International oil companies have re-ignited their interest in Russian oil attracted by the prospects of continued high production growth, massive reserves and high oil prices.

Despite the risks and challenges, Russia provides the largest remaining opportunity outside the Middle East and its reserves can still be acquired relatively cheaply. Furthermore, the number and wide range of opportunities offers something for everyone, for International oil companies (IOCs) of all sizes and inclination.

Driven by revitalized major Russian oil companies (ROCs), exports and revenues have risen significantly, the economic crash of August 1998 a fading memory. With sufficient upstream investment and the expansion and construction of key export pipeline systems (Baltic, China/Pacific and Murmansk), Wood Mackenzie has estimated from a bottom up field-by-field analysis in a recent report ("Russian Oil - Where are the Real Opportunities") that Russian production could peak at 12 million b/d in 2010, with crude available for export rising from 4.7 to 7.5 million b/d. But investment is the key.

Investment risk

Overall investment risks have declined over the past few years. The future of the Russian oil sector seems brighter than ever. Significant challenges still remain (infrastructure capacity, environmental issues, incomplete legislation, corporate governance, etc.). As investment under the established tax regime develops, however, IOCs are finding ways to mitigate those risks.

ROCs have become wealthy from higher oil prices and lower operating costs. No longer are they easily swayed by access to financing, as offered by IOCs in the past, or access to technology, now they have developed or bought in most of their own. Strengthened by growth and consolidation, ROCs have actually been acquiring IOC interests over the past few years (Aminex, Anglo Siberian, Bitech, British Gas, Harvest, Nimir, SOCO, etc.), proving to be aggressive and effective competition.

The Russian government has promoted IOC investment, although PSAs have been relegated to a status of "last resort" under legislation signed by President Putin in June this year and the long list of potential PSA projects was reduced to just a handful of major offshore projects dominated by ROCs. Fortunately, in the lower-risk developed areas such as West Siberia, IOCs are accepting that PSAs are no longer an option and are moving ahead without one, e.g. Shell's huge Salym project.

Opportunities

There are opportunities in exploration, but there is an absolute abundance of lower-risk opportunities in undeveloped greenfield and brownfield reserves with guaranteed production right across Russia. West Siberia has to be one of the pre-eminent regions of the world for such potential, but there are many other suitable regions in Russia. Such opportunities can be accessed through licensing or asset acquisition, joint ventures or mergers and acquisitions at a corporate level. Importantly, the assets or ventures can vary significantly in scale, so there are opportunities for smaller IOCs as well as the super-majors.

Licensing

Licensing could be a valid entry strategy for IOCs, although in recent licensing in West Siberia, IOCs needed to form Russian entities to take part. The long-awaited Subsurface Code should also soon finally confirm the rights and obligations of all license-holders.

Acquisitions and joint ventures

ROCs have made numerous assets available to IOCs under joint ventures. Some larger projects became bogged down by a desire for a PSA whilst other smaller ventures enjoyed a measure of success under the standard tax regime without production sharing agreements (ConocoPhillips' Polar Lights, Harvest's Geoilbent, Marathon's KMOC, Oxy's Vanyoganneft and Teton's Goloil). As in any joint venture, sufficient management control and choice of partner are keys to their success.

Mergers and acquisitions

Major corporate acquisitions have a high profile currently. BP took the lead completing its TNK-BP venture at the end of August, valuing TNK on a cash flow basis as well as reserves. BP structured its deal (US $9.6 billion including Slavneft) to align TNK's interests with its own.

Conclusions

IOCs can create real value by improving efficiency and applying western management techniques to Russian fields or companies, and some Russian owners are looking to cash-out. The deals are there to be made.