What Lies Beneath: Development of Russian Tight Oil to Offset Production Decline

by Stephanie Bryant

The Western Siberian Basin is the epicenter of Russian crude oil production, but more importantly, it is slated to be the setting of Russia’s very own shale oil and gas revolution. The Bazhenov formation is eighty times the size of the Bakken field and contains 75 billion barrels of tight oil, making it the largest tight oil reserve in the world. With production of conventional crude oil set to begin a steady decline by 2030, the Russian government is pushing to be able to fill the predicted deficit before it occurs. Using reductions in the Mineral Extraction Tax to create an environment more suitable to investment, as well as partnering with American companies that have the technological equipment and expertise gained during their own “shale revolution,” the Russian oil industry is expected by the government to boost tight oil production from the currently marginal production to 1 million barrels per day by 2025. This benchmark is feasible, but its successful attainment depends on a favorable tax scheme and the implementation of other “above ground” factors such as advanced technological capabilities, a sufficient number of high-horsepower rigs, and the ability of large corporations to adapt to an industry that requires flexibility.

In Anticipation of an Oil Production Decline

Curently ahead of Saudi Arabia and the United States, Russia is the world’s top oil producer, but experts say this level is unsustainable without new exploration and investment. Russia is producing primarily from declining fields, and the country’s current production level is unsustainable without new exploration and investment. Energy outlooks predict a severe decline by 2012, citing a lack of investment into new reservoirs. 60% of total Russian oil production comes from the Cretaceous sandstone of the Western Siberian basin, whose fields already peaked in the late 1980’s.

The General Scheme of Oil Industry Development produced the lowest forecast, predicting a 55% decline from the 2010 rate of 10.2 mmbpd to the estimated 2030 rate of 4.6 mmbpd. The average anticipated decline is 30% over the next 20 years. Since approximately 40% of the state’s revenue comprises taxes and export duties levied on the energy industry, production declines will have serious consequences for an already-strained federal budget. The HSBC estimates that if this downward trend is not corrected, the Russian state will experience an initial loss of $2.1 billion as soon as 2021. Although East Siberian, Caspian Sea, and Arctic green fields present a post-2030 solution, oil fields that contain tight oil reserves have already been developed for crude oil production and are, therefore, less costly to develop than unexplored green fields. Since tight oil may be a more economically reasonable avenue to combat production decline, the Russian government hopes to increase its share in total oil production to 10% by 2025.

The Tight Oil Reserve Solution: Bazhenov

Taking the aforementioned production outlooks into consideration, the government has encouraged investment into unconventional and tight oil reservoirs, the majority of which are found 2700-3100 metres below the surface of the Western Siberian basin in the Upper Jurassic Bazhenov shale. The EIA estimates that these strata of the Bazhenov formation contain the largest amount of technically recoverable shale oil reserves in the world, numbering close to 75 billion barrels. Covering a span of 2.2 million square kilometers, the Bazhenov formation is eighty times larger than the Bakken formation in the northern United States.

The EIA estimates that these strata of the Bazhenov formation contain the largest amount of technically recoverable shale oil reserves in the world.

The primary difficulty in development lies in the rock heterogeneity, as is generally the case with shale reserves. Wells that are mere kilometers apart provide different information concerning flow rates, reservoir formations and decline curves. This is discouraging for companies that need to how many horizontal wells to construct and where to place them, adding to the financial disincentive of tight oil development. However, the geological similarity of Bazhenov and Bakken has led Russian industry leaders to look to American companies for technological and financial assistance with pilot projects and development.

ExxonMobil-ization of Technology for Rosneft’s Tight Oil Licenses

Current tight oil producers in the Bazhenov are Surgutneftegaz, Lukoil and Rosneft. In order to meet the strategic goal of 10% of total oil production (1 mmbpd), production will have to increase exponentially. Rosneft stated that it believes it will be producing 300,000 bpd by 2020 and both Gazprom and TNK-BP (before its acquisition by Rosneft) each predicted production levels of 50,000 bpd.

Although the Energy Ministry believes these companies’ estimations are feasible, present production is only a small fraction of that. This low output is primarily due to the fact that producers are still familiarizing themselves with the geology and experimenting with the necessary technology in order to achieve the most economical production formula. Mass production is still not profitable. Large companies are hoping that Western seismic surveillance and hydraulic fracturing techniques will increase the future profitability of their unexplored licenses.

To this end, Rosneft and ExxonMobil officially formed a joint venture to undertake a pilot project on December 7, 2012, that was scheduled to begin in 2013 and will hypothetically end in 2015. Combining ExxonMobil’s technology and $300 million of investment with Rosneft’s experience with the geography and conventional crude production in the region, the results of this project will address overarching concerns about the nascent tight oil industry such as the heterogeneity of the rock formation, the profitability under the recently restructured energy taxes, and the amount of technology and geological expertise required to economically exploit these reservoirs. Or as Rex Tillerson, the CEO of ExxonMobil, so succinctly phrased it, “the real issue is can we develop it in a cost effective way? –same as the issue we have with tight and unconventional resources in North America.” The project will occur over Rosneft’s 23 licensed blocks covering an area of 10,000 square kilometers.

Tax Reform

Pushing to encourage corporate investment into development of new tight oil fields as early as 2011, the Russian government began amending its tax structure in order to encourage oil companies to invest in “hard to recover” resource development. Although the State Duma passed a bill in July of this year that would reduce the Mineral Extraction Tax using a coefficient based on reservoir porosity and permeability, it still may not allow enough revenue to entice the rapid investment required. According to this tax scheme, if a Bazhenov well is commercially viable, it will have a coefficient of zero and taxation will not occur for the first five years of well life, but this zero coefficient will not hold true for all tight oil plays. As James Henderson notes in his most recent treatise on the Russian tight oil industry, if the oil price is held constant at $100 per barrel, the current tax structure would actually produce a -5% economic rate of return and would require an export price of $200 a barrel to achieve a hurdle rate, or minimum internal rate of return, of 15%.

Although the State Duma passed a bill in July of this year that would reduce the Mineral Extraction Tax, it still may not allow enough revenue to entice the rapid investment required.

The tax amendment still does not account for more than a 20% dry hole percentage, or the percentage of wells that will not produce, or for non-commercial wells, both of which are fairly likely given the heterogeneity of the geological formation. 3D seismic surveys reduce but cannot eliminate the risk of developing dry holes by providing imagery of the field. Given Surgutneftegas’ 35% dry hole percentage in its exploration and production of tight oil, this tax amendment will need further reductions to increase the financial incentive to develop. Nor does the MET reduction take into consideration the varying output of wells, which is “the same problem being faced by the Russian industry as a whole.” Henderson further points out that even if a $9 million well is commercially viable and produces around 350 barrels per day, the economic rate of return will be significantly less than the hurdle rate. Given the recent slowing of economic growth and how reliant the state budget is, and will be, on revenue from the energy industry, it is unlikely that further tax reductions will be discussed until the results of the Rosneft/ExxonMobil pilot project in 2015 are analyzed.

Necessary “Above Ground” Factors

Beyond the necessary tax reforms, economic tight oil development faces a series of “above ground” demands before it will be an eligible contender to offset the decline in total oil production. Firstly, the number of rigs required to achieve and maintain a 1 mmbpd level of production is approximately 220. Those rigs would solely be dedicated to the development of new tight oil reserves in the Western Siberian Basin. Only 17% of the current rig count would be powerful enough to drill a horizontal well (1500 hp or higher), and those rigs are currently occupied with wells dug in 2012. Basically, an entirely new fleet will be needed just to focus on Western Siberian tight oil development. Rigs will be a $9 billion demand that American, Chinese, and Russian companies are already vying to fill.

Large companies have the resources to create strong logistical frameworks, but “all those things become weaknesses when you work with shale plays…and adaptive planning is what the smaller companies are good at,” writes Ed Crooks.

Another factor seen as critical to American success with shale oil and gas is the notable absence of large companies. With the departure of Shell from its Eagle Ford lease at the end of September, ExxonMobil is now the last major company in the American “unconventional game.” Instead, 89 small to medium operators were responsible for the “shale revolution.” In contrast, the Russian tight oil industry is dominated by large Russian companies who have joint venture agreements with large Western companies. According to Ed Crooks at the Financial Times, large companies have the resources to create strong logistical frameworks, but “all those things become weaknesses when you work with shale plays…and adaptive planning is what the smaller companies are good at.” Small companies may not stand much of a chance in the Russian tight oil industry, as both tax schemes and licensing procedures favor the monoliths.

Confidence in Tight Oil Development

Although all signs point to the uneven development of a potentially financially unsustainable industry, companies have remained active in their exploration efforts. RusPetro continued ahead into a partnership agreement with Schlumberger at the end of September to produce horizontal, multi-stage fractured wells on its 1200 square kilometer Bazhenov lease. Schlumberger likewise released a report maintaining that while any reserve development is costly, light tight oil reservoirs can be developed at a slower rate and are therefore lower risk. Further adjustments will need to be made after the results of the Rosneft-ExxonMobil pilot project are published in 2015, but most analysts remain cautiously hopeful. Among these is Oleg Mikhailov, an ex-pilot director at TNK-BP and current VP of oil and gas development at Bashneft who thinks the steep learning curve will ultimately be beneficial to Russia’s energy industry: “What is easy today was tight yesterday. What is tight today with technology and a good tax regime will be easy tomorrow.”

Stephanie Bryant is an MA student at the European University at St. Petersburg.


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