Energy Sector: Putting all eggs in one basket

Aliaksandr Autushka-Sikorski

Summary

The terms of supplies of Russian energy resources remain highly favorable, which, on the one hand, enhances the dependence on Russia for energy deliveries and, on the other hand, enables Belarus to put off reforms of its energy sector. As against the year 2012, in 2013, revenue generated by the country’s oil-processing sector dropped. However, the low price of Russian crude oil supplies still helps the Belarusian oil refineries stay highly profitable. For Belarus, natural gas prices remain almost three times as low as the fees that Russia charges European consumers; however, because of the fee differentiation scheme applied in Belarus, for some categories of domestic consumers, electricity rates are at least four times as high as those European.

The practice of cross-subsidy remains in place and keeps putting pressure on the cost of domestically-made products. The high electricity cost component in the production costs of Belarusian goods reduces their competitiveness notwithstanding low crude oil and natural gas rates.

Trends:

Oil sector: lower output and higher dependence

Vagueness about the agreements on Russian oil supplies remained throughout 2013, as the Russian side changed to quarterly supplies quotas. The move was caused by the much criticized ‘solvent/diluent’ trade scheme concocted by the Belarusian side back in 2012.1 Russia was mostly irritated by the fact that the ‘solvent/diluent’ trade scheme was formally legal and became possible because of the legislative gaps within the Customs Union that were skillfully used by the Belarusian side, which significantly increased the share of questionable oil export.

Furthermore, in 2013, Belarus was supposed to supply agreed amounts of oil products back to the Russian market in order to guarantee the import of crude oil. To make sure that Belarus met its obligations, Moscow changed to a more flexible ‘oil leash,’ which enables it to control the amounts of oil products delivered back to Russia and stop Belarus from looking for new schemes of generating super profits.

The ‘solvent/diluent’ business, which stripped Russia of USD1.5 billion to USD2 billion of budget revenues, was legally stopped in April 2013 by resolution No. 99 of the Eurasian Economic Commission (EEC) and de facto shut down in the third quarter of 2013. The EEC decided back then that compound organic solvents and diluents should be shifted to commodity heading 2710 of the foreign trade classification of commodities, making their oil products subject to payment of export duties by the Belarusian side. In 2013, Belarus cut export deliveries of its diluents compared with the 2012 level and got back to the volumes recorded in previous years.

In 2013, Belarus imported 21 million tons of Russian crude oil – 5.75 million tons in the first, second and third quarters each and 3.75 million tons in the fourth quarter of the year. Total import decreased by 3.4% year-on-year. The reduction in supplies in the fourth quarter was a result of the arrest of Uralkali CEO Vladislav Baumgertner (in the wake of the so-called ‘potash conflict’), which enraged Moscow. Formally, the main reason behind the drop in deliveries was the repair of a section of the Druzhba pipeline. Another reason why oil supplies were curtailed was Belarus’ default of its obligations under the agreement on supplies of oil products to the Russian market. Belarus had delivered half the agreed amount.

In January-November, Belarus exported 1.48 million tons of crude oil at an average rate of USD766 per ton (down by 1.8% and 2.4%, respectively), whereas oil product supplies amounted to 12.4 million tons at USD751 per ton (down by 23.5% and 10%, respectively). Crude export totaled USD1.13 billion in value terms, and oil product export reached USD9.436 billion.

In 2013, the Mozyr NPZ oil refinery processed 11.08 million tons of crude oil, down by 0.1% from the 2012 level. Gasoline and diesel fuel output went down by 3.4% and 2.4% year-on-year, respectively. The lower output was caused by the routine maintenance at the refinery and suspension of some of the processing facilities. Furthermore, in September, the company approved modernization plans, envisaging the installation of a high-octane gasoline-making unit and a black oil hydrocracking facility, which is projected to bring the crude conversion rate at the refinery up to 90% from 72% currently. The modernization program will cost USD1.4 billion, of them USD350 million will be financed from a loan committed by Sberbank of Russia. Because all of the Mozyr NPZ facilities needed to be suspended at least for some time due to the repairs carried out from October 2012 to October 2013, Belarus began accumulating oil products in storage facilities to ensure uninterrupted supplies in summer and winter, when demand for gasoline traditionally increases. An additional motive for the country to accumulate gasoline instead of exporting it was the expected decrease in crude oil import in the fourth quarter of 2013, after Russia announced that the Druzhba oil-main required repairs, as well as the breakdown of the catalytic cracking unit at the beginning of August.

At the insistence of the Russian side, Belarus virtually stopped exporting biodiesel fuel to Ukraine. The policy of accumulation of oil products in storage facilities resulted in a situation when Belarusian gasoline almost completely disappeared from the Russian market at the end of the third quarter. As for the long-term contracts for fuel supplies to Ukraine, Belarus repeatedly breached them throughout the year. In 2013, Belarus cut supplies to Ukraine by 32.4% year-on-year in volume terms and 40% in value terms.

Belarus will hardly be able to make up for the shrinking share of its oil products in the Ukrainian market in the next few years, the main reason being the anticipated launch of the Lisichansk refinery, scheduled for the spring or summer of 2014.2 It is planned that the Lisichansk refinery will produce Euro-4- and Euro-5-compatible fuels and process up to 8 million tons of crude oil annually. The high capacity of the Lisichansk refinery and the extensive logistical network of its owner – Russian oil major Rosneft – will enable the producer to deliver its products even to Western Ukraine (the refinery is situated in the Luhansk Region in the east of the country). Further, the Odessa oil refinery with a capacity of 2.8 million tons a year was put into operation after a pause in 2013.

By the middle of 2014, the competition in the Ukrainian market for oil products will have increased, which is expected to bring about a decrease in prices and make Ukraine a less attractive market for Belarus. Belarusian traders will likely redirect their supplies to the European market in 2014.

Despite the reduction in production volumes, crude oil processing and Belarusian refineries’ revenues from sales of oil products remain very high because of the preferential terms of trade in crude oil with Russia. In 2013, Belarus imported crude oil at an average price of USD 380 per ton, less than half the price of Russian crude at the German border. If it had been paying European prices, Belarus would have had to cough up an additional USD 9.5 billion.

In December 2013, the Belarusian government sent the leadership of Russia’s Rosneft a proposal to consider acquiring the state shareholding in Mozyr NPZ (42.67%) and OOO MNPZ Plus, which holds 12.25% in the refinery. Rosneft already holds a stake in the Belarusian refinery via its shareholding in Slavneft. In addition to paying the book value of shares totaling USD 518 million, the investor is supposed to increase the capacity of the refinery to 20 million tons. Although Rosneft was interested in the offer, it will probably take very long for Belarus to sell the refinery: the company is highly profitable, and the Belarusian administration will want additional ‘bonuses’ from the buyer.

In 2014, the terms of trade in crude oil became even more favorable for Belarus: at the end of 2013, the two countries signed a six-month supplies quota, which envisages supplies of 11.5 million tons of crude oil to Belarus during the first six months of the year, corresponding to Belarus’ original request to have 23 million tons of oil this year. However, the amount of oil deliveries directly depends on the successful implementation of the ‘five integration projects’ in which Russia is most interests: the creation of a holding between MAZ and KAMAZ, privatization of Minsk Wheeled Tractor Plant (MZKT) by Russian companies of the military industrial sector, a joint project between OAO Gazprom and OAO Grodno Azot, and mergers between OAO Peleng and the Roscosmos corporation, and between OAO Integral and the Roselectronika holding.

Gas sector: recession helps

Once Belarus and Russia signed the treaty to create the Common Economic Space (CES) and the agreement to sell OAO Beltransgaz to OAO Gazprom, the natural gas fees for Belarus dropped because Russia had stopped applying the European price calculation formula. In 2012, Russia reduced its natural gas price for Belarus from USD265 per 1,000 cubic meters to an annual average of USD165.6. In 2013, the average gas price remained virtually unchanged at USD160.5 per 1,000 cubic meters.

According to the materials prepared for the annual general meeting of Gazprom (disseminated last June), it had been planned to increase the gas price for Belarus to USD 183.7 per 1,000 cubic meters in 2014. However, the increase was even less serious, and in 2014, Belarus is paying USD167 per 1,000 cubic meters of natural gas. The rise in fees was limited by the price embargo imposed by President Putin. In 2013, Russia suffered from a recession, and the competitiveness of Russian products was undermined because of hikes in energy rates, which brought about price rises. Therefore, prices had to be frozen for domestic consumers: during the next five years, energy fees for domestic buyers (including in Belarus) will not be rising faster than the inflation rate.

In 2013, Belarus imported 20.3 billion cubic meters of natural gas, the same as in 2012. Therefore, the preferential gas price saved Belarus USD4.89 billion last year, considering that European consumers pay USD 400.59 per 1,000 cubic meters (natural gas price at the German border).

In 2012, the average gas price for corporate consumers amounted to USD 279 per 1,000 cubic meters, and in 2013, it went down by USD 4. Discounts were only offered to the enterprises subordinate to the Energy Ministry (USD 216 per 1,000 cubic meters) and OAO Grodno Azot (USD 218). The price did not change for Grodno Azot, whereas enterprises under the Energy Ministry enjoyed a USD 29 discount compared to the 2012 level.

Starting 1 January 2014, the average gas price for industrial consumers went down by USD 10 per 1,000 cubic meters, and for individual entrepreneurs and corporate entities, by USD 7.25. Gas fees will be cut by 13% from the 2013 level for producers of nitrogen fertilizers, by 7.7% for electricity companies and by 7.5% for state-financed organizations and utility enterprises.

In 2013, the average natural gas price for domestic consumers went up by USD 4 from USD 15.95 per 1,000 cubic meters to approximately USD 20 (exclusive of VAT). Gas fees rose, because since the beginning of 2013, the gas markup has been pegged to the inflation rate, which reached 21.8% in 2012.

Electricity: declarations amid price hikes

Despite preferential natural gas rates compared with European consumers, cross-subsidy that remains in place still causes major imbalances for the real economy. Electricity fees for industrial consumers are still quite high. As of 1 January 2013, the average electricity rate for manufacturing enterprises stood at USD 0.1382 per kilowatt-hours, which compares to USD 0.0353 paid by households. In 2013, electricity rates for companies increased by 0.72%, and for households, by 38.9%.

However, Belarus still enjoys quite low electricity rates compared with Europe. In the first half of 2012, Lithuanian industrial consumers and households paid USD 0.1512 per kilowatt-hour and USD 0.1635, respectively, Latvian companies and households paid USD 0.123 and USD 0.1802, and Polish consumers paid USD 0.1004 and USD 0.184, respectively. Bulgaria charged households the least of all EU member states – USD 0.1098 per kilowatt-hours – which was still almost three times as high as Belarusian households had to pay. High electricity rates result in higher costs of Belarusian products, thus affecting their competitiveness. According to the Economy Ministry, the price distortions cost the real economy more than USD1 billion annually.

The government has been making plans to phase down cross-subsidy for a few years now. In 2011, the Energy Ministry announced plans to do away with cross-subsidy within four years, i. e. by 2015. A necessary condition for the administration to increase electricity rates was the average wage to increase to USD 1,000 by 2015. However, following the depreciation of the Belarusian ruble in 2011, the likelihood of such a move decreased.

In 2013, when problems with sales of Belarusian products peaked, the authorities began discussing ways to eliminate cross-subsidy. Further, an agreement was reached in the framework of the CES on the elimination of exemptions starting 2015. First Deputy Prime Minister Uladzimir Siamaška and Deputy Prime Minister Piotr Prakapovič said that cross-subsidy would be phased down in two stages: in April 2014, electricity subsidies would be abolished, whereas in 2015, heating subsidies would be cancelled. The government must be thinking that splitting the move into two phases will reduce the burden on the balance of payments. The Economy Ministry believes the elimination of cross-subsidy will require up to USD 3.5 billion (on condition that the gold and foreign exchange reserves remain unchanged). It is planned to raise this money by way of placing state bonds in the foreign and domestic markets.

At the same time, the elimination of exemptions in trade within the CES will formally enable major consumers to buy both electricity and natural gas from Russia at Russia’s domestic prices. In 2012, Russian corporate consumers paid USD 97.8 per 1,000 cubic meters of natural gas and USD 0.068 per kilowatt-hour of electricity.

In November 2013, the president signed decree No. 499 On the construction of the Belarusian nuclear power plant thus giving the green light to the construction process. The document was signed as soon as the foundation and requisite infrastructure for the construction of the plant had been completed. Russia’s ZAO Atomstroyexport is the main contractor. The plant’s two units, to be launched in 2018 and 2020, will have a combined capacity of 2.4 megawatts.

In 2013, spending on the infrastructure of the nuclear power plant amounted to USD 120million, and in 2014, it is planned to double. The plant is expected to account for up to 40% of the country’s power balance at peak loads.

Although the construction of the nuclear power plant will reduce the dependence of the Belarusian energy sector on natural gas supplies, the plant will not help Belarus get away from the sole fuel supplier. Under the agreement with the Russian side, Belarus not only takes the USD10 billion loan from Russia, but also undertakes to buy uranium oxide from Russia. Further, if Belarus chooses to collaborate with alternative suppliers, it will have to take into account the design peculiarities of the plant for the production of uranium rods or cassettes. However, in this case Belarus becomes less susceptible to the ‘political’ component of the fuel price, the more so because uranium oxide prices, having reached their new 30-year high in 2007, are currently quite low.

Conclusion

In 2013, the petroleum ‘super profits’ generated by the Belarusian oil sector were slashed because of the elimination of the ‘solvent/diluent’ scheme. Nevertheless, oil processing still contributes enormously to budget revenues both in nominal terms and as percent of GDP.

The change to the quarterly crude oil delivery quotas and payments is a perfect example of Belarus’ heavy dependence on the stability of cheap oil supplies from Russia. At the same time, geopolitical loyalty is not the only condition for these supplies to remain stable. In 2013, Russia pegged its crude oil deliveries to Belarus to specific amounts of refined oil to be delivered back to the Russian market (3.1 million tons) and tightened control over the fulfillment of this obligation. In addition, Russia made the stability of oil supplies in the second half of the year conditional on progress in the implementation of ‘five integration projects.’ Therefore, Moscow increased the efficiency of the oil leverage without having to get involved in open conflicts, as Belarus has no chance to diversify its sources of energy import.

Although the anticipated elimination of cross-subsidy will facilitate the operation of Belarusian manufacturers, the ‘window of opportunity’ seems to be closed. On the one hand, Belarus needs to boost its competitiveness by cutting production costs; on the other hand, the elimination of cross-subsidy will require financing, which under the circumstances will most likely be taken from both external and internal borrowing, a policy that will increase the burden on the balance of payments in the medium term.