COMMENT RUSSIA AIMS FOR FAVORABLE CLIMATE FOR JOINT VENTURES

Aug. 10, 1992
Andrei A. Konoplyanik Deputy Minister Russian Federation Ministry for Fuel and Energy Moscow Nikolai N. Lisovsky Deputy Chairman Committee for Oil Industry Russian Federation Ministry for Fuel and Energy Moscow Unofficial estimates place potential investment by foreign firms in the Russian oil industry at $60-70 billion. Taking this into account, Russia must present a clear, long term strategy to potential investors. It must persuade them that the rather risky economic and political

Andrei A. Konoplyanik
Deputy Minister
Russian Federation Ministry for Fuel and Energy
Moscow
Nikolai N. Lisovsky
Deputy Chairman
Committee for Oil Industry
Russian Federation Ministry for Fuel and Energy
Moscow

Unofficial estimates place potential investment by foreign firms in the Russian oil industry at $60-70 billion.

Taking this into account, Russia must present a clear, long term strategy to potential investors. It must persuade them that the rather risky economic and political environment is at an end.

World markets have been very competitive in recent years in seeking foreign investors. That is why creation of a favorable climate for investors-domestic and foreign-is a vital issue for all host countries looking for foreign capital.

The Russian government intends to develop relations with all countries based on principles declared in the European Energy Charter and its legally binding documents. Under those documents, common energy and economic frameworks are to be established in the industrial world.

A set of nondiscrimination rules will assure equal access to energy resources, export markets, transportation, and technologies, as well as capital markets. That will promote a balance of interests between host countries and prospective investors in investment protection and in trade related and political issues.

From this point of view major improvements need to be made in Russian oil tax laws. Today's tax system is rather restrictive and indifferent to market fluctuations. That is because the current tax system relies too much on taxes on revenue, not profits.

Russia's current tax system is rather complex. Different calculations place the total number of taxes, tariffs, and duties at the federal, regional, and local levels at 39-42. Each one may not be very high, but their combined effect is considered by producers to be too high in international practice.

High taxes penalize operations with higher production costs, increase producer risks, and thus discourage new developments.

World Bank data show elsewhere in the world total government take of profits amounts to 40-80% at the margin, depending on profitability of the project. Taxes and price controls in Russia now appropriate as much as 100% or more of producer profits.

EXPORT TARIFF

The major negative effect on profits of foreign investors is the "export tariff" imposed last Jan. 1 with a flat rate equal to 26 European currency units/ton of crude, More than a dozen oil industry joint ventures have asked the Ministry of Fuel and Energy for exemptions from the tariff in order to maintain the economics of their production.

The dollar value of the tariff - $35/metric ton, or $5/bbl- is equal to about 30% of the world oil price.

The tariff was established to balance the difference between international and domestic oil prices for production units that had been exporting part of their oil and for intermediary or broker firms that were buying domestically priced oil for resale on the world market.

The tariff hit the economics of joint ventures hard because they were making their investment decisions based on world market prices.

There have been rather sharp discussions in the government between supporters and opponents of the tariff.

Among those that supported the tariff, even for joint ventures established before last Jan. 1, were "fiscal" ministries that helped create it: the Ministry of Finance, Ministry of Foreign Economic Relations, and Customs Committee.

Among those that opposed tariff imposition on joint ventures registered before Jan. 1 were ministries responsible for long term economic development-the Ministry for Fuel and Energy, Committee for Foreign Investments, and Ministry of Economics-even though Russian foreign investment law provides no grandfather clause.

As a result of these discussions, two joint ventures that were the first to address the Ministry for Fuel and Energy and Committee for Foreign Investments with their export tariff problems early in June won exemptions for their payback period.

Deputy Prime Minister E. Gaidar has signed the exemption decrees for the Komiarcticoil joint venture established by Gulf Canada, British Gas, and Russian Komineft Production Unit and the Polar Lights joint venture formed by Conoco and Russian Arkhangelskgeologia Production Unit.

The Ministry for Fuels and Energy and Committee for Foreign Investments are preparing a more general exemption decree to free from the export tariff -presumably for the payback period-au energy producing joint ventures established in Russia before last Jan. 1.

Let us hope this is only the start of rationalization of the Russian oil tax system.

SHORT TERM PRIORITY

Russia's No. 1 short term problem is trying to halt production declines in today's oil fields. It believes the quickest return on investment can come from restoration of idle oil wells.

Well shut-ins have grown in recent years for lack of equipment and technical resources. Last Mar. 1 Russia's number of idle wells exceeded 25,000.

The number of shut-in wells rose rapidly during the past 3 years, increasing by 2,100 in 1989, 6,700 in 1990, and 5,900 in 1991 by 5,900. The first 2 months of 1992 saw another by 1,600 wells idled.

Most of the shut-ins are in western Siberia. Last Mar. 1 they numbered 17,900, or 25.3% of western Siberia's total. Producing enterprises estimated their average lost oil production at 8 metric tons/day/well (58.4 b/d/well).

The average loss of oil production throughout Russia because of well shut-ins is about 30 million metric tons (219 million bbl)/year with an estimated export value of $3.6 billion.

Western firms can make their investments in well restoration programs under service contract arrangements in which Russian producers receive western credits to buy equipment, then repay the credits with a portion of oil produced by repaired wells.

This potential credit line has been rather well prepared by the Russian side. A lot of contracts for equipment purchases have been negotiated and many of them were signed.

But as a result of the U.S.S.R. Vnesheconombank bankruptcy in December 1991 all hard currency accounts of oil producing enterprises were frozen, and they cannot pay for their contracts. One needs to understand that new credit lines will be used as typical bridge financing for highly reliable, technically developed projects that well suit small and medium firms.

Support for this type of projects was proposed by the World Bank and European Bank for Reconstruction and Development (EBRD).

World Bank has been preparing a special petroleum credit line for Russia worth as much as $1 billion and is expected to increase this sum by millions of dollars through the energy portion of an urgent rehabilitation credit.

EBRD intends to provide the Russian oil economy about $500 million in addition to World Bank's oil loans. Three fifths of the EBRD sum will be proposed to five or six production enterprises for restoration of idle oil wells and purchases of imported production equipment.

In the medium term-3-5 years-it is possible to prevent an oil production decline through massive development of proved fields that are shut in for lack of money for domestic development.

Foreign companies are to be involved in this activity on a tender basis. The return on their investment will come in the form of guarantees for export of their portion of oil produced.

The companies will be given opportunities to invest their profits in stocks of established joint companies and privatized oil enterprises.

Foreign firms will receive access not only to marginal fields, as it was in the past, but to fields with favorable parameters-rather big with high productivity, for example.

To solve complex procedural problems, the Investment Tender Commission (ITC) was established under the auspices of the Committee for Foreign Investments attached to the Ministry of Finance. Head of the ITC is Leonid Grigoriev, who also heads the Committee for Foreign Investments.

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