No. 2, 2009

International oil companies are ready to partner with Russian companies in developing new fields on mutually beneficial conditions

Building a favorable environment for investments into the Russian oil and gas sector is critically important for the country. Today, in the period of economic recession, oil and gas companies have limited investment budgets. Therefore they will invest only after preliminary assessing the risk and return ratio on a global scale, and Russia will have to compete against other areas of investments.

New realities

Russia's role in provision of energy sources to the global community to maintain economic growth and development will remain significant and essential for the many years to come. Traditional east-west oil and gas supply channels will be supplemented by new ones (into countries of the Asian-Pacific region) as pipelines and relevant operational infrastructure are commissioned. We are talking, for example, about transportation of the Sakhalin-2 project liquefied natural gas and commissioning of the Eastern Siberia-Pacific Ocean pipeline.

Currently the Russia's share amounts to about 20% of internationally traded oil and 30% of natural gas deliveries. Nevertheless we do not see any output increase, and that evidences weaknesses of the national economy's most significant sector.

Russian producing oil and gas fields are depleting fast and experts acknowledge that already in the near future it will be difficult to maintain even the existing production rate without putting new ones into operation.

Major resources are concentrated in difficult-to-reach areas of Eastern Siberia and on the Arctic shelf; hence their development will face technical, environmental and financial challenges of magnitude and complexity never encountered before.

Thus, directors of Russian oil companies believe that maintaining output level at 8.5-9 million barrels per day in the course of the next 20 years will require about $1 trillion investments in new fields development. The scope of investments is so great that capabilities of a single oil company or oil and gas industry of a single country will not suffice.

Moreover, according to the Russian Energy Strategy program, by 2020 about 20% of Russian oil and gas will come from the shelf. It means that in the next decade Russia will need to put into operation just as many new fields as currently are developed in the North Sea. Meanwhile, it took technical expertise and capabilities of all major international oil and gas companies to tap the resources of the North Sea. Moreover, it took a 40 years journey from the first discovery of oil and gas fields to peak output in 1999.

International oil companies, such as Shell, are ready to partner with Russian companies in developing new deposits. We have gained unique experience of engineering operations in difficult environment; we possess the most comprehensive technological base and ability to create added value through application of integrated approach at every stage of the product life-cycle. But to ensure further investments into the oil and gas industry one needs a concise state policy and transparent rules of the game for potential investors.

Unthreading a legislation and tax maze

According to the RF Law on Subsoil, in case a field of federal significance is discovered during exploration, the government may refuse the rights to a subsoil user for such subsoil area "if that threatens the national defense and security." Here is the evident risk that investors might be offered inappropriate compensation, which in turn may seriously undermine their confidence in investing into exploration and supplementary exploration operations. In this connection we presume that the ideal solution will be to preserve the right of a foreign investor to use the subsoil block in case commercial resources are discovered. Any other options are overly complicated and prevent one from determining an adequate level of compensation for the loss of investor's rights, especially amid current price volatility.

The wording "threat to national defense and security" leaves us asking questions as well. As one of the possible solutions, for example, the Russian government may issue an addressed resolution (for tenders/auctions or in case of exploration licenses provided circumventing tender procedure) to confirm that the government will not recall the license and that it will ensure specific limits to foreign participation.

In addition the tax system needs calibration with policy objectives to increase oil and gas production. Under the current tax regime with respect to the offshore few investments, if any, would be capable of carrying the tax burden while ensuring profitability. For example, the tax holidays commence with license issuance, rather than start of field production.

Furthermore, it is necessary to consider including ‘profit sharing arrangement' in the Russian Tax Code (or Agreements on expense covering contributions) and to provide for exclusion of the profit tax from the taxable income relating to payments made by parties of such agreements. Such notion was introduced by OECD countries to be widely used nowadays in trade operations between the member countries.

Today oil and gas companies have limited investment budgets and will invest only after preliminary assessing the risk and return ratio on a global scale. Russia will have to compete against other areas of investments.

Investments into the oil and gas industry, especially in the development of new territories, first of all in the Arctic, significantly increase the risks for such potential investors. Thus, building a favourable environment for investments into the Russian oil and gas sector is critically important and the Russian government has to wage a policy that would take into account the balance between the risk and the profit.