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Russia’s Oil Lead Challenged as Taxes Strangle Drilling

Russia’s Oil Lead Challenged as Taxes Strangle Drilling
An employee carries a safety helmet through the snow at the illuminated Lukoil-Nizhegorodnefteorgsintez petroleum refinery, operated by OAO Lukoil, in Nizhny Novgorod, Russia. Photographer: Andrey Rudakov/Bloomberg

The U.S. and Saudi Arabia are approaching Russia as the world’s leading oil producer, with production rising 12 percent in the U.S. and 5.9 percent in Saudi Arabia last year. The U.S. production spurt is 10 times Russia’s 1.2 percent growth rate.

The prime reason, according to oil company executives on the ground, is the Russian failure so far to repeal taxes that devour more than two-thirds of the revenue from a barrel of crude and thus have choked output.

While Russia’s shale-oil deposits sprawl over territory twice the size of U.S. discoveries, energy companies have little incentive to explore them because of production and mineral-extraction taxes that take the equivalent of $71 a barrel when crude trades for $100, said Donald Wolcott, chief executive officer of RusPetro Plc, a Moscow-based oil producer with wells in Western Siberia.

The Russian bureaucracy and Duma, the lower house of Russia’s parliament, haven’t fulfilled President Vladimir Putin’s call 11 months ago for tax breaks to spur drilling, Wolcott said in a telephone interview.

“There are hundreds of shale and tight-oil opportunities in Russia but the one thing missing is a tax break” to make drilling economical, said Thane Gustafson, a senior director at IHS Inc. who led a panel with executives from TNK-BP and Lukoil OAO at IHS CERAWeek in Houston today. “The crews are there and the skills are there but it’s the above-ground tax issues that are limiting factors.”

Exxon Venture

Putin’s April pledge to reduce the tax burden on producers that explore more costly unconventional resources such as shale helped convince Exxon Mobil Corp. to undertake a $3.2 billion venture with Russia’s Rosneft OAO. In exchange for access to the Arctic Ocean and Siberia, Exxon gave state-controlled Rosneft entry into oil fields from the Gulf of Mexico to the Canadian Rocky Mountains.

Russian producers are getting back $22 to $24 a barrel at current prices, Andrei Gaidamaka, a Lukoil vice president, said today in a panel at IHS CERAWeek.

“At Lukoil, we would never sanction a well which would be producing below 150 barrels a day,” Gaidamaka said. “That is a very high flow rate by U.S. standards.”

The proposal before the Duma would double the so-called netback to $50 a barrel on certain tight-oil deposits, a “substantial” incentive, he said. He expects passage by mid-year.

Tax Relief

Other explorers counting on tax relief for unconventional drilling include TNK-BP, Gazprom Neft and Royal Dutch Shell Plc. TNK-BP began drilling pilot wells in formations including Severo-Khokhryakovskoye and Em-Egovskoye that hold an estimated 4.4 billion barrels of crude in December and January, respectfully, according to a Feb. 28 slide presentation. Those projects are expected to deliver their first crude later this year.

Gazprom Neft, the oil-producing arm of gas giant Gazprom OAO, has a partnership with Shell that plans to spend $80 million this year to explore the Salym shale exploration, Ekaterina Stenyakina, a spokeswoman for Gazprom Neft, said in a Jan. 31 e-mailed statement. The company estimates it has 3.67 billion barrels of resources in unconventional formations that would qualify for tax breaks, she said.

‘Adjusted’ Taxes

“Russia’s tax system needs to be adjusted to make their development economic,” Stenyakina wrote.

Russia produced an average of 10.73 million barrels a day last year -- leading the world for the second straight year -- according to an International Energy Agency report released on Feb. 13. Saudi Arabia ranked second with an average output of 9.57 million barrels a day while the U.S. ranked third with an average of 9.11 million barrels.

The IEA’s crude tallies include condensates and so-called natural gas liquids.

The impact of the production and mineral-extraction taxes when crude is selling for $100 a barrel means that, after paying pipeline fees, producers in Russia are left with about $22 a barrel to lease rigs, pay workers, rent equipment and service debt before recording any profit, said Wolcott, a petroleum engineer who oversaw production and reservoir performance at Mikhail Khodorkovsky’s Yukos Oil Co. from 1999 to 2005.

The production tax is the larger of the two, accounting for about $50 of the per-barrel levy when crude trades for $100. That would remain unchanged under Putin’s proposal.

Unprofitable Fields

The mineral-extraction tax, which accounts for about $21 of the government take, would be reduced or eliminated, depending on the criteria eventually adopted by the Duma, according to Wolcott. In addition to those two taxes, oil producers usually are charged another $7 a barrel in transportation costs, he said.

In other parts of the world, that level of taxation would make some fields unprofitable. Exxon Mobil, the world’s biggest energy company by market value, recorded production costs last year as high as $26.94 a barrel in some regions where it operates, according to a Feb. 27 U.S. Securities and Exchange Commission filing.

The company, based in Irving, Texas, spent as little as $3.74 a barrel to pump crude in Asia and as much as $26.94 a barrel in Canada and South America, according to the filing.

The Prize

Wolcott and others think relief is coming in Russia -- perhaps as soon as next month. The issue, he said, seems to be bureaucratic as Russian government regulators continue to mull how to structure the tax breaks and which geological formations will qualify. Once they weigh in, the recommendations will be forwarded to lawmakers for approval.

“Even when oil is $100 a barrel, here in Russia you’re operating in a low oil-price environment because of these really aggressive taxes,” Wolcott said. Tax relief “would certainly help” spur more drilling.

Companies must demonstrate that by spurring production, lower oil taxes will increase federal revenues, Sergey Vakulenko, head of strategy for Gazprom Neft, said today at IHS CERAWeek.

“The size of the prize is enormous,” he said.

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