EKIP– Expert Club for Economics and Politics A Different Opinion
As the world watches with rapture the unconventional oil and gas revolution in the United States, the world’s largest crude oil producer, Russia, is looking for ways to increase its energy production capacity and maintain its leading position in the market. After more than six years of refusing to acknowledge that the unconventional revolution is a fact, Russia has followed North America’s lead in the past two years. Signed in July 2013 by President Vladimir Putin, the new law on oil and gas production introduced tax breaks for companies that develop so-called tight oil. The goal is to increase unconventional oil production from 0.2% in 2013 to 11% over the next two decades. The new law, which came into effect on September 1, 2013, will provide up to $21 per barrel in tax incentives, which will contribute to greater investment in sophisticated drilling techniques for hard oil. In addition, the law provides a zero tax rate on production from large potential, unconventional oil fields, including Bazhenov, Abalak, Khadum and Domanik.
Accepting the obvious
Along with the new law, Russia announced its total oil and gas reserves for the first time since the collapse of the Soviet Union. The government claims that the country has 130.5 billion barrels (87.2 billion according to BP) of P10 oil and 74.8 billion of P50 [1]. This puts Russia in fifth place in reserves in the world, and with huge unconventional potential. However, many of Russia’s major oil fields are mature with high rates of decline. As a result, Russian oil companies desperately need investment and new technologies to maintain current production of over 10.5 million barrels per day. This will not happen unless the Putin regime liberalizes the contractual framework for oil and gas exploration and development, attracting international giants to Russia. In a sign that things are changing, in June 2013, the world’s largest oil company, Rosneft, signed an agreement with Italy’s ENI to develop deposits in the Barents Sea and the Black Sea. The same month, Rosneft also signed a contract with Norway's Statoil to develop 12 of the licensed blocks of the Domanik unconventional field in the Samara region.
Despite these first steps to attract investor interest in Russia’s oil and gas sector, the government needs an even more aggressive reform program in the sector to dispel doubts about the opacity and corruption of the Russian business environment. Still, it is not easy to forget the example of Shell, which developed the giant gas field on Sakhalin Island and was then forced to sell its majority stake to Gazprom on the pretext that it threatened ecological diversity.
The Land of Hope Bazhenov:
One of the companies most active in developing hard oil is Surgutneftegaz, which produces about 13% of Russia's oil. The oil giant already produces 2.6 million barrels of unconventional oil per year at the Aipimskoye field in the Bazhenov Formation. According to the company, the Khanty-Mansiysk region may contain another 3.6 billion barrels of reserves, for which the company has already developed 40 new technologies for technologically complex extraction. Thanks to Bazhenov, Russia has the largest shale oil production potential in the world. The Russian Ministry of Natural Resources predicts that daily shale oil production could reach 1 million barrels by 2025. There are many unknowns in front of this number, which are clearly visible in the contradictory data on total reserves, which vary from 15 billion barrels to over 1 trillion barrels. The US Energy Administration, however, is more optimistic, placing Russia in first place in terms of shale reserves in the world – about 75 billion. The Bazhenov Formation resembles the geological structure of the Bakken and Eagle Ford fields in the US, which is encouraging for large Russian companies that plan to invest billions in the development of the giant field.
Obstacles and hopes
The shale revolution in Russia is still far away and the future is unclear. The development of the Bazhenov field requires huge investments that will increase the cost of drilling a single well by 7-8 times. If the development of a conventional reservoir in Russia costs about $1 million, then horizontal drilling at great depths, which is necessary for the development of difficult oil, will require $7-8 million. The development of the Bazhenov field is facing obstacles similar to those of the shale fields in the United States, where after the initial high daily production rates, the oil flow from the wells sharply decreases. To maintain pressure, it will be necessary to constantly drill new wells, which significantly increases the cost of each barrel of oil. The production tax deduction does improve the profit opportunities of oil companies, but nevertheless the overall tax on the supply chain remains too high. Currently, the export duty on crude oil alone is 60% of its cost, which limits the incentive for oil companies to invest in increasing production amid stagnant consumption on the local market.
The risks of maintaining the tax status quo, however, far outweigh the benefits to the state from large tax revenues. Russia desperately needs to breathe new life into its large oil fields to halt the inevitable decline in production over the next twenty years. Many experts expect daily production to fall from 10.5 million barrels today to below 6 million by 2030. Some are even pessimistic, citing figures of below 5 million barrels. This would be disastrous for the Russian economy and budget, which depend on more than 50% of tax revenues from oil and gas. Without them, Russia can hardly continue to maintain a huge stabilization fund, redistribute state wealth to the backward regions of the country, and maintain its ultra-modern military. So a shale revolution is desperately needed by Russia. The alternative is not only economic oblivion, but potentially the loss of its leading position in the international political system.
[1] P10 reserves characterize oil reserves with a chance of production of at least 10% probability; P50 reserves have a 50% chance. Proven reserves are those with a chance of production of at least 90%. In the oil industry, such reserves are called 1P reserves.
