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Home / Issue Archive / 2009 / April #4 / Making Oil a Family Business Could be Win-Win for Russia

№ 4 (April 2009)

Making Oil a Family Business Could be Win-Win for Russia

Small and medium oil companies globally comprise an important part of the oil and gas industry. According to the U.S. Department of Energy, small and medium producers drill 90 percent of the oil and gas wells in the U.S.

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   These small – often family businesses – produce 85 percent of natural gas produced in the lower 48 states (all states except  Alaska and Hawaii), and they account for 60 percent of U.S. oil production. Russian sources put Canada at 33 percent of the total oil production, with global levels of such producers on the market lingers at around 15 percent.

   In the U.S., it sometimes happens that one family lives off the royalties of a single well and passes that well on to it's children and grandchildren.

   This is not the case, however, in Russia where in the year 2000, small and medium-size producers accounted for only 10 percent of Russia’s oil production – a not so insignificant volume unless you consider that as of 2007, their share had shrunk to a mere 4 percent.

   There is a popular Russian fairy tale about a peasant family that can’t quite pull a giant turnip up out of the ground until the family gets together, and as a team – father, mother, child and even the dog, cat and mouse – manage to loosen the roots and bring home their next meal.

   Why can’t this work with the oil industry? And why is the share of small and medium-size producers shrinking to the point of becoming non-existant? This rapid decline is due to the lack of statutory support for small business operating in the upstream segment. The state has failed to provide adequate conditions for small business’ growth in this industry, which leads to dramatic consequences.

   The authorities take time, practically forever, to solve the issues native to small business. The key reason for this is the lackluster work of the pen-pushers at various levels, as well as the methods used by the authorities. Unlike in the majority of the western countries, in Russia such processes are extremely bureaucratized. Often, the usual token-approach to the problems of small business, results in protracted decision times and endless approvals, with members of various panels and commissions drowsing away at the meetings. At times, there is no sign of even normal human interest in countering a problem, making a right choice, a breakthrough.

   But in any case – why is it so vital for Russia to develop small and medium energy companies?
One of the reasons – 75 percent of the domestic raw materials base is small and tiny fields, and while large oil companies have no interest in developing this base, this represents a tremendous niche for the small business.

   Some data point out that about 40 percent of our Russian wells have been abandoned due to high water cut, complicated production, difficult production and low yield – and the number of such wells will only grow with time. Ostensibly, such a situation opens up a wide range of possibilities for small business development.

   It also is useful to remember the large social impact of developing small business, particularly in crisis conditions. For many towns and remote locations, such companies can be the salvation of oil production regions which might otherwise suffer imminent unemployment. Small companies operating to their full potential can dramatically boost hydrocarbons’ recoverability index, which in Russia country is far from ideal.

   In 2008, the small companies outside of vertically integrated oil companies produced over 20 million tons of crude, delivered to satisfy energy needs of the region. This promotes competition and lower prices on regional markets. Currently some 160 small and medium oil companies operate in Russia. The main regions promoting small producers are Khanty and Mansy Autonomy – Yugra region, Tatarstan Republic and Komi Republic.

   Recently Russia’s State Duma held an extended session of the energy panel on the issue “On Statutory Support for Small and Medium Business in Oil Industry During the Crisis”. Yuri Lipatov, head of the State Duma Energy Panel, noted at the meeting: “The regulations in force, including these on the state support for small companies, taxation and revenue, pay no account to operational specifics of small and medium companies in the oil and gas segment. Such companies see practically no state support. In the time of economic crisis, these businesses have been left out of the governmental anti-crisis program. One could say, the companies are on the verge of extinction. This is why we need to design a new judicial framework of state support for the small and medium companies of the oil and gas segment.”

   What hampers the operation of small business in the upstream and where is help required? The state must define the framework to reflect specifics of subsoil usage and providing the classification terms for small and medium business. Thus, turnover levels and a number of staff for such companies must be higher than in other industry segments – the oil industry has its own standards.

   The state also must simplify access to the fields for the small producer via various streamlined licensing options, and to provide small producers with pipeline access, transport infrastructure and to refining facilities. Already, to process the crude produced by small companies, a 7 million tons per annum refinery is being build in Tatarstan.

   Small companies need help in attracting investments and support, particularly in the field of innovations. For efficient cooperation of vertically-integrated oil companies and small producers in transferring licensing rights and rights for joint production. Clearly, vertically-integrated oil companies and small producers are companions rather than competitors and thus must help each other out.
The design of an efficient framework for tax incentives for small producers and a scaled taxation approach present another important issue for the industry. To remain profitable, low debit wells or difficult fields must entail lower tax on natural resources production.

   After the meeting, the State Duma’s Energy Panel decided to set up a follow-up group of the Energy Panel, which would include members of other State Duma panels, representatives of oil-producing regions and industry-related authorities. The group will be required to draft a framework for judicial support for small and medium business in the oil and gas segment.

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