Oil & Natural Gas Corp. (ONGC), India’s biggest energy explorer, is banking on the world’s largest shale oil reserves to save its Russian acquisition. Stumbling blocks include oil prices at a five-year low and U.S. sanctions.

Imperial Energy Corp., which the Indian state-run explorer bought in 2009 for 1.4 billion pounds (US$2.1 billion), will drill four wells in Russia’s Bazhenov shale formation by July, seeking to find enough oil to start commercial production, said Narendra Kumar Verma, managing director of ONGC’s overseas unit, which owns Imperial. Failure would mean seeking options, including selling the unit, he said.

“We’re banking on that silver lining,” Verma, the chief of ONGC Videsh Ltd., said in an interview in his office in New Delhi. “We have to think of alternative strategies. All options are open,” should Bazhenov flop, he said.

ONGC plans to more than double its oil and gas production from overseas fields in four years even as it seeks to reverse declining output from Imperial’s fields, revive assets in troubled Sudan and Syria and boost output in Venezuela. It gives away 79% of its revenue from Imperial’s fields as taxes to the Russian government, which is facing the prospect of defaulting on its debt amid sanctions following the annexation of Crimea from Ukraine.

“At the moment, Bazhenov is the promising thing,” Verma said. “We have to see how much it yields, as shale oil wells are costlier due to horizontal drilling and hydro-fracking.”

Shale oil is trapped in non-porous, shale-rock formations, also found in the Bakken area in North Dakota. The oil can be extracted by cracking open the rocks using a mixture of water and chemicals at high pressure, a process called hydraulic fracturing, or fracking, pioneered in the 1990s in the U.S.

Biggest Reserve

Bazhenov may hold as much as 360 Bbbl of recoverable reserves, Bloomberg Industries said in a December 2012 report, citing estimates by Russian subsoil agency Rosnedra. Venezuela holds 298.35 Bbbl, the world’s biggest known oil reserves.

Russia’s Bazhenov has yet to yield oil. The formation has proved to be tougher to drill than areas in the U.S., prompting Russian oil majors such as OAO Rosneft and OAO Gazprom Neft to seek partnerships with U.S. and European companies.

Contract Ended

Imperial had given Denver-based Liberty Resources LLC a contract to drill in its shale-oil acreage in the Bazhenov formation. Liberty ended the contract following U.S. sanctions on Russia, Verma said. Imperial is now drilling two wells on its own and plans to drill a total of four by July, he said.

France’s Total SA is reevaluating plans to explore for shale oil with Moscow-based OAO Lukoil in Bazhenov. Royal Dutch Shell Plc and Norway’s Statoil ASA may also miss out on Russian shale, Bloomberg Intelligence analyst Philipp Chladek wrote in an Oct. 3 report.

Russia can develop its shale oil resources even without foreign partners, Interfax reported Dec. 29, citing Lukoil President Vagit Alekperov. The development is not profitable at current oil prices, Interfax reported in the interview.

Russia has potentially the biggest shale oil resources, followed by the U.S., according to a January 2014 report by the U.S. Energy Information Administration. Shale basins in the U.S. have helped boost the country’s production to the highest in more than three decades, drawing it into a price war with Saudi Arabia as oil prices slump to the lowest since 2009.

Larger Share

The Russian government will allow companies that produce in the Bazhenov formation to retain about 40% of their revenue, compared with 21% that Imperial gets now, Verma said.

“If we are able to have substantial production from Bazhenov, then our net back may improve, bottom line may improve and we may sail through,” he said. “I’m not saying we will make profits, I’m saying the company may sail through.”

Current output at Imperial’s fields in western Siberia, which holds part of the Bazhenov formation, has declined to about 7,000 bbl/d from 17,000 bbl/d in April 2010.

Even in a scenario where oil is at $100 a barrel, Imperial is left with $6 after spending as much as $15 on production, and paying oil extraction levies, Verma said. It pays about $2 a barrel as income tax to the government and the remaining $4 has to fund operating costs, capex and administrative costs, he said.

Oil Glut

Plunging crude oil prices is making it worse for Imperial, Verma said. Brent crude, a benchmark for more than half the world’s oil, declined 48% last year in London trading, the steepest annual loss since 2008. Weak economic growth in China, a global oil glut and OPEC’s refusal to cut output have pushed crude into a bear market since June.

“Though shale oil prospects opens a new window for Imperial, the near-term concern remains due to subdued prices,” said Dhaval Joshi, a Mumbai-based oil and gas analyst with Emkay Global Financial Services Pvt. “The biggest question is whether shale oil is a viable option at $50 oil price.”

In Russia, ONGC Videsh owns 20% in the Sakhalin-1 project off the country’s far eastern coast, which it acquired in 2001. The project produces both oil and gas and ONGC Videsh gets a share of the output or equivalent revenue from the sale. The company is also in talks with Rosneft, Russia’s biggest oil producer, to study the possibility of buying stakes in two other oil and gas fields in Russia, ONGC Chairman Dinesh Kumar Sarraf said in November.

Below Expectations

Imperial has always performed below expectations for ONGC. A plan to revive production from Imperial’s fields was scrapped just months after ONGC completed the purchase in 2009 because the fields didn’t meet expectations. India’s federal auditor in March 2011 said ONGC lost 11.8 billion rupees in the 15 months ended March 31, 2010, after Imperial produced at half of the target rate.

ONGC announced the plan to buy Imperial in August 2008 and completed the purchase in 195 days. Brent crude, which slumped 62% in that period, reached $36.6 a barrel in December that year as the global financial crisis deepened. ONGC then justified the acquisition saying oil would rebound to $100 a barrel.

Most negotiations for the Imperial acquisition “happened in the peak price of oil, but before closing it slid,” Verma said. “We could not come out of the deal.”