bmi emerging europe oil and gas insight march 2016

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CONTENTS

Emerging EuropeOil and Gas

BMI’s monthly market intelligence, trend analysis and forecasts for the oil and gas industry across Emerging Europe

March 2016 Issue 118

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www.oilandgasinsight.com

ISSN: 1750-7723

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Europe ............................................................................................1Even More Bearish On Central Asian Oil Exporters .................................................. 1

CEE Risks/Rewards: Worsening Upstream, Minor Refining Gains .............................. 3

CEE: Gas Over Oil, But Demand Growth Weak ........................................................ 6

Turkey ............................................................................................8Gas Discoveries Highlight Strong Prospectivity ........................................................ 8

Russia ............................................................................................9Oil Production Peaked In 2015 .............................................................................. 9

EUROPE

Even More Bearish On Central Asian Oil ExportersBMI View: In light of the extreme oil price weakness into 2016, the macroeconomic and social stability outlook for Kazakhstan and Azer-baijan – the biggest oil exporters in Central Asia – has deteriorated even further, prompting us to adopt an even more bearish outlook on both. Nevertheless, the possibility of economic and/or banking sector collapse in either remains limited due to the strong sovereign risk profile in both countries.

The macroeconomic and the social stability outlook of the two main oil exporters in the Commonwealth of Independent States (CIS) region – Azerbaijan and Kazakhstan – have significantly deteriorated in light of the sizeable plunge in global oil prices in the beginning of 2016. Both countries are heavily dependent on oil, which accounts for 95% of goods exports, 75% of budget revenues and 40% of GDP in Azerbaijan, and for 80% of exports and more than half of public sector revenues in Kazakhstan. Following signs in early January 2016 of further slowdown in Chinese economic growth, Brent crude prices have declined to below USD30/bbl at the time of writing, their lowest level in 13 years. This has prompted us to aggressively cut our oil price outlook (we now forecast Brent crude to av-erage USD42.5/bbl in 2016, from USD51/bbl previously). The extremely weak outlook for oil prices, especially in H116, will further compound the already elevated fiscal constraints for the two oil exporters, boding poorly for the economic landscape in the coming months.

In light of our oil price forecast changes, we now expect the Azeri manat to average AZN1.7/USD in both 2016 and 2017, from AZN1.5 previously. Likewise, we forecast more pronounced weakness for the Kazakh tenge, and we expect it to average KZT347/USD in 2016 from

Depreciatory Pressure EscalatingExchange Rates, KZT/USD (LHS) & AZN/USD (RHS)

Source: Bloomberg

2 www.oilandgasinsight.com

Emerging Europe Oil & GasEuropE

KZT332/USD previously. As a result, we have downgraded our forecast for real GDP growth for Azerbaijan to a contraction of 0.3% in 2016 from 1.4% previously, and for Kazakhstan to 1.0% from 1.6% previously.

FX Adjustment Can't Preserve Fiscal BuffersWhile both Azerbaijan and Kazakhstan have made significant fis-cal and external adjustments throughout 2015 to the new reality of lower oil prices, the policy responses have been inconsistent and/or delayed, exhausting rapidly reserves, with Azerbaijan likely to fare worse than Kazakhstan. The Azeri authorities defended the value of the manat for the majority of 2015, despite rising depre-ciatory pressure from declining oil prices, until mid-December 2015, when they shifted to a free-floating currency regime. The delayed policy response saw the country's FX reserves dip by half from USD13.8bn at the beginning of 2015 to USD6.2bn at the end, while the rainy day sovereign wealth fund (SWF) – State Oil Fund of Azerbaijan (SOFAZ) – diminished from USD37.1bn in the beginning of 2015 to USD33.6bn at the end.

In contrast, the Kazakh authorities shifted to a free-floating exchange rate regime much sooner than their Azeri counterparts – in August 2015, following a previous devaluation in February 2014 – which helped preserve fiscal buffers to a larger extent than in Azerbaijan. As a result, Kazakh FX reserves stand at USD28.1bn as of December 2015, down from just USD29bn at the beginning of 2015. However, Kazakhstan's SWF has registered sizeable declines – to USD64.2bn in December 2015, having fallen by 16% in 18 months. In light of both countries' declining SWFs, both leaderships have signalled willingness to invest fund assets

in riskier investments, in order to boost potential returns, making the outlook for the vehicles even more precarious.

Austerity Needed Despite FX adjustmentWhile being a necessary pressure valve, the FX adjustment will not be sufficient to relieve pressure on the budget. In Azerbaijan, oil trades at AZN56.7/bbl at the time of writing, significantly below the average price of AZN85.2/bbl in 2013 and AZN77.9/bbl in 2014. In Kazakh tenge terms, oil trades at KZT11106/bbl, similarly much be-low the average prices in previous years. This, alongside the reduced fiscal buffers, has ramped up budget pressure for both governments, prompting the authorities to embark on a highly conservative fiscal trajectory – in Azerbaijan's case a three-year austerity programme announced in December 2015, and in Kazakhstan in a very tight 2016 budget plan. Despite the fiscal belt-tightening, we nevertheless forecast both countries to shift into modest budget deficits in 2016, following years of registering surpluses.

Social Stability Outlook DeterioratingAusterity will compound the negative impact on households from rising imported inflation stemming from the FX adjustment. In our view, Azerbaijan is poised for a more turbulent period in the coming months than Kazakhstan. Public protests across Azerbaijan against the manat devaluation and rising inflation have already started to take place, most prominently in a series of public clashes with riot police in cities around the capital Baku in mid-January. We expect the social stability outlook to continue to deteriorate in the coming months, with the authorities likely to ramp up repressive measures, as evidenced in the deployment of military trucks in Siyazan in mid-January to suppress the riots.

FX Convertibility Restrictions Bode PoorlyFurther darkening the macroeconomic outlook in Azerbaijan has been the latest move by the authorities to ward off the escalation of depreciatory pressure on the manat by restricting FX convertibility at FX exchange offices. The Azeri banking sector runs a sizeable short open FX position due to the high level of FX-denominated deposits – at 70% as of H115 – making the sector vulnerable to rising deposit withdrawals and USD purchases in the wake of the December devaluation. As a result, while the restriction on FX convertibility will cushion the banking sector from an excessive rise in the value of its liabilities, it will have a negative impact on the economy. The capital controls will further erode business and

Fiscal Constraints Remain In PlaceBrent Crude, AZN/bbl (top) & KZT/bbl (bottom)

Source: Bloomberg

Inflation Eroding Living StandardsConsumer Price Index, % chg y-o-y

Source: Respective Statistics Agencies

3www.oilandgasinsight.com


consumer confidence, and although they are measures designed to stabilise the currency, they could potentially backfire, undermin-ing further confidence in the currency. This, in turn, could ramp up further depreciatory pressure on the unit.

Banking Sector Remains VulnerableIn Azerbaijan, the capital controls will be insufficient to cushion the negative impact on the banking sector and credit growth stemming from the manat devaluation. The debt servicing costs of FX bor-rowers have significantly risen, jeopardising their ability to service their debts, and threatening to worsen further banks' asset quality. Non-performing loans (NPLs) are already elevated at 12.7% of gross loans as of end-2014, and their share will continue to increase, rais-ing loan-loss provisioning, and tightening credit conditions. Another point of pressure will be reduced capital ratios due to the boosted value of risk-weighted assets stemming from the AZN devaluation.

The Kazakh banking sector has likewise come under pressure from the FX adjustment in terms of widening open short FX position, reduced capital ratios, and deteriorating asset quality. We believe the Kazakh banking sector is a less vulnerable position than its Azeri counterpart. While NPLs remain elevated at 9.2% of total loans as of September 2015, the level of FX-denominated loans remains much lower at a quarter of total loans, meaning the impact of rising FX debt servicing will have a smaller impact on aggregate in Kazakhstan than Azerbaijan. The level of dollarisation in Kazakhstan is smaller, with USD deposits at 52% of total, in contrast to Azerbaijan at 70%. This means that the imposition of restrictions on FX convertibility is less likely in Kazakhstan; however, we do not rule such possibility.

But Sovereign Profiles Remain SolidWhile the economic outlook for both countries has significantly deteriorated, and while the banking sectors in both are poised for a period of losses and contracting loan growth, we reiterate that the possibility of a banking sector crisis and or economic collapse remains limited. The main reason is that both sovereigns remain in a strong position to extend aid to their respective banking sectors, if needed. Net sovereign external debt (defined as gross government external debt less FX reserves and other debt claims on foreigners) stands at -60.3% of GDP in Azerbaijan, and at -38.1% in Kazakh-stan as of end-2014, making them the biggest net creditors relative to GDP in the region ('-' indicates the government is a net external creditor). The banking sectors in both remain relatively small, with total assets at 54% in Kazakhstan, and 41% in Azerbaijan. In the case that banks fail to meet the minimum prudential capital adequacy ratios, we expect the governments to extend a form of regulatory forbearance similar to Russia, following the sharp devaluation of the rouble at end-2014. In the case of liquidity squeeze, we expect the central bank to continue extending currency swap arrangements, especially to bolster local currency liquidity.

CEE Risks/Rewards: Worsening Upstream, Minor Refining GainsBMI View: The CEE region ranks as the least favourable oil and gas investment region in our index, limited by heavy state influence, poor infrastructure and a weak demand outlook. East of Caspian countries with high resource and production volumes dominate the upstream index despite Kazakhstan's downgrading this quarter, while fuels demand profiles in Turkey and Czech Republic support a top downstream score.

Key themes that emerge from BMI's Oil & Gas Risk/Reward Index (RRI) for the Central and Eastern Europe (CEE) region include:

• The CEE region continues to underperform globally, remain-ing below Africa in Q216 in our regional Oil & Gas RRI.

• Overall there has been a fall in the CEE upstream score that has been partially offset by a marginal rise in the downstream score. Compared to last quarter, the average Upstream RRI score for the region fell to 43.2 from 43.6, but the Down-stream increased from 38.4 to 38.6. These two have offset each other to maintain the regional average at the same level as last quarter.

• The worsening of the upstream score is reflective of the low oil price environment dampening E&P prospects.

• Low oil prices have bolstered the oil demand growth projec-tions, albeit mildly, for CEE consumers such as Hungary, Czech Republic and Bulgaria. This is reflected in the higher Downstream RRI score this quarter, with the regional aver-age rising from 38.4 to 38.6.

• The oil and gas consumption boost however should not

Poland Alone As Standout MarketCEE Countries Plotted By Upstream Risk/Reward Score

Note: Higher score = lower risk. Source: BMI

CEE: HIGH RISK, LOW REWARD Upstream RRI Downstream RRI Overall RRI

Developed States 49.8 51.4 50.6

Middle East 55.6 41.0 48.3

Asia 47.4 48.2 47.8

Latin America 46.1 42.0 44.0

Africa 48.1 35.5 41.8

CEE 43.2 38.6 40.9

Note: Scores out of 100. Higher scores = lower risks. Source: BMI



detract from the fact that the downstream sector in CEE countries is the second worst performing globally, with ageing and inefficient facilities, fuel subsidies and currency depreciation weighing on the score.

• Upstream developments remain polarised, with resource-rich Russia and the Caspian countries maintaining or increas-ing output over the next 10 years, and Eastern European countries becoming more dependent on imports.

• Poland remains top of our RRI, supported by conventional gas production growth and a positive fuels demand outlook.

• Kazakhstan remains in second place despite a reduction in its overall score. The fall is mainly due to a weaker upstream outlook as the expected output from the Kashagan field was downgraded in our forecasts.

• Hungary's overall score received a boost with an upgrading of the downstream index. This is primarily thanks to a strong demand outlook for refined fuels in our forecast period.

• Russia continues to underperform falling down to fifth posi-

tion. The fall is due to a poor upstream outlook, with weak growth prospects in both oil and gas production despite rich reserves. Ukraine, Croatia and Bulgaria remain bottom of our index, held back by poor infrastructure, high levels of corruption and a weak economic outlook.

Upstream: China Still The Target MarketThe Caspian countries largely perform well in our Upstream RRI due to strong below-ground potential and a positive production growth trajectory. Kazakhstan remains at the top of our upstream regional table due to its large oil and gas reserves and its relatively immature state of development. Azerbaijan is placed third due to its strong gas production outlook with gas sales to Turkey and Europe increasing from 2019. Turkmenistan, Uzbekistan and Kazakhstan have all im-proved their upstream score due to a ramp-up of gas exports to China.

Despite the strong reward scores, risks still remain high due to poor above-ground environments. Uzbekistan, Turkmenistan and Kazakhstan rank alongside Russia and Ukraine in terms of risk. High levels of state intervention, restrictive licensing and limited export outlets are some of the issues holding back more substantial upstream progress in the region. This has failed to deter state-led Chinese investment, though with growing dependency on energy from the region, especially from Turkmenistan, we expect Chinese investment in these countries to slow over the coming years.

Poland is the only country within the low risk/high reward window. The country is having success with conventional gas de-velopments and is forecast to see steady production growth over the coming years. Poland's low risk profile is its main advantage here, with comparatively low levels of state influence, good infrastructure and a stable long-term policy outlook.

Countries with a similar low risk profile and upside to production could also improve their score over the coming quarters and join Poland. In particular we highlight Romania, where a final investment decision on the Domino gas development would significantly im-prove the upstream production outlook. We also highlight Albania, where Shell and Petromanas are progressing onshore oil develop-

CEE UPSTREAM, DOWNSTREAM AND OVERALL RISK/REWARD INDEX Upstream R/R Index Downstream R/R Index Oil & Gas R/R Index Rank

Poland 52.2 47.3 49.8 1

Kazakhstan 62.6 34.8 48.7 2

Turkmenistan 50.7 40.3 45.5 3

Turkey 39.4 51.2 45.3 4

Russia 46.7 42.6 44.7 5

Czech Republic 37.6 47.8 42.7 6

Romania 44.3 40.9 42.6 7

Azerbaijan 53.1 28.5 40.8 8

Hungary 34.0 45.9 40.0 19

Slovakia 40.1 36.6 38.3 10

Albania 40.5 34.1 37.3 11

Uzbekistan 37.9 35.2 36.6 12

Slovenia 34.3 37.8 36.0 13

Ukraine 38.4 33.2 35.8 14

Croatia 39.3 32.2 35.8 15

Bulgaria 40.4 29.5 34.9 16

Average 43.2 38.6 40.9 -


Sanctions To Bite By 2020CIS States – Oil Production (000b/d)

f = BMI forecast. Source: National sources, BMI



ments in Blocks 2 and 3, with plans to spud the Shpirag-3 well in Q216, potentially boosting output in the coming years. Exploration in the Bulgarian Black Sea over the coming quarters could also boost the longer-term outlook.

Russia continues to underperform, given that its holds the larg-est hydrocarbon reserves in the world. Heavy state influence in the upstream is a key weakness for Russia's struggling upstream position. Lower oil prices are weighing on government revenues, driving changes to tax policy, in turn weakening company revenues and investment strength. EU and US sanctions restricting access to finance and oil technologies are also limiting medium-term growth potential and the country's risk/reward score.

Downstream: Turkish STAR The Bright SpotTurkey maintains its lead in our CEE Downstream RRI, though its score has fallen slightly this quarter due to a weaker fuels demand outlook. The depreciation of the lira against foreign currencies has

limited the potential boost from lower oil prices. Turkey is forecast to see the largest downstream capacity expansion in CEE, through SOCAR's 214,000b/d STAR refinery at Izmir. We forecast this to be the only newbuild refinery in Europe (excluding the Caspian and Russia) over the next five years.

Cheaper feedstock has supported ailing refineries in the CEE over much of 2015, though it will only offer temporary respite to the less efficient facilities. Growing refined fuels supply from the US, Middle East and Asia, where cheaper feedstock and economies of scale boost margins, will squeeze out less efficient refiners. Lower complexity CEE facilities will be at risk.

We note that a number of countries dominant in the upstream segment perform poorly in the downstream. Many of these ex-Soviet states have been slow to modernise their refining sectors. The state remains dominant in much of the downstream segment in Uzbeki-stan, Azerbaijan, Turkmenistan and Kazakhstan. Fuel subsidies, relatively small fuels markets and limited export infrastructure in

CEE DOWNSTREAM RISK/REWARD INDEX Downstream Industry

Rewards Downstream Coun-

try Rewards Downstream

Rewards Downstream Industry Risks

Downstream Country Risks

Downstream Risks

Downstream R/R Index

Turkey 36.7 64.2 43.6 80.0 52.6 69.0 51.2

Czech Republic 23.3 52.0 30.5 100.0 70.2 88.1 47.8

Poland 34.4 44.0 36.8 75.0 67.1 71.8 47.3

Hungary 27.8 38.0 30.3 95.0 63.1 82.3 45.9

Russia 46.7 50.0 47.5 20.0 48.1 31.2 42.6

Romania 20.0 49.0 27.3 85.0 54.7 72.9 40.9

Turkmenistan 43.3 28.0 39.5 40.0 45.7 42.3 40.3

Slovenia 16.7 34.0 21.0 85.0 64.8 76.9 37.8

Slovakia 12.2 38.0 18.7 85.0 68.5 78.4 36.6

Uzbekistan 27.8 38.0 30.3 40.0 56.2 46.5 35.2

Kazakhstan 37.8 28.0 35.3 20.0 54.2 33.7 34.8

Albania 23.3 24.0 23.5 70.0 41.7 58.7 34.1

Ukraine 24.4 30.0 25.8 60.0 36.3 50.5 33.2

Croatia 20.0 32.0 23.0 55.0 51.6 53.6 32.2

Bulgaria 12.2 34.0 17.7 60.0 52.6 57.1 29.5

Azerbaijan 24.4 28.0 25.3 20.0 60.0 36.0 28.5

Average 26.9 38.2 29.8 61.9 55.5 59.3 38.6


Turkey Tops The ListCEE Countries Plotted By Downstream Risk/Reward Scores

Note: Higher score = lower risk. Source: BMI

Huge Capacity, Weak MarketCEE Refining Capacity 2015 & 2024 (000b/d)

f = BMI forecast. Source: National sources, EIA, BMI



these countries make private investment unattractive. As a result, the Caspian countries underperform in our Downstream RRI.

CEE: Gas Over Oil, But Demand Growth WeakBMI View: Weak prices will deflate the CEE oil production out-look, while challenges with emerging market economies will hinder demand growth for both oil and gas. This dynamic will see the energy-importing Central European markets benefit, while Russia and the Caspian states will struggle. Chinese demand for natural gas will dictate the potential for growth.

To highlight the key themes that will unfold in BMI's Central and Eastern Europe (CEE) oil & gas forecasts, we have compared the region through the following key indicators:

• Oil Production• Oil Consumption• Refining Capacity• Gas Production• Gas Consumption

Oil Production: Output Growth StallingA weaker rouble has allowed Russian oil companies to maintain capital expenditure despite the fall in oil prices. This has also fo-cused investment on maximising output from existing assets and gas condensate fields, driving production growth in 2015 and cementing Russia's dominant position among CEE oil producers. However, over the 10-year forecast period from 2015-2024 we expect restricted access to technology and debt markets due to sanctions to cause oil production to dwindle from 2016.

The littoral states of the Caspian are the other main oil producers in the region; combined, they produce around 20.0% of CEE oil. Over our forecast period from 2015-2024, we only see two CEE countries increasing oil output: Kazakhstan and Turkmenistan. That said, with a high dependency on exports to China and lim-ited export options due to the geographical position, production growth will be tame.

The 270,000 barrels per day (b/d) Kashagan development in Kazakhstan will be key to supporting falling output, rather than driving substantial growth. The increase in Turkmenistan oil production will meet domestic consumption growth and enable exports to regional markets

Oil Consumption: Weak EM GrowthThe impact of weak oil prices is stunting government revenues and deflating currency values in Russia and the Caspian states. High inflation and weak economic growth will restrict disposable income and pressure fuels consumption growth among the countries with the highest potential to add new demand. Russia and the countries to the east of the Caspian remain heavily dependent on commodity exports and are increasingly reliant on China.

Some of the strongest demand growth will come from Central European countries, particularly those that have benefited from lower oil prices. We highlight Poland and Hungary, which have both seen a much improved macroeconomic outlook and are due to see stronger fuels demand growth than previously forecast. None-theless, compared to major consumers such as Russia and Turkey, new demand volumes from Central Europe will be relatively small.

We forecast an increase in oil consumption in the CEE region from 2016-2025, though average y-o-y fuels demand growth will be just 1.2% over our forecast period. This will add less than 1mn b/d of demand over the next 10 years.

CENTRAL ASIA-CHINA GAS PIPELINE EXPANSIONSOperational Date Capacity (bcm) Gas Supply

Line A 2009 15 Turkmenistan – Amu Darya

Line B 2010 15 Turkmenistan – Turkmengaz

Line C 2014 25 Turkmenistan – 10bcm; Uzbekistan – 10bcm; Kazakhstan – 5bcm

Line D 2020 30 Turkmenistan – Galkynysh

Source: CNPC

CEE Production To Struggle From 2020Major CEE Producers – Oil Production (000b/d)

f = BMI forecast. Source: National statistical agencies, EIA, BMI

EM Demand Growth Momentum SlowsCEE – Oil Consumption (000b/d)

e/f = BMI estimate/forecast. Source: National statistics agencies, EIA, BMI



Modernisation Over Capacity GrowthThe refining sector in the CEE region is generally of low complexity, particularly in the former Soviet countries. While some countries are able to benefit from domestic feedstocks, the region is less competitive with the more advanced facilities in Europe and the US, and larger, newer facilities in the Middle East and Asia. Changes in Eastern European refining centres will come as facilities either downsize capacity or modernise as they attempt to compete. Key to modernisation projects will be deeper refining of residual fuels and more flexibility in product slates. All Russian refineries will be re-quired to produce Euro-V standard fuels by mid-2016, while further improvements in Eastern Europe will improve refining efficiency.

From 2016 to 2025, we only forecast a net increase in crude oil refinery capacity in Turkey, with small additions in Russia, Kazakh-stan and Uzbekistan. Capacity growth in the latter three countries will come from expansions of existing refineries. Turkey will be one of the only countries to build a greenfield refinery in the region. The

SOCAR -led STAR refinery has secured its financing needs and is due to be operational by March 2018. The refinery is specifically targeting the domestic market for diesel, kerosene and high-end petroleum products which are currently imported into Turkey.

Gas Ramp-Up Depends On China's HungerThe CEE gas production forecast is very positive, driven by signifi-cant increases in output from Russia and the Caspian under contract with China. Combined, the CEE region is set to produce 15.4% more gas in 2024 than in 2015; Caspian countries will produce nearly 42.0% more gas.

Russia is by far the largest gas producer in the region. We expect steady growth in exports as lower gas prices pull more demand from Europe alongside increasing pipeline and LNG deliveries to China from 2020.

Turkmenistan will provide the most significant gas production growth in the CEE region, also driven by exports to China. The country is undertaking major developments at the Galkynysh and

CENTRAL & EASTERN EUROPE – OIL & GAS PRODUCTION & CONSUMPTION, REFINING CAPACITY & TRADE 2013 2014 2015f 2016f 2017f 2018f 2019f 2020f 2021f 2022f 2023f 2024f

Emerging Europe oil production, 000b/d

13,769.3 14,289.3 14,285.1 14,346.9 14,612.0 14,860.8 14,863.6 14,833.8 14,775.9 14,840.9 14,802.0 14,766.4

Emerging Europe oil production, % y-o-y

1.5 3.8 0.0 0.4 1.8 1.7 0.0 -0.2 -0.4 0.4 -0.3 -0.2

Emerging Europe oil consumption, 000b/d

6,808.4 6,763.3 6,597.1 6,594.2 6,641.7 6,734.8 6,846.9 6,967.1 7,068.9 7,167.2 7,268.0 7,364.7

Emerging Europe oil consumption, 000b/d, % y-o-y

2.6 -0.7 -2.5 0.0 0.7 1.4 1.7 1.8 1.5 1.4 1.4 1.3

Emerging Europe oil net exports, 000b/d

6,960.9 7,526.0 7,688.0 7,752.8 7,970.3 8,126.1 8,016.8 7,866.7 7,707.0 7,673.7 7,534.0 7,401.7

Emerging Europe oil net exports, 000b/d, % y-o-y

0.6 8.1 2.2 0.8 2.8 2.0 -1.3 -1.9 -2.0 -0.4 -1.8 -1.8

Emerging Europe oil refinery capacity, 000b/d

11,125.5 11,080.9 11,080.9 11,203.4 11,203.4 11,452.6 11,452.6 11,452.6 11,452.6 11,452.6 11,452.6 11,452.6

Emerging Europe oil refinery capacity, 000b/d, % y-o-y

5.3 -0.4 0.0 1.1 0.0 2.2 0.0 0.0 0.0 0.0 0.0 0.0

Emerging Europe gas production, bcm

866.8 839.8 854.5 869.6 882.9 892.2 915.7 944.1 964.1 971.8 976.2 979.6

Emerging Europe gas production, bcm, % y-o-y

1.3 -3.1 1.7 1.8 1.5 1.1 2.6 3.1 2.1 0.8 0.5 0.3

Emerging Europe gas consumption, bcm

747.0 726.8 725.4 730.7 736.3 742.7 752.0 760.8 769.0 776.8 784.5 792.4

Emerging Europe gas consumption, bcm, % y-o-y

3.1 -2.7 -0.2 0.7 0.8 0.9 1.3 1.2 1.1 1.0 1.0 1.0

Emerging Europe gas net exports, bcm

119.8 113.0 129.1 138.9 146.6 149.5 163.7 183.2 195.1 195.0 191.7 187.2

Emerging Europe gas net exports, bcm, % y-o-y

-8.7 -5.7 14.2 7.6 5.5 2.0 9.5 11.9 6.5 0.0 -1.7 -2.3

Emerging Europe LNG net exports, bcm

6.8 5.1 3.0 2.1 2.3 6.8 10.7 14.3 19.2 23.1 25.1 27.0

Emerging Europe LNG net exports, bcm, % y-o-y

72.2 -25.9 -41.0 -30.1 9.6 197.4 56.7 34.2 34.3 20.2 8.4 7.8

f = BMI forecast. Source: National sources, BMI, EIA


Emerging Europe Oil & GasTurkEy

Bagtyyarlyk fields with the aim of sending up to 65bcm of gas to China from 2020. Uzbekistan is also planning on ramping up gas exports to China, targeting delivery of 25bcm in 2016, up from 10bcm in 2014. Kazakhstan is also due to cash in on China's gas needs by increasing exports over the coming years. That said, we see risks in China's ability to accept and use such large volumes of gas over the coming five years, given weak uptake by industry and the cheaper alternative of coal.

From 2020, we note limited new opportunities for Caspian gas exports. We do not expect China to increase gas imports from these countries above the volumes already agreed, given the country's strategy of diversification to maximise supply security. Currently Turkmenistan supplies around 80.0% of Chinese pipeline gas im-ports. We expect the Caspian countries will have to develop new export routes, possibly to Europe, to continue growth.

Gas production from Azerbaijan is set for a boost with phase II of the Shah Deniz project, planned to export 16bcm of new gas to Turkey and Central Europe from 2019/20. While we see a decline in gas production in the majority of Eastern European markets, we see upside in Romania with the Domino discovery expected to signifi-cantly change the country's production profile from as soon as 2020.

Gas Consumption: Demand FaltersSimilar to the refined fuels outlook, the CEE gas consumption story remains weak given faltering economic growth in Russia (and

China) impacting economic growth in Kazakhstan, Turkmenistan and Uzbekistan. All three depend on Russia and China for the bulk of their international trade. The Caspian region holds among the best gas consumption growth potential in the region, though risks to this outlook are increasingly to the downside over the next 10 years.

Turkey will see stronger gas demand driven by the residential, industrial and power sectors. Demand in EU countries will pre-dominantly remain flat over the next 10 years as energy efficiency in the economies improves. We are expecting demand in Ukraine to fall as it attempts to limit its dependence on Russian gas supply by reducing gas consumption.

Over our 10-year outlook, we forecast gas consumption growth of 0.9%. Total demand in the region will rise by about 68bcm by 2024, though with over half of this expected in Turkmenistan, Kazakhstan and Uzbekistan, we see widening downside risks.

TURKEY

Gas Discoveries Highlight Strong ProspectivityBMI View: The positive exploration results in the Thrace Basin show good prospectivity and has led us to revise up our gas production forecast, with the potential of further gas discoveries presenting upside risk.

Valeura Energy has confirmed a natural gas discovery in its first exploration well – Bati Gurgen-1 – drilled in its Banarli licence. The Banarli licence is situated in the Thrace Basin which is Turkey's main gas-producing region. Valeura Energy already has an established presence in Turkey's north west region, with producing wells spread across its 20 onshore operated licences. This offers the possibility for lower-cost and fast-track development of new discoveries, tying into existing infrastructure.

Two wells have been drilled in the Banarli licence, both showing encouraging results. The Bati Gurgen-1 exploration well produced at 0.096 million cubic metres per day (Mcm/d), giving it the potential to add an additional 0.034 billion cubic metres (bcm) to Turkey's gas production. Bati Gurgen-1 will give a small boost to Turkey's 2016 gas production, raising it from 0.45bcm originally forecast to 0.48bcm – an increase of 6.7%. We estimate that production from the well will commence at the end of January 2016 once the tie-in

Upgrades Not New CapacityCEE Refining Capacities (000b/d)

e/f = BMI estimate/forecast. Source: National sources, EIA, BMI

China Central To Production GrowthMajor CEE Gas Production Growth Countries (bcm)

e/f = BMI estimate/forecast. Source: National sources, EIA, BMI

Limited Gas Demand GrowthCEE Natural Gas Consumption (bcm)

e/f = BMI estimate/forecast. Source: National statistics agencies, EIA, BMI


Emerging Europe Oil & GasruSSIa

pipeline to the dehydration facility at the Gurgen-1 well is completed.The Yayli-1 exploration well also encountered gas, with ad-

ditional well testing planned to complete the drilling programme, confirming pressure and additional reservoir information. Once appraisal is complete, the expectation is that the Yayli-1 well will tie into the Bati Gurgen-1 infrastructure, giving it a ready export route at a reduced cost compared to a standalone development. A successful completion of the drilling programme and subsequent tie-in will provide a further small uptick in domestic gas production.

Valeura Energy has applied for a further four licences in the Thrace Basin, as it continues to invest in the region, highlighting its prospectivity. We currently expect Turkey's natural gas reserves and production to decline throughout our forecast period, with production expected to fall from 0.48bcm in 2016 to an estimated 0.37bcm by 2025. Further gas discoveries in the Thrace Basin would help reverse this trend.

While the discoveries are small, the recent success by Valeura Energy will encourage further investment from Valeura in the region and could draw in new players. The increased interest shown by Valeura in Turkey is also a strong indication that the New Petroleum Law, passed in June 2013, has been successful in creating a more appealing regulatory environment. This is important as encouraging greater domestic gas production is a central part of Turkey's attempt to diversify its supplies and become less import-dependent.

RUSSIA

Oil Production Peaked In 2015BMI View: Russian oil production will fall from 2016, after averag-ing a post-Soviet high in 2015. Challenges to maintaining oil pro-duction at maturing assets in Western Siberia will counterbalance production from expected new oilfield developments.

Russian crude oil and condensate production averaged 10.716mn barrels per day (b/d) over 2015, according to the Russian Depart-ment of Energy. Record post-Soviet production was achieved despite lower oil prices over 2015 and pressure from US and EU sanctions on the oil sector.

A key factor behind the increase was the depreciation of the rouble against the dollar, which supported income from oil exports despite the fall in crude oil prices. As a result, capital expendi-ture into domestic developments – in rouble terms – was largely sustained over 2015.

The main beneficiaries have been the smaller domestic produc-ers. Rosneft and Lukoil, Russia's two largest oil producers, and those which have more significant international positions both saw their Russian oil production fall in 2015. Smaller domestic-focused firms, particularly Bashneft and Tatneft, experienced strong increases in oil output.

Russia Oil Production Peaking In 2015Russia – Oil, NGL & Other Liquid Production ('000b/d)

f = BMI forecast. Source: Russian Department of Energy, BMI

Smaller Domestic-Focused Companies Gain Ground

Russia – Crude & Condensate Production & y-o-y % change, 2015

Source: CDU TEK

Turkey's Gas Import DependanceNatural Gas Net Exports (bcm)

e/f = BMI estimate/ forecast. Source: BMI, EIA

Emerging Europe Oil & GasruSSIa

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The smaller companies, which predominantly operate within Russian borders, have increased production through investment into new assets in non-mature regions, such as the Timan-Pechora, Sa-mara and Orenburg areas. Both Rosneft and Lukoil have significant positions in Western Siberia, which, while being Russia's central oil production area, is suffering from natural decline.

Western Siberia is experiencing decline rates of around 3%-4% a year. Lukoil estimates production from its Western Siberian as-sets fell around 6.1% in 2015, while Rosneft saw a 3.3% fall. This indicates that US and EU sanctions are having an impact on the Russian oil sector by restricting access to the technologies required to maximise recovery rates at mature fields.

An increase in horizontal drilling has improved oil output in mature areas over 2015, though without more significant wide scale application further upside is somewhat limited (see 'Horizontal Drill-ing Poses Upside Risk To Production', November 13 2015). Lack of access to thermal, gas and chemical improved recovery technologies will see Western Siberian production continue to decline, despite the relatively low recovery of in-place oil.

We forecast natural decline rates at maturing Russian assets to have a greater impact on production over the coming years, coun-terbalancing production from major new oilfield developments to support increased exports to China. Over the 2016-2018 period, Rosneft is planning on launching some 350,000b/d of new sup-ply from projects in the Krasnoyarsk area, though we forecast oil production to fall over this time as Russian companies struggle to mitigate decline at mature fields.

bmi emerging europe oil and gas insight march 2016

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