Tight Oil Developments in Russia

James Henderson : The Oxford Institute for Energy Studies
Part 1, click here to read part 2

Introduction
Production of unconventional oil has transformed the US energy landscape, creating the potential for that country to reduce its reliance on oil imports and to contribute to the possibility of North America’s becoming energy independent by the end of this decade. As Fattouh and Sen point out, however, in their recent OIES Comment, despite the forecasts of many commentators that this would cause a revolution in oil supply and prices, the impact on the global energy market has in fact been somewhat less dramatic than expected. This working paper aims to take a similarly realistic view of the potential for tight oil production in Russia, something which has been highlighted by the recent study of global shale oil and gas resources undertaken by the EIA, which named Russia as the possessor of the world’s largest shale oil reserves.

The main focus of attention has been on the Bazhenov shale which lies beneath Russia’s main producing reservoirs in West Siberia and is indeed the source rock for many of the giant fields that have been at the core of the country’s oil output, which is now running at approximately 10.5 mmbpd. Rosneft, LUKOIL, Gazprom Neft and others have highlighted the potential for the Bazhenov and Russia’s other tight oil reservoirs to help achieve the government’s objective of maintaining overall production at current levels in the face of the natural decline in many of the country’s older fields. Joint ventures with ExxonMobil, Statoil and Shell have started to introduce international expertise and technology, and the future output from Russia’s tight oil reservoirs has been estimated by the Ministry of Natural Resources at up to 1 mmbpd by 2025.

The exploitation of this underdeveloped resource, however, is at a very early stage and a number of issues have already emerged. The geology of many of the reservoirs seems very heterogeneous, with markedly different well results being produced only kilometres apart. Well costs are high and, in common with most shale reservoirs, decline rates are rapid, meaning that costs need to be recovered early in the production cycle if an economic return is to be made. The current tax system in Russia, however, does not anticipate this type of well performance, being focussed on revenues rather than profits, and tax rates are also very high. Although reductions on specific taxes have now been introduced, they may not be enough to encourage wide-scale investment. Furthermore, it is not just oil company investment that is required but also significant expenditure by oil service companies on new rigs and fracking equipment, a lack of which could easily delay the achievement of production targets.

As a result, this paper aims to address these and other issues in order to assess the potential progress in the development of Russia’s tight oil reserves. Section 1 provides some initial context of the potential importance of unconventional oil in Russia as a means of alleviating the declining production of existing West Siberian assets and as a bridge towards the longer term development of areas such as the Arctic offshore. Section 2 then outlines a definition of what is described in Russia as ‘hard-to-recover’ oil, differentiating between shale reservoirs such as the Bazhenov and other tight oil reservoirs such as the Achimov and Tyumen formations which are often found in the deeper layers of existing fields. Section 3 then reviews corporate activity in the sector to date, highlighting in particular the new joint ventures formed by Rosneft, the development work carried out by Gazprom Neft and Shell in the Salym area and the new focus of LUKOIL on its deeper and tighter oil assets.

Section 4 then moves on to a discussion of the commercialisation of Russia’s tight oil resources, and in particular highlights the tax concessions that have already been granted for ‘hard-to-recover’ oil, while also discussing further changes that may be needed to catalyse full scale development in projects with a very different cash-flow profile to traditional Russian oil fields. Section 5 addresses another key issue for the industry, namely the availability of rigs of high enough quality and power to drill the numerous horizontal wells that will be needed if 1 mmbpd of production is to be achieved. It concludes that not only will it be difficult to build enough new rigs, but also that the oil service industry may well be reticent to invest heavily until it more fully understands what the future of the unconventional oil industry in Russia may be. Section 6 then reviews a number of other issues that could hinder development of tight oil in Russia such as a corporate landscape dominated by a few large players, the Law of Strategic Reserves, the Licensing Laws and Environmental and Water issues. Section 7 then offers some conclusions which suggest that, although the potential for a significant increase in unconventional oil production in Russia certainly exists, the achievement of the aggressive Ministry of Natural Resources target is likely to take longer than anticipated.

1. Unconventional Oil in the Context of Russia’s Energy Strategy
The Russian government’s Energy Strategy to 2030 indicates that it is keen to maintain the country’s oil production at or above the level of 10.4 mmbpd seen in 2012, and the outlook for 2013–2015 remains quite positive as new fields are set to be brought onstream and existing developments arrive at peak output. A number of domestic and international commentators are now, however, forecasting that Russian oil production could be close to its peak, with the inevitable decline of Soviet era fields prompting an overall fall in output by 2020. Figure 1 and Table 1 show two Russian government targets, contained in the Energy Strategy to 2030 and the Geology Development Strategy, both of which see a gradual rise in output towards 10.7 mmbpd by 2030, but the more independent forecasts also shown suggest that these targets may be rather optimistic. The most radical low case scenario, produced for the Government Energy Commission in 2011, shows a collapse in oil output to below 5 mmbpd by 2030 if the current tax and regulatory conditions in the Russian oil sector are not changed. Even the less pessimistic forecasts, which anticipate some government reaction in terms of tax breaks and other encouragement of investment, see production falling to a range of 7–9 mmbpd. Only one forecast, that from the US Energy Information Administration, sees production exceeding the Russian government targets.

The debate about the exact extent of any possible decline has largely focused on whether the Russian government will provide sufficient tax incentives to encourage the development of fields in new regions of Russia such as East Siberia and the Offshore, with a particular recent focus on the Arctic following the announcement of Rosneft’s joint ventures with ExxonMobil, Statoil and ENI. It has become increasingly clear, however, that the likely start date for any production from this region will not be until well into the next decade, given that the first exploration well is not due to be drilled until 2014 and the subsequent appraisal and development of any discovery would be likely to take at least a decade. Indeed some Russian oil industry players remain sceptical about the economics of any major developments in the Far North. In 2013 LUKOIL’s Leonid Fedun was quoted as stating that ‘if someone asked me to invest money in Arctic exploration and development, I wouldn’t give a kopeck. We have many more investment opportunities that carry less risk.’

One of the specific investment opportunities to which Mr Fedun is referring, and into which his company is currently investing significant funds, is the exploitation of Russia’s unconventional oil resources. Although the development of what is often referred to in Russia as ‘hard-to-recover’ oil is not a new topic, with the discovery of shale oil in Russia dating back as far as 1967, it has become much more interesting following the improvements in the technology for the extraction of shale oil and gas developed in the US over the past decade. Indeed the other main focus of Rosneft’s JVs with both ExxonMobil and Statoil is the application of new technology on the company’s tight oil reserves in West Siberia and European Russia, and a number of recent estimates suggest that the resource base to be exploited across Russia is enormous, although uncertain. The level of this uncertainty is captured in the wide spread of high and low estimates: total tight oil reserves in Russia have been put in the range of 15 billion to 1.05 trillion barrels. Even individual companies have very broad assessments of their own resources, with Rosneft quoting numbers in the range 6–18 billion barrels and TNK-BP offering forecasts of between 4 and 19 billion barrels. Given that Russia’s total proved reserves are estimated at 87 billion barrels it is clear that even numbers at the lower end of the range would be significant additions to the country’s oil reserve base. This potential was further confirmed by a recent assessment of global shale resources by the US Energy Information Administration which calculated that Russia has the world’s largest shale oil resources with a total of 75 billion technically recoverable barrels.

2. Defining Unconventional Oil in Russia
Before progressing from these resource numbers to potential production estimates it is important to emphasize that the definitions of unconventional reserves in Russia are somewhat blurred in a multitude of terms used to describe the hydrocarbons being explored by various companies. The broadest definition is ‘hard-to-recover’ oil, and this is often used by companies looking for a catch-all to describe reserves that need tax breaks from the government to encourage investment. ‘Hard-to-recover’ reserves include shale resources, such as those found in the often-cited Bazhenov geological layer, but also include bitumen, a very viscous crude that is extracted from shallower reservoirs using mining or steam heating techniques, as well as oil that comes from conventional reservoirs that happen to have low permeability and/or porosity. Indeed this breadth of definitions is one reason why the Russian government has been relatively slow to introduce tax breaks for the oil industry, for fear that companies would use ‘creative reserve auditing’ to bring as much of their production as possible into the ‘hard-to-recover’ category.

Narrowing the definition to more traditional unconventional shale and shale-like reserves, the US EIA tight oil resource estimate for Russia specifically includes only the Bazhenov layer. This layer is highly significant as it is believed to cover the entire 2.6 million km2 area of the West Siberian basin and to act as the source rock for 85 per cent of the conventional oil fields located there. The Bazhenov is located at a depth of 2,700–3,100 metres in the Upper Jurassic rock strata (see Figure 2), and has a permeability of less than one millidarcy with a porosity of between 2 and 6 per cent and a reservoir thickness of 20–30 metres, making it comparable to the Eagle Ford and Bakken shale formations in the USA. As with many tight reservoirs the oil tends to be light (34–43 degrees API, with an average of 38 degrees compared to the Urals blend figure of 32–33 degrees) and has a relatively low sulphur content of 0.6%. As a result it can flow quite freely once the tight sandstone reservoirs have been accessed through horizontal wells and broken open using multi-stage fracking techniques.

The Bazhenov, however, is not the only new tight oil play in Russia, as similar types of resources are also found in two other layers, the Achimov and the Tyumen, that have not been included in the US EIA analysis because of a lack of available data. Nevertheless, they are very much part of the tight oil development work that a number of companies in Russia are currently undertaking and are certainly included in any definition of ‘hard-to-recover’ oil. The Achimov layer is generally located just above the Bazhenov at a depth of 2,500–3,200 metres (see Figure 2), with the oil trapped in tight sandstones confined by shale. The reservoirs tend to be of average porosity but low permeability, but nevertheless have a tendency to have better flow rates and lifetime production than the Bazhenov layer. A number of gas condensate fields have already been developed from this rock layer, including by the Gazprom/Wintershall JV Achimgaz, and the shallower depth of the reservoirs means that they tend to be cheaper and easier to operate than their deeper counterparts. In contrast the Tyumen layer, which covers the same geographic area as the Bazhenov but at a lower depth of 2,800 to 3,200 metres, tends to contain narrower reservoirs with mixed permeability, making it a more difficult target for drilling and generally more expensive to develop. Nevertheless, a number of companies, including LUKOIL and TNK-BP, have been exploring the potential of this reservoir below existing conventional fields and see it as another potential boost to overall production capacity.

The geographical extent of these three tight oil reservoirs and the large resource estimates associated with just one of them (the Bazhenov) have encouraged the Russian government and oil industry to believe that the development of unconventional oil in Russia could be the short-to-medium term solution to the risk of a potential production decline. Indeed a number of corporate and ministry production forecasts have been made that suggest the possibility of significant output being achieved by the end of this decade. Rosneft has tentatively estimated that it could be producing 300,000 bpd of unconventional oil by 2020, while TNK-BP has more cautiously forecast output of 50,000 bpd on the same timescale and Gazprom Neft has suggested that it could produce a similar amount. More optimistic overall forecasts have emanated from the Russian Energy Ministry and the Ministry of Natural Resources, and as shown in Figure 3 the latter suggests that total tight oil production in Russia might exceed 1 million bpd by 2025 and reach 1.7 million bpd by 2030. The uncertainty surrounding the development of this new resource, however, is underlined by the fact that the Energy Ministry forecast, although positive, is much lower at only 440,000 bpd by 2020 before declining to 400,000 bpd by 2025.

This uncertainty reflects difficulties in a number of areas, including licensing, levels of taxation, definition of strategic resources, environmental legislation, availability of sufficient oil service equipment and a lack of variety in the companies developing the resources, but at the most basic level the issue of geology remains the primary concern at present. On the positive side, it is asserted by a group of scientists led by Ivan Nesterov at the Russian Academy of Sciences that the high oil saturation across the key Bazhenov shale layer means that oil can be produced commercially at any point across its geography. Other specialists such as Valeriy Soloviev, Chief Expert of Gazprom Neft’s Research and Technical Center (NTC), are also positive and believe that ‘taking into account the potential resources of the Bazhenov formation, it is a great candidate for further exploration and development’.

An alternative view is presented by scientists such as Vladimir Teploukhov, Head of the Logging Data Interpretation Department at NTC, who stresses that ‘the Bazhenov formation stores too many surprises, and the surprises are still there despite decades of research. The main challenge for geologists and development engineers is how to accurately pinpoint recoverable reserves and the areas of their concentration. The volume of effective oil-saturated pore space of the Bazhenov formation has not been identified with the desired precision. Data on permeability and porosity of the Bazhenov rocks are insufficient. In addition, the characteristics may vary enormously in different locations. Sometimes even neighbouring wells produce completely different data. For as long as these issues remain unanswered, the development of the reserves continues to be too risky’.

It is clear, then, that despite the huge resource potential of the Bazhenov and associated tight oil strata in Russia, the geology is yet to be fully understood, and it is this fact that has heightened calls for increased government support for companies which are preparing to investigate the possibilities for commercial production. Before discussing what levels of government support may be needed, as well as what other issues may need to be resolved, it is worth first reviewing the major corporate activity to date in order to assess how companies currently view unconventional oil prospects in Russia.

In the next excerpt, we will focus on the major companies involved in unconventional oil and gas production in Russia. Click here to read it