Anna Belova, upstream analyst at GlobalData, outlines the external pressures on the Russian oil and gas industry, and how the global geopolitical situation has reshaped the field of exploration and production.

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Figure 1. Rouble correlation with global crude oil price.

In June 2014, global crude oil prices peaked and began a decline that has continued to date. The official Urals marker price, used to calculate Russian extraction taxes and export duty, dropped from $105.15 per barrel (bbl) in July to $60.90/bbl in December 2014. The rouble is closely tied to international crude prices and mirrored their decline by losing its value against the dollar.

While each barrel of exported crude brings less dollar-denominated revenue, each dollar results in a higher rouble-denominated cash flow. By paying taxes and operating costs in rubles, Russian operators therefore reduce their exposure to global crude price decline.

In the long term, however, the low-price environment will negate the exchange rate and reduced tax benefits, and put financial pressure on operators and the Russian Government. Futhermore, rouble-denominated costs will increase significantly in 2015, with the official inflation rate expected at 15%.

Expanded US and EU sanctions within Russian financial and energy sectors

Added external pressure on the Russian oil and gas industry stems from the increased EU and US sanctions, announced on 12 September last year, that specifically target the energy, defence and financial industries. The oil and gas sector is affected by limited access to financing, and by limitations on technology transfer for unconventional and offshore developments.

"While the sanctions specifically focused on exploration and production from offshore and unconventional resources in Russia, their effect has spread throughout the country’s entire oil and gas industry."

While the sanctions specifically focused on exploration and production from offshore and unconventional resources in Russia, their effect has spread throughout the country’s entire oil and gas industry. Western companies began pulling away from activities in Russia – ExxonMobil and NADL suspended their deals with Rosneft, and Schlumberger recalled some managerial and technical personnel from the country, for example.

In response to sanctions, the Russian Government and industry operators intensified their focus on partnerships with Asia-based interests. When the South Stream gas pipeline to Europe was cancelled on 1 December, an immediate alternative for Russian gas was proposed by President Vladimir Putin – a subsea pipeline across the Black Sea for deliveries to Turkey.

Call in the MET

The adjustment mechanism linking the mineral extraction tax (MET) rate to the Urals crude price means that the tax burden on exported oil has stayed relatively constant despite the oil price slump over the past quarter.

The reference price for MET in December was $61/bbl compared with an average of $107/bbl in the first half of the year – a drop of 43%. In response, the MET rate in dollars-per-barrel has dropped by 50%. However, the significant drop in the value of the rouble means that the rouble-denominated oil MET rate has risen significantly compared with the international oil price.

Bill number 605370-6 passed its third reading in the Russian Duma on 19 November 2014 and was then signed into law by President Putin on 25 November. The most significant aspect of the bill relating to the sector is the codification of the so-called tax manoeuvre, which significantly redistributes the tax burden on oil production from export duty to MET.

The MET base rate, before the application of coefficients relating to price and other factors, will increase from the current rate of R493 to R766/t in 2015, R857/t in 2016 and R919/t in 2017. Conversely, the marginal rate of export duty will fall from its current level of 59% to 42% in 2015, 36% in 2016 and 30% in 2017.

The upstream oil and gas sector The Russian oil industry is represented by ten vertically integrated companies, 180 independent operators and three companies producing under production-sharing contracts. Vertically integrated companies produce more than 87% of all Russian hydrocarbon liquids, which include crude oil and condensate, from 111 individual production units. Daily oil production reached a post-Soviet peak of 10.51 million barrels a day in 2013. Production further inched up in 2014, averaging 10.56 million for the year, with significant increases observed in November and December.

One major trend responsible for the observed production increases is the continuing development of new fields in frontier petroleum provinces. In East Siberia, fields such as the Vankorskoye, Verkhnechonsk and Talakanskoye group continue to build up production to planned capacity levels. Elsewhere, the Trebs and Titov fields in the Timan-Pechora basin, and the Messoykha Project in north-western Siberia are operating under test production and will move to full field development in the near term. Offshore, Yuri Korcahgin in the Caspian Sea, Prirazlomnoye in the Pechora Sea and Severnoye Chaivo on the Sakhalin Island shelf contribute to the country’s production growth.

"Over the past decade, Russian operators have steadily increased the fraction of hydrocarbon produced from offshore developments."

Gas production in Russia is dominated by Gazprom, which produces more than 71% of gas in the country and holds the monopoly for pipeline gas exports. Novatek is the largest independent gas producer, responsible for close to 8% of production, with other independent producers extracting just over 5% of Russian gas. Vertically integrated companies other than Gazprom produce more than 11% of natural and associated gas. the remaining fraction is produced by companies operating under production sharing contracts.

Russian production and exports decreased over the second half of 2014 compared with 2013 levels, which averaged 65 billion and 20 billion cubic feet a day (bcfd) respectively. Aside from the seasonal effect of lower summer gas demand, the halt in deliveries to Ukraine and the reduction in exports to some European markets to prevent the reverse flow into Ukraine are responsible for the observed decreases.

Production and exports increased by year-end; however, the Ministry of Energy ceased publishing gas data in October 2014 (see Figure 4, above right). In the longer term, the expedited development of East Siberian gas resources is anticipated with midstream trends, whether pipeline or liquefied natural gas (LNG), oriented toward China and other Asia-Pacific consumers.

The trend towards offshore

Over the past decade, Russian operators have steadily increased the fraction of hydrocarbon produced from offshore developments. The second half of 2014 saw an upswing in offshore activities by all major operators.

On 4 September, Rosneft announced the start of first stage of production from the Chaivo North field on the shelf of Sakhalin Island. Gazprom Neft began drilling an exploration well in the Dolginskoye field in the Pechora Sea; its proximity to the producing Prirazlomnoye asset allows production synergy. LUKOIL continues with infrastructure development on the Caspian Vladimir Filanovsky field, having installed riser blocks in September 2014.

Notable discoveries and licences

One of the largest recent oil discoveries in Russia took place in late 2014. On 27 September, Rosneft announced a new field discovery in the Kara Sea within the Vostochno-Prinovozemelskoye 1 block. The Universitetskaya 1 well encountered hydrocarbons at 2,113m, and the new field was named Pobeda, the Russian word for victory. ExxonMobil was Rosneft’s partner in the discovery – however, the ongoing sanctions limit the US company’s continuing participation in the project.

Analysis of Rosnedra subsoil auctions that took place in 2014 revealed that 33 oil and gas blocks were licensed through competitive auctions during the period. All new blocks are within established production zones in Volga-Ural, Timan-Pechora and West Siberian basins.

The highest bonus payment was recorded for the Otdelny block in Khanty-Mansi Autonomous Okrug, awarded to Gazprom with a payment of $15.26 million.

In addition to the auctioned blocks, four offshore blocks with resources of federal significance were awarded to Rosneft and Gazprom without auctions. This continues the trend of offshore blocks being granted to companies in which the government holds a majority stake, with offshore production seen as a major strategic direction for the Russian oil and gas industry.