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. Last Updated: 07/27/2016

Oil Exploration Seen as a Key to Growth

Russian oil companies must embark on more exploration and production from new "greenfield" oil sites if they are to sustain the rapid production growth rates of recent years, analysts say.

Russian crude output growth especially is showing signs of tapering off -- bad news for a world in which production capacity is already stretched because of rapid demand growth and slow progress on new ventures in the OPEC cartel.

Russia's tremendous production growth this decade has been driven principally by "brownfield" rehabilitation of existing fields, which allowed some firms like Sibneft and Yukos to grow output by over 20 percent per year.

Overall oil production has risen 50 percent since 1999.

As firms concentrate on squeezing out every last drop from old sites, exploration spending has stagnated, and companies' production targets for 2005 are much lower than in past years.

The International Energy Agency says future Russian capacity additions would have to come from new greenfield developments such as those in Eastern Siberia.

"The pace of production growth is expected to slow in the near term as most low-cost opportunities to boost output -- the low-hanging fruit -- have been exploited," the IEA said.

Analysts say production growth in Russia and the Caspian will in the near future hold the key to stabilizing crude markets. Tight capacity was one of the factors behind oil's record-busting rally last year.

"As OPEC capacity growth has been relatively slow, it is fair to say Russia and the former Soviet Union will be key incremental sources of supply for the next three to four years," said the IEA's David Fyfe.

The IEA projects 600,000 barrels per day of additional supply capacity in 2005 in the former Soviet Union -- 60 percent of total non-OPEC new supply. This compares with 940,000 bpd in 2003 -- almost the entire non-OPEC incremental supply.

The Russian government earlier this month projected a 5.7 percent output rise in 2005, down from 11 percent growth in 2003 and over 9 percent last year.

"We see FSU supplies nudging down from the incredibly high levels of 2002-2004, but they will slow down, not totally evaporate," Fyfe added. "They will be able to sustain increases of about half a million bpd for the next two to three years."

Two major FSU projects -- Kazakhstan's Kashagan and the Azeri-Chirag-Guneshli fields in Azerbaijan -- will be the major landmarks for this decade, adding over 1.5 million bpd by 2009.

The ACG fields will start producing 200,000 bpd this year, rising to a million bpd by 2010. Kashagan will come on stream in 2008 at 450,000 bpd, ramping up to its peak in the next decade.

But TNK-BP chief operating officer Larry McVay said old Russian fields cannot be written off.

A 1 percent improvement in recovery rates adds 700 million barrels to reserves, he said. "There is life yet in brownfield," McVay said. "We see a lot of opportunities still to enhance production and reserves through brownfield development, by employing good oil field practices."

Russian companies are aware of the issue. LUKoil, which has been most active in greenfield development, said last year output from existing fields could grow only until about 2010, and it was time to develop alternative areas.

Its new fields in Timan Pechora, Yamal and the North Caspian have added 1 billion barrels of oil to its proven reserves, and it hopes to produce 1.2 million bpd from them by 2010.

TNK-BP and Sibneft have also acquired new acreage for exploration, and Sibneft has said new fields acquired in 2001 and 2002 could account for up to 30 percent of production by 2010.

Analysts say the production surge since 1999 severely overstretched export pipeline capacity. The lack of export infrastructure in Eastern Siberia has hampered development of greenfield deposits there.

However, approval for a $11 billion pipeline to Russia's Pacific coast, due by the end of the decade, could provide a boost. Caspian projects such as Kurmangazy, remote from Western markets, should also get a boost from a new BTC pipeline that will be able to export crude directly to the Mediterranean.

Recent political and legislative uncertainty in Russia and Kazakhstan could limit foreign investment, though, while domestic firms are hampered by fiscal and licensing issues.

In Russia, for instance, exploration license holders do not automatically have the right to develop a field in case of an oil strike; the license has to be re-tendered.

Also, the new fiscal regime effective from 2005 affects 90 percent of export revenues at oil prices above $25 a barrel, making overseas sales less profitable, and therefore reducing incentives to invest in long-term, capital-intensive projects.

"The Russian government wants to encourage companies to explore more, and greater exploration in Eastern Siberia will be crucial for this Pacific pipeline to be viable," said Credit Suisse First Boston analyst Vadim Mitroshin, who estimates Russian reserve replacement as averaging 70 to 80 percent.

"If the government wants more exploration, it could give some tax relief to stimulate this," Mitroshin said. "There needs to be a mechanism to allow companies to recover exploration costs."

n The government may let foreign companies help develop offshore oil and gas fields because Russian companies can't do the work as quickly on their own, Bloomberg reported Monday, citing Interfax.

The development of offshore projects should be a priority in Russia, which will have difficulty replacing oil reserves without offshore resources from 2015, Interfax said, citing Natural Resources Minister Yury Trutnev.

Last week Trutnev said that the government plans only to allow companies with at least 51 percent Russian ownership to bid for the sites.