Expert Ural No.17-18 (554) 2013
The existing levels of private and government investment in oil exploration cannot result in a rapid expansion of the resource base. Financing should be stepped up at least threefold for the industry to maintain growth levels in hydrocarbon production in the next 15 years.
The Russian government approved the state program “Replenishment and Usage of Natural Resources till 2020” a month ago. Its main objective is to replenish mineral resources and spur geological exploration. The required level of financing is set at 3 trillion RUB both from the budget (only 12% of the total amount) and from non-budgetary sources. Some 2.4 trillion RUB should be spent on exploration for hydrocarbons.
Serious investments in oil exploration are critical today (the issue of the expansion of gas reserves will be not so relevant in the next five years due to development of Yamal and Eastern Siberia): in 2010 and 2012, the government sold its last unallocated large onshore fields (the Trebs and Titov fields, the Imilorskoye field, Lodochnoye, and the Shpilman field), While no fields of comparable size have been discovered recently. The goal of the state program is to add 6 bln tons of oil reserves. Will the announced investment result in a large-scale expansion of the hydrocarbon mineral base?
There isn’t too much
According to Rosnedra, since 2005 the addition of oil reserves in Russia has exceeded annual production. In 2012, the difference was 31.5%. In total, within seven years oil and condensate reserves in Russia increased by 5.5 bln tons, versus 3.7 bln tons of production.
It is interesting that despite the positive statistics we hear almost nothing about the discovery of large fields. In the last three years, among the most significant discoveries we can mention four oil and gas fields in the Irkutsk Region, in Krasnoyarsk Territory and the Astrakhan Region, with up to 50 mln tons of reserves in each of them. Andrey Tretyakov, Head of Rusgeology, notes that the number of discovered hydrocarbon fields in Russia is stable but that the fields are smaller and smaller in size. The average amount of oil reserves is currently around 1.5-3 mln tons. Tretyakov explains that this indicates that most of the explorations aimed at discovering fields is conducted in already explored areas and not in new areas.
President of the Russian Geological Society Viktor Orlov indicates that the real situation with the addition of reserves is much worse than is being stated. “New oilfields compensate production for not more than 10-15% while the real scope of exploration in the last two years has been extremely limited. As a result Russia currently has no attractive, unallocated hydrocarbon fields.”
The annual addition in the resources base happens through a re-calculation of existing reserves at well-known fields and the application of a high oil recovery factor (ORF). This is not taken into account in the estimation of the replenishment of reserves. Evgeny Grunis, Head of the Research Directorate at the Fossil Fuel Geology and Development Institute, notes that the unreliability of the economic reserves in Russia is frightening: “Currently around 50% of the reserves are based on ORF, and 10% of the reserves are based on old geophysical field materials. In other words economic reserves in the country should be divided into two groups.”
This is clearly not enough for Russia to retain its status in the global oil market. According to the Energy Strategy of Russia till 2030 (approved in 2009), the target level of oil and condensates production in Russia by 2030 should be 530 mln tons p.a. (in 2012 production stood at 518 mln tons with great difficulty). But Ernst&Young estimates that the capacity of existing and allocated onshore fields will not be enough to reach these targets starting from 2025: “Before 2025 Russian oilmen could still ramp up production through the application of EOR methods and advanced technologies but by 2030 and even further by 2035 the only way to close the gap will be by developing new, yet unexplored fields.”
Acceleration is required
Gennady Shmal, President of the Union of Oil and Gas Producers, believes that exploration, primarily exploration drilling, should be increased more than threefold for Russia to be able to follow the principle of accelerated development of the resource base. In Soviet times we drilled 7.5 mln meters of E&A wells every year while in 2012 we drilled only 700,000 meters of E&A wells.
Researchers believe that the number of discoveries should be increased both in new onshore and offshore areas and in traditional areas. For example, only 60% of the area of the Khanty-Mansi Autonomous District has been explored.
However, as was clear during the meeting of the Natural Resources, Environmental Management and Ecology Committee of State Duma (on March 12), it will be impossible to triple the scope of exploration until the authorities find new incentives to spur a development of the industry. Vladimir Kashin, Chairman of the Committee, notes the total inadequacy of funding for exploration both from the state and subsoil users. According to market participants, just in the last three years funding amounted to around 400-500 bln RUB, while the Energy Strategy implies annual exploration funding at the level of 300 bln RUB.
Actually, prior to 2005 exploration was financed from the federal and regional budgets in approximately equal proportion. But after the re-distribution of authority and abandonment of the “second key” principle in the subsurface resource management (all authority was given to the federal government), investments from the regions dropped to a minimum level, while the federal government failed to fill the gap.
It was expected that subsoil users will be active in exploration. But that did not happen. The level of investments by Russia and international, vertically integrated oil companies significantly differs: with comparable production levels, for example, Petrochina in 2011 invested $US3.6 bln in exploration, Petrobras invested $US2.6 bln, while leading Russian companies invested around $US0.5 bn, each.
The small investments in exploration by oil companies are explained by the reserves to production ratio they inherited from the Soviet era. According to Ernst&Young, estimates until recent times, active exploration was not a priority for Russian oil majors: they had enough oil gas reserves on the average to cover 20 years of operations, while the RPR of the global majors is at the level of 13 years. With such stocks oil and gas companies are in no rush to invest in exploration. As Ernsy&Young analysts note, this is also explained by the need to finance current infrastructure projects.
“Companies are not interested in investing in exploration under the current tax burden: the risks are very high” says Igor Melnikov, President of NPO Soyuzneftegazservis. The structure of taxation for a ton of oil implies that 70% of the cost goes to the government, while oil companies get only 10% in profits, which is used to finance exploration.
— The idea is clear: representatives of one of the oilfield services companies explained that if you invest in refinement the investment pays back in three-four years, and gasoline stations pay back after two years. Exploration, on the other hand, pays back after 10-12 years. Prior to 2002, a significant portion of exploration was financed through the mineral resource replenishment tax and oil companies were ready to take risks by drilling exploration wells in areas that did not even have potential reserves. Now they are not ready to do this.
As a result, according to members of the Public Council for the Problems of Replenishment of the Resource Base in Russia (set up by Russian scientists in early 2012) neither oil companies nor the government conduct full-scale exploration of the country's territory. Deduct to add. The main proposed incentive for hydrocarbon exploration currently considered by the relevant ministries and committees is to deduct the amount invested in exploration from the Mineral Extraction Tax (MET).
Representatives of oilfield services companies have an alternative option: increasing the MET rate (currently, it amounts to 4.500 RUB/ton) and deducting exploration costs from the calculation of the amount of taxes. Nikolay Levitsky, President of Geotech Holding, says: “It is necessary to set the exploration tax deduction from MET at the level of 500 RUB for each ton of oil. This will correspond to around 250-270 bln RUB p.a. At the same time, we propose to increase MET by 300 RUB/ton. Then, the government will pay 200 RUB of the expenses and oil companies will add 300 RUB.”
Experts are confident that such a tool as the deduction of expenses from MET will impose an obligation on oil companies to spend the money appropriately and will incentivize exploration. According the Pavel Filippenkov, Managing Director at Trade Portal, the development of Russia’s numerous small and medium-sized fields can also become more profitable with deductions from MET. The state holding Rusgeology also backs the idea, proposing to invest the money earned in such a way into the exploration of unallocated areas.
The Public Council for the Problems of Replenishment of the Mineral Base is also expected to submit some proposals to the Russian government: namely, it will propose to introduce deferred or installed payments for licenses and the abandonment of the VAT for fields where the subsoil user has not confirmed the government’s forecast and has made no discoveries. According to the members of the Council, this could attract independent oil companies ready to invest in exploration.
Evidently, without significant changes in the legal and fiscal framework, the Russian exploration industry will be unable to reach the targets set by the government program and Energy Strategy. As a result, Russia could lose its leadership in the global oil market, which by 2030 should be growing by 34%.