No. 1, 2004

Oil of Russia magazine talks to Vladimir Konovalov, executive director of the Petroleum Advisory Forum (PAF)

Many oil analysts cautiously predict that future Russia will remain what it is now, a quiet backwater for investors, first of all - portfolio investors. With last year's foreign investments standing at $9,6 billion, the projected figure for the current year is even less than that—$10,6 billion. The Russian government cannot agree with this state of affairs, particularly so in the area of oil and gas projects developed on the basis of production-sharing agreements (PSA). Only three out of 27 agreements of this kind—Sakhalin-1, Sakhalin-2, and the Kharyaga project—are really working. Negotiations on the other 24 are still in progress.

Q: Today, endless discussions about the necessity or otherwise of PSA legislation have given way to this conclusion shared by practically all participants: it is high time the interminable debates were translated into concrete actions yielding tangible results (investments, jobs, barrels of oil and cubic meters of natural gas, personal earnings, budget revenues, corporate profits). Are you of the same view?

A: To my regret, the PSA legislation to this time makes only slow progress. Meanwhile, the principal law was approved as early as 1996 and was followed by another one, On Changes and Amendments to Legislative Acts Incidental to the Law on PSA. Later, however, the legislative process was interrupted, because it was necessary to put into effect a chapter of the Tax Code (TC) devoted to production sharing (it was approved in the first reading on June 27, 2002). Today, six long years after, neither an efficient and feasible PSA program is available, nor do we have new hydrocarbon development projects.

The Petroleum Advisory Forum (PAF) was founded in 1994. The PAF members are 25 foreign oil companies (Exxon/Mobil, BP, British Gas, ChevronTexaco and others) which are working in Russian oil and gas sector or planning to invest in it. PAF's mission is: · providing support for international oil and gas companies, acting in Russia. · cooperation with federal and local authorities in the country's investment climate improvement.

Nevertheless we are still optimistic and believe that eventually there will be a working production-sharing legislation in place. The hope has a strong leg to stand on: the atmosphere inside Russia in connection with PSA has improved markedly, that is reflected in the following:

l establishment of political and economic stability, which has made it possible for the authorities to evaluate economic development in the long term.

l parties concerned agree that the PSA regime is of great importance for encouraging investments into large-scale and capital-intensive projects.

l to strengthen its position as a reliable and long-term supplier of energy resources to the world markets, Russia needs investments into projects implemented off the traditional oil producing areas.

As of today, several projects (Sakhalin-1, Sakhalin-2, the Kharyaga project) are yielding practical benefits, but agreements on them were signed prior to the approval of the Law on PSA. For our part, we in the Petroleum Advisory Forum think that PSA is an essential instrument for any investor, both foreign and Russian.

Q: It looks like in Russia the PSA legislation has been through all thinkable and unthinkable "diseases"; there is also a large amount of approved legal documents as well as some experience of implementation of production sharing in this country, both positive and not quite so. For example, the legislation now in force is somewhat muddled, which creates additional risks for potential investors…

A: The improvement in the PSA atmosphere is due to a start in cooperation between the Russian government, the Duma and investors. But there is much work ahead in this sense. The PSA chapter in the Tax Code (TC) just outlines a range of issues, which must be tackled. Their greater part forms the basis of the PSA regime and, to make the relevant TC chapter more effective, it is necessary to consider these problems in detail and hold corresponding consultations.

Q: What is the PAF planning to concentrate on at present?

A: Our plan for the immediate future was to concentrate our efforts on the TC chapter devoted to the tax regime of the PSA. We have submitted to the Duma's relevant working group our proposals regarding possible modifications and amendments. Hopefully Russian MPs will get down to discussing them after the recess.

Q: Do you think that today Russia enjoys a higher level of investment attractiveness than was the case at the very start of the work to develop the PSA legislation?

A: One of the best indicators of a favorable investment climate is the level of direct foreign investments. As you may know, these were more than $4 billion over the last few years. It is a very low indicator by comparison with both other countries and Russia's real potential.

Nevertheless at present, the three PSA-based projects I have mentioned are picking up speed and in this connection we expect a rise in direct foreign investments to a level exceeding $20 billion. This undoubtedly is a good incentive for the signing of new production sharing agreements although negotiations on them are sure to require a certain amount of time.

Q: Previously some ordinary Russian people held against the Law on PSA the fact that foreign companies preferred foreign equipment as they made efforts to develop Russian hydrocarbon fields, while ignoring the Russian servicing potential. There was a lot of infighting on that account at different levels-in the State Duma, inside the government, and locally. What is the state of affairs at present?

A: Using Russian equipment and workforce in PSA-based projects is in the common interests of both foreign investors and the Russian state.

At the same time, what motivates the oil companies as they work to gain the planned profits on investments is the necessity of cutting costs to the maximum.

Currently, hundreds of Russian contractors have passed muster in the course of competitive selection and work on PSA-related orders. True enough, many Russian companies ensuring those deliveries will have to go through restructuring and technological modernization in order to be at the same competitive level as the best world producers.

In keeping with the law On PSA now in effect, 70% of the overall amount of equipment used in any production-sharing projects should be placed with Russian companies. Equally, 80% of the entire workforce should be Russian. For their part, foreign investors believe that all matters related to percentages of Russian participation are better considered within the framework of negotiations on terms of implementation of each particular project separately.

Q: And the last thing. As they analyze the state of Russia's investment market, many Russian media often accuse business people at home of wishing to take their capitals out of the country. Allegedly, they set a bad example to foreign investors, who would be dissuaded from coming here seeing how local capitals leave the country. As is common knowledge, Mikhail Kasyanov's government makes efforts to keep money at home. What is your view on this score?

A: Any kind of capital flight is a clear sign of political and, moreover, economic instability. It is a sign of uncertainty with regard to the ownership right. Regrettably, a good reputation is easily lost and hard to regain.

The same applies to any government, which seeks to demonstrate to the population that it, the government, can be trusted and that investments will not be "nationalized." I believe that in recent years Russia has chosen the correct vector in its course of reforms, putting the emphasis on the solution of the key problems: improving structure of taxation, strengthening the force of law, reducing the bureaucracy. But it takes time to implement these initiatives in full measure. Also it is necessary to be patient and consistent while dealing with current agendas, and, I am sure, this will bring the desired results.