Practical Difficulties of Valuing Russian Oil Reserves
Authors: Gochenour D. Thomas 
Published: December 2007

D. Thomas Gochenour

The Russian oil industry has been organized along the lines of vertically integrated companies, although these companies do not control their own transport infrastructure. For more than ten years the industry has been "decapitalized", production has fallen by more than 55%, while exploration and reserves replacement has nearly ceased. Desperate for new capital, the major Russian companies have engaged Western auditors and reservoir engineers to put a value on their reserves. This process is neither straightforward, nor are the valuation going smoothly. There are a number of fundamental difficulties. This paper addresses the problems with valuation that have been encountered to date. The biggest problem is the system of reserves definition that includes an economic component, as is common practice and is recommended by SPE. Reserves estimates are based on data, which the companies often do not themselves possess. Field production decisions are based on fundamental economics that no longer apply in the Russian market, and basic assumptions about production and lifting costs, levels of depreciation all are fundamental issues which have not been determined and which are readily available to the valuer. This paper will review the problems encountered to date and the likely future progress that will be made in arriving at a fair market value and acceptable reserves figures for Western investors and lenders.

Background

Since 1991, the Russian government has re-organized the oil industry through first the corporatization of the state producing associations and then by privatization of resulting companies. The companies were set up as vertically integrated companies (VICs) whereby nearly 30 crude producing units were included with refining and marketing units as subsidiary companies of the larger holding unit. The state retained control of the oil and products transport system, thus leaving these vertically integrated companies seriously weakened and subject to outside control. At the end of 1996 there were 13 of these vertically integrated companies, all but one of them at least partially privatized. Some of these companies, YUKOS for example, have reached an advanced stage of privatization and have been since early 1995 approaching Western debt and equity markets.

The issue of reserves valuation was not addressed early in this process and has been approached on an ad hoc basis by the various VICs. Most Russian companies have up to now been content to rely on the reserves estimates that they inherited from the Soviet administration of reserves, but about ten of the VICs or their component subsidiary companies have begun on their own to re-assess their reserves positions. The state administration has been slow to respond but by the end of 1996, there was widespread recognition amongst managers of the VICs and state authorities that Soviet reserves standards were out of line with international practice and did not adequately reflect the economics of the industry.

Western reserves engineering evaluators, such as Miller & Lents, Netherland, Sewell Associates, Troika Energy Services, and Ryder Scott, to name just a few, were invited in by the VICs to review and audit their reserves, often at the behest of the Big Six accounting firms and in conjunction with the VICs' initial efforts to develop accounting and financial reporting in accordance with Western standards. These Western firms have all encountered a number of systemic and local difficulties in evaluating the reserves of the VICs. But these difficulties are being overcome and some specific problems partly reflect a slowly changing policy situation and a very dynamically changing macro-economic situation which have major impacts on the Russian oil industry today.

These practical difficulties can be categorized in four areas:Objectives of the Reserves SystemDefinition and Calculation of ReservesOrganization and Administration of DataEconomics

Objectives of the Reserves System

The Soviet system for the oil industry was output oriented and was not motivated by profit maximization of individual fields.

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