Yugra is ready for an investment revolution

01.11.2011 — Analysis

The Yugra government is making attempts to boost up oil production. Offering tax benefits, the government authorities are urging oil companies to increase investment in prospecting of new oilfields and in development of low yield wells. Experts expect that benefits will help to halt the plunge in oil production and to retain jobs. The further growth requires fundamental revision of the tax legislation and government support in geological prospecting and exploration. However, as the RusBusinessNews columnist has found it out, the federal government is not ready for reforms in the oil industry so far.

The Yugra Parliament has decreased the rate of the profit tax by several points for the oil companies that make investment in the capital assets (fixed assets) and undertake expenditures on geological exploration in the autonomous district. There has also been offered preferential treatment in taxation of corporate property, which is applied to the real property within the boundaries of oil-bearing land commissioned into development after January 1, 2011. The incentive rate will also be applied to the property created within implementation of the investment project for recovery of fractions from associated petroleum gas.

According to Pavel Sidorov, the director of the Department for Economic Development of the Khanty-Mansi Autonomous District - Yugra, the tax benefits will account for 9.1% in the total investment of oil companies in 2012, with the further 9.4% - in 2013 and 9.8% - in 2014. Oil companies can channel the released resources to development of any activities performed by them, including development of low-yield oil wells. The government authorities, offering preferences, expect an increase in additional investment in oil production, a larger taxable base in terms of the corporate profit and property tax, and retention of jobs.

It is not the first time that the regional government has bolstered the oil industry. Clouded prospects of oil production press to such support. As it was stated at the Oil-Gas Fuel & Energy Complex-2011 Forum by Sergey Bastrikov, General Director of the Siberian Research Institute Of Petroleum Industry, in 2007 Yugra reported the output of 278 million tons of black gold, whereas by 2011 the output went down to 266 million tons. By 2020 the output may decrease by another third. The decreasing output is caused, first of all, by depletion of the older oilfields and more challenging conditions of production, which are typical of the new fields.

Being concerned about dim prospects of shrinking revenues and jobs, the Yugra government authorities decided to back up oil companies through tax benefits. The rates and the types of bolstered activities are regularly reviewed. Starting from January, 1, 2012, the emphasis will be placed on increasing the hydrocarbon production levels, while decreasing taxes related to exploration and drilling operations. However, oil companies have not been satisfied: They said that today no one is interested in deep exploration drilling that is extremely costly. The companies suggested increasing reserves through development of older oilfields, by improving oil reservoir performance and giving a boost to construction of networks and infrastructure for associated gas utilization.

Eventually, the compromise solution has been found. According to Lyubov Malyshkina, the head of the Department for Ecological Safety and Environmental Management at Surgutneftegaz, OJSC, due to the decreased profit and property tax rates, companies will be able to increase investment and retain jobs. The production can be maintained at the current level through branching of the existing wells or through drilling the new ones.

Undoubtedly, oil companies would like more substantial support. The region has many worked-out deposits that need specific taxation treatment. For several years there has been a discussion that the mineral extraction tax should be lower for low-yield wells and for wells with sticky oil; however, such fiscal loosening is the prerogative of the federal government, but it does not make any steps. In addition to taxes, something must be done with the non-licensed stock of prospects: L. Malyshkina states the oil companies do not have many areas for exploration; therefore, the production increase depends directly on the land available to companies. The combination of tax benefits and bulk selling of land property through auctions would help to build up oil production. There are reserves to do this.

Vladimir Koltsov, the head of the technological department at NizhnevartovskNIPIneft, OJSC, agrees that the production can be increased through exploitation drilling; however, the discovered oil fields cannot be "tapped" endlessly. There will not be any new fields without a serious approach to deep prospecting drilling. Risks are enormous: Oil may not be found, accidents may happen; that is why private companies are not enthusiastic about geological exploration. In the Soviet times, prospecting attempts were financed from the geological exploration fund that was supported by all oil and gas organizations. The responsibility for allocation of funds rested with the sector ministry, which, eventually, accepted all risks. In the 1990s this fund, along with the centrally planned economy, disappeared, and there were no new oil fields any longer. Therefore, in V. Koltsov's opinion, tax incentives will not be able to solve the problem of a substantial increase in reserves.

Igor Shpurov, General Director of the West-Siberian Research Institute of Geology and Geophysics, a federal state unitary enterprise, thinks that the government should play first fiddle in exploration of deep horizons, as the cancellation of the mineral replacement tax resulted in a dramatic reduction of funds allocated for geological prospecting. Today, there must be system solutions in provision of incentives for prospecting work and development of oil fields - first of all, those where reserves are difficult to recover. Such incentives can include preferential tax treatment for the mineral extraction tax for the wells with sticky oil, administrative preferences, and a specific licensing policy. The expert is sure that the government should try to find incentive mechanisms to stimulate prospecting work and adopt legislative innovations that would help to start up the mechanism of efficient public-private partnership, including incentives in exploration and development of non-licensed fields. Private business will be interested in deep drilling, if it understands that the government means business.

Natalia Fortunatova, Deputy General Director of the All-Russian Research Geological Oil Institute, a federal state unitary enterprise, thinks that the main problem related to the decreased production is that oil companies do not have comprehensive knowledge in exploitation of mineral resources. The field production in Yugra is becoming more challenging (oil lies at deeper levels, subsurface structure is becoming more complex), but oil companies do not have professionals who would know how to operate in these conditions. Engineers have gained some experience while working at their oilfields, but, but their knowledge is fragmentary. Such scrappy information leads to wrong conclusions; therefore, many exploration operations are not completed.

N. Fortunatova thinks that today's main task is to delegate the responsibility for exploration and discovery of new oil deposits to the government, as information and human resources (generally, well advanced in years) are concentrated in government institutions. Experts, who have worked in geology for many years, understand that research focused on individual oilfields is not sufficient - the entire picture must be studied. The leading part belongs to science; profound research and feasibility studies are required so that oil producers would be sent to available fields. Natalia Fortunatova believes that after the government takes over exploration functions, the next stage should include reforms in tax legislation to stir oil producers' interest in challenging oilfields or the fields that reached the end of their production life.

Vladimir Malakhov, the head of the laboratory at the Institute of Energy Research of the Russian Academy of Sciences, is sure that the federal authorities will not agree to decrease revenues. The present-day situation is intricate: Oil prices can go down, the Russian balance of trade can change or any other economic troubles can happen. The size of the Russian Reserve Fund depends directly on the mineral extraction tax. Furthermore, it is one of the most transparent taxes, and it will be difficult to replace it with something adequate. The expert thinks that any other tax can broaden possibilities of oil companies in manipulating payments to the budget - for example, through transfer pricing. Therefore, in the near future Russia is free of risk of plunging into taxation reforms in the oil sector.

In the meantime, Alexei Belogoriev, the head of the expert analysis department of the Institute for Energy Strategy, thinks that the taxation system has to be changed in the near future: The amount of investment in geological exploration and search for new oilfields is decreasing, and without incentives offered to oil companies oil production levels are unlikely to increase.

Vladimir Terletsky