Billion Dollar Bonfire

For decades national and private oil companies have been burning the gas associated with oil production. Natural gas is released when oil is produced but is less profitable, especially in remote locations that lack sufficient infrastructure and markets to exploit it.

To put the size of this issue into perspective, globally it has been estimated that the amount of associated gas burnt as a by-product of oil extraction is equivalent to about one third of the European Union’s annual gas consumption. Billions of dollars are simply going up in smoke, and in the Russian industry this is no different.

It has been estimated by some that the value of all the associated gas that is burnt in Russian drilling operations is equivalent to $7 billion dollars worth of revenue each year. In the last couple of years though this has been changing, with Lukoil, TNK-BP, Rosneft and Surgutneftegas all among the big players who have announced they are looking to exploit more of this particular asset.

To get an independent perspective on this trend in the market O&G had the pleasure of speaking with James Balaschak, Partner at Deloitte Russia. Balaschak has extensive experience in the oil and gas sector, and based in Moscow, works as a consultant with several of the biggest Russian oil companies.

Changing outlook

According to the US based National Oceanic & Atmospheric Administration between 1992 to 2006 the level of global flaring remained relatively static, despite increases in oil production. This indicates that oil companies are reducing the amount of flaring, and this trend certainly seems to have picked up in Russia recently.

However, it is fair to say that Russia has trailed some other regions of the world. The Russian Government’s own figures shows Russia is the second biggest flarer after Nigeria, and satellite images of western Siberia reveal the scale of flaring. It has been estimated that the 15 billion cubic meters of associated gas that is burnt in Russia is the equivalent of the power from nine nuclear power stations.

However, although this is a huge amount of power, Balaschak points out that relative to the total production of gas in Russia, the figures are fairly small. With Gazprom alone producing around 500 billion cubic meters each year, he estimates that Russia produces over 600 billion cubic meters each year. And in monetary terms, even if $7 billion is being burnt, this is still dwarfed by the revenues the industry is pulling in already. “If you look at Russia’s oil and gas production combined, the value is hundreds of billions of dollars, versus seven billion dollars worth of associated gas. So relatively this hasn’t been a top priority in the past,” Balaschak explains.

Although Russia remains energy rich, and its oil revenues aren’t going to reduce anytime soon, Balaschak suggests that there are a couple of dynamics in the market that have prompted the Russian industry to look at its use of associated gas in more detail. “Gas production is levelling off, so the country needs all its natural gas, both for its internal needs, and to maintain the exports it has,” he argues.

But another big factor is that Russia’s electro-power sector, which is hugely dependent on natural gas, is struggling to meet the growing demand for electricity in the domestic markets. It is no surprise that as Russia grows richer it is using more electricity, and demand for gas is rising.

The impact of this factor is two-fold. Not only does it create more favourable conditions and incentives to make more from natural gas assets, but also the potential lack of electricity is prompting the oil industry to think about its own power needs.

“In the oil fields where the associated gas is produced, there is the risk that regional power suppliers won’t produce enough power,” Balaschak says. “So now all the big Russian oil companies are looking at this. I see two things happening. Either they can collect the gas and build the infrastructure to take it to market. Or they can use it for self-consumption, so some of the oil companies are taking their associated gas, putting in gas turbines, and producing their own electricity.”

Balaschak also points to the impact of the deregulation of the power generation sector as a definite driver in this space. “The process of unbundling the sector will create a competitive market for power by the end of 2008, so you’ll have private companies generating and selling power. It’s going to create competition and incentives for operating efficiency, as well as creating greater transparency and allow access to capital markets.”

Business case

Gas and oil production tends to be in remote and unpopulated locations, and this is certainly true of the some of much of Russia’s activities in Siberia. We ask whether the remote, hostile environments of the Russian sector have slowed down the utilization of associated gas?

“I don’t think this is a huge issue, as the infrastructure is already in place,” Balaschak answers. “It is more or less parallel with the infrastructure for oil collection, so I don’t think this is a problem.” He argues instead that the new focus on associated gas is simply a step along the way in the evolution of the Russian industry.

“I think as far as associated gas goes, it is just one of those things that the industry is getting round to doing. You’ve now got these private companies, rather than government owned, and they’re in the business to make money. They’ve been busy with lots of other things, but they see this waste and they can actually put together a business case to improve their operations – either sell it or produce power.”

This is the key for Balaschak. Although the marginal profits on better use of associated gas are small, they definitely exist, and so the industry is building the business case to improve profitability. “In some cases the companies are at point one, where they’re asking how much associated gas they have,” he explains. “If they can gather the data they can take a more granular approach at the field-level about what they should do.”

The recent past has been a good time for the Russian oil and gas sector. Production has been increasing year on year, and the high oil price has meant the sector has been taking full advantage. This has led to the opportunity for capital expenditure on infrastructure investment, and Balaschak agrees that this has definitely been a factor in the increased focus on the associated gas sector.

“The industry is taking the opportunity to invest and drive efficiencies when it has the money rather than when it doesn’t. and it should,” he says. The impact of this investment is certainly being seen in the area of associated gas. It all makes sense really. More efficient operations mean higher profits, and this is a low-hanging fruit that the industry has set its sights on picking.