Foreign oil companies "will probably have to abandon their preoccupation with PSAs (production sharing agreements)" as a means of acquiring oil and gas reserves in Russia, a merger consultant predicted May 21 at a global energy conference sponsored by KPMG LLP in Houston.
"Probably the only way that foreign companies can move into Russia is through some M&A (merger and acquisition) or other strategic equity transaction," said Brooks Frazier, regional director for RPI Inc., a consulting firm covering M&A activity in Russia's oil and natural gas sector.
"Looking at the Russian legislation right now for PSAs, it's pretty alarming," Frazier said. "Unless a miracle happens, only the three grandfathered PSAs in Sakhalin and other tough areas, and maybe a handful of others, might survive."
M&A activity
The recent agreement by BP PLC and two Russian investor groups (OGJ Online, Feb. 17, 2003) to invest $6.75 billion in a new company, TNK-BP, that would incorporate major Russian oil companies Tyumen Oil Co. (TNK) and Sidanco Oil Co. was "a bold move," said Frazier.
Meanwhile, OAO Yukos and OAO Sibneft are in the process of a $35 billion merger into YukosSibneft Oil Co. (OGJ Online, Apr. 22, 2003).
As a result of those deals, Frazier said, "A lot of oil executives have come to us, with the feeling that these floodgates have opened now." However, he said, few Russian companies are ready to cede in such deals the corporate control that Western companies generally demand when investing billions of dollars in Russia.
Moreover, Frazier said, "We doubt there will be another major deal in the short term, especially in this (Russian) election cycle. There are parliamentary elections coming up at the end of this year, and a very important presidential election in March of next year."
Meanwhile, he said, options remain open for "medium-size deals," such as Marathon Oil Corp.'s recent agreement to acquire Khanty Mansiysk Oil Corp. for $275 million (OGJ Online, Apr. 23, 2003). Asset swaps also are attractive to Russian companies, he said.
Otherwise, he said, there are "not many viable options for Western companies to add production or reserves quickly" in Russia. "Only a handful" of the many joint ventures formed between western and Russian companies "in the early 1990s, when Westerners poured into Russia," is left, Frazier said.
Investment, technology
Russian firms have been the primary investors in Russia's oil and gas sector in recent years, said Bruce K. Misamore, chief financial officer and deputy chairman of the management committee of Yukos. Beginning in late 1999, he said, there was increased investment in Russia's upstream industry, triggering a rapid rise in Russian oil production.
The Soviet Union's oil production peaked in the 1980s at more than 12 million b/d. Now Russia's is projected to increase to 11 million b/d by 2010 from present levels of 8 million b/d.
Stephen O'Sullivan, comanaging director of research for United Financial Group in Houston, credits higher oil prices and the use of Western technology by Russian companies for the recent increase in Russian production. However, he said, use of new technology is limited to only a few of the biggest Russian companies. "There's probably 60% of the industry out there that hasn't even used these technologies," he said.
New infrastructure needed
Moreover, O'Sullivan said, that production growth is not sustainable without the addition of new pipelines and other infrastructure to move Russian oil and gas to international markets.
The bulk of Russian production will continue to come from Western Siberia, with that output expected to peak in 2017-20, said Misamore. But beginning in 2005, there will be a pronounced increase in production from Eastern Siberia and the Sakhalin Island area—together "the biggest thing happening" in Russia, Misamore said.
"The reason for development in eastern Siberia is future sales of crude oil to China, a very valuable place for the Russian oil market to go," he said. There are plans to start construction "late this year" on a pipeline to China that would be completed in 2005, "starting initially at 400,000 b/d and going to 600,000 b/d by 2010," said Misamore.
"The decrease in oil production in northeastern China is what's giving rise to the need for Russian oil," he said. "We would anticipate there would be much greater increases in Russian oil exports to China during the following years as well." Last year, Yukos initiated exports of oil directly from Russia to the US. Yukos currently exports 2 million bbl/month to the US and wants to expand that away from Russia's current dependence on the European market. However, Misamore said, "Right now, we are facing some infrastructure constraints in Russia."
One of the big projects pending is a proposed pipeline from western Siberia to Murmansk, an ice-free port on Russia's northern coast. That would provide a significantly shorter and cheaper route to US markets than the current outlet through the Black Sea, said Misamore. It also would provide Russian oil "access the other side of Europe" through the port of Rotterdam, he said.