Neft i Kapital
Moscow
Oil field service and supply companies , handmaidens to production, are facing opportunities in Russia of boom proportions as indigenous producers face up to the need for modernization, if the current expansionist mood is to continue.
This year, the Russian oil majors will be investing at least $6 billion collectively in oil and gas field development work-evidence that their financial potential has soared from the crisis period of 1998-99.
Rising oil output in Russia, together with high world oil prices, has underscored the need for state-of-the-art ancillary services and technology.
Soviet legacy
Not long ago, the Soviet Union was the world's unrivaled leader in the production of primary fuel resources; in the mid-1980s, it produced up to 620 million tonnes/year (12.4 million b/d) of oil and up to 700 billion cu m/year (67.7 bcfd). of natural gas. It had a support infrastructure, which is now described as "services," that corresponded to the scale of production. This ensured initial field geology work; seismic surveys; analyses of reserves; design and commissioning of facilities; and well drilling, completion, and workovers.
After the Soviet Union's collapse, the Russian Federation inherited the bulk of its oil and gas services infrastructure, research and educational institutions, design institutes, machine and instrument manufacturing-and a few economic "millstones," about which more later.
The largest oil and gas fields and the bulk of hydrocarbon reserves in the former Soviet Union are in Russia and include particularly promising areas where development is under way or is to be started, such as the Caspian Sea basin, Timan-Pechora region in North European Russia, Eastern Siberia, and Russia's Far East-including Sakhalin Island.
In terms of oil reserves and production, Russia is still one of the world's leading countries-No. 1 in terms of natural gas-with an overall hydrocarbon potential several times greater than that combined in all the other FSU republics.
All major oil and gas fields in the Soviet Union were explored and commissioned with no foreign assistance. Major hydrocarbon basins discovered in Western Siberia, Ural-Volga, and Yamal regions in those days still produced a substantial share of Russia's fuel.
Service sector lags
But Russia's oil services capabilities at the time were gradually falling behind world standards.
In the West, the service and supply sector of the early 1980s had developed into a powerful, specialized, technology-intensive industry. It had become one of the most profitable and advanced high-technology markets, worth tens of billion of dollars, where competition was tough, new technologies were constantly replacing one another, and the most expensive computer-based systems were applied intensively.
The situation is different in Russia.
For example, one Russian oil delegation was stunned during a recent visit to a Royal Dutch/Shell floating platform where 12 wells had been sunk at water depths of 1,000 m and 10 holes were being drilled. The Russians were amazed that only a handful of Shell employees were among 160 workers on the platform-the rest were employed by service companies carrying out the bulk of the work. When the Russians queried about this circumstance, they were told, only half-jokingly, that Shell had the production license and the rest was the service companies' business.
It was a lesson for the Russians that, in the modern world, the oil company has to properly organize the field development process, pick contractors, and ensure optimum production costs that guarantee profits-and those profits should be large enough to pay for the costly services provided by specialized firms.
Today in Russia, many producing companies still carry out their own service operations through specialized, in-house units. Some of them seem to have attained relatively good results (for instance, OAO Surgutneftegaz) and claim this has saved them a lot of money. But whether this is true is hard to tell because they base their estimates on corporate transfer prices, rather than market prices.
There is also the Soviet inheritance of the "millstones"-essentially, the subsistence economy supporting vast local infrastructures that oil companies and their service units had to carry on their balance sheets, which in Western countries would be carried by national or local authorities.
Privatization of Russia's oil sector is diminishing those obligations. Until recently, oil companies were short of funds to pay for outside services.
Modernization
Now, however, the Russian services market is starting develop in line with global trends, and specialized service companies-most notably PetroAlliance Services Co.-have been emerging. Some of them have made serious progress, in particular, in the provision of geological and geophysical services.
Mark Elliot, marketing manager at Schlumberger Ltd., admits the oil services market in Russia is no walk-over for Western firms: "I think, if you look at the market share of Western internationals, it is no more than 25%-but I have no firm basis for that other than my own perception.
"It is no playground. It is a tough market competing with local firms. Although some aspects of the business have not been well-developed, and Western companies have been able to expand quite rapidly, if you look at the business as a whole, the Russians are doing extremely well."
Russian oil rebound
The Russian services market was given a boost last year, when oil companies managed to make big profits on exports and, consequently, invest heavily in production.
Vagit Alekperov, the president of Russia's largest oil company, OAO Lukoil, admitted that last year was remarkable for his company and the whole of Russia's oil sector due to the unique price situation.
Last year, Russian oil companies produced 323.3 million tonnes of oil-a 5.5% increase from 1999. Crude oil supplied to Russian refineries increased only by 5.7 million tonnes, or 3.3%, while exports of Russian oil outside the Commonwealth of Independent States grew 11% from 1999, reaching 124.4 million tonnes.
The boom in profits came from high oil prices and the upsurge in exports. The bulk of those exports went to Western Europe, while supplies to other CIS member nations, whose ability to pay is limited (particularly in Ukraine), went down 48%.
In the first half of the 1990s, oil production in Russia began declining each year. Production stabilized at just over 300 million tonnes/year (6 million b/d) by 1998, The growth in prices in 1999 made Russian oil exports more profitable, which enabled Russian oil companies to increase investment in oil production substantially.
As a result, there was some economic recovery in Russia and, for the first time in years, 1999's oil production edged up by 1% over the previous year.
The lure of high world oil prices was the main force that began driving the country out of a deep crisis. Last year, Russian export-grade Urals crude averaged $24-25/bbl. In 1998, Urals export crude fetched half that price, $12.50/bbl, and reached $17.60/bbl in 1999. Even though the Russian cabinet has marked up oil export tariffs several times, exporters can hardly complain.
According to Russia's Ministry of Energy, about $1.5 billion was invested in 1999, which was not impressive, given the scale of Russia's oil industry, but nevertheless was up by 60% over the troublesome 1998.
Optimists predicted that oil companies would be able to invest twice that amount, $3.0-3.2 billion, in the upstream oil and gas sector in 2000.
Last year's high oil prices led to a considerable increase in investment in basic production. Speaking to an energy working group of the Russian-British intergovernmental committee for trade and investment in London at the end of June, Russia's first deputy energy minister, Gurami Avalishvili, said that investment in Russia's upstream oil sector last year was up by 172% from 1999. Capital investment employed in the oil industry was 129.9 billion rubles, or about $5 billion at that time's rates of exchange, surpassing the most optimistic forecasts.
The impetus it gave was so strong that this year the Russian oil industry's growth is unlikely to decrease. From January to June this year, production of oil and gas condensate in Russia, 167.75 million tonnes, was up 7% from the same period last year.
Oil exports outside the CIS states in the first half were up 7.7% up from the first half of 2000, reaching 73.5 million tonnes. If nothing out of the ordinary happens, this year Russia will produce more than 340 million tonnes of oil-and most of that incremental output will go to Western Europe.
In May and June, most Russian oil companies published their reports on the results of last year (see related story, p. 67). According to Russia's Ministry of Energy, a sharp increase in investment-up by 71% last year over 1999-in development drilling saw 48% more new wells commissioned and the number of idle wells cut by 5.5%. The development of 43 new fields began last year.
It was particularly important that Russian oil companies were able to step up investment in production substantially. For example, last year, Lukoil invested five times more than in the 1998 crisis year, according to Alekperov. In the first quarter of this year, Lukoil's investment in production was 1.6 times up from the same period of last year.
This trend is also apparent in other Russian oil and gas companies.
Service market turnaround
These favorable changes had an immediate effect on the Russian oil field services market.
As soon as major Russian oil companies became strong enough to pay for quality services, competition emerged among service providers.
Western service company giants such as Schlumberger, Halliburton Co., Baker Hughes Inc., and Western Atlas (the latter two merged in 1998 to form Baker Atlas) were the first ones to enter the Russian service and supply market.
The majority of the Russian public knows little about the western major service firms working in Russia, let alone the many smaller firms. As evidence of that, Halliburton only became widely known after its Norwegian branch joined the salvage operations in the Barents Sea where the Kursk submarine sank last summer. A Russian newspaper conducted a "serious investigation" to discover that Halliburton was not Norwegian but was a US company headquartered in Texas. The newspaper concluded: "Halliburton must have joined the Kursk salvage operations exclusively to enter the vast Russian oil market."
There was no mention of Halliburton's collaboration with Russian companies for more than 10 years, nor about it having a strategic partnership with Russia's Tyumen Oil Co.
Russian offices of western service companies should, perhaps, pay more attention to their public relations.
Companies such Halliburton, Schlumberger, or Baker Atlas can provide virtually any service and can be brilliant in preparing a field development project, deciding how many wells will be optimum, and carrying out 3D seismic modeling. During latter stages, they can offer such services as contract drilling or drilling support, well monitoring, and completions.
They are unchallenged leaders in the Russian service market in terms of availability of equipment, technologies, and their financial potential. Moreover, they develop some equipment and technologies themselves.
When they spot an opportunity, they quickly fill the niche. This happened with seismic surveys in the first half of the 1990s. This is also the case with cementing and well construction technologies as well as the stimulation of production in high water-content conditions, a common characteristic of some old Russian fields.
Some major Russian oil companies have developed strategic partnerships with western services majors. In October 1998, Tyumen Oil Co. (TNK) and Halliburton Energy Services signed a cooperation agreement for the Samotlor field's rehabilitation, exploration, and development in the Khanty Mansiyski Autonomous Okrug.
Cumulative oil production at Samotlor has reached 2.1 billion tonnes since its development started more than 30 years ago. The field is now at the declining production stage, its water encroachment rate is high, many wells are idle, and the bulk of equipment is worn out and outdated. But Samotlor accounts for nearly half of TNK's proven commercial reserves of 2.38 billion tonnes, and the company wants the field to yield as much oil as possible.
Also in 1998, Russia's second largest oil company, OAO Yukos, formed a strategic alliance with Schlumberger to provide services for 5 years.
Yukos has also formed an independent company on the basis of its own service units-the Siberian Services Co. SSC is intended to be an integrated company capable of providing a whole range of services to oil producers in line with international standards. Until the new Yukos unit gains its feet, Schlumberger will provide assistance to the new company with advice, personnel, and technologies.
The list of western service companies working in Russia has been expanding steadily. In May, Russian oil major OAO Sibneft signed a contract with the French drilling contractor Pride Forasol. Under the contract, eight horizontal wells will be drilled at Sugmutskoye field. Pride Forasol will handle the drilling on these wells, while support operations, such as well logging, cementing, and perforating, will be performed by other prominent service companies, including Halliburton and Schlumberger. Drilling the eight wells, plus other services, will cost Sibneft $60 million. This is the current price of quality western services. And this is only eight wells on a small block of an average-size field in Western Siberia with reserves estimated at 11 million tonnes.
Russian service firms
Russian oil companies often have to choose a western firm, because the Russian service market is still too weak and the quality of Russian materials, tools, and equipment fails to meet modern requirements.
According to Andrei Konoplyanik, a prominent Russian oil analyst, Russian factories now produce about 90% of the equipment required by oil producers, but only 14% of it meets world standards. Western service firms will have a competitive edge over the Russians for a long time.
Nevertheless, Russian service companies have become more competitive in the past 2 years, and some are beginning to rival western majors service companies. This is particularly true about companies that have bought and mastered western technologies, but there are not many of them.
Russian rival
One example of an emerging rival to the western service majors is Russia's largest oil service company, PetroAlliance. It is the unchallenged leader among Russian service companies, even though it cannot yet claim a place among the world's top service companies.
Not long ago, PetroAlliance was a purely geophysical company. It now works in onshore exploration in Western Siberia, Timan-Pechora, and Kazakhstan and offshore, for example, at Lukoil's northern Caspian license blocks.
PetroAlliance has been developing steadily, and recently it mastered modern borehole technologies, including well workover technologies with water shutoff, ideal for Russia's watered-out fields.
It has won a competitive round recently for well workover operations at Megion, in the Khanty Mansiyski Autonomous Okrug, where Russian oil major OAO Slavneft operates. It was a tough competition. Seven bids were submitted, including those from joint ventures formed with prominent western firms.
PetroAlliance has had a rollercoaster history. PetroAlliance was formed in 1995 as the Russian-US joint venture MD Seis (which had started operations in 1989) and the first company of its kind in Russian oil services. The US cofounder, Western Atlas, became part of Baker Atlas in 1998, when severe economic crisis swept Russia's oil sector. In the heat of the 1998 crisis, when orders plummeted and oil companies stopped paying for services, the company's western coventurers sold their stake in it. The company's Russian managers bought them out and still own it.
PetroAlliance began as a geophysical company. It has since broadened the range of its services. It specializes in providing integrated services during field exploration and development, such as seismic surveys, data processing and interpretation, geological and hydrodynamic modeling, reserves estimation, well logging, perforation, and vertical seismic profiling.
The company undertakes well repairs and servicing, including well casing, acid treatment, and water shutoff. It has a strong unit dealing with the application of information technologies in oil services and software.
In addition to its branches in Russia and in other CIS states, PetroAlliance has an office in Houston.
PetroAlliance's strategic partner-even though this has not been formalized-is Lukoil. PetroAlliance works in Lukoil's fields on the Caspian shelf, in Western Siberia, and in the Timan-Pechora area. Other major clients include Yukos, OAO Gazprom, State Oil Co. of the Azerbaijan Republic, Kazakhoil, and Rosneft.
Service sector competition
In April, Russia's main oil magazine, Neft i Kapital, organized a workshop in Moscow to discuss the problems of Russia's oil services market. Schlumberger's business development manager, Vladimir Pivovarov, admitted that his company is finding competition much tougher today than 10 years ago, when it started working in Russia.
Most Russian regional service companies were created from former geological and geophysical units-as a rule, they still have in their titles the words "neftegazgeologia" ("oil and gas geology") or "neftegazgeofizika" ("oil and gas geophysics").
Having lost centralized financing sources, the companies were decaying, losing personnel, lagging far behind the world level, and they only managed to retain clients through old personal contacts or, predominantly, by pursuing predatory pricing policies.
Two years ago, several of these privatized companies got a "gift" from the government: the fuel and energy ministry bought modern western equipment for seismic surveys for them, providing a new lease of life.
PetroAlliance's president, Alexander Djaparidze, believes that Russia does not have a service market in the strictest sense. Russia does not have a truly competitive business environment, and nonmarket measures, such as the windfall of modern seismic equipment, will not help promote competition.
He said, "In the oil sector, there still is the dangerous illusion that they can save on services. The fact that some companies charge ridiculously low prices, with the government's support, provides a base for that illusion. But it is an axiom for us that low prices for modern services mean low quality. That false-economy savings will result in millions unearned by producing companies. No one should save on services-they should make money on services."
Opportunities for growth
Still, opportunities are opening up for services companies, including western ones, in Russia. Several factors prompt this.
First, the clients-Russian oil companies-will not see a decrease in profits in the near future. They will continue stepping up investment in their core production, and the bulk of the money will go for services.
Organization of Petroleum Exporting Countries Sec. Gen. Alí Rodríguez, at OPEC's July 3 summit in Vienna, said that any serious changes in the world oil market are unlikely until the end of this year. Prices would not go down sharply, staying at $22-28/bbl for the OPEC basket of crudes-a level comfortable for both importers and exporters, he said. This forecast certainly satisfies Russian fuel producers.
Second, demand for services in Russia will grow because of the growing urgency among Russian oil producers to become integrated into the global petroleum business.
Russia's deputy energy minister, Valery Garipov, believes that oil producers in Russia still fail to meet basic technological standards. They are behind schedule in commissioning new fields, in the scope of development drilling, reservoir pressure maintenance operations, associated gas utilization, and the application of new enhanced oil recovery methods. The stock of mothballed and idle wells is still too big, which reduces the ultimate oil recovery ratio by 5-7 percentage points.
There is further scope for service companies to grow, according to PetroAlliance's Djaparidze. In his opinion, if Russian oil companies seek to integrate in the world system, be listed on stock exchanges, and increase their market capitalization by adding reserves, they will require audits conducted in line with western standards. That means an audit of all data concerning exploration, production, and field structures using modern technologies. Those technologies are available only to advanced service companies. Therefore, there will be brisk demand for their services.
According to the Russian Ministry of Energy's forecast, in the coming 15 years, the role of service firms in the Russian oil industry will be very significant. The scope of geophysical operations and exploratory and development drilling, in particular, will have to grow.
Companies will have to commission new fields and rehabilitate wells. Modern EOR, hydraulic fracturing, and reperforating techniques will be a golden opportunity for the sector.
Most discoveries of new fields during this period will most likely occur in areas with complex subsurface conditions, and their development will be very costly. The application of modern drilling, development, and production technologies will be inevitable. This is an equally golden opportunity for service companies.
There is no doubt that the future in the Russian oil services market belongs to specialized firms possessing modern technologies, equipment, and skilled specialists. It makes no difference to clients whether it is a foreign or Russian company, if it can attain the desired results.
This is confirmed by policies pursued by the leaders of Russia's oil industry, such as Lukoil, Yukos, and TNK and other companies actively collaborating with the best Russian and foreign service companies.
Schlumberger Ltd. Marketing Manager, Mark Elliot "I think, if you look at the market share of Western internationals, it is no more than 25%…It is no playground. It is a tough market competing with local firms. Although some aspects of the business have not been well-developed and Western companies have been able to expand quite rapidly, if you look at the business as a whole, the Russians are doing extremely well."
The authors
Sergey Alexandrovich is CEO of Neft i Kapital (Oil & Capital), a Moscow-based independent monthly magazine covering Russia's oil and gas sector. Robin Morgan is the magazine's English-language editor.
