It took Serinus 10 years for declaring commerciality of the Moftinu area, 10 years out of which 5 were lost due to delays in permits and approvals, told us two of the officials of the company, Jeffrey Auld, CEO Serinus Energy and Alexandra Damașcan, President of Serinus Energy Romania. However, Serinus would like to continue to grow in Romania, because “Romania could be an energy leader in Europe”. But… Without changes to the increasing levels of difficulty imposed on businesses and on the fiscal regime – the windfall tax appeared again and again in our dialogue –, it is not assured that Serinus will be able to convince its investors to further bet on Romania.
In recent years, the Black Sea offshore aside, there was a little public discussion on the gas operations in Romania. What have Serinus done since early 2017, when you decided to proceed with the Moftinu Gas Project?
Jeffrey Auld (J.A.): Serinus is a committed investor in Romania. Our original investments were premised on the promise of stable fiscal terms in a developing market, at that time adjacent to the European Union. Serinus worked hard to bring those original investments into reality. In 2017 the company made the decision to commit to the development of the Moftinu Gas Project, which was a significant commitment. In the midst of construction of the gas plant the Government of Romania introduced Government Ordinance 114. This caused a great deal of concern to our investors and in many cases, investors were urging us to stop committing capital to Romania until fiscal stability returned. We took the view that the Government would recognize the damage Ordinance 114 had done and would seek to repair this damage. This did not happen. Even more damaging was the introduction of the Windfall Tax in 2018. This tax was put in place just before Serinus began producing from the Moftinu Project. The Windfall Tax had the effect of diminishing the company’s expected return on investment by 60%.
Alexandra Damașcan (A.D.): Since 2017 Serinus has continued to invest in an environment that is becoming increasingly hostile in the form of irrational taxation. The company has always hoped that the detrimental effects of Government Ordinance 114 and the Windfall Tax would be recognized and repaired. Rational changes to these laws as well as the Petroleum Law would be beneficial to Romania and without such changes, investors will increasingly look elsewhere in the world to invest their capital.
The Moftinu field is known from the 1970s, but it was only in 2014 that something useful was discovered. What made the difference in the Serinus approach?
A.D.: It was known since the 1970s that there was hydrocarbon potential in the Moftinu area. It was not until Serinus drilled the Moftinu 1000 well that the commercial success of such a field could be realized. After drilling Moftinu 1000 well, Serinus understood immediately the potential of the Moftinu area. A seismic acquisition program was done covering 80 km2 at the Moftinu field, followed by five successfully drilled wells which eventually proved the commerciality of Moftinu field. To put things in perspective, it took Serinus 10 years to end up declaring commerciality of the Moftinu area, 10 years out of which 5 were lost due to delays in permits and approvals triggered by non-functional petroleum and construction laws. The hurdles the company faced were wholly avoidable and the field could have been developed in half the time it took. This has a real impact on future fields and ultimately on the pace that Romania can grow its onshore gas production.
What is different in how an independent O&G company works from how large companies like Romgaz and OMV Petrom treat a field?
A.D.: As Serinus has grown, its responsibilities as a good corporate citizen have increased. Now, as the third-largest gas producer in Romania, these responsibilities are even more important. Serinus is a material employer and taxpayer in the Satu Mare area with 24 employees and 2021 turnover (January-October 2021) of 82 million lei. Our responsibilities are to all our stakeholders, and we must balance our obligations to our host government in Romania and our obligations to our shareholders to run a growing and profitable company.
These obligations and responsibilities are no different for Serinus than they are for OMV and Romgaz who have hundreds of employees and larger financial resources. How a smaller company deals with these responsibilities is different. The loss of one day’s production is damaging to any company but it is particularly noticeable and damaging to a smaller company. Interruption, overly burdensome paperwork can all affect a smaller company directly. A company of Serinus’ size does not have the luxury of having hundreds of projects that can offset the delays in any one project. If Serinus is delayed in one project the whole company must slow down and wait for the results of the delayed project before moving on to the next phase of growth. This means that bureaucracy affects small companies much more than large companies. Such burdens delay growth and growth is beneficial for Romania and Serinus.
The effects of uncertain fiscal regimes also have a huge effect on growing companies. The Windfall Tax is an excellent example of how growth can be halted by a poorly designed tax. Larger companies with older projects will have already earned back their original investment so the Windfall Tax is simply a revenue tax for them. Smaller growing companies have had this tax imposed upon them before they have even earned back their investment. In some cases, this tax is so punitive that some projects will pay vast amounts of windfall tax but will never pay back the investors for their original investment. It is clear that if an investor does not earn back the money invested then it is very unlikely that they will invest again. Such policies hurt growth and hurt small companies which are the engine of growth. There needs to be a fair advantage provided to the small independent companies so that they are willing to invest more and more in Romania.
Are there any other fields in Romania where an approach similar to what you had in Moftinu might prove beneficial?
A.D.: All of the fields in Romania have their own risk and particularities. Each operator knows better the field weaknesses and strengths so, we can say that indeed, if all of us were to follow the same approach for our fields, then the results might be affected only by an unfair fiscal and legal regime. Moftinu was only one field in a 3,000 km2 concession area. Our G&G team has identified so far at least 32 similar prospects which could if fiscal terms are fair, follow the success of the Moftinu commercial discovery.
Are there significantly enough gas volumes in the Romanian onshore underground for the authorities to take into consideration stronger incentivization for O&G operations?
J.A.: Serinus believes that Romania could be an energy leader in Europe. We believe that a fairer and more balanced tax system combined with streamlined permitting and approval processes could be a potent combination in attracting further investment. Serinus does not just think this is the case… We are told so by our investors.
What kind of actions do you see necessary for Serinus and other companies like you to record better results faster?
J.A.: Primary laws such as Petroleum Law, Electricity and natural gas Law and their applicable norms should be modified or replaced with new ones, offering to investors streamlined regulatory and permitting processes, efficient and certain title transfer procedures/assignment procedures, recognizing the obligations in a contractual relationship between several co-Titleholders, and provide better and consistent correlation between Petroleum Law and Environmental Law and Water Law. These are changes that would improve the investment climate for gas exploration and development in Romania. Delays associated with multiple layers of bureaucracy must be eliminated if companies are going to invest and grow.
On the fiscal side, the Windfall Tax is a damaging tax that is hindering investment. The Windfall Tax needs to be changed urgently to allow the Government to receive a fair portion of the benefits of growth whilst allowing investors an opportunity to earn back their invested capital before paying considerable funds to the Government. For Serinus, we are a gas producer with investment plans to increase our production in Romania significantly, but we must rely on the cash flow we earn from our current operations to fund our future investments. The Windfall Tax as it is currently constructed takes funds away from the business before the projects have had the opportunity to repay the original investment. This structure adds years to the payback period for investors. The longer it takes for us to earn a return on our capital, the longer it takes to re-invest this capital in further exploration and development. The result is slower production growth.
You describe the Windfall Tax as a significant disincentive to investment. Please, describe the mechanism responsible for this effect!
J.A.: It acts as a disincentive due to the very high incremental fiscal burden it imposes at the very low gas threshold price of 47 lei/MWh. The rate of burden is 60% at this threshold with no deductibility of operating costs, very limited deductibility of capital costs, and only the deductibility of royalties paid. This is not a windfall tax but a revenue tax. Companies must pay a significant portion of their revenue prior to even earning back their at-risk investment. The fiscal burden becomes even more extreme at the second Threshold gas price of 85 lei/MWh, where the government take increases to 80% of revenue less royalties and companies can no longer further deduct the capital it has spent on exploration and development. Since these threshold prices are not indexed to inflation, as the cost of exploring, developing and operating gas fields goes up, the burden will become even more pronounced and further impede investments going forward. This fiscal burden also does not account for the production decline that happens to all gas fields. This means that producing fields will be shut in sooner as the production revenues can no longer cover the costs of operating the field. Considerable resource volumes could be left unproduced due to this very inflexible and burdensome tax.
The recent historical increase in the gas price in Romania demonstrates how the windfall tax diminishes the market supply response from domestic gas producers. Beyond the 85 lei/MWh threshold, the government takes almost all of the incremental revenues earned above this price. Producers, therefore, do not adequately react to the price signals of the market. It is said that the cure for high prices is high prices; this is because higher prices incentivize an increase in production and that increase ultimately brings prices back down. The Windfall Tax as it is currently constructed removes this market incentive for growth and in its place shortens the life of existing production. The tax also increases the size of a discovery that is required to be economically developed. Essentially this tax forces producers to leave smaller discoveries unproduced. This lack of supply response will further distort the gas market and make higher gas prices a fait accompli.
The government faces a tremendous economic opportunity. They can design a fiscal system in which they can earn a fair and reasonable fiscal take while allowing investors to earn back their capital and generate excess capital for reinvestment in the country’s onshore gas opportunities. Over time, the production can grow to eliminate the costly need to import foreign gas. This will help to reverse the huge outflow of funds used to pay for this foreign imported gas, further enhance the energy security of the country and its consumers, use the domestic gas production to replace more carbon-intensive energy sources currently employed in the country, all while maximizing the long-term fiscal return and stability to the country’s finances. The windfall tax as currently designed trades off these long-term benefits of gas and energy self-sufficiency for short-term government financial gain.
Are you interested in other concessions in Romania?
J.A.: Serinus is an established participant in the energy business in Romania. It is logical that we would wish to grow. However, as incremental taxes like the Windfall Tax and further bureaucracy are applied, it is increasingly difficult to convince our investors that Romanian is the best place for Serinus to invest its capital. Currently, the ability to earn financial returns in Romania, even with higher commodity prices, is lower than in many other countries. The competition for capital does not need to be a race to the lowest tax returns but the current Romanian tax regime is perceived as being unfair to investment. Companies like Serinus invested heavily only to find the Windfall Tax was implemented permanently and our economic returns were severely diminished. This uncertainty is unhelpful. Investors look for fairness and predictability and can move their investment to regimes where they see these practices of fairness and predictability. Romania is currently losing investment to other jurisdictions where investment is incentivized. As mentioned above, with the right policy incentives in place that provide a more reasonable sharing of the benefits to cover the significant risks faced in exploring new gas resources, then investors could be very interested in the new licensing round. To incentivize interest in the new Licensing Round, major improvements on the current Petroleum Law and Fiscal Regime should be pursued. This would include a commitment to fiscal stability that needs to be clearly mentioned in the legislative changes, in order to provide the certainty required to attract investors.
What has been the impact on Romania from this under-investment in onshore exploration and production?
J.A.: The lower investment has resulted in declining domestic production, while at the same time gas demand in Romania has steadily increased. This has resulted in higher gas prices. In effect, the higher level of taxation taken by the government is passed on to the consumer in the form of higher prices they pay for their energy. The more capital the government takes out of the system in the form of fees and taxation the less capital there is to invest in growth. This price response is somewhat dampened by the increasing imports of foreign gas into the Romanian market, but this also has a huge cost on Romania in the outflow of funds from the country in payments to foreign gas producers. Since the beginning of 2020, Romania imported over 4 billion cubic meters of foreign gas which has resulted in an outflow of over $1.5 billion from Romania at average market prices during this period. This is a 1.5 billion dollars sent out of the country that otherwise could have been invested to grow production and create domestic jobs.
This foreign imported gas is not subject to the same taxes as locally produced domestic gas. Imported foreign gas is actually exempt from the Romanian Windfall Tax and therefore has a competitive advantage in the Romanian market. Bizarrely the Romanian government is incentivizing the import of foreign gas at a very high cost to the state of Romania as opposed to incentivizing the development of more domestic gas. The funds that flow out of the country to pay for foreign imported gas are not invested back into the Romanian economy.
How is Serinus positioning itself in all this fuzz about deep decarbonization of industry and society?
J.A.: Serinus is at the forefront of decarbonization. Natural Gas is a key transition fuel that will allow coal-intensive power generation to be replaced with cleaner gas-generated electricity. Ultimately this is a fuel that can help transition power generation from coal to natural gas to renewable power. According to the International Energy Agency only 2.4% (32,474 TJ) of Total Energy Supply was provided by wind and solar in 2019. During the same time, over 44% of Total Energy Supply was generated using Coal and Oil. As Romania develops its renewable sector it is critical to reducing the most carbon-intensive of the fuels used for power generation. Each unit of energy generated by natural gas produces half the GHG emissions of coal. Increased gas production allows Romanian to reduce its emissions now and still allows the country to progress to a longer-term renewable energy mix.
Are there specific threats you see, from the EU legislation, for the near future, the EU methane strategy, for example?
J.A.: Serinus welcomes the EU Methane Strategy. We are very careful to monitor and eliminate any fugitive emissions from our operations. We engage third part experts to monitor our fugitive emissions and make immediate remedial efforts if such emissions are detected. We welcome future EU Legislation to make all industries cleaner and more efficient.
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This article first appeared in the printed edition of Energynomics Magazine, issued in December 2021.
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