December 16, 2022
In North America, Europe, and some other jurisdictions the total cost of production, referred to as the Full Cycle cost, is calculated based on six components:
Finding & Development (F&D) – Capital costs which includes:
- Completion including casing, cementing, fracking
- Land and seismic
- Tie-in, facilities, and other incremental infrastructure costs
Overhead – Includes all general and administrative (G&A) expenditures (head office); these costs are necessary expenses for doing business.
Producer Return or Cost of Capital – In North America it is calculated based on rate of return (15%) before income tax, equivalent to cost of capital.
Basis Differential – Differential between the oil price at the point of sale (in the producing basin) and a certain reference point. In the US, this reference point is the West Texas Intermediate (WTI); in Russia, the cost presented here is Urals which is FOB at the Primorsk oil terminal in the Baltic Sea.
Operating Cost – Lifting and field processing costs. Although operating cost is generally similar for different basins, the cost per unit of production increases as productivity decreases. As such, operating costs for mature fields are higher than those of new fields.
Royalties & Production Taxes – Taxes for government and royalties for freehold owners and others. Taxes include severance, conservation, and other taxes and will differ between jurisdictions.
However, the total production cost in Russia is calculated differently than full cycle costs in North America due to different specifications within the Russian oil industry. The main differences include:
- Cost of capital is usually not included in the total production cost calculation. In Russia, producers receive funding for large projects based on special agreements with government-run or government-affiliated financial institutions.
- Reported production costs usually includes drilling new wells, EOR, and other capital to maintain production of existing fields*; it does not include capital expenditures for exploration and development of new fields, including tie-in costs. Such costs are reported separately for individual projects.
- In Russia, all oil and gas mineral rights belong to the state, rather than freehold owners and local jurisdictions. The main component of the Russian tax system is a federal tax on production of natural resources. There are also several holidays (allows for a reduction in royalties and/or tax rates under certain conditions), export taxes, etc. However, it should be noted, that the taxation rules are constantly changing. Essentially, the state will take most of the profit from oil companies since there funds are a major source of government revenue. Russian oil companies either belong to the state (like Gazprom and Rosneft), or closely associated with the state (Lukoil or Surgutneftegas).
As a result, the cost of Russian oil includes four components: cost of maintaining production from old fields, cost of development of older fields, cost of developing new fields (which may or may not apply to individual basins and fields), and basis differentials relative to Urals. Russia does not have a comprehensive and standardized reporting system related to the operation of oil companies. Incorrys estimates the cost of Russian oil based on available reporting from government sources and operators. However, costs vary significantly between different regions and fields and pipeline tolls also differ due to distances between oil fields and export terminals. This leads to uncertainties related to the estimation of total Russian oil costs.
In order to compare the costs between Russian and US oil, Incorrys presents total cost of Russian oil alongside with their four components of cost of the Permian basin in US. These components include F&D and Op Cost combined, G&A, and basis differential.
- Average production cost of Russian oil in H2, 2021 was USD $15.60/Bbl, up from USD $13.50 in 2012 and USD $13.70 in H1, 2021. The increase in production costs is primarily due to maturity of existing fields and very high expenses for new drilling, completion and EOR**.
- Weighted Average Basis Differential reaches USD $5.44/Bbl in H2, 2021 up from USD $3.34/Bbl in 2012 and is expected to grow in 2022. The Weighted Average Basis Differential is estimated based on pipeline tolls for three production regions (excluding Sakhalin).
- Weighted Average Total Cost of Russian oil reaches USD $40-45/Bbl in 2021. In addition to production cost, G&A and Basis Differential it also includes the cost for development of new fields which reaches USD $18.40/Bbl in H2, 2021. Most new fields are located in remote areas of Siberia and require significant infrastructure investment. If new fields are not developed due to lack of capital and technology, it will lead to an overall decline in production.
- Total cost of oil in Russia without new field development cost is comparable to costs in the Permian and other US Tight Oil basins.
* Calculation of Production Cost of Russian Oil – https://magazine.neftegaz.ru/articles/ekonomika/743056-metodika-formirovaniya-udelnykh-norm-zatrat-po-dobyche-nefti-i-raschet-sebestoimosti-v-neftegazovykh/, https://www.neftvnb.ru/text/calculation/sebestoim.pdf
** Production cost of Russian oil: https://rg.ru/2022/02/19/rossijskaia-neft-s-kazhdym-godom-stanovitsia-dorozhe.html