News Lack of production sharing laws slows joint ventures in Russia
David Knott
Senior Editor
When Russia opened its doors to foreign oil companies in 1990, there was a rush to secure a piece of the country's potentially vast oil wealth.
Since then, many of the ventures between Russian and non-Russian partners have become bogged down with operational problems and an ever changing tax and legal regime.
There is a stockpile of massive developments building, while government grinds with seeming reluctance toward passing laws that will allow outside firms to do big business.
Meanwhile, small ventures seem to be having a better time of it and are producing and exporting oil. There is even growing confidence that rising domestic oil prices will soon make sales in Russia viable.
However, while some projects have begun to bear fruit, as at almost any stage of western companies' progress in Russia since glasnost, there seems to be much more promise than money being made.
Last year saw the worst performance of Russia's oil industry since the collapse of the Communist regime, but the outlook has brightened for some of the joint ventures involving foreign firms.
Small ventures seem to be making progress after a sticky start, although for major development projects the main stumbling block is the lack of production sharing contract legislation.
Familiar problems
At a London conference last March, Vadim Dvurechensky, deputy minister at Russia's Ministry of Fuel & Energy, gave a now familiar catalogue of causes of petroleum sector problems.
The list included:
- Low investment and excessive depletion of oil and gas fields under the Soviet regime.
- Government controlled oil prices that rose slower than costs.
- Inability of customers to pay for oil they received.
- Slow progress in changing legislation.
But Dvurechensky said oil production had stabilized of late after years of decline, and oil industry reforms currently being debated in government would once more make Russia attractive for foreign investment.
In 1994, Russia's total oil and condensate production was 317 million metric tons, Dvurechensky said, while gas production amounted to 607 billion cu m. "Oil production fell 10% over the year," he said. "In 1987-88 Russian oil and condensate production peaked at 570 million metric tons."
An increase in domestic oil prices had brought Russian crude oil to 40% of the price paid internationally, but further hikes would be prevented by customers' inability to pay.
Dvurechensky warned, "In 1995 the insolvency of consumers will be one of the main destabilizing factors in Russia's oil industry. Only 40% of supplies are now being paid for by customers."
But Dvurechensky said oil and condensate production had bottomed out recently at 800,000-810,000 metric tons/day and appeared to be stable. He expects 1995 production to be 300-310 million metric tons.
Russia's 40 or so joint ventures were said to have produced a total 11.2 million metric tons of oil last year, up from 10.3 million metric tons in 1993. Dvurechensky expects joint ventures to produce 18.3 million metric tons this year.
Legislation
"Government can now grant special terms to joint ventures," Dvurechensky said. "Export tax looks likely to be abolished Jan. 1, 1996.
"At the end of February, the Duma adopted the first draft of production sharing legislation. In 2-3 months we hope the production sharing laws will be ratified to open the industry for foreign investment."
Dvurechensky's optimism soon proved to be unjustified, however. Early this month Russia's Federation Council, the upper house of its parliament, voted to reject draft legislation for production sharing contracts (PSCs).
No concrete reason has emerged for the rejection of production sharing rules, on which development of several major fields hinges. However, it appears that a disarray in voting procedures prevented about half of the council members from voting. Although the PSC legislation is said to be popular among council members, Speaker Vladimir Shumeiko dampened enthusiasm ahead of the vote by citing risks to Russia's long term interests.
Elections in December and revisions to the draft by Duma are now expected by analysts to delay approval of production sharing legislation another year (OGJ, Oct. 16, Newsletter).
The draft legislation had been passed by the Duma, Russia's lower parliament, in June. Now the production sharing proposals must be reviewed by a reconciliation committee of the Duma and put to the vote again.
This could in theory be finished in time for a vote ahead of a general election in Russia slated for Dec. 17, but the likelihood of this is small. Tom Cross, chief executive of Dana Petroleum plc, London, which is involved in two joint stock company ventures in western Siberia, said western companies are still waiting to hear why the legislation stalled.
"The rejection was not a surprise," Cross said. "This is a major piece of legislation, which went through the Duma only after two or three readings. The legislation will go ahead, but first there will be lots of posturing and politicking ahead of the elections."
One source said the current slow progress in providing a stable production sharing regime is preventing further investment in Russia by joint venture companies.
"All the ventures are still on swampy ground," said the source, "and are hesitating to push forward in exploration activities. In the case of successful exploration, the ventures are reluctant to invest whatever earnings they make in Russian projects."
Operating problems
Etienne Deffarges, vice-president of Booz Allen & Hamilton Inc. in Paris, said the outlook for Russian joint ventures is still difficult.
The two major problems, he said, are the financial arrangements under which joint ventures have to sell crude and, above all, large scale transportation.
"Some joint ventures appear to be able to produce oil and make a little money," Deffarges said. "It is only small joint ventures that can make money, though, because they do not need to rely on major infrastructure for exports."
Despite the recent government opposition to legislation for Russia's oil production ventures, Deffarges is cautiously optimistic about their outlook.
"Legislative obstacles come and go and come and go in Russia," Deffarges said. The Federation Council's rejection this month of key production sharing legislation was a setback, "but it will get resolved eventually."
Brian Hall, chairman of Dublin's Aminex plc, which is involved in two ventures in the Komi republic, agreed with the diagnosis of finance and transport as Russia's main problems.
"The taxes are draconian and keep changing," Hall said. "All you can do is pay them on time and so avoid severe penalties. But the main impediment to producing oil is the transportation system.
"Russia's special export organizations were abolished this year, but there are new ones in place. Producers find themselves still tied to exporters, bound by routes that are still effectively in monopoly hands."
However, Hall views the rising domestic oil price with optimism. With the price within Russian about $9/bbl and rising, it soon will make sense to sell oil locally and perhaps before long even pay for contract refining locally.
"In 6 months to a year we will have gotten to the point where we can consider domestic sales," Hall said. "It's certainly no longer a case of being able to sell oil in Europe but only give it away in Russia."Polar Lights
Among Russian joint ventures, the most prominent success story to date is Polar Lights Co., a 50-50 venture of Conoco Inc. and Timan Pechora region state geological firm Arkhangelskgeologia, initially formed to develop four fields in the Arctic Circle.
Polar Lights placed its Ardalin field on production in August 1994, marking the first commercial production from a major oil field developed by a Russian-U.S. venture (OGJ, Oct. 9, p. 49).
Ardalin holds estimated reserves of 110 million bbl of oil, while satellite Oshkotin, Kolva, and Dyusushev fields are estimated to hold a further 20 million bbl.
Field development, expected to take 3 years, is to involve drilling of 11 producers and 13 water injection wells. Construction of a 40 mile pipeline allows all production to be exported.
Ardalin complex production is expected to rise to 25,000 b/d of oil in 1996. The venture ultimately may build a crude oil terminal (OGJ, Sept. 5, 1994, p. 38).
A Conoco official said the venture wants to pursue other developments north of Ardalin under a production sharing arrangement, which may involve a $2-3 billion investment in the region.
"We are looking at putting in infrastructure in the northern area in partnership with Russian and other western companies," the official said. "There are lots of reserves in the area but no export links, and several future projects hinge on transportation."
Here Polar Lights is considering development of Yuzhno Khilchuyu, Khilchuyu, Yareiyu, and Inzerei discoveries, which hold estimated reserves of more than 1 billion bbl of oil.
Conoco also is one of a group of western companies that recently signed a protocol toward development of the supergiant Shtokmanovskoye gas/condensate discovery in the Barents Sea.
Russian firm Rosshelf was unexpectedly granted sole rights to develop the find in late 1992 but has begun negotiating again with a western group, following a feasibility study 2 years ago (OGJ, Aug. 23, 1993, p. 16).
Amkomi venture
Another success story is that of a 50-50 venture involving Aminex plc of Dublin and Komineft, the local production company for the Komi republic of western Siberia.
Their Amkomi venture has achieved profitable production from North Aresskoya and Isakovskoya fields, aided by an exemption from export taxes.
Amkomi has taken on another five discoveries in the vicinity and plans to begin drilling as part of development of the strikes during 1996.
On Oct. 14 Aminex also signed final agreements with Komineft for development in Kirtayel oil field, about 100 km from the venture's first operation.
Aminex's Hall said production from North Aresskoya and Isakovskoya amount to 2,000 b/d. Aminex entered this joint venture in 1993, when the two fields produced 1,150 b/d of oil.
Two wells drilled by the Russians had run into problems. When Aminex began work in the field, Hall said, it received a great shock when large volumes of water appeared in production.
"We slowed production so we could investigate," Hall said, "and to our relief found the water production was caused by poor cement jobs in the wells rather than reservoir problems.
"We learned the hard way that Russian cement quality is not fine enough for this purpose because it sets with cracks and defects, enabling water to channel through cement into perforations."
Aminex overcame the problem by importing fine cement from Europe, and by mixing additives with Russian cement: "Now we have no problem, but other joint ventures are likely to meet the same difficulty."
Kirtayel is a single reservoir with "a western estimate" of 50 million bbl of oil reserves. Here, Amkomi is funding the venture with a contract more similar to a production sharing agreement than a typical joint venture.
"Aminex will fund a development program with loans," Hall explained, "part of which will be recovered from each well as it is tied in. Once the loan is paid off, Kirtayel will become a normal 50-50 venture."
First oil produced from Kirtayel under the joint venture is expected in mid-1996. Ten existing wells in Kirtayel field are producing poorly because there is no water treatment plant.
Amkomi plans to recommission eight of the wells and install a treatment plant to boost total production from these wells to about 2,000 b/d and drill further wells to yield a further 400 b/d each.
Hall said Aminex made a profit in 1994 from its Amkomi operations, but investment in development work and improvements in the fields have killed profits in the first half of 1995.
"This situation will improve next year," Hall said, "as further production comes on stream. Still, there couldn't be a harder country to work in, even though we have been very well supported by our shareholder, Zarubezhneft."
Zarubezhneft bought an interest in Aminex in 1993 because it had no producing assets in Russia even though it is a Russian oil company (OGJ, Feb. 27, p. 24).
YoganOil
Dana is 50% partner in YoganOil, along with Lukoil, Russia's largest oil producer; and Kogalymneftegaz, regional producer and operator of western Siberia's 2.5 billion bbl Vat-Yoganskoye oil field.
YoganOil is developing South Vat-Yoganskoye field, near Vat-Yoganskoye, which has estimated reserves of 35 million bbl of oil. South Vat-Yoganskoye oil is processed and exported through Vat-Yoganskoye facilities.
Dana's Tom Cross said South Vat-Yoganskoye is producing from a single well under a long term test. This well was a recompletion of one of the field's three exploration wells.
The field's 550 b/d production is sold locally. Cross said the oil brings an attractive price on the local market, but YoganOil plans to export oil next year.
"Profits are similar for domestic sales and export now," Cross said, "but this is not where it's heading. We are spending the money on field development and drilling, so we are comfortable for now with domestic sales."
Cross explained that, after the domestic oil price hike last year, a local sale price of about $9/bbl will yield the same return as exports, whereas a $15/bbl price would be hit by $6/bbl in export taxes and pipeline charges.
In February, YoganOil plans to drill the first in a series of 54 development wells in South Vat-Yoganskoye field. Once full development is under way, Cross said, "we are confident we will make money."
Dana last July bought a 30% interest in western Siberia's Sortymskoye oil field, reckoned by Russian partners to hold proved and probable reserves of 130 million bbl.
Dana's partners in Sortymskoye are Tyumenneftegaz and Obneftegazgelogiya. The field lies near the Surgut producing center and less than 10 km from giant Ombinskoye and Mamontovskoye fields.
Eight exploration and appraisal wells were drilled in Sortymskoye before Dana's buy-in. Cross said Dana has finished a reserves audit and is in the development planning stage.
Under study is early production by tying in four or five of the existing wells followed by full scale development with produced oil exported either through Ombinskoye or Mamontovskoye facilities.
"We hope to start development of Sortymskoye in 1996," Cross said, "but first we need to register the joint stock company with authorities. We have started the feasibility study that is required for registration."
Cross attributes Dana's success in Russia to project selection: "We studied more than 40 projects before we picked our first. Nine out of 10 we were shown we wouldn't touch because they have no chance of making money. Our two projects have existing infrastructure. We concentrate on optimizing new developments close to major fields."
White Nights
The White Nights joint venture to develop oil and gas fields in western Siberia apparently has had more than its share of setbacks, but partner Anglo-Suisse Inc., Houston, reckons now "it's going fine".
White Nights partners are Phibro Energy Production Inc. 45%, production association Varyeganneftegaz 50%, and Anglo-Suisse 5%. The venture was set up in 1990 to develop and produce oil from Tagrinsk, West Varyegan, and Roslavi fields in the Tyumen region.
At one point it appeared as if the pioneering White Nights project was likely to fall apart as Russian tax authorities went into a feeding frenzy (OGJ, Nov. 8, 1993, p. 32).
An association of Russian ethnic groups later filed a lawsuit against White Nights, challenging the validity of its license. The claim was upheld in its first appearance at a Moscow court (OGJ, June 13, 1994, p. 31).
An Anglo-Suisse official explained that the Russian courts eventually found in favor of White Nights: "It was a ridiculous claim, anyway."
When the venture was formed, production from the fields on stream, Tagrinsk and West Varyegan, amounted to 65,000 metric tons/month of oil but was in rapid decline.
Now the venture is still producing at the same level, exporting its oil through existing infrastructure. It is discussing development of the small Roslavi discovery.
"This year the venture has drilled its sixth well," said the Anglo-Suisse official, "and we have done a lot of hydraulic fracturing. We have a further drilling program planned from another drillsite.
The official said reserves in place amount to 200 million bbl of oil, and Tagrinsk field would be shut in if it were not for White Nights. Anglo-Suisse also is working with Russian producer Sidanco: "When legislation permits, we will begin looking for other ventures."
Other projects
Also in Russia, Germany's Deminex is involved in exploration of four contract areas north and southwest of Volgograd under a joint venture set up in November 1991 with local firm Nizhevolzhskneft.
The four tracts cover a total 22,000 sq km of exploration acreage in the midst of producing fields. The July 1993 exploration license carries an obligation to drill three wells.
"We are doing additional exploration in an area which is still oil prone," a Deminex official said. "We are drilling our second exploration well, north of Volgograd."
The venture acquired seismic data in 1994 and later that year drilled a dry wildcat. Beyond the three wells, Deminex plans to develop whatever it finds, to fund further investment in exploration.
Texaco programs
Last year, Texaco Inc. completed a project to work over 63 wells in Sutormin field of western Siberia, which was started in 1993 on behalf of Sutorminskneft (OGJ, Mar. 8, 1993, p. 22).
A Texaco official said the company has two major projects in mind: one in the Timan Pechora region, the other off Sakhalin Island.
Timan Pechora Co. is a combine of Texaco 30%, Exxon Corp. 30%, Amoco Corp. 20%, and Norsk Hydro AS 20%. It is negotiating a PSC covering 73,000 sq km within the Arctic Circle.
Texaco also is in a 50-50 combine with Mobil Corp. in pursuit of a license to develop a 7,000 sq km block off Sakhalin Island. This project, which the official said the press has labeled Sakhalin III, includes development of the Kirinsky discovery.
"Both projects are on hold until production sharing laws appear," the official said. "In Timan Pechora we are in the latter stages of negotiating a deal, but for Sakhalin we are at an early stage."Still more projects
When the PSC legislation was halted by the Federal Council, state firm Rosneft said the delay will not affect spending of $67 million on preliminary work in 1996 for the $12.7 billion Sakhalin I project.
The venture is expected to be split 60% between Exxon and Sodeco,and 40% between Russian partners Rosneft and Sakhalinmorneftegaz. First phase of the project is expected to bring production to a peak at 200,000 b/d of oil and 1.4 bcfd of gas in 4 years.
Last year, a group of western firms signed a production sharing agreement for a $10 billion development of two other fields off Sakhalin Island under what has become known as the Sakhalin II project.
Partners are Marathon Oil Co. 30%, McDermott International Inc., Mitsui & Co. Ltd. and Royal Dutch/Shell 20% each, and Mitsubishi Corp. 10%.
Combined reserves of Piltun-Astokhskoye and Lunskoye fields, which form the Sakhalin II project, are estimated at 1 billion bbl of oil and condensate and 13 tcf of gas (OGJ, July 4, 1994, p. 32).
Amoco Corp. is working with Yuganskneftegaz and Yugraneft to- ward development of Priobskoye in western Siberia and expects production of almost 500,000 b/d of oil from extended reach wells drilled from sand pads.
The company said a multibillion dollar program would be needed to develop Priobskoye, but work would not begin until the "...passage of comprehensive, consistent and unambiguous oil and gas legislation."
Also waiting in the wings is development of Prirazlomnoye field by BHP Petroleum Pty. Ltd., Rosshelf, and Brown & Root Inc. The discovery lies in 20 m of water off northern Russia.
The area is ice bound 8 months/year. But lack of production sharing laws--not weather--is holding back a plan to produce first oil from the field in winter 1998.
Pullouts
While most western joint venture partners appear to be hanging on in the hope of eventually making a return on their investments, some have decided to pull the plug.
Although attempts by France's Elf Aquitaine SA to explore in Russia's Volgograd and Saratov regions were not strictly joint ventures--Elf held 100% of its two exploration licenses there--the company faced the same problems as joint ventures.
Last May, Elf relinquished the two licenses, citing frustration with Russia's lack of production sharing legislation. That left Volgograd and Saratov authorities to plan for new tenders.
An Elf spokesman said the reason the company didn't choose to enter a joint venture in the first place was that it foresaw too many problems with those projects.
"Elf pulled out because of big problems with production sharing legislation," said the spokesman. "The situation was just not settling down. And we had problems with the administrations of Volgograd and Saratov, which were taking too long with everything."
Elf has not given up hope on Russia and is keeping an eye open for opportunities when production sharing legislation is in place.
"Russia has been a big disappointment for many people," said the spokesman, "yet at first people thought it may become the new Middle East."
Norwegian independent Saga Petroleum AS was involved with Shell International Petroleum Co. Ltd. in a plan to explore in the Timan Pechora region.
But the partners ended the venture after they found that their attempts to set up exploration and production programs were being stonewalled by local authorities.
"Nothing was happening in the venture," said a Saga official, " and we thought we could go no further. For the time being, Saga is not getting involved in Russia, but we will come back when the production sharing situation is clarified."
In early February, Gulf Canada Resources Ltd. pulled out of the KomiArcticOil joint venture in which it held 25%. Gulf said the venture no longer fitted its strategic focus, and while the investment is technically sound, there were too many delays through political and economic uncertainties.
A month later, British Gas plc snapped up Gulf's interest, boosting its share in the project to 50%. British Gas later reported the venture had brought a western drilling rig to the field and boosted production to 16,000 b/d of oil from 4,000 b/d (OGJ, Sept. 4, p. 33).
New offers
Even as western oil companies watch in frustration as Russia finds more obstacles to production sharing legislation, Russian authorities are laying more bait to attract foreign oil and gas investments.
Earlier this year Russian government announced a sale of 10-15% of state oil and gas assets to begin this year in a bid to attract direct investment despite problems with Russia's joint ventures.
Analysts viewed the acquisition of shares in Russian companies as a way to avoid prohibitive taxes, absence of financial and legal guarantees, and spoiling tactics against foreign ventures by Russian firms.
ARCO was first and so far the only western company to make a move, securing a 6.3% interest in giant Lukoil for $250 million.
An ARCO official said the purchase was simply a response to an attractive offer at a time when the company is expanding its international operations rather than a ploy to avoid joint venture involvement.
"ARCO is pursuing two parallel paths," the official said. "The acquisition is one, bringing us benefits from Lukoil's considerable production assets in western Siberia."
Before the purchase of Lukoil shares, ARCO also was discussing with Lukoil an exploration and production project that would be a joint venture.
"We saw shares purchase as an investment opportunity," said the official, "rather than as a short cut into Russia. Lukoil returns a profit and will be a good equity investment.
"We are also pursuing a joint venture, and we hope our investment in Lukoil will lead to a closer working relationship for the venture. However, a project with Lukoil is not necessarily the only Russian joint venture we would consider."
A second stage of privatization began in Russia last Sept. 25 when government released a list of 29 companies that will be privatized later this year.
Among the companies are oil producers Lukoil, Yukos, Sidanko, and Surgutneftegas. Gas giant Gazprom is notable for its absence.
A report in London's Financial Times said the sale will take the form of a plan under which government will auction the right to manage its interests in state firms in exchange for loans.
Critics have objected that the program will transfer some of Russia's most valuable companies to private ownership for less than their true value.
Moscow said the plan is intended to raise money for its cash-strapped treasury. It is expected to raise 8.7 trillion rubles ($1.9 billion).
The report suggested Gazprom's exclusion from the list was due to a "privileged relationship" of the company with Prime Minister Victor Chernomyrdin, formerly boss of Gazprom.
In September, Yamal-Nenets Autonomous Okrug of western Siberia opened its first international licensing round, offering seven delineated fields and three exploration blocks (OGJ, Aug. 14, p. 17).
The blocks on offer are said to hold proved and probable reserves amounting to more than 830 million metric tons of oil, 30 million metric tons of condensate, and 270 billion cu m of gas.
Among the discoveries offered for development, Taz is the plum, with proved and probable reserves estimated at 541.5 million metric tons of oil, 12.7 million metric tons of condensate, and 197.7 billion cu m of gas.
Bidders are required to submit a list of fields in which they wish to participate and to buy data packages by Nov. 15. Field development proposals are required by Mar. 1, 1996.
Development plans will be studied during Mar. 1 to Apr. 1, 1996, after which Yamal-Nenets authorities will call a meeting of participants to view opening of bid envelopes containing details of financial proposals. Announcement of license awards will follow.
Twenty-four companies, two thirds of which were Russian and one third western, attended the Moscow seminar on acreage details in September. Eighteen western and one Russian firm attended a London meeting. Copyright 1995 Oil & Gas Journal. All Rights Reserved.