Transcript of the beginning of the meeting:

Dmitry Medvedev: Today we will be discussing the outlook for developing and studying the reserves of Russia’s continental shelf. Without a doubt, this is one of the key priorities of the national energy sector. We must do everything possible to secure the rational use of these reserves while taking the necessary decisions and working to develop the continental shelf. Our future is connected with the development of Eastern Siberia, the Yamal Peninsula and the Arctic shelf and the Far Eastern seas.

It is clear that shelf projects are more expensive than projects to develop onshore reserves. What do we need? We need to create the necessary infrastructure, namely special port facilities, offshore platforms, ice-class tankers, auxiliary vessels and other infrastructure elements. Of course, we also need reliable geological information, which, I must say, is lacking. We also need modern exploration, production and hydrocarbon transportation technologies, including underwater technologies, which is a highly complex issue, as we know. Furthermore, we need an understandable and sustainable legislation to be able to take long-term decisions. Due to the specifics of offshore projects, all our decisions must be long-term. I believe that everyone who plans to implement offshore projects must understand this. Only in this case will we be able to accumulate the necessary – and very large – financial resources for this.

I’d like to remind you that the draft programme for the development of the continental shelf and the production of its mineral reserves was discussed at a Government meeting last August. The Ministry of Natural Resources was instructed to work jointly with other departments and companies to improve the document. Today we will be discussing a number of parameters that are crucial for achieving the programme’s goals.

Before we begin, we need to discuss one more issue that not only has to do with Russia’s interests but concerns all countries: environmental security. Everyone remembers about the Gulf of Mexico oil spill. We must reduce the possibility of such disasters to a minimum. In the past, Russia as a G8 member advanced the initiative of creating an international legal framework to prevent oil spills. This is extremely important, and we also need our national legislation to provide corresponding insurance and compensation instruments. We need to stimulate the creation of new technologies that will prevent damaging the unique Arctic ecosystem or will at least minimise the effects of these kinds of dangerous accidents.

In January this year, the President signed a bill amending the law on the continental shelf, which states that offshore projects will be approved only if they include spill prevention for oil and oil products, as well as relief plans and approved requirements for these plans.

Next. This is something that we have discussed on many occasions. Geological exploration, the so called regional work, is not progressing quickly enough. This happens for a number of reasons, including natural and climatic factors, and the geological features of Russia’s shelf area, as well as the vastness of the area that needs to be explored – over 6 million square kilometres. The remote East Arctic waters such as the Laptev Sea, the East Siberian Sea and the Chukchi Sea, are very poorly explored at this stage.

Today we are considering various arrangements which could help intensify offshore geological exploration, such as the possibility of regional exploration with federal funding, as well as with investment from state controlled companies or the introduction of a new type of subsoil work – geological exploration without damage to the subsoil integrity. These are the issues we must focus on.

It is also obvious that investors of all kinds seek stability and predictable government policies. A number of important decisions have been made including restrictions on the type and number of offshore operators. Russian state companies and their foreign partners also enjoy privileged tax and customs mechanisms.

We need to discuss what we are going to do next. Russian companies, which have extensive experience in mineral development (including offshore projects in the Caspian and overseas), are asking to extend the list of operators allowed to work on the shelf. We’ll discus this as well.

Finally, better control over companies’ compliance with their mineral licence agreements, and protection of federal financial interests remain our priorities. This includes a whole range of complicated issues, which we need to address. We need to make progress in taking balanced decisions which would benefit Russia’s interests and those of future generations of Russians, while also keeping in mind our immediate profits and dividends.

Let’s begin the discussion. We’ll hear from Sergei Donskoi, the Minster of Natural Resources. Go ahead please.

Sergei Donskoi: Thank you. Mr Medvedev, colleagues. Allow me to report on the prospects of geological exploration and development of Russia’s offshore resources.

It is hard to overestimate the role of offshore resources in the global energy balance. Interest in offshore development is growing as onshore resources in conventional oil and gas provinces become depleted for obvious reasons. This is confirmed by international statistics.

According to the well-known analytical group Wood Mackenzie, continental shelves account for over two-thirds of the hydrocarbon reserves discovered over the past ten years and over 90% of the total value of the producing fields discovered over the past ten years. The amount of aquatic drilling, including in the Arctic, has been steadily increasing recently in countries such as Norway. Interest in the Arctic shelf of Alaska is expected to grow.

The Russian continental shelf has huge resource potential. The initial aggregate hydrocarbon resources are estimated at about 100 billion tonnes BOE. The Arctic shelf reserves have about 76 billion tonnes BOE. Huge gas condensate fields, such as Shtockmanovskoye, Leningradskoye and Rusanovskoye, to name a few, have been discovered on continental shelves.

The speed of developing the unique resource potential of the Russian shelf depends directly on the level of its geological exploration and the speed of exploration activities, such as seismic surveys and exploratory drilling and its volumes.

The Russian shelf is ten times less studied geologically than the US continental shelf off the Chukchi Sea and 20 times less than the Norwegian shelf. Seismic studies in the most promising areas of the Arctic seas cover 0.15 km per one square km, except in the Barents Sea and the Pechora Sea, whereas in the eastern seas this number does not exceed 0.1 km per one square km. Without more intensive geological exploration of the shelf there will be no major discoveries, and the prospects for large-scale development will be put off to 2030 and beyond.

The Russian continental shelf is being developed under 107 licenses, including licenses issued under state contracts and in transition zones. The amount of work performed under the licenses has so far been insufficient for proper development of the shelf. In 2008-2010, 11 wells were drilled on the shelf and four fields discovered. To compare, 110 wells were drilled and 44 discoveries made in Norway over the same period. Offshore production in 2011 amounted to 13 million tonnes of oil and 55 billion cubic metres of gas, mainly in the Okhotsk Sea and the Caspian Sea.

Pursuant to the federal law On the Continental Shelf of the Russian Federation and in accordance with the directive of the Prime Minister, the Ministry of Natural Resources has developed the programme Development of the Continental Shelf and its Mineral Resources (approved in general at a Government meeting on July 2, 2012). The Government has instructed the working group headed by Deputy Prime Minister Arkady Dvorkovich to finalise the programme. I’m referring to the following issues: facilitating the intensity and efficiency of the exploration work, including on the continental shelf; developing an economic model that would  improve the investment appeal of exploring the continental shelf and developing its mineral resources (and introducing appropriate tax measures); providing adequate oversight over licensing requirements by relevant mining companies; environmental safety issues in the event of environmental damage; a possible increase in the number of subsoil users operating on the continental shelf.

We have identified a few problems during the finalising process. The solutions they require affect each other and also greatly affect the key programme indicators. I’m referring to the decision to grant licenses for developing the continental shelf to state companies which now enjoy exclusive rights to develop offshore fields; the decision under which state companies will possibly return a portion of the licensed areas granted to them under licenses if they are not interested in exploring or developing them (the unallocated subsoil fund); the decision to possibly allow private companies to develop the mineral resources that state-owned companies aren’t interested in; the possibility of codifying in law prospecting and evaluation phases of the exploration work as separately licensed activity with the potential granting of rights to conduct regional studies to the service companies conducting multi-client research; and, finally, the possibility of using new variables of the economic taxation model of shelf development in case private companies are allowed to conduct offshore operations. Further I will briefly describe these alternative solutions.

Under applicable legislation, the state companies Gazprom and Rosneft have put together application packages for licensing shelf areas and submitted them to the authorities. We have reviewed 12 applications filed by Rosneft to license the Arctic shelf development. In late 2012, we received 17 applications from Gazprom which are now being considered and coordinated by the federal executive authorities. So far, the Ministry of Natural Resources has received applications agreed with the Federal Agency for Mineral Resources only from Rosneft. I will focus on them in greater detail later, but Gazprom will also coordinate its license obligations and purported areas of development with the ministry.

If the state companies get properly licensed to operate on the Russian shelf, 80% of promising oil and gas offshore areas will come under such licenses. Under current law, this will mean that for at least ten years these areas – half of which are the size of an average European country – will be reserved by state-owned companies. The level of exploration of the area under licenses is a fraction of what’s required to complete the initial phase of regional exploration (prospecting) and is clearly not a sufficient assessment of available oil and gas reserves. The amount of seismic work under license obligations is also insufficient to consider these areas properly studied.

According to international scientific research, the  minimally studied areas are the ones with a density of 2D seismic studies of 0.35-0.5 running km per one square km. Norway, for example, licenses areas only after they have been studied at a level of 0.6-0.8 running km per one square km of 2D seismic studies. To achieve this level, license obligations of state companies in the areas under licensing need to be increased several times relative to now. Such an approach would inevitably lead to state companies focusing on the most lucrative and promising fields that make up no more than 10%-20% of the initially declared license areas. Just before the meeting, we received a letter from Rosneft where the obligations under the areas subject to licensing will purportedly reach 0.35 running km per one square km. However, the state will be interested in further exploring and prospecting these areas even after the regional studies have been completed.

Various approaches are used internationally to explore areas that are not being developed by subsoil users. The main mechanisms for encouraging subsoil users to return areas that they believe hold no promise for them are either an obligation on their part to return a part of areas after expiration of a certain period of time (for example, in Brazil and Norway), or establishing progressive royalty rates that increase over time (such as rental payments in Canada, the United States, Brazil and Norway), or a combination of these two mechanisms.

The effectiveness of this approach can be seen in the newly discovered giant Sverdrup field in Norway, which is the world's biggest discovery made in 2010-2011. The area under this field was licensed on three occasions. In 1965, the license covering this area was fully owned by Exxon, all its 2,146 square km. From 2001 to 2006, this area belonged to the consortium with the participation of Statoil. This time the licensed area was 815 square km. In both cases, the areas were rented out as low-promising ones. Once the geophysical information became freely available, an independent company Lundin made its own interpretation of the data. The company got access to the shelf and discovered a large field. However, the return of unused areas to the unallocated subsoil fund will not resolve the problem of studying and developing these fields.

The only realistic way to continue exploration in those areas is by offering them on lease to other interested companies. Given this, we should examine the possibility of leasing potential deposits to private operators who have the expertise and the capacity to prospect for, evaluate and develop  outer continental shelf (OCS) resources. Shelf deposits could also be offered to Russian-controlled agencies for prospecting and evaluation services on condition the integrity of the deposits is not undermined. Such agencies could be granted a licence under a multi-client scheme, meaning that geological information to be obtained through prospecting will be free for them to use as they see fit, including selling it off to interested parties in conformity with Russia's information export and confidentiality regulations. To realise this, an enabling mechanism should be developed. We've outlined such a tool in our OCS programme in association with the Economic Development Ministry. Here is what it could look like.

With regard to offshore areas where regional prospecting has not been followed up by further interest in exploration and development bids from state-run companies, it would be advisable to establish procedures for offering similar onshore deposits of federal standing on lease, either at the request of a company and the upholding of the request by a federal regulator, or in the event of several bidders vying for the same zone, or if the zone in question has been found to be rich in top-ranked minerals and fossil fuels, decisions on the lease are up to the federal Government to make, based on the outcome of a tender. The right to develop a mineral deposit discovered through prospecting shall be granted to the company responsible for the exploration works.  A bidding mechanism could be elaborated to make it possible for state-run operators to join in as partners, either based on standard conditions or on terms and conditions agreed by the parties involved.   

Potentially mineral-rich areas leased to state-run companies could also be made accessible to prospecting agencies for multi-client regional exploration services, for a term of up to five years. The geological data obtained by such agencies through prospecting shall be reported to the state, and may also be shared with third parties, including as a paid-for service. Depending on the exploration findings, a licence for prospecting and evaluation (or for prospecting, evaluation, development and production) could be granted either on the basis of the same formula as the one used for deposits of federal standing or to the winner of a  private tender.  

Now I'd like to speak briefly about the systemic OCS investment clause enacted by Government Resolution 443-R of 12 April, 2012 According to calculations made during the final stage of drafting the OCS programme, once that resolution is implemented and appropriate legislative amendments are introduced, Russia will have one of the world's most liberal taxation systems for hydrocarbon production on the outer continental shelf.

The new taxation system is structured in such a way as to compensate for the high environmental and technological risks run by state-run companies and their partners while prospecting in hitherto unexplored continental shelf areas of Russia, while at the same time ensuring good performance on shelf development projects involving a limited lineup of licensed operators and foreign agencies contracted to perform prospecting services.

To uphold the principles of tax stability and ensure the execution of agreements between state-run companies and their foreign partners, tax rates set by the government resolution should also be applied to state-run companies' continental shelf operations, because if the proposals of the Natural Resources Ministry are to be implemented, it is public companies that will have to assume the risks of regional prospecting. And if the lineup of operators is expanded, higher tax rates than those set in Resolution 443-R should perhaps be introduced for private operators. Such a move would be in line with international practice, and it would also bring in more revenue into Russian treasury coffers.

The new taxation system should focus on profit taxation. By our estimates, this would allow Russian treasury revenues to be substantially increased without discouraging private companies from carrying on with their large-scale shelf development operations in this country. The OCS programme would thus benefit both financially and in terms of output.

In keeping with a decision we made at a meeting with Deputy Prime Minister Arkady Dvorkovich, a request has been forwarded to the relevant companies and federal executive bodies, inviting them to comment on each of the options tabled by the Natural Resources Ministry. The results of this survey are presented in this screenshot. As you can see, the relevant government agencies and companies approve of the proposed solutions by and large, except for the one about adjustments to the economic model.

The Energy Ministry and the companies Rosneft, Gazprom, Zarubezhneft and Lukoil have all spoken out against the parallel application of two taxation schemes, one for state-owned companies and another for private ones.

The Finance Ministry argues that the idea to extend the lineup of shelf operators needs further elaboration. Gazprom deems it feasible to extend the lineup solely by engaging more state-run company subsidiaries. But there's no disagreement over the possibility of multi-client OCS exploration and of secondary leasing to independent operators for deposits that no state-run company is interested in developing.

In conclusion, allow me to touch on one issue crucial to OCS exploration and development: the environment. I'd like to go back to the law passed in December, which was mentioned here earlier today, which introduces amendments to the continental shelf and internal seas regulations. These amendments require that OCS operators should have the necessary expertise, technical capacity and financial resources to rapidly deal with the aftermath of man-made disasters, such as oil spills, including in ice-covered areas. 

Before submitting its OCS programme to the Cabinet for approval,  the Natural Resources Ministry will be happy to amend it in collaboration with interested companies and government agencies and in line with the discussions we've had here today, as well as the latest relevant data.  

While finalising the programme together with the Economic Development Ministry, it would make sense to provide for a mobilisation stage, of two to three years in length, during which appropriate amendments could be introduced, requirements to potential operators worked out, issues elaborated concerning transport and industrial safety for operations in the Arctic region, and rules related to the sharing of geological data defined. The timeframe for that mobilisation phase should be linked to the commitment of state-run companies to hand back their licences on explored deposits they are not interested in developing, so that those deposits can be leased on to other operators. Thank you for your attention.

Dmitry Medvedev: Thank you. As far as the environment is concerned, I've already said that this is an absolute imperative. We'll be acting in such a way as to avoid doing any damage to the environment. As for the primary objective of our meeting, I see this as reaching compromise solutions concerning certain key issues we may disagree upon. This is a topic that requires further discussion. 

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