Failure to Increase Funding for Exploration Could Precipitate a Crisis for Russian Companies

Moscow, 25 May 2011 – Ernst & Young’s study “The Future of Russian Oil Exploration” indicates that Russian companies on their own are unlikely to succeed in maintaining a stable level of oil production over the next thirty years. The most compelling argument in support of this view is the need to invest billions of dollars in projects with a high level of risk. Only by investing in a large number of such projects can companies maintain a positive risk profile, but this will require them to raise the limits of exploration costs and change the existing balance of development, exploration and acquisition costs.

Our report focuses on the exploration in the oil sector, as oil exploration at the moment is a more pressing issue than gas exploration for the domestic upstream sector”, says Alexey Kondrashov, partner and head of Ernst & Young’s Moscow Oil & Gas Center and international tax practice in the oil and gas sector.

Until recently, Russian oil and gas companies have not felt a pressing need for active exploration, due to the considerable potential of existing sites. By international standards, the reserves of major Russian producers have an average life of twenty years, while international oil and gas majors will be able to produce at their current level for thirteen years without an increase in reserves. A detailed analysis of these findings indicates that Russian companies will focus on current and prospective sites until 2025, but after that, at the current level of exploration, they are likely to face the problem of replenishing their reserves.

 
Oil production
(million tons)

To keep oil production at a level of 500 million tons after 2030, investments in exploration will have to be increased. Based on an assessment of the combined exploration budget of Russian oil producers, we conclude that the sector will not be able to do without financing from abroad. Deals financed at the exploration stage have great potential, though this may limit long-term profitability.

According to Alexey Kondrashov, investments in exploration must clearly be increased for the long-term and ongoing development of the Russian oil sector, which generates over half of state revenues. “The low level of investments in exploration is a result of current economic conditions, i.e. high oil prices, the proven reserves of Russian companies, insufficient equity and ineffective taxation. Companies and state agencies should now seek a comprehensive solution to the problems holding back investments in exploration”, says Kondrashov.

Andrey Kobzev, Director of Ernst & Young’s Moscow Oil & Gas Center, says: “In Russia the time has come for more active and larger-scale exploration, including on the continental shelf. Our calculations show that in order to maintain oil production at its current level after 2030, exploration costs will have to be more than tripled. But there are also a number of legislative, political and tax problems standing in the way of attracting foreign capital. Success in this area will depend not only on big-figure capital investments, but above all on commercial oil production”.

 
Figure 3. Exploration costs as a percentage of total investments
(average for the three previous years, %)

“Experience clearly shows that investments in exploration alone are not enough for immediate production”, says Alexey Loza, partner and head of Ernst & Young’s CIS Oil & Gas Group. “There is also a need for major investments in infrastructure and time for appraisal drilling in order to select a development scheme that will yield maximum added value. And it is crucial to understand how much time it will take to get from initial exploration to the first oil production”.

It currently takes eight or nine years between discovery and the start of production. Russian companies, however, manage to begin commercial production in a record-breaking five to seven years. But this is typical of onshore projects; offshore sites can take considerably longer to develop. We assume that commercial production on the Russian shelf will begin only after 2024.

Oil production as a result of new exploration projects
(projection, million tons)

Twenty major oil and gas areas and basins have been discovered on the Russian shelf, ten of which have proven oil and gas reserves. Major Russian companies are seeking to form joint ventures to explore and develop the country’s unevenly explored Arctic shelf. The majority of localized hydrocarbon resources (around 94% of the total) have been found in the western part, while the hydrocarbon potential of the eastern part, along the continental slope and in the deep Arctic basin, is regarded as inferred or contingent. The petroleum potential of the Black Sea and Azov Sea should also not be underestimated.

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