The Last of the Mohicans

The sanctions pressure on Russia, most glaringly evidenced through the penalties targetting the energy sector, has changed the modus operandi of the affected corporations. With no long money from the western markets available, companies are cutting down exploration and development budgets and, in some cases, stabilizing their debt burdens and streamlining operations. While Russia’s oil and gas companies still being in the black, receiving most of their revenue in dollars, they have nevertheless felt the strains of the sanctions deeply. This is the setting against which one of the key public auctions of recent years will take place – for the rights to the largest unallocated deposit, the Erginskoye oilfield.

The Erginskoye field is the largest of all deposits sold off in the past three years through public auctions. This fact alone is enough to whip up interest in the upcoming auction. The fate of the field is now up for grabs by major Russian companies, whose rivalry has been exacerbated due to economic recession and the sanctions. Discovered in 1995, the field is currently the last remaining area of subsoil resources of federal value that has not been allocated so far. As part of the West Siberian petroleum basin, with its extensive oil infrastructure and an abundance of other oilfields in close proximity, the Erginskoye field seems to be a “slam dunk” for the winner of the auction, despite the considerable investment involved. The only thing left is to set a date for the auction.

REUTERS/Sergei Karpukhin

According to preliminary estimates, the field will bring 103 million tonnes of oil and roughly 100 billion cubic metres of gas in reserves. The initial plans were to auction the field off in 2010, back when the reserves were thought to be 69.4 million tonnes, falling just short of the list of fields of federal significance (those with over 70 million tonnes of oil in reserves). Further exploration at the Erginskoye field conducted in 2010 led to its reserves being adjusted upwards by more than 33 million tonnes.

Taking the significance of the field into account, the Ministry of Natural Resources and Environment of the Russian Federation has set some rather tough requirements for the future development company: it will have to start production within two years of the license date and will have to refine the oil output at a Russian refinery that conducts a high level of secondary processing. The requirements are largely the doing of the competing oil companies striving to shape the terms of the auction to match their own interests.

Gazprom Neft and Rosneft are among the candidates most likely to win the license. The Erginskoye field is close to the Priobskoye field, whose northern part is being developed by Rosneft’s Yuganskneftegaz. Independent Oil and Gas Company owned by former Rosneft head Eduard Khudainatov is developing a few other fields including the West Erginskoye field just south of the Erginskoye field. Russia’s largest privately owned oil company, Lukoil, has both confirmed and denied its alleged interest in the field, while such a palpable infusion could have reinvigorated its Siberian portfolio against the backdrop of falling output from its established West Siberian fields.

The Khanty-Mansi Autonomous District has traditionally been the home base of Surgutneftegas, which could also take advantage of its available infrastructure to incorporate the Erginskoye field among its assets. Furthermore, unlike its rivals, which are burdened with considerable debt, Surgutneftegas commands sufficient financial assets to outbid its competitors. Surgutneftegas has repeatedly confirmed its intention to fight for all more or less significant fields in the Khanty-Mansi Autonomous District, despite the fierce competition. This much is clear from the fact that Rosneft and Gazprom Neft are prepared to resort to drastic measures and make use of their ties with the authorities.

In March 2016, RBC reported that Gazprom CEO Alexei Miller had asked President Putin to set the terms of the auction in such a way that it would favour Gazprom Neft. The requirements suggested by the head of Gazprom include incorporating in the tender documentation terms demanding that 100 per cent of the field’s oil output be processed at Russia-based refineries to produce Euro 5 compliant fuel, and commercial operations at the field begin within a year of the auction. Incidentally, the demands were integrated in the documentation almost in their entirety. The first requirement plays primarily into the hands of Gazprom Neft, which boasts Russia’s biggest refinery in Omsk. The Omsk Refinery, which has a capacity of 400,000 barrels of oil per day, is expected to switch entirely to Euro 5 standard fuel in 2016. Furthermore, the fuel it produces is traditionally marketed domestically.

Rosneft has also attempted to influence the auction result by lobbying its interests. According to media reports, Rosneft is poised to block any preferences that might be extended for foreign funds, including the UAE-based Mubadala Development. Russian Direct Investment Fund CEO Kirill Dmitriev urged President Putin to use the fund to attract foreign financing into the Erginskoye field. Attracting investments from the United Arab Emirates would have been unthinkable in the pre-sanction economy. But with the sanctions targeting the Russian energy sector, mid- and long-term financing has been put out of reach of Russian oil companies. Rosneft is not looking to attract foreign investors, since it has succeeded in bringing its net debt down to $23.9 billion,with a moderate debt to EBITDA ratio of 1.23, after repaying a number of loans taken out for the acquisition of TNK-BP.

Despite predictions by Minister of Natural Resources and Environment Sergey Donskoy that the auction would take place in October 2016, it is likely to be postponed until 2017. The contributing factors include, above all, an unfavourable economic environment, where, despite repeated statements that the Russian economy has bottomed out, recovery is yet to be seen. The Russian government is also likely to wait until oil prices climb back up to $50–60 per barrel. Surely it will be no problem to reschedule an auction that has been postponed repeatedly over the past six years.

Having said that, the Federal Subsoil Resources Management Agency may also wish to postpone the auction until 2017 to ensure positive financial results in the coming year. The agency has already completed a very successful deal this year, selling off two fields in the Nenets Autonomous District (Vaneivissky and Layavozhsky fields). The winning bidder, Gazprom, paid the agency a total of 23.3 billion roubles, three times the starting price. The auction value of a number of medium-sized fields (Nyakhartinskoye, Borulakhskoye and Kungasalakhskoye) surpassed 1 billion roubles bringing in a favourable financial result for the agency for the year. The starting price of the Erginskoye field will presumably be set at 5.35 billion roubles, but fierce competition means that the final value will likely shoot above 25 billion roubles.

In retrospect, the decision made by Russian President Vladimir Putin back in 2012 to hold auctions to distribute deposits of federal value in place of tenders, which had been used until then, now seems to be a prudent one. Certainly, companies are trying to influence the terms of the auction before it is actually held. However, the positive result will be that the biggest bidder in the auction will win in an unquestionable and transparent manner, honouring the principles of equidistance of the competitors from the government. It would eventually be wise to withdraw privileges from government-owned companies and companies with close ties to the government like Gazprom and Rosneft and offer equal opportunities to all Russian enterprises.