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Tax incentives to stimulate Russian shale oil activity

By Nadia Rodova in Moscow

August 29, 2013 - Interest in developing Russia's enormous tight oil reserves is poised to grow as the government's long-awaited tax breaks, designed to make crude production from unconventional fields profitable, come into effect from the start of September.

The stimulus gives oil producers a reduction of between 20% and 100% in the mineral extraction tax (MET) rate, depending on reservoir permeability and layer thickness.

In particular, crude produced from the most promising Bazhenov oil play in West Siberia will enjoy an MET rate of zero.

Other shale and more broadly tight oil reserves will see tax reductions at between 20% and 80% from the standard rate.

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The move is aimed at mitigating investment risks and helping compensate for the significant capital expenditure associated with shale oil development, Merrill Lynch said in a research note, adding that it would allow a pilot shale project to generate a "decent" internal return rate (IRR) at a 0% MET rate and oil prices above $90/b.

Depending on the exact parameters, tight oil projects could yield a 14-43% IRR, analysts at Renaissance Capital calculated in a study.

But, because the development of shale oil reserves still poses a number of challenges that oil companies will have to overcome, Russia may not necessarily see a substantial boost in shale oil production anytime soon.

Ambiguous resources

The US Energy Information Administration, in a recent shale oil study, estimated that Russia holds the largest technically recoverable shale oil resources in the world, at around 75 billion barrels.

The US' shale oil resources, ranked number two in the report, are estimated at 58 billion barrels.

The EIA said its assessment for Russia focuses mainly on the Bazhenov shale in West Siberia, as there is not enough public information for a quantitative resource assessment of shale resources in other Russian regions, such as Timan-Pechora in the northwest.

In Russia, the figure of 100 billion mt, or 730 billion barrels, of total unconventional oil resource potential across the country as a whole is generally used, although estimates differ significantly and additional exploration is needed to further quantify the reserves.

These enormous resources have been virtually untouched so far as their development was always considered to be economically unattractive under the standard tax regime in Russia.

Oil production from US shale plays is about 2 million b/d at present, and is projected to rise to 4 million b/d over the next decade, continuing to transform the global oil market.

In Russia, however, combined tight oil reserves account for just 0.2% -- or around 20,000 b/d -- of the country's total crude production of around 10.4 million b/d, according to the energy ministry.

Of the total tight oil output, production from shale plays averages just 10,000 b/d, according to estimates from the natural resources ministry.

Of this, 7,600 b/d is produced by Surgutneftegaz, which has been experimenting with production at Bazhenov for decades; 2,000 b/d comes from Lukoil; and around 1,400 b/d by Rosneft, according to the ministry.

The geological structure at Bazhenov is such that gaining positive results from multistage hydrofracking -- the technology that has allowed a rapid boost in shale production in the US -- is more tricky than at North Dakota's Bakken formation, for example, where the structure is more brittle.

Producers would first need to find a way of tailoring the technology to the specifics of the local Russian shale formations.

The Bazhenov formation, like the similar Khadum formation in southern Russia or the Domanic formation in the Urals region, is deeper than conventional oil reserves and differs from them also by geological composition, with narrow pay-zones and low permeability.

Other key challenges include Bazhenov's highly heterogeneous structure over short distances and low recovery rate, of just around 2%-3% at present, as well as rapidly reducing well flow rates, which can halve over the course of a single year.

Apart from the technology issues, though, other factors also make it difficult to predict whether a feasible boost in production from shale reserves in Russia could be possible any time soon.

Next page: Russia lacks competitive environment of US

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