Norway – Russia.
Delimitation Treaty 2010.
Incentives and Obstacles for Oil and Gas Exploration and Production.

Sergey Seliverstov
Content
More than three years have now passed since the Kingdom of Norway and the Russian Federation signed the Treaty concerning Maritime Delimitation and Cooperation in the Barents Sea and the Arctic Ocean (the "Treaty")1. Following ratification by both parties, the Treaty entered into force on 7 July 2011. This means, inter alia, that vast areas of the Barents Sea are now covered by a specific international regime governing the exploration for, and production of, hydrocarbons. This article aims to analyze how this legal regime will influence government and commercial activity.
1. Mandatory unitization and its general consequences
As the Treaty's title indicates, its main objective is the delimitation of marine areas, putting to an end more than 20 years of negotiations and finally establishing the maritime boundary between Norway and Russia. The delimitation in turn opens the way to the exploitation of mineral resources in these previously disputed areas.

Apart from this, the Treaty envisages certain conditions with respect to the future exploration for, and production of, hydrocarbons, which will be facilitated by the establishment of a clear and undisputed border. Article 5 of the Treaty introduces a unitization requirement for all transboundary hydrocarbon deposits and Annex II to the Treaty further sets forth detailed rules concerning the Unitization Agreement to be concluded between Norway and Russia.

Unitization in this context is the term used to refer to a legal regime governing the joint exploration for, and exploitation of, oil and gas deposits (as well as other types of mineral deposits) that are crossed by various types of borders, (e.g., borders between states, municipalities or simply different landowners). Unitization in respect of onshore oil fields first gained ground in Europe in the 1860s2 when it was put into practice by enabling legislation in the relevant jurisdictions. In the United States it has been practised since the 1930s3 when enabling legislation was enacted there. The unitization of offshore oil and gas fields is a more recent phenomenon. Here it is worth mentioning that Norway has substantial experience in this area of international law, beginning with its involvement in the pioneering Agreement between the Government of the United Kingdom and the Government of the Kingdom of Norway relating to the delimitation of the continental shelf between the two countries (the "UK-Norway Agreement"). This was concluded back in 1965 and has formed the basis of, and been followed up by, a number of North Sea unitization agreements. The most well-known of these, which was concluded between Norway and the UK in 1976, relates to the giant Frigg field4 (the "Frigg Agreement").

Unlike the UK-Norway Agreement, where the unitization formula is not very sophisticated, the unitization requirement envisaged in the Treaty is rather detailed:

"2. If the existence of a hydrocarbon deposit on the continental shelf of one of the Parties is established and the other Party is of the opinion that the said deposit extends to its continental shelf, the latter Party may notify the former Party and shall submit the data on which it bases its opinion.

If such an opinion is submitted, the Parties shall initiate discussions on the extent of the hydrocarbon deposit and the possibility forexploitation of the deposit as a unit. In the course of these discussions, the Party initiating them shall support its opinion with evidence from geophysical data and/or geological data, including any existing drilling data and both Parties shall make their best efforts to ensure that all relevant information is made available for the purposes of these discussions. If the hydrocarbon deposit extends to the continental shelf of each of the Parties and the deposit on the continental shelf of one Party can be exploited wholly or in part from the continental shelf of the other Party, or the exploitation of the hydrocarbon deposit on the continental shelf of one Party would affect the possibility of exploitation of the hydrocarbon deposit on the continental shelf of the other Party, agreement on the exploitation of the hydrocarbon deposit as a unit, including its apportionment between the Parties, shall be reached at the request of one of the Parties (hereinafter "the Unitisation Agreement") in accordance with Annex II.

3. Exploitation of any hydrocarbon deposit which extends to the continental shelf of the other Party may only begin as provided for in the Unitisation Agreement."


As is evident from the provisions quoted above, the requirement for a Unitization Agreement may be triggered by geophysical and/or geological data obtained by either of the Parties to the Treaty. This brings us to the question of the role of such data and of the legal regime for obtaining it.

At the same time, it is important to stress the necessity for the Parties – following the discovery of a deposit – of reaching agreement on the deposit's exploitation, which may only take place by mutual consent. In order to be able to start joint production of the hydrocarbons, the Parties will need to reach agreement on a wide range of issues. This is likely to be no easy task and Annex II of the Treaty provides a framework for resolving difficulties that may arise.
2. Exploration – incentives and competition
Taking advantage of developments in offshore exploration techniques, both Norway and Russia have conducted a number of seismic and geological surveys in the Arctic over the past few decades. These have resulted inter alia in the discovery of the giant Shtokman gas field in the Russian part of the Barents Sea. Nevertheless, no substantial discoveries have been made (at least officially) in the areas that were disputed prior to the conclusion of the Treaty. As a result the maritime boundaries, including the boundaries of the continental shelf, have been determined prior to the discovery of any transboundary hydrocarbon deposits.

The lack of existing geophysical data on the previously disputed areas significantly increases the importance of exploration activities. Suppose that one Party is able to establish the existence of a hydrocarbon deposit on its continental shelf. Unless the other Party produces some data to prove that the deposit lies on both sides of the border, and as such is covered by the mandatory unitization rule outlined above, it may miss, or at least significantly delay, its opportunities to require the conclusion of a Unitization Agreement.

Secondly, the initial assessments of the amounts of reserves on each side of the border will play an important role in the negotiation of both the Unitization Agreement and the Joint Exploitation Agreement. These assessments may also influence technological aspects of the production plan and, ultimately, the profits distribution ratio.

The latter is especially true if the profits from joint exploitation are to be divided on the basis of the apportionment of the total reserves (as opposed to the overall production). This consideration may not be of importance, however, if the Parties agree in the Unitization Agreement on a revision mechanism similar to the one applied in the Frigg Agreement. According to the provisions of the latter agreement, "The licensees shall be required to conduct all operations necessary for each revision and to secure that at the time the production from the Frigg Field Reservoir ceases the share in the total volume of Frigg Gas received by the licensees of the Government of the United Kingdom and the share thereof received by the licensees of the Government of the Kingdom of Norway shall each correspond to the final apportionment of the reserves in place".7 In this case the initial apportionment of the reserves is less important, since by the time production terminates, the shares of hydrocarbons received by the licensees of each Party should correspond to the finally apportioned share of reserves.

Nevertheless, the value of geological information concerning offshore areas adjacent to the borderline may be significantly greater if it is received sooner rather than later. Moreover, the Treaty allows the Parties to undertake exploration activities independently of each other, suggesting that there will be a degree of competition at both an inter-government and inter-company level. Accordingly the Treaty provisions would appear to provide a significant incentive for accelerated exploration activities on both sides.

It is important to note here that the distinction between unilateral actions and joint activities (with the latter permitted solely within the framework of the Unitization Agreement) lies at the point where exploration drilling ends and production drilling begins. Paragraph 2 of Article 5 of the Treaty, as quoted above, mentions 'existing drilling data' as an example of evidence of the transboundary character of the deposit. At the same time, Annex II, in paragraph 7 of Article 1, prohibits each Party from withholding a drilling permit from a legal person who has a right to explore for and produce hydrocarbons on that Party's respective side of the delimitation line, so long as the proposed drilling is for purposes relating to the determination and apportionment of the transboundary deposit. Such a prohibition should be envisaged and, if necessary, specified in detail in the Unitisation Agreement.

The distinction described above is similar to that employed in the Frigg field unitization, where drilling activities were a precondition for recognizing the transboundary character of the field and the follow-up conclusion of the Frigg Agreement.
3. Production – obstacles, risks and counterbalances
According to the Treaty, the commencement of production activities (as opposed to exploration activities) in relation to a hydrocarbon deposit that is considered transboundary in nature is conditional upon the conclusion of two agreements: a Unitization Agreement between the Parties; and a Joint Operating Agreement between such companies as have exploration and/or production rights in the area in question, in accordance with each Party's national legislation.

Annex II lists 13 items upon which the parties to the Unitization Agreement (the States) and the parties to the Joint Operating Agreement (the companies) must agree. Some of these items involve issues that are very substantial and extremely sensitive for the Parties.

For example, agreement will have to be reached on the following points: the geographical and geological characteristics of the transboundary hydrocarbon deposit and the methodology used for data classification; a statement of the total amount of the reserves in place in the deposit and the methodology used for such calculations; apportionment of the hydrocarbon reserves between the Parties; approval of a unit operator to be appointed by the companies holding the rights to exploit the deposit; and sharing and exchange of information (including geological data) and inspection of the offshore installations of each Party9. The Joint Operating Agreement between the companies will also need to be approved by each Party before production start-up.

Annex II also envisages a consultation requirement that will apply to each Party with respect to such health, safety and environmental measures as are required by its national laws and regulations. Specifically, a Joint Commission shall be established in connection with such consultations.

It is positive that the Treaty contains such an extensive list of prerequisites in respect of the Unitization Agreement. It is interesting to note that some such prerequisites were present in the Frigg Agreement and other similar agreements, whereas the earlier UK-Norway Agreement did not impose any specific list of requirements in respect of future unitization agreements. It does seem, however, that it may be difficult to Norway and Russia to reach a compromise on at least some of the above issues. Different technological approaches and business cultures may significantly hinder the negotiating process, especially bearing in mind differences in resource evaluation methodologies and the necessity to build unique infrastructure for each project. An absence of consent on just one of the mandatory elements will delay the conclusion of the Unitization Agreement and consequently delay the start of production.

The Parties' mutual interest in receiving profits sooner rather than later should be, of course, the key driver in the negotiating process. Apart from that, the arbitration mechanism envisaged in Article 3 of Annex II is intended to counterbalance any unwillingness by one of the Parties to enter into a Unitization Agreement. The article provides that an ad hoc international arbitration will take place if the Parties have failed to resolve an issue relating to the Unitization Agreement within six months of the date on which either Party requested negotiations.

Article 4 of the Annex II sets forth an additional dispute-resolution mechanism applicable to apportionment disputes. This involves the appointment of an independent expert empowered to issue a binding decision.

These dispute-resolution procedures have inherent risks for both Parties and accordingly act as an incentive to reach agreement on the substantial elements of the Unitization Agreement without resorting to arbitration or the appointment of an independent expert. As a result, the Treaty should operate successfully in practice.
4. Conclusions
The overall structure of Treaty provisions governing the exploration for, and production of, transboundary hydrocarbon deposits represents a solid basis for cooperation between the Parties, who now have a significant incentive for joint exploitation of the subsea resources.

The Treaty regime will lead inevitably to an increase in demand for offshore seismic services and exploration drilling. Possible asymmetries in geological information may give rise to competition between the Parties and accelerated exploration, unless the Parties (or the companies/ licensees) agree to conduct joint exploration activities.

Difficulties and delays may occur in reaching a compromise on the substantial conditions of the Unitization Agreement, which is a mandatory precondition for the start-up of exploration. However the Treaty's dispute-resolution mechanisms provide an incentive to reach agreement, as the risks associated with the third-party arbitration or independent expert appraisals should encourage the Parties to overcome their disagreements. Ultimately, however, cooperation is not merely an option – it is the only viable solution.