Although the decline has been somewhat tempered by investments made over the last ten years, we have witnessed the collapse of Romania’s oil and natural gas wealth myth.
Despite that, there is still cause for optimism, as Romania ranks among the top three European states least dependent on energy imports, with only 21% of national consumption being covered by imports. Only Denmark and Estonia rank above Romania, while the EU average for energy import dependence is over 50%. However, Romania’s dependence on a single source of natural gas imports is a risk.
State-of-the-art technologies provide new opportunities for exploitation of fresh resources. Romania must cope with three major challenges at the same time: increasing the recovery rate of mature fields, while developing offshore natural gas deposits and shale gas. Recent exploration of the Romanian perimeters of the Black Sea, as well as the onshore Dobrudja and Moldavia regions of Romania, has generated enthusiasm regarding the potential of deep-sea offshore gas and shale gas fields. Romania is not, however, a new El Dorado for oil and gas production, with its mature onshore deposits being almost depleted and the new deposits being difficult and expensive to exploit.
Accessing these resources involves massive investment in the upstream sector and in the transport infrastructure. Romania has a relatively well-developed infrastructure for crude oil, but that for natural gas requires substantial investment. A large part of the transportation network – including the one to be used for handling Black Sea gas output in anticipation of the actual exploitation forecasted for the 2020s – is in need of rehabilitation and development. The system used by the gas transportation operator is manual and needs upgrading. Connecting fully to the EU’s and neighbouring states’ gas networks is also a must to achieve diversification of sources and ensure access to the EU market.
The government has committed to continuing the privatisation of state-run energy companies and deregulation of the natural gas market (by 2014 for industrial consumers and by 2018 for household consumers, respectively) to make the local energy market more attractive to investors. A reduction of the price paid by end-consumers is also possible, further to the expected increase in unconventional gas production, as was the case in the US, where prices fell considerably ($115 /1,000 mc).
Substantial investment funds are available worldwide for the upstream sector
According to recent analysis, worldwide financial resources available for investments in the upstream sector are estimated at USD 1,800 billion between 2011 and 2014. Investments by government and national oil and gas companies represent 35% of that total, with 65% coming from private sector investors.
In terms of resource types, 85% of investments will be directed towards conventional deposits, deep sea offshore exploitation, low porosity gas reservoirs and shale gas.
In terms of geographical coverage, the largest investments will be drawn by the dominant players on the energy market: the US, Russian Federation, Canada, China and Brazil. Newer and highly dynamic players, such as Australia, Angola and Nigeria will also draw significatnt investments.
In Europe, the countries with the best prospects of attracting investment in the oil and gas upstream sector are Norway, Great Britain, Italy and Romania. There are differences between these countries, however, in terms of infrastructure quality, sovereign risk and financing costs, technical expertise and specialist workforce quality. Romania has the potential to become an SEE regional hub (export of gas, know-how and specialist company services), but it faces fierce worldwide competition for investment.
For various types of investment options, decisions are influenced by risk factors and profitability
Investment decisions in this sector are made after analysis of the opportunities arising from the availability of various types of resources, depending on the ease of access to resources and the deposit recovery potential, but also by considering three risk factors: production complexity, commercial factors, political and fiscal factors.
Production complexity is influenced by the technology requirements of the rigs, by the needed operational abilities and know-how available in each company for the exploitation of various types of resources.
Commercial factors are ease of market access, the oil and natural gas transport infrastructure, the degree of deregulation of the crude oil and gas market, but also current market demand, on which the profitability of exploiting difficult to access deposits – involving higher drilling and extraction costs – depends.
The political and fiscal factors are the stability and transparency of the tax and legal framework.
After analysing all these factors, investors set their profitability targets. For instance, the exploitation of shallow water mature fields in the Gulf of Mexico and the North Sea involves lower risks (quality energy infrastructure, stable tax framework, etc.), but the profitability rate is lower for investors, while the government take through taxes, levies and royalties is higher (with generous tax deductions available for investments).
In Africa, however, where the development of local deposits would involve substantially high political and fiscal risk factors, where the transport infrastructure is rudimentary and governments impose production sharing agreements, higher profitability is expected.
Prospects for the Romanian oil and natural gas sector
In Romania, technical and geological risks pertaining to oil and natural gas fields are high and rising. The major challenge for the local oil and natural gas industry is to attract investment, given the maturity of the onshore deposits and the need to implement new costlier technologies.
Production in Romania is sourced both from onshore deposits and shallow water offshore deposits, with the potential of deep-sea offshore reservoirs and unconventional gas to be gauged.
Regarding the exploitation of conventional onshore deposits, given their high degree of depletion, the technical difficulties in improving their recovery rate are compounded and growing, as are the exploitation costs.
The Black Sea offshore fields are potentially promising, in theory, but there are substantial technical challenges, while the underlying risks and drilling and extraction costs are high (20% chance of success, with costs exceeding USD 150 million per well).
The highest risks are for unconventional gas (shale gas), which require state of the art technology and expertise only available at the energy giants.
The highest overall risk for Romania in terms of energy security would materialise if all of the following were to occur at the same time: considerably dwindling output from conventional fields (further to reduced investment triggered by higher royalties), failure of new offshore area and unconventional field prospects (disagreement on tax treatment or negative public opinion opposed to the use of certain technologies being the likely deal breakers), delay in deregulating prices and potential failure of the Nabucco project (either full cancellation of the project or an implementation decision leaving Romania out of the transport route, e.g. choosing the TAP route).
Governments – companies balance
During the last 150 years, the oil and gas industry has had a strong strategic and political component, with control over this sector and resources being a source of disagreements between competing states. Such “disagreements” have at times escalated into military, economic and financial conflicts.
Governments play a significant role in the sector, as they have legislative power, if not always the investment money. Private investors are increasingly influential, however.
There are major differences between the objectives of governments and those of companies regarding oil and gas deposit exploitation. Governments are interested in maximising aggregate tax contributions of companies in the sector and plan levies, taxes and royalties in the earliest stages of projects. Companies are interested firstly in financing their investments and then make payments to the budget in the later stages of projects.
Governments focus on drawing investment and enhancing the overall competitiveness of the country, whereas companies concentrate on outperforming the competition.
Where long-term objectives are concerned, governments seek the development of the energy sector as a driver of general economic growth, while ensuring energy security and boosting infrastructure, whereas companies plan to maximise the return on shareholder investment, in a sustainable manner, in the long term.
Where flexibility is concerned, governments are interested in diversifying their resource portfolio in order to mitigate risks, whereas companies seek to remain agile on the market and adaptable to changes in economic circumstances.
Until recently, the aim used to be reaching the balance between government and oil company priorities – a “win-win” situation.
It is ever more obvious, however, that in this game of opposing interests, the civil society plays an ever greater role, by exerting pressure on governments and on companies in the private sector on matters pertaining to the costs of energy products and their environmental impact. From this perspective, reputation management is essential in the ongoing energy game, e.g. the negative impact of the Gulf of Mexico oil spill on BP’s image, but also the political cost, for Spain’s People’s Party, of the Prestige oil tanker wreck in November 2002.
This is why we need to reach a “win-win-win” situation for all the parts involved, governments, investors and civil society.
Aggregate tax contributions vs. Internal Rate of Return (IRR)
During public debates, the focus is on the level of royalties paid by the sector, but company contributions to the budget should be seen as the big picture. If one considers payments made by companies to various budgets as royalties, excise duties, customs duties, VAT, corporate income tax, social security contributions of employers and employees, dividend tax, council taxes, as well as sponsorship and corporate responsibility initiatives, it is plain to see that the level of aggregate tax contribution is substantially higher than the royalty payments.
Furthermore, aspects which are more difficult to quantify, but crucial, should also be considered. Oil companies contribute to ensuring energy security, investments in the sector have a multiplying effect in the economy, help to transfer know-how and play a significant role in training the local workforce and promote a positive image of the country.
High risk projects require high IRR, with governments usually accepting in such cases lower aggregate tax contributions in order to attract investment, enhance energy security and enjoy the benefits noted above, whether they are quantifiable or not.
The analysis of the IRR and of the aggregate tax contribution for the onshore sector in a number of countries shows that as a rule when project risks go up, and implicitly the IRR, the aggregate tax contribution goes down.
There are countries with an overall low risk (Great Britain, Germany and Norway) where for particular types of deposits investors would demand a high IRR, which has an impact on the aggregate tax contribution. In many countries, the tax treatment is adjusted depending on the type of deposit.
It is also known that the abrupt and inadequate change of the taxation framework may have major negative consequences on investments, as found in the UK and the Canadian province of Alberta (where, after an increase in tax rates, investors redirected their interest towards British Columbia).
With low-risk countries or projects, governments levy higher taxes on project profits. As already mentioned, to boost investment for high-risk projects, governments take a smaller share of the profits.
Given the need to put an end to the constant decline of the domestic oil and natural gas production during the last 30 years, Romania needs substantial investment in the development and exploitation of its oil and natural gas reserves.
State-of-the-art technologies provide new opportunities, allowing exploration and, where chances of success materialise, subsequent exploitation of the deep sea and shallow water offshore fields in the Black Sea and shale gas deposits.
All this involves grand scale investments to which the government cannot commit on its own, while Romania is engaged in a fierce global competition to draw investment.
Investment decisions are influenced by risk factors, but also by the profitability investors need. The risk factors are the size of exploitable resources, the complexity of production, the commercial terms and the political and fiscal framework. Romania is not necessarily in a privileged position, with high and rising technical and geological risks pertaining to its deposits. A realistic approach that would enable the country to draw the investment required to reach its regional energy hub potential is a must.
High-risk projects require a high internal rate of return (IRR). A balance is needed between the government’s need for budget revenues and the oil companies’ drive to have their projects financed and yield a reasonable return on investment. As such, the sustainable growth of this sector requires a considered approach.
The oil and gas sector generates economic growth, contributes to energy security and provides a wide array of budget revenues. The aggregate tax contribution paid by companies in the sector is a more appropriate benchmark given that aside from royalties, excise duties, customs duties, VAT, corporate income tax, social security contributions of employers and employees, dividend tax, council taxes and levies are also paid, etc.
Investments in the sector are risky, as they are long-term commitments and require a clear-cut, transparent, stable and predictable legal framework. It also takes balanced communication and an honest professional dialogue that will lead to a “win-win-win” situation for all the parties involved – governments, companies, the civil society– and that in turn will encourage investments.