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CNBC Transcript: Interview with Alexander Novak, Minister of Energy of the Russian Federation

Following are excerpts from the transcript of a CNBC interview by Geoff Cutmore with Alexander Novak, Minister of Energy of the Russian Federation

Geoff Cutmore: So minister I want to start about the recent meeting with OPEC and what ultimately your aim is when it comes to reopening dialogue with OPEC and the Saudi government.

Alexander Novak: Really it is a few years now since we renewed the energy dialogue with our colleagues, OPEC countries. These are regular meetings a few times a year.

Nowadays these meetings are of a special importance and significance, in particular over the past year because of we saw a serious decrease in oil prices, so we consult each other more, get advice, exchange information, market data and statistics, as well as production and demand forecasts for both the short-term and mid-term.

We also talk about new technologies used in the world, and about those prospects in store for the oil- and-gas industry from the point of view of its development. In the near future there will be expert consultations in which we shall examine issues relating to the condition of the market today. These issues, of course, worry all of us because it impacts oil producing economies as well as the growth rate of the global economy. It is a special concern for the sensitive economies that are reliant on oil revenues.

Geoff Cutmore: And I just want to be very clear, I think I may have misspoken when I said you had meetings with OPEC. There was some apparent differences in the ministry about whether there is going to be a meeting with OPEC, as a group, beyond just the meeting with the Saudi government, can you just clarify for us whether you will be meeting OPEC as a group?

Alexander Novak: Indeed consultations of various formats take place, including bilateral and multilateral formats. This year I have met my Saudi counterpart, Mr Al-Naimi three times. In May we had consultations within the framework of OPEC, and Russia was invited. Now we are going to have a similar exercise in October that will bring together OPEC and non-OPEC countries, member states and observers, those who have leading roles and are exporters of oil in the markets, so this is quite a well-established format.

Geoff Cutmore: And can I just ask you - will you be discussing price and output in these discussions?

Alexander Novak: Doubtless we speak a lot about the current market situation and the prices and about our projections, but we also talk about output supply and demand. These discussions that have been going on for almost a year now. We also communicate with our colleagues in a bilateral format - I meet with my counterparts from Venezuela, Ecuador and Algeria. During these meetings we mainly talk about probable output, about forecasts of global demand and in separate regions, for example in Asio-Pacific region etc.

I would like to add that I do not want to conceal, that some of the OPEC Members have proposed an initiative to reach greater coordination in terms of adjusting output to balance supply and demand that is in dis-balance now. These issues are, of course, discussed but at the moment there are different points of view. As far as the Russian federation is concerned we don't think adjustment is an efficient means, because it is purely a short term measure, and in the future it will result in a greater misbalance of the oil market.

Today we have low prices, which are market driven and they correct a company's capital expenditure, reducing investment in extraction, particularly for expensive projects, where oil is hard to extract, when oil is highly sticky, deep water oil or shale oil. This is a market measures, market measures of balancing that will produce a more long term and efficient method of balancing demand in the market.

In 2014 we saw huge disequilibrium in the supply and demand ratio, demand was ahead of supply by 1.5 million barrels per day, but things have started to change and in the third quarter this year the output has become lower by some 300,000 barrels a day and by late 2016, as we believe, the situation will become normal and finally the market will be balanced, something that is basically necessary in order to have stable prices and sufficient investment for the oil and gas industry will, once again, become possible.

Geoff Cutmore: The EIA is suggesting there will be a glut running well into 2016, does it not concern you that the oil price having come up to nearly $50/barrel, if the EAI (sic) analysis is correct they're probably going back down now, to levels which will not be comfortable for Russian producers.

Alexander Novak: Estimates are all different. Nevertheless the majority of experts agree that the adjustment will continue into 2016, that the growth of demand will outperform the growth of output. Of course much will depend on the growth rates of the global economy, especially in South East Asia and China in particular. Nevertheless we and our colleagues agree that in the 2nd half of 2016 a balance will be achieved, that prices well be balanced.

The current price reflects reflects the distortion in the supply and demand equilibrium. No doubt for Russian companies, the reduction in prices results in lower foreign exchange revenues, but still we have such a competitive advantage because of our flexible exchange rate of the Rouble in respect to the dollar.

If we consider rouble denominated revenues of our companies, they have been maintained flat thanks to the flexible exchange rate, something that enabled our companies to preserve their potential for investment that was made in the oil and gas industry both last year and this year as well.

On the whole that has softened the situation a bit and our companies adjusted to a reduction in prices. Also lots will depend, first on internal economic policy, steps like taxation and other initiatives, more or less though I can say our companies have quite stable operations given the conditions of lower prices.

Let me just add according to results seen this year we expect Russia's oil output will be preserved, will be flat or even slightly higher - approximately by 100,000 barrels per day higher than last year.

Rouble denominated revenues of our corporates will remain the same or be even be a bit higher than 2014. This means that we shall preserve our potential - the point is that we don't wish to step up our production - we do not strive to increase it. It is important for us to ensure the same levels that we have had over the past several years.

Geoff Cutmore: Minister your production levels are already at post-Soviet highs - some analysts looking at that number say that either you need to maintain production to support government revenues or you are engaged in maintaining production because it is inflicting a lot of pain on American shale producers, is there truth in either of those statements?

Alexander Novak: Well first of all I would like to say that the gas and oil industry is one of the most important industries in Russia.

A lot of people work in the sector directly and the industry is a customer for a large number of companies that that supply products and services to the oil and gas sector. Of course our strategy, despite the depletion of our old fields, is to make a point of developing new ones, which is much more difficult. That is why new technologies are used, labour effectiveness is increasing, enabling us to develop our industry and enhance productivity. With respect to Russia's export influence on global markets in the past years, we have maintained our output rate pretty much unchanged over the past 3-4 years, but we have witnessed a lot of inflow, of a lot shale oil from the United States.

The US alone has been responsible for an additional five million barrels a day, which is a large amount and the market hasn't been able to process this huge quantity of oil.

In my view, therefore, there are two factors that influenced overproduction: very high rates of growth in shale oil extraction and an increase in production by OPEC countries that over the past year have increased production by 1 million barrels a day - that's a huge number for a market that normally grows, on average, by 1 million barrels a day per annum.

So it's the shale plus the overall over supply that has resulted in the drop in the oil price and a drop in CAPEX in the most expensive projects. As I have previously mentioned, it is the shale oil, deep sea oil and other hard to explore deposits, we believe all these developments are entirely market driven and as of today these things are defining the market price.

Geoff Cutmore: So do you want to drive those American shale producers out of business?

Alexander Novak: Definitely no one has such goals because it is all market competition, and in fact, there are a lot of countries in the world extracting and exporting oil - countries that used to import oil now have domestic production, so buy less from the market.

I want to stress again that Russia does not exert pressure on the market with any additional supply on its part. On the contrary, it's supplied by others and the normal growth rates of international oil markets is 1 million barrels a day per annum, but the supply growth that I have previously mentioned is well in excess of that. This additional increase is not produced by Russia, but by other countries. We aim at maintaining at our rate and our share and remaining competitive in tough conditions.

It all depends on competition and the economics of projects, like for example, the US has some very expensive projects and given the low prices now no investments will go into their fields and other countries that have costly extractions as well. It is a normal market situation. The biggest companies will survive, increase their labour productivity, increase their effectiveness - these are the defining factors that influence investment policy in this environment of competition.

Geoff Cutmore: The finance minister would like to increase taxes on the energy producers. If that happens into 2016 does that mean we will see a cut in Russian production?

Alexander Novak: Any change in taxation, no doubt from the point of view of short-term investments, affects the industry negatively.

The current proposals made by the Ministry of Finance are considerably softer than the initial ones, it now sees additional revenues of 150 billion roubles in 2016. But in order to evaluate the consequences we, with our companies, exchanged information, sought advice. No doubt this will still reduce CAPEX, reduce the level of drilling by a small volume, and we estimate it will have an impact on production at the end of 2016 and the beginning of 2017. We expect 5 million tonnes less, which is around 100,000 barrels a day, a slight decrease. No doubt much will depend on the investment policy of the companies and on their ability to optimise costs appropriately to enhance their efficiency and productivity. But it is impossible to guess right now because only when the investment plans by corporates have board approval and corrections are made to investment programmes, only then can we talk about concrete figures. But on the whole, no doubt, any deduction of cash flow means less investment and that will somehow impact the sector's development.

Geoff Cutmore: I Just want to understand how you see the strategic supply of energy to the west currently. In recent weeks it seems there has been a shift to the Nord stream two pipeline as opposed to running through the south and going via Turkey. Is that a policy from the ministry now? Perhaps not to go through Turkey, to play down and to not focus on that route and to focus on the Nord stream two route to Germany and other western countries? Is this a shift about in the way you think about how you are going to supply the West as things are settling down with the Ukraine?

Alexander Novak: As a matter of fact the Nord Stream 2 was considered long ago by investors, when the Nordstream 1 construction was still in progress. Even then investors were considering the issue of the possibility of the setup of the 3d and 4th thread of it, of the Nord Stream pipelines, which would provide additional volumes for consumers in Germany and in other countries, in France and central Europe.

According to all estimates and we see it - there has been a decline in European production, proprietary production in places like Norway and the United Kingdom. So some additional volumes for this part of Europe will be necessary and despite the fact that today we are seeing a lot of renewables, the advent of renewables, they will not be able to substitute natural gas completely.

The gas consumption growth rate will still grow. The additional volume from Nord Stream 2 will cover the needs and energy safety of Europe in the future. It is in no way connected to the routes of gas supply to the South-Eastern part of Europe, which has a path across Turkey, or what is dubbed the Turkish Stream.

It is supposed to have two branches with aggregate capacity of 31.5 bn cubic meters per-annum. One of the branches will be for domestic Turkish consumption, the other will serve consumers in South-East Europe. These are two completely unrelated projects and they are aimed at the diversifying routes to Europe and ensure reliable and sustainable supplies.

And I would like to draw your attention to one additional fact, the point is that the Nord stream 2 was a project implemented by a consortium of European companies. Apart from Gazprom it includes: Shell, BASF/Wintershall, OMV,E.on and Engie. None of these companies would invest in a project if they were not certain in its economic viability. As for the Russian Federation, we are ready to take part in the market of Europe. We have long-standing relations with Europe. For many decades Russia was a reliable supplier of energy resources.

In spite of the current policy directed at the diversification of gas supplies to Europe, Russia is ready to compete and supply its gas. Russia is a rich in gas and resources, it is our competitive advantage, and we are ready to compete with others on market terms and in-line with EU legislation. Now big, trans-border infrastructure projects are being implemented for this reason, setting the ground work for the future supplies as was the case back in the 50s and 60s when a different oil and gas infrastructure was being built.

Geoff Cutmore: And just let me finish by asking you what is your working assumption for the headline oil price over the next 12-18 months, in dollar terms.

Alexander Novak: Well as I have said on many occasions the price will not be high, and in figure terms I believe it is going to fluctuate around 50, 55 and 60 dollar a barrels with short term fluctuations, ups and downs, but anyway 55-60 will be the benchmark price over the, or the headline price over the upcoming 12-18 months and I presume we have seen evidence of an era of low oil prices as new factors have come into play such as new technology and greater production capability so in the future we will see low oil prices and we need to adjust ourselves to that and learn to live in this new context.


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