The U.S. Geological Survey estimates that 25% of the world's remaining undiscovered conventional oil and gas reserves are located in the Arctic, with most of it in offshore reservoirs. These reserves are difficult and expensive to produce, requiring tax incentives in most situations to make production worthwhile. Russia, one of the world's top oil producers, has realized that, and Prime Minister Vladimir Putin recently updated the country's offshore tax rules to encourage development.
Important changes
Russia is looking to draw $500 billion in investment for offshore projects over the next 30 years. In order to do that, the country enacted several changes to the rules that govern its offshore oil and gas industry:
- Export duties -- abolished! But only for the next five to 15 years, and it is contingent on a project's profitability. This could save companies as much as $460 per ton of oil.
- Value added tax on imported equipment -- abolished! But only on equipment that Russian companies do not manufacture.
- Mineral extraction tax -- as low as 5%! But only on the most complex Arctic projects.
- Additional taxes will be kept low and held at the same rate for 15 years once production has begun.
The changes to the tax laws will certainly encourage foreign investment, but guidelines still ensure that Russian companies must own at least 70% of offshore projects.
What to expect
Previously, Russian state-owned producers Gazprom and Rosneft were the only companies allowed in the Arctic. Look for private Russian oil giant Lukoil to be a big winner here, as well as foreign giants ExxonMobil (NYSE: XOM), Total (NYSE: TOT), and Statoil (NYSE: STO).
ExxonMobil announced a deal with Rosneft to explore the South Kara Sea last summer, and on Monday, we got a closer look at the details of the $3.2 billion deal.
Rosneft will pick up a 30% stake in Exxon's West Texas La Escalera Ranch project, a 30% stake in its Cardium oil project in Alberta, and the option to buy a 30% stake in 20 other drilling areas, yet to be determined.
On the Russian side, Exxon and Rosneft have completed 70% of a seismic program in the Black Sea and expect to begin exploratory drilling in 2014. They have also begun environmental assessments in the Kara Sea, with the hopes of drilling there by 2014 as well.
Another deal
Statoil and Total partnered with Gazprom to explore the Shtokman gas field located in the Barents Sea, but recently postponed the project for a variety of reasons, one of which was the uncertain tax climate. Statoil already operates a gas field in the Barents Sea, a region that is estimated to also contain 250 million barrels of oil.
But it will be a difficult and expensive region to develop, making the changes to the tax laws that much more important. Icebergs and freezing water temperatures are just part of the reason why cost estimates for the project range from $20 billion to $40 billion right now.
Gazprom, Total, and Statoil expect to make a final investment decision on the project by July 1.
Foolish takeaway
The Arctic offshore region may be one of the last chances for Big Oil to move the needle on its oil reserves. Though we may not know much about commercial viability for the next two years, it is a project worth keeping an eye on. Click here to add the companies above to My Watchlist and stay up to date on the offshore drilling story.
