New drilling in Soviet-era brownfields makes it unlikely that Russia will help ease the global glut
At well pad number 258, Iosif Stefanishin watches with pride as a drill bit burrows deeper and deeper into swampy Siberian plain. This is Russia’s oil heartland, where thousands of miles of forest and mud are interrupted only by clusters of fuel tanks and shiny processing plants.
Mr Stefanishin has been drilling for oil here since Soviet times. The cluster of fields under the control of Yuganskneftegaz, the division of state oil company Rosneft where Mr Stefanishin works as a drilling supervisor, are some of the world’s most prolific. Last year, they pumped 1.25m barrels a day — one in eight barrels produced in Russia, or enough to supply the entire needs of Turkey and Poland combined.
“The market situation has changed, the equipment has changed,” he says of his years working at Yuganskneftegaz since 1986. “Our company was always good.”
But the deposits here were first extracted in the 1960s and the fields are beginning to show their age. Output at Yuganskneftegaz fell nearly 8 per cent from 2012 to a low last summer.
In response, Rosneft has embarked on a surge in drilling and investment. The 2.8km-deep well that Mr Stefanishin is overseeing will be one of 1,500 drilled in 2016; in the first half of this year, Yuganskneftegaz’s drilling rate was 148 per cent higher than the same period two years ago.
Rosneft’s new focus on its Soviet-era brownfield assets comes after the tumble in global oil prices and western sanctions forced it to temper its ambitions to develop new resources, most notably in the Arctic. But after years of under-investment in western Siberia, the effect of Rosneft’s shift on the oil markets could be significant.
Even with production from brownfield operators like Yuganskneftegaz in retreat, Russia’s oil industry, aided by investments in new projects made before the fall in oil prices and cushioned from it by the rouble’s weakness, has defied pessimistic forecasts to lift production significantly since 2014. Kirill Molodtsov, deputy energy minister, yesterday said the country had been pumping an average of 11.09m b/d so far in September — a post-Soviet high.
With Rosneft’s new strategy, Russia is on track to challenge its record production of 11.4m b/d set in 1987. Goldman Sachs analysts predict that Russian output will increase by 590,000 b/d in the next three years.
“In the current oil price environment, Rosneft will shift its attention to better management of brownfields,” says Karen Kostanian, oil analyst for Bank of America Merrill Lynch in Moscow. “If Rosneft can indeed reverse its brownfield decline rates, then the projections of Russian oil production for the next few years are underestimates.” It could also help Moscow persuade foreign investors to buy a 19.5 per cent stake in a company — worth about $11bn at current market prices.
For Igor Sechin, Rosneft’s powerful chief executive, maximising production at its ageing brownfields marks a significant change of emphasis. Mr Sechin, a close ally of President Vladimir Putin, has had one overarching focus for much of the four years he has been in charge of Russia’s dominant state oil champion: the Arctic. In 2012, while unveiling a partnership with ExxonMobil, he described the development of Arctic oil as “more ambitious than man’s first walk on space or sending man to the moon”. Two years later he said Rosneft would “open a new oil province” with reserves equivalent to Saudi Arabia’s.
With ExxonMobil suspending its participation in the joint venture following US sanctions over Moscow’s actions in Ukraine, Mr Sechin has recently struck a different note. Speaking at the St Petersburg International Economic Forum in June, the Rosneft boss enthused not about the Arctic but about western Siberia’s brownfields.
“We believe that in the next 10 years the greatest potential is connected to the effective use of our unique resource base of conventional oil, including in the areas where there is existing infrastructure in western Siberia,” he said.
Rosneft’s surge in drilling at its brownfields appears to dash hopes that Russia will reduce oil production in conjunction with Opec. With its economy hurting from the fall in oil prices, Moscow has been enthusiastic about the possibility of a deal with the oil producers’ cartel to rein in production: earlier this month it agreed to co-operate with Saudi Arabia to “stabilise the oil markets”, and it is due to meet Opec countries in Algiers next week.
Mr Sechin has, however, long spoken out against the viability of a deal with Opec, and Russian observers and industry insiders are deeply sceptical that the country will modify its production, regardless of whether a deal is announced in Algiers.
The Rosneft chief presents its strategy as an implicit response to Russia’s two rival producers: the US, whose rapid increase in shale output has been the major contributor to a glut on the oil markets, and Saudi Arabia, whose decision to fight for market share helped trigger the price crash.
“The quality of the US resource base is such that it needs quite high prices to be exploited,” Mr Sechin said in St Petersburg, while the oil price tumble Saudi Arabia helped to unleash had been “quite painful” for Riyadh.
The basis for Mr Sechin’s confidence is Yuganskneftegaz. Headquartered in Nefteyugansk on a tributary of the Ob river, the company was the cornerstone of Mikhail Khodorkovsky’s Yukos oil group until he was thrown in jail and his company bankrupted in 2006. Now Yuganskneftegaz accounts for 31 per cent of Rosneft’s production.
The unit’s history epitomises the changing fortunes of oil production in western Siberia. The company has struggled to maintain output, and Rosneft has replaced the management team three times in four years.
In the past 18 months, however, Rosneft has managed to stop the rot. The company is more than doubling its drilling rate, from 750 wells a year in 2014 to 1,700 a year from next year. It is also increasing the use of advanced techniques, such as hydraulic fracturing and horizontal drilling. According to Khasan Tatriev, director of Yuganskneftegaz, 13 per cent of the wells it will drill this year will be horizontal, up from 4 per cent three years ago.
The increase has not come cheap: Rosneft’s capital expenditure at Yuganskneftegaz was 79 per cent higher in the first half of 2016, at Rbs70bn ($1.1bn) than in the first half of 2014.
Vladimir Shmatovich, head of strategy at pipemaker TMK, says there has been an increase in the use of fracking across the Russian oil industry. “People are trying to suck as much as possible from existing deposits. Hydro-fracking is a natural way to do that. It’s expensive — but less expensive than drilling greenfields,” he says.
Rosneft’s investment is already showing results: Yuganskneftegaz’s monthly production has been rising steadily since the middle of last year, and since April has been rising year on year. But that is not enough for Rosneft executives, who want to boost Yuganskneftegaz’s output by almost 10 per cent by 2019, adding 120,000 b/d of production.
Central to Rosneft’s plan to revive production at Yuganskneftegaz is the development of deposits known in Russian as “hard-to-recover resources”.
The terminology is important: until 2014, such resources were often described by western and Russian companies in English as “shale”. When the US and Europe imposed sanctions restricting sales of equipment and services to Russian shale oil projects, many feared they would scupper development of such projects.
But Russian executives say only the giant Bazhenov formation, which is estimated by the US energy department to hold 75bn barrels of oil, has been affected. Meanwhile, work on other “hard-to-recover” deposits, such as the Tyumen or Achimov, has continued. Like shale, these are low-permeability formations which require horizontal drilling and fracking to exploit, but the executives say they are geologically distinct from shale and therefore do not fall under the sanctions.
Rosneft in numbers
10% Rosneft’s increased output target for Yuganskneftegaz by 2019, adding 120,000 b/d of production
1,700 New wells Rosneft plans to drill every year from 2017 (13% of which will be horizontal), up from 750 in 2014
$45 Current price for a barrel of Brent crude, down from about $114 in June 2014
“There are some things connected to the Bazhenov which fall under sanctions,” says Alexander Vitevsky, chief geologist at Yuganskneftegaz. “But in fact the main part of our hard-to-recover resources is not the Bazhenov: it is prospects in the Tyumen and Achimov formations.” He says the Bazhenov accounts for an “absolutely insignificant” share of Yuganskneftegaz’s resources.
Mr Tatriev predicts that output of hard-to-recover oil at Yuganskneftegaz will increase more than threefold to 200,000 b/d by 2020.
At well pad number 258, Mr Stefanishin rattles off a list of western service companies working with Rosneft. “We have working with us very successful companies — Baker Hughes, Halliburton — we’re using their rotary steerable systems for drilling horizontal sections.”
There are signs that Rosneft is preparing to use Yuganskneftegaz as a model for its other brownfield assets. It has lifted drilling at Samotlorneftegaz, another western Siberian subsidiary, by 50 per cent this year. “We’re applying the same strategy as Yugansk — the plan is to turn around all these brownfields,” Eric Liron, Rosneft’s first vice-president, told investors earlier this year.
But the push to revive Yuganskneftegaz production, including the use of fracking techniques, is costly. According to Mr Tatriev, the company’s capital expenditures will total Rbs353 a barrel of oil over the next five years, more than double the level of 2014.
For some in the Russian oil industry, Rosneft’s new wave of investment into western Siberia carries an echo of a previous era — and with it, a warning.
This is not the first time that Russia has tried to pump its way out of a crisis. Samotlor is the largest oilfield
in Russia and the second largest in the world. Yet it became a watchword for mismanagement, as ever more ambitious production targets in the 1970s and 1980s led to unsustainable drilling that flooded the reservoir with water, leading ultimately to a drop in production by more than three quarters as the Soviet Union collapsed.
Could Rosneft be embarking on a similarly flawed strategy?
“The perception from professional oil and gas people who look at Rosneft is that they’re chasing production at all costs,” says a Russian industry veteran.
People close to Rosneft privately concede that its investments in western Siberia are not motivated by profitability alone. They are also driven by the need to maintain Rosneft’s overall production levels — which are critical to the Russian government’s tax revenues.
While the company has increased the sophistication of its operations, the turnround in production is also the result of a huge increase in drilling.
“You’re just bringing forward production,” says the industry veteran. “That’s not always the right thing to do from a value perspective.”
Taxation: Investment case hit by need for cash
If western sanctions are not a barrier to Rosneft’s plans to revive Yuganskneftegaz, its own government could turn out to be more problematic.
The main reason for the historical under-investment in Russia’s brownfields was not lack of interest, but the tax system. Russia taxes its oil producers based on their output rather than profitability, providing little incentive to invest in more sophisticated and expensive drilling techniques.
Before the fall in oil prices, Moscow had attempted to stimulate investment in new fields by offering tax breaks to greenfield projects.
“At higher oil prices, it was a very easy trade-off for the Russian government: don’t touch the taxation on brownfields which provide income for the budget, exempt greenfields from taxes and attract foreign investment,” says Karen Kostanian, an analyst at Bank of America Merrill Lynch. “The paradigm under low oil prices is different. Now the Russian government might choose to stimulate higher production at brownfields with lower taxation.”
That idea was endorsed by Vladimir Putin, Russia’s president, at a meeting with energy executives last year when he instructed the government to start working on a new tax system.
But in the short term, the Russian government appears more likely to raise taxes on producers than cut them.
Faced with a persistent budget deficit and the prospect of its stabilisation fund running out of money next year, the finance ministry is discussing a raid on the oil industry to raise Rbs200bn ($3bn) in additional tax revenues next year.
“The key variable that determines oil production in Russia is not oil prices but the fiscal terms,” Rosneft chief executive Igor Sechin said at the St Petersburg International Economic Forum in June.
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