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Investment strong despite fall in Russian licensing activity

Prospective areas with existing infrastructure and strong reserves profiles remained the most attractive upstream acreage for investors in recent years. Analysis by Alexander Chesnokov, Mikhail Gerasimchuk and Denis Afanasyev, of Deloitte

Oil and gas companies' investment in exploration and production (E&P) remains stable despite the fall in licensing activity in Russia in recent years, according to recent Deloitte analysis of the country's upstream activity. The most attractive regions for new E&P acquisitions are the mature West Siberian, Timan-Pechora and Volga-Urals oil and gas basins. About 70% of total spending was in West Siberia, where Lukoil, Rosneft and Novatek were the key investors in licence blocks.

However, investment by independent producers was strong, and accounted for about $300 million over the past three years. Licences in the Volga-Urals region have the highest cost per barrel of oil equivalent (boe), significantly above the range of $0.35-0.40 per barrel achieved in West Siberia and Timan-Pechora. This reflects companies' willingness to pay above the initial cost for acreage in regions they already operate in and where infrastructure is already in place. 

For the analysis, which covers 2011-13, Deloitte examined 166 licence areas and analysed key licence costs by region and company. Reserves and resources data are based on the Russian reserves and resources classification system. The analysis uses Deloitte databases supplemented with a variety of publically available data sources.

The number of licences that the Russian government puts up for auction decreases from year to year, as does the number of blocks awarded. 

The reserve structure has also been changing, with a larger proportion of non-tangible reserves categories, which need to be explored and would be considered as higher-risk investments. Despite this, investment on the acquisition of E&P acreage remains largely flat, mainly due to significant spend in the mature region of West Siberia, followed by the prospective Volga-Urals and Timan-Pechora regions.

All major Russian operators actively participated in licensing rounds, with about half of the licences awarded between 2011 and 2013. Rosneft, Lukoil and Surgutneftegaz were the most active investors, playing on their existing production bases in West Siberia.

The cost of a licence per barrel varies significantly with the highest costs found in well-developed regions such as Volga-Urals and West Siberia and the lowest in East Siberia. The East Siberia and Far East regions are considered to be a base for future exploration activity, which will demand significant investments by oil and gas companies. 

Siberian results

The total investment in Russian acreage by oil and gas companies between 2011 and 2013 amounted to around $3.5 billion. About 70% of this was spent in West Siberia, which remains the most attractive region for E&P investment in Russia. Timan-Pechora and Volga-Urals are two other regions of high E&P interest.

The large amount of investment spent on West Siberian licence acreages can be explained by the confidence in reserves: the licences hold 95% of the C1 and C2 reserves of all the awarded blocks. Developed infrastructure also makes the blocks attractive targets.

In 2012, Lukoil acquired the Imilorsky acreage in West Siberia, with reserves of 193.7m tonnes in the C1 and C2 categories. This acquisition accounts for half of all expenditure on E&P upstream acreage over the three-year period. The Imilorsky Block includes the Imilorskoe, West Imilorskoe and Istochnoe fields, in the Khanty-Mansiysk autonomous district (Yugra). The company offered a one-time payment of $1.6 billion for subsoil use, a figure which represents about 74% of all spending on licence blocks in 2012. The high cost should be offset by production growth and the region's good infrastructure to support development. 

The average licence cost is also highest in West Siberia, estimated at $76.1m, followed by Far East and Timan-Pechora with $27.8m and $26.1m, respectively. The Far East acquisitions are mostly related to the offshore blocks in the Sea of Okhotsk. The most significant payment in Timan-Pechora was made for the Yangareysky Block, for which Bashneft paid approximately $87m.

Lukoil was the biggest spender on upstream acquisitions between 2011 and 2013. Another active player was state-controlled Rosneft, closely followed by the country's largest independent natural gas producer, Novatek. Novatek licence blocks, bought at an average of $65m, were three times more expensive than those purchased by Rosneft. Independent oil and gas companies were significant investors, but with a relatively small average cost per acreage ($3.3m), as independent producers generally acquired blocks with low-quality reserves, or resources evaluated as C3, D1 and D2.

A look at the changes in annual spending on acquisitions between 2011 and 2013 shows that without Lukoil's $1.6bn Imilorsky purchase, volumes have remained largely consistent. 

Rosneft halved its total expenditures on E&P in 2013 compared with 2011, but over the same period Surgutneftegaz significantly increased its investment, spending $160m in 2013, up from just $12m in 2011. Independent producers have shown substantial growth in investment over the period. 

The average cost of licence acreage has also increased every year, and in 2013 it was 20% higher than in 2011. Companies paid more than $1m over the initial cost suggested by the government on 30 occasions between 2011 and 2013.

Lukoil, Rosneft, Bashneft and Surgutneftegaz were most likely to pay a premium over the initial cost, often because these major players either had existing infrastructure in place, or the block was close to others already owned by the company, or the region was regarded as strategically important to the company .

Lukoil' massive overpayment of almost $800m for the Imilorsky licence reflects its location near the company's West Siberia production area cluster, and its Tevlino-Russkinskoe oilfield, which is already connected to the Transneft export pipeline. 

Oil from the Imilorsky Block can be easily transported to Lukoil's refinery near Perm. Some operational facilities, such as roads, pipelines and power lines, are also already in place. The firm paid almost double the cost proposed by the government.

Lukoil and Bashneft concentrate their production in the Timan-Pechora region and cooperate extensively. Such arrangements, where a partner's infrastructure can be exploited, can also lead the players involved to pay significantly more than the initial cost. 

Bashneft will potentially be able to use Lukoil's existing operational and transport infrastructure, particularly its oil-export terminal on the Barents Sea, and its Kharyaga-Usa pipeline to Usinsk, in the Komi Republic, to transport oil from Bashneft's Yangareysky and Sibriyaginsky blocks along with oil from Lukoil's Severo-Komandirshorsky and Verkhneyangareysky blocks.

The average payment above the initial level for these blocks was $65m. The average cost of a licence per boe, for C1 and C2 reserves associated with discovered fields, is estimated to be $0.5/boe. Average costs for risked C3, D1 and D2 resources are estimated at $0.15/boe.

The highest costs per boe over the past three years paid by companies has been in the Volga-Ural oil and gas basin and averaged $0.95. 

Kubanneft's purchase of the Akhtanizovsky Block in the Southern Region, for $1.30/boe, was a clear exception. In West Siberia and Timan Pechora, the average cost is between $0.35/boe and $0.41/boe. For other blocks in the Southern Region, costs averaged less than $0.04/boe.

The most expensive oil per boe costs in the period under review were paid by Lukoil, averaging more than $1.00/boe, including $1.20/boe for the Imilorsky acreage. At the opposite end of the scale, Novatek's boe cost for reserves was minimal. Most of the company's acquisitions were in the Yamalo-Nenetsky autonomous area, which has poorly developed infrastructure.

Despite the reduction of licensing activity in Russia in recent years, investment in E&P acreages remain stable. The most attractive regions for new acquisitions are the mature West Siberian, Timan-Pechora and Volga-Urals plays.

Approximately 70% of total investment was made in West Siberia, with Lukoil, Rosneft and Novatek being the key investors. However, investment by independent producers was strong at around $300m over the last three years. Licences in the Volga-Urals region have the highest cost per barrel of oil equivalent, significantly above the range of $0.35-$0.40 achieved in West Siberia and Timan-Pechora, reflecting companies willingness to pay above the initial cost for acreage in regions they currently operate in and with developed infrastructure.

Alexander Chesnokov, Mikhail Gerasimchuk and Denis Afanasyev work in Deloitte’s Petroleum Services Group in Moscow

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