preferential taxation of technological enterprises and cooperating refining companies, to an outright ban on imports and administrative pressure on oil companies to invest in research and development, and procure Russian products. There is a consensus within the government for the need to support import-replacement, but so far no clear strategy has been laid out1213.

At the moment, there are a number of domestic products that offer competition to imports; for instance Izomalk isomerisation technology14, and fluid catalytic cracking technology G-43-10715 (Table 2). ►

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Oil & Gas Russia Downstream

Table 2. Major oil refining technologies licensors in the world and Russia

TECHNOLOGY DESIGNATIONLICENSOR

WORLD RUSSIAN

Vacuum gas oil Axens, CBI Lummus Global, KBR, ExxonMobil, Shell, Stone & Webster, UOP, Haldor Topsoe

TIPS RAS,VNII NP,OAO VNIPIneft

Residue Chevron Lummus Global, IFP, KBR, UOP

Developed by TIPS RAS and VNIPIneft

Hydrocracking Vacuum gas oil Chevron Lummus, Global Axens, UOP

None

Residue UOP, Axens, KBR, Chevron Lummus Global

TIPS RAS

Coking Delayed CBI Lummus, Foster Wheeler, Conoco Philips

Bashkir Scientific Research Institute of Petroleum Refining

Fluid ExxonMobil None

High-quality motor oil production Chevron Lummus Global, ExxonMobil

None

► Action is being taken to reduce importdependence on catalysts. The Angarsk catalyst plant will be aiming to phase out some of the most vital imports16. The Omsk catalyst plant, supplying Gazprom Neft refineries, is designing plans on the construction of new facilities to enter the competitive market17.

Russian scientists have been developing very promising solutions for hydrocarbon processing, such as heavy hydrocarbon feedstock hydroconversion18 and solid-acid alkylation19, but these projects are in the experimental-industrial testing phase at best.

Even so, a range of technologies and equipment are unavailable in Russia and a complete departure from imports in the short and medium term would not be possible without negative consequences for the industry. That, however, does not preclude reducing the share of Western companies in favour of alternative suppliers. Amid the crisis in relations with the EU

"Amid the crisis in relations with the EU and the US, Russia has decided to move in the direction of accelerating political and economic convergence with Asia-Pacific countries, first and foremost with China.”

and the US, Russia has decided to move in the direction of accelerating political and economic convergence with Asia-Pacific countries, first and foremost with China. Cooperation in the energy industry is the main driving force behind this tendency. In 2014-2015 the development of the transport infrastructure and hydrocarbon production projects came to the forefront. Nevertheless, it should be noted that Chinese and Korean

companies possess sufficient technological and industrial potential in the field of oil refining to compete with Western companies.

Future outlookThe political crisis, along with the dramatic changes in the global energy market, will inevitably affect the direction that the development of Russian downstream activities takes.

In the new economic reality, a radical reduction in investment plans is most likely, especially as regards lowest-margin projects. The new tax policy will push low-tech refineries, not sufficiently outfitted with conversion units, to the brink of profitability. According to the authors’ estimates, this will probably lead to a significant drop in crude oil refining, to 75% of the 2014 level by 2025.The impact on the domestic market, however, will remain minor, as straight-run products will continue to mostly be exported. According to ERIRAS estimates, even if a significant share of the modernisation plans were to be abandoned, the Russian downstream sector will still be capable of ensuring the domestic market fuel supply in the long term, perhaps with small volumes of imports from Belarus or Kazakhstan (Table 3). ►

Table 3. Oil fuels production and demand balance forecast

2013 2014 2015 2016 2017 2018 2019 2020 2025

Crude oil refining, MMb/d 5.52 5.78 5.73 5.64 5.55 5.43 5.33 5.07 4.41

Motor fuels, MMb/dGasoline

Demand 0.90 0.90 0.89 0.90 0.91 0.93 0.93 0.94 0.92

Production 0.91 0.96 0.99 1.00 1.02 0.99 1.02 1.01 1.02

Export 1.01 0.06 0.10 0.10 0.11 0.06 0.08 0.07 0.10

Diesel Fuel

Demand 0.64 0.64 0.63 0.64 0.66 0.68 0.70 0.71 0.80

Production 1.52 1.59 1.64 1.61 1.59 1.57 1.59 1.55 1.43

Export 0.88 0.95 1.01 0.96 0.94 0.89 0.89 0.84 0.63

Jet Fuel____________

Demand 0.21 0.21 0.21 0.21 0.21 0.22 0.22 0.22 0.23

Production 0.23 0.23 0.25 0.25 0.25 0.26 0.26 0.26 0.27

Export 0.02 0.02 0.04 0.04 0.04 0.04 0.04 0.04 0.04Fuel Oil

—

Demand 0.23 0.24 025 0.24 0.23 0.22 0.22 0.21 0.20

Production 1.48 1.55 1.51 1.43 1.38 1.30 1.18 1.06 0.68

Export 1.25 1.31 1.26 1.20 1.15 1.08 0.96 0.85 0.48

Naphta

Demand 0.40 0.40 0.38 0.38 0.38 0.39 0.39 0.40 0.44

Production 0.54 0.62 0.63 0.65 0.62 0.66 0.64 0.55 0.47

Export 0.14 022 0.24 0.26 023 027 0.24 0.03Source: ERI RAS

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Source: Khadzhiev. S.N., Kapustin. V.M., Maximov. A.L., Chernysheva E.A., Kadiev. Kh.M., Gerzeliev I.M., Kolesnichenko N.V. Promising technologies for petroleum refining and petrochemistry. Oil refining and petrochemistry, No.9,2014.

Oil & Gas Russia Downstream

The volume of exports of straight- run products is going to suffer a major decrease, which will have a negative impact on European businesses interested in their purchase for further refining.

Regarding the prospects for business cooperation with foreign partners operating on the Russian market, it is important to understand that at the time of writing, a revision of the medium-term modernisation programmes is taking place in order to reduce excess diesel fuel production capacity, as well as to further investments optimisation.A particular objective of this process is the construction of expensive hydrocracking in favour of delayed coking units20.

The option of non-cooperation with foreign companies seems extremely unlikely; however, Western companies working in Russia should expect a decrease in consumer activity along with increased competition, by both local producers and Asian companies, and the possible creation of administrative barriers by the government. Nevertheless, no major Russian oil company has yet to cut back working relations with a Western company, and a large-scale downstream import-replacement programme is still yet to materialise.

For Western companies wanting to maintain their current position in the Russian market, key points to consider include:

■ Distillation, hydrotreating and hydrocracking units will inevitably decline in popularity, while coking and FCC are going to be those most in demand

■ Import-replacement programmes are most likely to be implemented in some form. Developing cooperation withand committing to investment in Russian companies is a way to achieve preferential treatment from the government

■ The limited amount of foreign currency available to Russian oil companies will hinder their ability to import technologies and consumables. Competitive pricing along with flexible payment schemes, such as instalment payments, willhelp to secure long-term contracts

The overall short-term prospects for Russian downstream appear hazy, with much of the current activity being led by projects launched way before the crisis. The sector is yet to adapt to the new challenges, and what exact course will be taken, is yet to be seen. ■

References1 Russian Federation: Crude Oil Exports 2000-2015. Federal Customs Service and Federal State Statistics Service. Available from www.cbr. ru/statistics/print.aspx? file=credit_statistics/oil_products.htm

2 Gasoline crisis in Russia. Kommer­sant, D80 page 2, 6 November 2011.

3 Systematic analysis of the Quadripartite Agreements, Oil, gas, and business journal, 06 ,2015 (0 .13 -18 )

4 Energy Strategy of Russia for the period up to 2035. Available from: www. minen ergo.gov.ru/upload/iblock/621/621 d 81 fOf b5a 11919f912bfafb3248d6.pdf

5 The law of the Russian Federation. About the customs tariff. 0 5003-1 21 May 1993 as amended by 24 November 2014.

6 Energy Strategy of Russia for the period up to 2035. Available from: www. minen ergo.gov.ru/upload/iblock/621/621 d 81 fOf b5a 11919f912bfafb3248d6.pdf

7 Project for the manufacture and delivery of hydrocracking reactors for Tuapse Re­finery (OJSC Rosneft). Available from: www.omz.ru/en/project/project3

8 Novokuibyshevsk refinery will soon receive R-101 hydrocracking reactor, Volga News,18 October 2013.

9 Izhorskiye Zavody will manufacture equipment for JSC Gazprom Neft Omsk Refinery, 23 March 2015. Available from: www.omz-izhora.com/ press-center/press-release/?ELEMENTJD=825

10 Izhorskiye Zavody successfully delivers two reactors to Tatneft site, 28 September 2015. Available from: www.omz.ru/en/news?id=594

11 Implementation of investment projects at Syzran refinery, 14 April 2009. Available from: www.riasamara.ru/rus/ news/region/econ- omy_and_business/article43199.shtml

12 Ministry of Energy of the Russian Federation order 0210,31 March 2015.Approval of Action Plan on import- replacement in the oil refining and petrochemical industry of the Russian Federation, 31 March 2015.

13 Putin has demanded to set realistic targets for import replacement, 26 Au­gust 2015. Available from www.tvc. ru / news/show/id/75204

14 I somalk-2 - pentane-hexane fraction isomerisation technology. Available from www.nefthim.com/developments/ c5-c6-fractions-isomerization-isomalk-2/

15 Khadzhiev. S.N., Kapustin. V.M., Maximov.A.L., Chernysheva E.A., Kadiev. Kh.M.,Gerzeliev I.M., Kolesnichenko N.V. Promising technologies for petroleum refining and petrochemistry. Oil refining and pet­rochemistry, 09,2014.

16 Sechin: Russia will be able stop import­ing catalysts for oil refining, 14 August 2015. Available from www.dp.ru/1043g6/

17 Gazprom Neft will build a new plant for the production of import-substituting catalysts in the Omsk region, Interfax-Russia, 6 July 15. Available from www.interfax-russia.ru/Siberia/citynews.asp?id=628578

18 Technology for almost complete processing of heavy oil residues created in Russia, Information Agency Devon, 12 October 2015. Available from: www.iadevon.ru/news/pe troleum/v_rf_sozdana_tehnologiya _prakticheski_polnoy_pererabotki _tyazhelih_neftyanih_ostatkov-3232/

19 Moscow refinery is exploring the possibility of a solid acid alkylation implementation, 15 January 2015. Available from: www.rupec.ru/news/30729/

20 Bashneft presents its development strategy through 2020. Bashneft,12 October 2015. Available from: www.bashneft.com/press/releases/8277/

Dmitry Grushevenko is also a leading expert at the Energy Institute of the Higher School of Economics and a senior lecturer at the Gubkin Russian State Oil and Gas University. Established in 1985, the Energy Research Institute of the Russian Academy of Sciences (ERIRAS) is a major scientific centre at the forefront of fundamental and applied research. ww w .eriras.ru/eng

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